Centene Corp (CNC) 2016 Q1 法說會逐字稿

Good morning and welcome to the Centene Corporation first-quarter 2016 financial results conference call.

(Operator Instructions)

Please note this event is being recorded.

I would now like to turn the conference over to Ed Kroll, Senior Vice President of Finance and Investor Relations.

Please go ahead.

Thank you, Emily, and good morning, everyone.

Thank you for joining us on our 2016 first-quarter earnings release conference call.

Michael Niedorff, Chairman and Chief Executive Officer; and Jeff Schwaneke, Executive Vice President and Chief Financial Officer of Centene will host this morning's call.

The call should last approximately 45 minutes and may also be accessed through our website at Centene.com at the Investor Relations section.

A replay will be available shortly after the call's completion, also at Centene.com, or by dialing 877-344-7529 in the US and Canada, or in other countries by dialing 412-317-0088.

The playback code for both dial-ins 10083202.

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 most recently filed Form 10-Q filed today April 26, 2016, Form 10-K which was filed February 22, 2016, 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.

And with that, I'd like to turn the call over to our Chairman and CEO, Michael Niedorff.

Michael?

Thank you, Ed.

Good morning, everyone, and thank you for joining Centene's first-quarter 2016 earnings call.

We are very pleased to have closed the Health Net acquisition within the first quarter, as projected.

I would like to begin with a few comments on why the addition of Health Net is transformational.

In closing the acquisition, Centene has achieved the following -- further critical mass, including additional product diversification within the government-sponsored healthcare space.

We are a $40 billion-plus company.

We are the largest Medicaid managed care organization in the country serving 6.7 million Medicaid members at March 31.

We are the leader in three of the largest Medicaid states, California, Texas and Florida.

We are the largest provider of managed long-term support services, one of the fastest-growing segments of the market.

We have a four-star Medicare Advantage product that can be exported to additional markets, and we provide services under contracts with the US Department of Defense and Veterans Affairs.

This greater scale enhances the positive view of Centene nationally as well as by state and local governments.

It strengthens our ability to help shape sound public healthcare policy.

In addition, it enhances our purchasing power and is beneficial from a balance sheet perspective.

Centene is now clearly a large cap company.

We recently joined the S&P 500 index.

This is important to us as this index is regarded as the best single gauge of large-cap US equities.

Additionally, it will widen our potential investor base and lead to increased liquidity of our stock.

Lastly, this acquisition enhances and solidifies the sustainability of Centene's long-term growth rate.

I would now like to comment on the timing of the approval process and provide an update on integration.

While the regulatory process in California was lengthier than expected, it was fair and the undertakings contained no surprises.

We will be making investments in certain state affiliated investment grade vehicles as well as in a local service center.

The placement of a service center in California is consistent with Centene's local approach.

We will work with the state to find a suitable location in an economically disadvantaged area where job creation is needed.

The investments in charitable contributions associated with these undertakings have been included in our guidance and will remain over a multiple year period.

The planning portion of the integration process was largely completed prior to closing.

Our integration team did extensive work to ensure a smooth and seamless combination.

We were able to hit the ground running the day of the close and integration is proceeding as expected.

Before I provide first-quarter highlights, I want to remind you that our first-quarter results included only eight days of Health Net's financials, as the transaction closed on March 24.

Our prior guidance had assumed a March 1 close date.

We have updated our 2016 guidance to reflect the later close.

This is a timing issue only and we remain confident that our previously anticipated run rate earnings remain on track.

Additionally, we have adjusted our reporting to reflect the increased scale of the business and our new product mix.

We believe this provides meaningful information to investors and it will continue to evolve as we complete the Health Net integration.

Turning to the first-quarter financials, we are pleased with the results of the first quarter.

There were many moving parts when combining the two companies, including one-time charges and prorating with timing.

Total revenues increased 36% year over year to $7 billion.

Membership at quarter end was 11.5 million, representing an increase of 7.1 million members or 162% over the first quarter of 2015.

The HBR improved 110 basis points year over year to 88.7%.

The first-quarter pretax margin excluding acquisition-related costs improved 30 basis points year over year to 3%.

We reported adjusted diluted earnings per share of $0.74.

This compares to $0.55 in the first quarter of 2015.

Jeff will provide further financial details including the updated 2016 guidance in his prepared remarks.

A quick note on flu.

We saw an uptick in flu during the first quarter.

The flu has appeared to have peaked in March, and overall costs were in line with our expectations.

Overall we continue to see as well as anticipate stable medical cost trends.

Next, market and product update.

First, we will discuss recent Medicaid activity.

Washington state -- in April, Centene commenced operations under the Apple Foster Care contract in Washington as the sole provider for this program.

The contract is performing in line with expectations and we anticipate serving over 20,000 Foster children.

With the addition of this contract, Centene will serve approximately 100,000 Foster Care beneficiaries across all of our markets.

Nebraska -- also in April Centene executed a contract with Nebraska as one of three managed care organizations to administer the state's new Heritage Health program which covers 230 Medicaid, CHIP and ABD enrolled.

This contract is expected to commence in the first quarter of 2017.

Texas -- we expect the STAR Kids contract in Texas to commence in the latter part of 2016.

Centene is the only managed care organization in Texas that participates in all of the state's Medicaid and Medicaid-related product lines.

Next, Medicaid expansion.

At March 31, we served approximately 985,000 Medicaid expansion members in nine states.

This represents an increase of more than 650,000 recipients over the first quarter of 2015.

This growth was primarily driven by the addition of Health Net's Medicaid expansion [members].

In January the Governor of the Louisiana signed an executive order to expand Medicaid coverage under the ACA.

This is expected to begin in July and is now included in our updated 2016 guidance.

Medicare and Duals -- at March 31 we served over 303,000 Medicare and Dual beneficiaries.

We continue to expect to launch additional Medicare Advantage plans in four Centene states in 2017.

The new Medicare Advantage brands will be launched under our four-star banner which will give us the benefit of incremental premium revenue.

Next, health insurance marketplace.

Centene's exchange experience continues to be favorable and we are achieving margins at the higher end of our targeted range.

Our marketplace strategy has been and continues to be focused on targeted low income subsidized individuals, many of whom were previously Medicaid eligible.

We designed our exchange solutions to be able to leverage our Medicaid platform, including provider networks.

In the majority of our markets we have both Medicaid and market-based product offerings.

We coined the term churn to reference those members who obtain coverage through high quality affordable Centene product in either Medicaid or the exchange.

In the first quarter, over 90% of our exchange members were subsidy eligible.

This is consistent with 2014 and 2015.

Centene has maintained a disciplined approach to pricing from day one.

In fact, we are in a net payable position for the three Rs program.

At March 31 we served over 680,000 exchange members across 15 states.

At year end we expect over 550,000 exchange beneficiaries due to the normal attrition.

Now Centurion -- our correctional health visits continues to successfully expand.

At March 31, we served 59,000 correctional members, represents year-over-year growth of 38%.

In April, Centurion replaced its existing one-year contract in Mississippi with a new three-year contract, which is expected to commence in July.

Also in April we began providing correctional health services in three regions in Florida.

This marks Centurion's sixth state population.

Finally, commercial -- we ended the first quarter with over 830,000 commercial members.

We are fully committed to the success of the existing business, especially in California.

However, we have no plans at this time to expand into additional states.

Shifting gears to our rate outlook, for Medicaid we continue to expect in 2016 composite rate adjustments of between 0% and 1%, consistent with the past [three] years.

We have known rates for our Medicaid, representing approximately 65% of the projected 2016 member [months].

For Medicare Advantage final 2017 rates were announced on April 4. These were in line with our expectations of an approximate 1% increase.

In conclusion, with first-quarter results we're off to a good start in 2016.

We expect this momentum to continue throughout the year.

We are on track with our integration of Health Net.

Our synergy targets remain $75 million for the first 12 months following the close, and $150 million in the second 12 months following the close.

While we remain committed to long-term margin expansion we continue to expect the 2016 pretax margin to remain relatively flat compared to 2015 as we focus on integration.

Our group pipeline is bigger than ever with the additional products and capabilities in Health Net.

We are optimistic about the future and our ability to extend Centene's leadership position in government-sponsored healthcare.

As a reminder, our investor day is on June 17 in New York City.

We look forward to seeing you then.

We thank you for your continued interest in Centene.

Jeff will now provide further details on our first-quarter financial results.

Jeff?

Thank you, Michael, and good morning.

This morning I will begin with highlighting the results for the first quarter of 2016 and then provide an update on our 2016 full-year guidance, including the acquisition of Health Net.

First I would like to highlight the effect of the Health Net transaction on the first-quarter 2016 results.

As previously announced, we completed the acquisition of Health Net on March 24, 2016 for a purchase price of $6 billion, including the assumption of debt.

In connection with the completion of the acquisition, we incurred approximately $189 million or $0.83 per diluted share of transaction costs which includes accelerated stock compensation, [severance], [investment] banking fees, legal costs and the present value of a [$65] million charitable donation under agreements with various regulatory agencies.

Additionally, we have [included] eight days of Health Net activity in our first-quarter 2016 results.

The eight days of activity represent approximately $350 million of revenue and had a minimal effect on our HBR G&A ratio and adjusted diluted earnings per share.

Now on to the first-quarter highlights.

For the first quarter, membership was 11.5 million members, an increase of 162% between years, driven by the Health Net acquisition.

Total revenues were approximately $7 billion, an increase of 56% over Q1 of 2015.

The cost of launch per share for the first quarter of 2016 was $0.13, and adjusted diluted earnings per share of $0.74 when included Health Net acquisition costs and [intangible] amortization compared to $0.55 on an adjusted basis last year.

In more detail, total revenues grew by $1.8 billion in the first quarter, primarily as a result of expansion of [new programs] in many of our states in 2015, growth in the health insurance marketplace business, and eight days of revenue with the Health Net acquisition.

Our Health Benefits Ratio was 88.7% in the first quarter of this year compared to 89.8% in last year's first quarter and 88% for the fourth quarter.

The 110 basis point decrease year over year was also an improvement in the overall HBR for higher [achieving] membership, particularly long-term care and growth of the health insurance marketplace membership, which continues to perform well.

Sequentially the 70 basis points increase from the fourth quarter reflects a [greater] start to the flu season [which was more --] for the first quarter of 2016.

In the first quarter 18% of premium and service revenues [kicked] the flu business compared to 23% in the first quarter 2015.

The existing business metrics for the quarter include Health Net [since] the acquisition fee, and we expect the percentage of revenue for new business to decrease to a single-digit percentage by the end of the year due to the [unearned] revenue base in the denominator.

The Health Benefits Ratio for new business was 90.6% and 88.3% for existing business in the first quarter.

The health insurance marketplace product continues to perform well in 2016 with over 680,000 members at March 31.

With the addition of Health Net we continue to be in a net favorable position for the risk corridor and risk adjusted [components] of the three Rs.

As part of our initial evaluation procedure associated with the acquisition, we have reduced the [risk value] of the Health Net risk corridor (technical difficulty).

Additionally, consistent with our historical accounting prior to the guidance, we will not report any risk corridor (technical difficulty) 2016 benefit year.

Our general and administrative expense ratio was 11.3% in the first quarter this year, or 8.3% without the costs associated with the Health Net acquisition, compared to 8.3% last year and 8.7% in the fourth quarter, also excluding the Health Net acquisition [fund].

The decrease from the fourth quarter of 2015 reflects the reduction in costs related to the open enrollment period for the health insurance marketplace.

During the first quarter we incurred $0.02 per diluted share of business expansion costs compared to $0.06 in the prior year.

Investment and other income was $15 million in the first quarter compared to $9 million last year and $8 million in the fourth quarter.

Interest expense was $33 million for the first quarter of 2016 compared to $10 million for the first quarter of last year and $11 million for the fourth quarter last year.

The increase is due to the issuance of $2.4 billion of senior notes on February 11, 2016 to fund the cash portion of the consideration for the Health Net acquisition.

Consistent with what we have done in the past matching our balance sheet exposure to short-term interest rates, on March 30, 2016 we entered into interest rate swap agreements for a notional amount of $1.6 million [securing] a substantial portion of our senior notes to a floating rate of interest at [3-month] plus LIBOR plus [4.36%].

We reported tax expense of $17 million on pretax income of $2 million for the first quarter of 2016 due to the non-deductibility of certain Health Net acquisition costs, as well as the non-deductible relief of the [health insurer fee].

GAAP diluted loss per share for [continuing] operations for the first quarter was $0.13.

Adjusted diluted earnings per share for the first quarter was $0.74.

Adjusted diluted earnings per share [excludes] $0.83 associated with the Health Net acquisition costs and $0.04 associated with intangible amortization.

Cash and investments totaled almost $8 billion at quarter end, including $139 million held by unregulated subsidiaries.

We estimate our NAIC risk-based capital percentage to be in excess of 350% of the off-price [control level].

Debt on March 31 was $4.3 billion, including $515 million of borrowings on [the revolver].

Our debt to capital ratio was 44.3%, excluding our non-recourse mortgage note, compared to 34.7% in the fourth quarter of 2015.

Our medical liability totaled $3.9 billion at March 31, representing 42 days of claims payable, normalizing for the Health Net acquisitions.

During the first quarter, we made provisional estimates for the fair value of the medical claims liability associated with Health Net.

We have not completed our fair valuation exercise and are now subject to change.

Any change to the provisional estimates will be reported as an adjustment to the opening balance sheet and will have no effect on net earnings.

Cash flow from operations was $195 million in the first quarter compared to $85 million in the first quarter of 2015.

Additionally, you will note that we have adjusted our reporting this quarter to reflect the scale of the business' new products.

We believe this provides meaningful information to investors as we continue to evolve as we complete the integration of Health Net.

This concludes my remarks for the first quarter results and now I would like to provide an update on our full-year guidance.

We have adjusted our 2016 guidance to reflect the March 22 closing of the Health Net acquisition.

We have lowered the top and bottom end of the revenue guidance by $1 billion, lowered both ends of our adjusted diluted earnings per share guidance by [$0.05], to reflect the transaction closing shifting from March 1 to March 24.

Changing the closing date does not have an impact on our run rate revenues or earnings.

We now expect total revenues to be between $39 billion and $39.8 billion, which represents an increase of approximately 73% at the midpoint of our guidance [numbers] as compared to 2015.

Our 2016 guidance for our Health Benefits Ratio is 87% to 87.5%, a decrease from 2015 of approximately 160 basis points at the midpoint of the guidance range.

The reduction in HBR year over year was due to the addition of Health Net which operates with a lower HBR due to the higher mix commercially business, and growth in the health insurance marketplace which operates in the lower HBR and higher G&A ratio.

General and administrative expense ratios are expected to be between 9.4% and 9.9% for 2016.

On an adjusted basis, when excluding acquisition costs, the G&A ratio is expected to increase by 75 basis points [in three] years to 9% to 9.5%.

This increases is due to the addition of Health Net which operates at a higher general and administrative expense ratio due to the mix of business, offset by additional leverage associated with revenue growth and cost savings.

Other revenue and expense, interest income is forecasted to be between $90 million and $100 million and interest expense is estimated to be between $180 million and $190 million.

We estimate business expansion costs of $0.25 to $0.30 for 2016.

We estimate that our effective income tax rate for 2016, excluding non-controlling interest, will be 55% to 57%.

The relatively high expected tax rate reflects the impact of the non-deductibility of the health insurance [fees] and the non-deductibility of certain acquisition costs associated with the Health Net acquisition.

For 2016 we anticipate the health insurance [fees] increases to approximately $450 million.

We estimate our diluted shares outstanding to be between 162.5 million and 163.5 million shares.

In 2016 we expect GAAP diluted earnings per share to be between $2.45 and $2.80, adjusted diluted earnings per share to be between $4 and $4.35.

These amounts include Health Net and their related synergies for nine months and eight days of 2016.

Adjusted diluted earnings per share excludes two items -- first, the amortization of intangible assets associated with the acquisition, which we estimate to be between $0.50 and $0.55 per share; and, two, Health Net acquisition-related expenses, which we estimate to be between $1 and $1.05 per diluted share.

Additionally, our guidance assumes no receivables [through the corridor] program to payables through this adjusted program in 2016.

We believe the guidance amounts provided today are generally consistent with financial information in the joint proxy statement adjusted to include only nine months and eight days of Health Net activity due to the March 24 closing.

We continue to expect $75 million of net synergies in the first [12 months] following the closing of the transaction.

We estimate our operating cash flows to be between 1.5 to 2 times net earnings.

That concludes my remarks and, operator, you may now open the line for questions.

(Operator Instructions)

Our first question is from Scott Fidel of Credit Suisse.

Thanks.

First question, just interested if you can give us some insight into how the Health Net business has been performing recently.

Interested in some of the products or markets for them that may be performing better, and if there's any markets where they are seeing any headwinds relative to when you were initially anticipating the guidance.

And then, just relative to Health Net, Jeff, just wanted to clarify, it was a little hard to hear you.

Just on Health Net's risk corridor receivable, I just want to clarify, you did say that you wrote that down to zero, right?

This is Jeff.

I will answer the second question first, which is, yes, we did write that down to zero.

And I think we had mentioned that previously on our investor days that, that was the anticipation of the plan.

Scott, regarding your first questions, I think we commented it is performing in line with our expectations.

Rone, you may want to add some comments, some more color to it.

But it is against what we originally planned.

It's a little bit up and down but, on balance, in total, it is performing where we expected.

That's exactly right, Michael, in line with our expectations in aggregate.

Okay.

And then, a follow-up question just on the exchange business.

First, if you could just tease out what the California exchange enrollment was out of the total.

And then, just talking about the additional growth you had this year, if there is any particular states where you saw that driving the growth.

And then, just any early indicators on if the risk mix or the membership profile of the new growth is different than the existing HIX members that you have already added?

Thanks.

I'll start with the last question first.

We are starting a pattern here.

I would say that we are seeing the mix consistent with what I described in the churn and our strategy for 2014, 2015 and now 2016 is intact.

The other question, relative to California, I don't have an exact number at hand but it was a sizable chunk of the business.

Thank you.

Our next question is from Chris Rigg of Susquehanna Financial.

Good morning.

Thanks for taking my questions.

Just a follow-up here to Scott's question on the risk corridors, Health Net, historically, there has been always these perpetual concerns about their days claims payable.

When we think about the medical claims liability at this point, were there any other reconciling adjustments at close to the reserves, or do you feel comfortable where they were at on March 24?

Chris, this is Jeff.

In my prepared remarks, I mentioned relatively all the fair valuation exercise related to the Health Net balance sheet, it remains open and, really, just due to the timing of the closing being relatively close to the end of the quarter.

So what I indicated was that we have made provisional estimates for all these things and we would expect that there is potential for true-up in the second quarter as we complete our fair valuation exercise.

And that would not run through the income statement?

Or it would just be a one-time item that you would spike out?

No, that would not run through the income statement.

Those effectively go back to the day one opening balance sheet that we would've acquired.

So, those would be balance sheet-only adjustments.

Okay, great.

And then, just a more forward-looking question, obviously you still have the four companies involved in the big M&A transactions right now, obviously speculation about divestitures there.

Are you guys interested at all in potentially being a potential divestee for Medicare Advantage assets, or do you think you're going to go at it organically at this point?

Thanks.

I think there's a couple elements.

One, we do not participate in any processes or auctions, whatever you call it, today.

So, to the extent that is, we're out of that.

Two, the controlling issue, and particularly in the Medicare-related business, will be the network.

If they have a network that is not in our sweet spot, which is at the lower socioeconomic level, then we won't have any interest in it.

We have so much organic opportunity.

Our pipeline is very robust.

I'm not -- we are not really of a mind that we need that to meet our growth targets.

If it is there and it makes sense, we do it.

Great, thanks a lot.

Our next question is from Christine Arnold of Cowan.

I know the regs were just out last night and they're volumous.

Do you have any first-blush takeaways, positive or negative?

And can you give us a sense of potential large contracts on the RFP radar screen?

Is Louisiana still on track for July 1?

And where does Alabama stand?

Okay.

One, I will agree with you on your first statement: it was voluminous and it did come out late last night.

We did have a quick review of it.

We see nothing that is troublesome to the Medicaid business.

We are comfortable with what we have seen.

We will continue to evaluate it.

If there's something different we will try to let people know through healthcare conferences and things.

But right now it seems just fine.

Your second question was?

A sense for potential large contracts.

Does Louisiana have a contract [to buy one]?

And where does Alabama stand?

Is there anything else we should be (technical difficulty) on our radar screen?

Louisiana, we believe, is on track for July 1. And, Rone, I think Alabama is on track for --?

Yes, Alabama is on track for the fourth quarter this year.

For the fourth quarter this year.

And then there's other ones we are obviously waiting to hear, like others -- it's been public that we are one of the people that bid on Pennsylvania.

We expect to hear about that momentarily, and that would probably be a first-quarter start.

There's a lot out there.

Great, thanks.

Our next question is from Kevin Fischbeck of Bank of America.

Great, thanks.

I just wanted to ask you about the exchanges.

Obviously, you've got United looking to exit a number of exchanges, and some of them, they're your biggest competitor at the local level.

I just wanted to see what you thought or if you were at all concerned about the potential to take in some of that membership when you've got some of your competitors leaving?

I think United -- and I have a lot of respect for Steve Hemsley and his people, and what they do and their approach to things.

But they are in a different market than we are, from what I can see.

They lost a lot of individuals, ACA, and they're at the higher end, in the Platinum and the Gold.

To the extent that they have a membership that would fit within our model, sure, we'd take them on.

But I'm not anticipating a large gain from that, either, just because of the differences.

Are you looking at entering more state exchanges for 2017?

Right now that is under evaluation.

And based on the results we have had to date, we continue to do it.

Obviously it works where we have our Medicaid.

I think I commented in my prepared remarks that it works well where we have a strong Medicaid product because it's -- we get the term we coined, churn, in and out of Medicaid.

So, yes, we would do that where those factors are in place.

And I think you said that you were going to enter four states for Medicare next year.

Any color on potential discussions with provider networks and things like that, how that is progressing?

Obviously, we believe it is going well.

And, once again, at many conferences I have commented it is a $700 billion category, of which 65% is at 400% of the federal poverty level and lower.

That is our sweet spot, and that is where our networks are now.

And so, to the extent -- and that is why, when people ask about some things that others may have to give up, we question the network that they serve.

But we think we have in place a network that, that population prefers to use, and we will just expand it.

Very candidly, when you're in Medicare, you have more orthopedic surgeons and other things that affect more of the elderly population.

And so, we are throwing that out, as appropriate, and we have a strong team doing it.

All right.

Great, thanks.

Our next question is from Peter Costa of Wells Fargo Securities.

Thanks for the question.

You're no longer spiking out loss ratios by segment.

Can you give us a feeling for how those loss ratios may have progressed this year -- or this quarter?

And then, in particular, the Medicaid expansion business, what is going on in the rate environment there?

Jeff, do you want to make some comments?

I think the Medicaid expansion business has been relatively consistent.

I think, as you're aware, there's minimum MLR rebate payables in a lot of our states.

The HBR year over year has been very consistent.

I think in my prepared remarks we mentioned improvement in the complex care HBR year over year and quarter over quarter.

That was really driven by, what I would say, the long-term care and some of that in the duals product, as well.

In terms of where we spike out and how we do it, I think we also commented, that is going to have to evolve because, with the eight days of Health Net added in, it changed the mix dramatically, and yet there was not a lot of time to take that approach and feel comfortable that we're giving you the kind of information that made sense at that point.

So, we will continue to work on it.

I think we have always looked for transparency where we had confidence and we are providing sound information.

Okay, thanks.

And, in terms of -- this is a follow-up -- the Specialty Services business seemed to be a little bit under pressure relative to the way it's been the last year.

Can you talk about what's going on there and what you expect going forward?

If you are looking at the service revenue line, the decrease is really due to a lower volume in our specialty pharmacy, specifically related to hepatitis C. And I think that is probably a general industry trend there.

And then, we did have the loss of a co-op customer in our pharmacy services business.

Jesse, anything you want to add to that?

No, I think that's right.

Those are on -- as Jeff referenced on the specialty pharmacy front, there's some more macro trends with respect to that particular therapy, and then just a one-off customer-specific item that was in the one-time category.

Okay, thanks.

Our next question is from Andy Schenker of Morgan Stanley.

Thanks.

Just following up real quick on the services line.

When should we see Health Net's volumes flow through the various components within that other -- some contractual obligations limiting your ability to roll through some of maybe the pharmacy or the behavioral services into their book?

So, how should we see that play out?

Thanks.

I think what you will see is, if you take Centene's 2015 service revenue and roughly layer in the government services business for Health Net, then that would be close to what we would expect for 2016, obviously prorating for the nine months and eight days.

Right, but then going forward, is there -- how should we think about the longer-term upside opportunity as well?

I think part of the issue -- Andy, this is Jesse Hunter -- is how that will be reported.

So, you have some internal versus external.

So, to the extent that you're talking about the integration, if you will, of the specialty services, that is -- the comments there are consistent with what we talked about separately.

There is very much a plan to insource what we can in terms of the specialty services.

That will happen over the course of time in a way that we feel like those things can be done efficiently and effectively.

But that won't necessarily flow through the line item on the P&L that you are referencing.

Okay, thanks.

And then, you called out the investment and expansion cost of $0.25 to $0.30.

It was a little hard to hear on the call but it sounded like there was only $0.02 in the quarter.

If you can maybe talk about how those costs ramped through the year.

I assume there's some pretty heavy investments in the end of the year for Nebraska, but anything else we should think about around seasonality of those costs?

Thanks.

I think you are right, it is probably weighted more towards the end of the year, specifically with Alabama and Nebraska.

Okay.

And then, just one quick modeling question, as well.

Run-rate interest expense, given the timing of the debt issuance and the corridor and the swaps, what should we be thinking about for the run-rate interest expense going forward?

Thanks.

I think I gave you the -- it is challenging to tell you that because a lot of our interest expense now is based on a floating rate of interest.

I think I gave you the components, the $2.4 billion.

Obviously the coupons we issued, the $1.6 billion, is at LIBOR plus 4.3%.

It would be north of $200 million on an annualized basis.

Okay.

Thank you.

Our next question is from A.J. Rice of UBS.

Hi, everybody.

Maybe one granular question and then one big-picture one.

In the Q1 cost trend, obviously your MLR year to year improved nicely.

A lot of the managed care companies, and providers, for that matter, are calling out Leap Year and Easter.

You said that flu was in line with your expectation.

How about those two dynamics, and how much of an impact did they have?

Do they offset each other, in your view?

Any comments there.

This is Jeff.

I think the way we always look at Leap Year is it's an extra day of medical costs when we do our forecasting, when we put our budget together.

I think Easter may have had a slightly favorable impact to that.

But the way we really forecasted it was just we include an extra day of medical costs in the quarter.

Okay.

Again, I think the improvement that you're seeing is reference to the complex care and, additionally, the growth in the Medicaid expansion -- excuse me, the health insurance marketplace products, and they carry a lot lower HBR than our average.

Sure.

Then maybe a bigger picture, there's a lot of -- there's moving parts this year, even more than usual.

There's always a lot of opportunities and some challenges.

I wonder, if you look at the guidance that you now are blessing and reiterating, with the exception of the 3.5-week delay on the deal, would you point to one or two things that look like might be -- if you end up beating the estimates, coming ahead of the estimates, that those would be the likely sources of potential upside?

And is there one or two things that are the challenges you face as you look out at the rest of the year?

I think if we saw something that was certainly one-sided, we could adjust the guidance in line with that.

There is no one thing that we can call out -- and Jeff can add this, if he wishes.

The only thing I'd call out that's a positive or a negative -- as I have talked about historically, we have a size and a scale that, with 24, 25 states growing the number, 260 different contracts within those states, at any given time you'll have one contract in a state that's an issue and you'll have a couple that are offsetting it.

So, it's the security and stability of diversification.

That is what makes it so hard to call out any one particular thing, because I'd like to think there is no one issue that can have a total deleterious effect on the whole Company.

Hope that helps.

Okay.

All right, thanks a lot.

Our next question is from Sarah James of Wedbush Securities.

Thank you.

I wanted to circle back to the exchange risk mix.

It looked like, in the Q, risk adjusters were up about 120% versus the combined Centene-Health Net at year end.

And, at 680,000 enrollment, I was getting up about 36% from the 500,000 range you previously talked about.

So, I'm just trying to understand the delta there between the degree to which risk adjusters went up versus the degree which enrollment went up.

This is Jeff.

I think you are correct.

Risk adjustment, the liability payable did increase during the quarter.

I would say that is a function of -- we are seeing the same kind of member demographics that we have seen consistently.

And, as you are aware, we have been in a risk adjustment payable for the last two years.

So, adding additional member volume has really just increased that risk adjustment payable.

The degree of difference between the enrollment change and the adjuster balance was just surprising.

One of your peers this quarter had talked about their risk mix deteriorating.

So, I just wanted to make sure there wasn't (multiple speakers).

That is their issue.

I think in our comment I said that we saw our performance at the high end of our range.

So, our experience is contrary to that.

You would have to ask them why their performance is so different from ours.

Sure, absolutely.

And then, I know it is early days on this, but as Zika tends to progress to south Florida, are you noticing any increased demand for OB visits or ER?

And how is the dialogue going with the state on how to address those additional costs?

Ken, do you want to comment on the --?

To date, there has only been just symptomatic flu-type cases of Zika.

There has not really been a case of the catastrophic consequences, except for one in Hawaii.

We are tracking that.

The projections of Zika are really unpredictable, based on Latin American experience.

We are optimistic that the government's position, or [file] chief's position, that the disease burden on the United States should be very small is probably very accurate.

And the cost of testing or visits should be relatively minimal.

Great.

Thank you.

Our next question is from Josh Raskin of Barclays.

Thanks, good morning.

Just a quick clarification or two.

The Health Net merger costs went up about $0.30.

I know it is excluded from your adjusted earnings, but is that just the charitable contribution or was there something else in there?

Josh, the primary driver was the present value of the charitable contribution.

And there was some shifting of, I would say, stock compensation and severance, really, spreading over the quarters versus all one time.

But the charitables are the most significant item.

Okay, that's helpful.

And then, what was the Health Net membership change on a sequential basis, if you could just look at what Health Net membership did?

Josh, I don't think we're going to get into too much.

I would say it is relatively flat but, again, we're not really going to start separating the Health Net and Centene businesses on a going-forward basis.

We made a very conscious decision last year that, at this point now, it is all Centene.

And we'll just report it as a consolidated Centene business, as trying to compare one from the other.

I just look at the total and it's all headed the right way.

Okay.

I just wanted a starting point, but that's fine.

And then, just lastly, on the Medicare expansion, I know you talked about the four new markets.

What does success look like?

What critical mass do you need?

Or should we think of this as existing Medicaid markets, so infrastructure may be more in place, you don't necessarily have to see a big ramp in membership to make those plans successful next year?

The infrastructure, of course, is in place.

The advantage we have is that we have very strong decentralized plans.

If you will, to coin a word, our local CEOs and their teams know how to indigenitize a product in their market.

Because you don't just take something from California and parachute it in.

There is that aspect of it.

I think the thing that we are cognizant of and thinking about is there is a different acquisition cost in Medicare products, as some of us have done, historically understand.

So, it will not take a gigantic amount of critical mass to start to see it provide some margin to us.

But I expect, in the first few quarters, to have some expense that will not necessarily be fully offset by the revenue.

That is something we will get more into at year end when we have the specifics and give guidance on 2017, as we always do.

And, Michael, on that, what is the network strategy?

I assume you will need to augment your networks for different providers in the Medicare business versus Medicaid.

And I'm curious what your thought is on rates.

Are you paying off a Medicare fee schedule or do you think you can look something more like Medicaid?

I think it will be a combination, depending on the particular services.

We are going to -- as I said earlier, I think you're going to find you're going to have to have more orthopedic surgeons type, you're going to have gerontologists, you're going to have certain -- you may have more rheumatologists, those things.

Some of those subspecialties, I expect the rates will be higher than the Medicaid level because we're not using it much in Medicaid.

We're not driving the volume there.

So, it is a matter of just being very surgical, as we have demonstrated before.

But the primary care will take -- will be our current network and we will adjust the rates as we see appropriate against the -- as we do now, with the exchange versus Medicaid.

But it's all in line with -- for providing adequate, equitable reimbursement and protecting our margins.

Perfect, thank you.

Our next question is from Brian Wright of Sterne Agee.

Thanks, good morning.

Can you give us an update on adjusted scripts annually on a combined basis and maybe how that compared to before the transaction?

On scripts?

Yes.

As I said, we are looking at it as a total business now.

And to try and break that out, it probably takes more time and energy for any benefit from our running the business.

Is that thought of as an area in the synergies category or is there any opportunity in there?

Sure, there's synergy.

Jesse, why don't you --?

Yes, Brian, this is Jesse.

Definitely, as we referenced before, pharmacy is a meaningful part of the overall synergy story.

So, the additional volume from the combined business is part of that.

But we're not going to go down a path of breaking out specific script volume in conjunction with that.

I might add, Brian, I have said in various investors conferences, we are now purchasing $5 billion in pharmaceuticals.

So, you're going to get the benefits of that kind of scale.

In my script, I commented on the purchasing power this Company now has as a $40 billion company versus a $22 billion company.

Great.

If I could just have one detailed follow-up, with the new exchange members, do those go into the existing MLR or new business MLR?

How does that break out?

We include those in existing.

I think our definition of new and existing was a significant -- or a geographical or product expansion.

So, these are really in existing states, and so we count that as organic growth and it's in the existing business.

Great, thank you so much.

Our next question is from Ralph Giacobbe of Citigroup.

Thanks, good morning.

I just wanted to circle back on the risk corridor.

Is the write-off the $214 million previously on the Health Net books or has that number changed?

Obviously, there had been -- it changed because there is activity between the December balance sheet and when we acquired the company on March 24.

I'm not going to get into the exact number.

Okay.

And then, maybe can you help us with the timing, at least, in terms of -- when you get visibility from the government, because you wrote it down to zero, if you get anything back?

I know last year it was 13%.

Can you help us with timing?

Does that ultimately run through the P&L if you get anything back?

Yes.

The question is, if we get something back.

And, yes, it ultimately would.

Our requirement under accounting standards is to fair value that receivable as of the date of acquisition, using information as of the date of the acquisition.

So, that is what we did.

Again, these are all provisional estimates.

We haven't finalized that.

But that is what we did and that would be our view.

Okay, fair enough.

And then, it looks like you had a fairly big increase in the return of premium payable on the balance sheet.

I think it went up to about $579 million.

It had been running at a couple hundred million.

Is that just the addition of Health Net?

And is that all rebate dollars?

And does that just reflect California coming on and the rebate back from the Medicaid expansion?

Yes, you are correct.

It is the addition of Health Net.

I think if you look at Health Net's 10-K, they have disclosed that, over the last couple of years, they have had increases in the MLR rebate payable in the California business, specifically related to the Medicaid expansion.

So, that is all driven by that amount.

I think the dollar amount of the rebate is somewhat north of $400 million on rebates for the Medicaid expansion business for Health Net in California.

Okay, that's helpful.

Thank you.

Our next question is from Dave Windley of Jefferies.

Jeff, on your provisional estimates -- you referenced that you have also taken a look at medical claims reserves on the Health Net side and made some provisional estimates there, would you be willing to add some color to that directionally, magnitude, anything like that, that would help us there?

I'm thinking about that in the context of the combined days claims payable dropping by a couple days.

I'm not going to get into any specifics.

Again, I think the most important piece is that, really, with the timing of the acquisition we have made what I would call high-level estimates, and we haven't completed the analysis.

We look to complete the bulk of that analysis in the second quarter.

Again, the accounting requirement's to make sure that we have those reserves at fair value as of the acquisition date.

Realistically, we should only be responsible for eight days of March.

That is the work that we are looking to complete in the second quarter.

But you are responsible for liabilities that predate the acquisition, right?

Because you are buying their liabilities, too.

That is exactly right, but we fair value those, and we have not completed our analysis on those yet.

And any adjustment to the opening balance sheet, again, would be a balance sheet-only adjustment.

Okay.

A separate question -- on the synergy commentary, Michael, you referenced the $75 million.

We are familiar with that number.

I think the way that was presented originally was it was $75 million for each year, in addition to -- or over and above any savings that Health Net had previously expected to achieve through their Cognizant deal.

So, I know you were expecting to get both buckets.

What about the pace of achievement of the Cognizant-related savings that -- they are no longer Cognizant related, but are those pro rata with your synergy achievement or are they on the old schedule?

Or how should we think about that?

It is all there, it's pro rata.

If you look at our guidance, it's been consistent.

We're realizing it as we expected it.

Mark is familiar with all of it, having come in as CIO, just working through it.

It is where we expect it to be, and it's pro rata, and it's just as we had reported previously.

Okay.

We're achieving what we want.

Okay, great.

Last question, what are your expectations around reduction of debt to capital over time?

What is your target, and by what time frame?

Jeff, we've talked about --

I think we previously commented that we are looking to get our debt-to-capital ratio into the high 30% -- mid- to high-30% range in the next 18 to 24 months.

I think that still continues to be the plan.

We started off with a little higher midpoint because of the stock price, but we will still get there.

Okay, great.

Thank you.

Our next question is from Ana Gupte of Leerink Partners.

Thanks for fitting me in this morning.

The first question is, again, on the regulatory framework for the managed Medicaid Federal MLR floor.

I'm trying to get some clarity on -- is this going to, again, be on a blended basis across the expansion in TANF lives with long-term support services, ABD, and so on?

And, in essence, does it become a tailwind for you as you cross subsidize this?

Or did that come out of the final reg?

It wasn't clear to me.

And does that differ by state?

You probably had -- we've had our Board meetings and our committee meetings and things taking place last night and today.

I'm not trying to be smart about it, but you probably had more time to look at it than we have to this point.

I just had our Washington office give us a quick summary that they see nothing deleterious to our operation and no surprises.

That is the extent I have right now until the team moves past the next day or so and then can really dig into it.

Got it.

Okay, understood.

We'll look forward to an update.

Another regulatory question -- in 2017, I completely understand that you, with the [250%], roughly, limit on the exchanges, are more profitable than those that are seeking to be more than Medicaid Plus.

But next year, when reinsurance goes away and then United is exiting from multiple states, might there be pressure, as they're pooling the risk with you, on your risk adjusters?

Do you foresee margin compression in states that are --?

If you look at it, on the risk adjusting, we feel we're the net payer in all our states.

It really does not have an impact in the same sense that somebody that has the receivables.

But would it be a net payable to a larger degree, if you will, next year because the margins for the Aetnas and the Anthems of the world, and the Blues, will be even worse, I would imagine, unless they get a huge amount of price increase.

Even if so, they may not get --

Maybe I'm not following the question 100%.

But, if our acuity goes up, our payable on risk adjustment would go down, if that's what you're trying to --

No.

I was more saying that risk adjusters will be pooled as though you are profitable, and maybe they are not.

It's a pooled program, as I understand.

So, if they're in worse acuity, even though you may get better acuity, might your payable be meaningfully higher than it is in 2016?

Because if they raise prices a lot, healthier people could fall off.

So, their risk gets worse, if you will.

So I'm wondering what happens there.

Rone?

We price for the estimated risk pool in the state.

And we try to be careful about looking at the changes that are going to happen from one year to the next with respect to that risk pool.

And I think we have had a pretty good track record with respect to being able to do that to this point.

I think that if they raise their prices, some of the healthier members, we would hope, would accrue to us with respect to that.

And, again, we try to carefully look at the dynamics of how that would affect the actual risk adjustment amount that we might have to reflect related to our acuity, including how the risk adjuster pool works in each state.

I think that we have reflected what we think is an accurate view of the dynamics for 2017.

Just back to another comment you mentioned.

The reinsurance program is going away in 2017 and that is certainly something that will need to be reflected in our pricing in 2017, and something that we are very mindful of.

Thanks so much.

Appreciate squeezing me in.

Our next question is from Matthew Borsch of Goldman Sachs.

Thank you for squeezing me in.

I had a question on the -- and I know you don't want to break it out, but when you are starting with this Health Net -- large book at Health Net ACA exchange membership, is it profitable now?

And was it profitable when you exclude the risk corridor from that business?

Or do you have to do something to get it to profitability?

And what level of profitability is that?

Because I assume it is somewhat less than what Centene has realized.

This is Rone Baldwin.

In aggregate, the exchange business at Centene -- excuse me, at Health Net has been profitable.

The one area of challenge with respect to the exchange business at Health Net has been Arizona.

And Health Net did take actions with respect to this open enrollment period to make changes in the product line-up and the pricing for Arizona to be able to get that back on track.

But California, they pursue a strategy very similar to Centene's strategy in terms of tailored narrow networks with a focus on the subsidized population.

That has worked well for them.

They are seeing results in line with what we've seen on the exchanges.

This does -- this is a view that also takes into account the risk corridor with respect to not booking any receivables for it going forward.

Okay.

And just one more, if I could.

As you think about California moving ahead, how do you think -- what is going to be the key growth driver in that market?

Given the Medicaid expansion has already happened, the exchange take-up has been fairly robust, where do you grow in that market?

It will still be very balanced growth.

There's probably 4 million lives unidentified -- undocumented, as well as unidentified, Medicaid lives, plus all the categories that are there that will provide growth.

This ongoing exchange business, we continue to increase penetration.

So, it is what you see against all our markets with other new products and things that we do over time.

I'm not going to tip my hand to the competition what I have in mind, but we have thoughts and expect it to grow consistent with our rates of growth.

Okay, thank you.

Our next question is a follow-up from Christine Arnold of Cowen.

Thank you, again.

I have a quick follow-up on the tax rate in 2017.

You'd referenced before, changes to the compensation tax rate.

And then, there has also been a new FASB rule.

How should we be thinking about the tax rate in 2017, obviously excluding HIF -- like an ex-HIF tax rate, 2016 to 2017?

Thanks.

I'm not going to get into 2017 tax-rate guidance.

We are a little early for that.

But I will tell you -- and we have quoted this number before -- that the HIF is roughly over 10% to our tax rate.

So, that will be -- obviously get you to somewhere in the 40% range.

But that's all I'll say at this point.

Okay, thanks.

This concludes our question-and-answer session.

I'd like to turn the conference back over to Michael Neidorff for any closing remarks.

Thank you all.

I would hope you got the sense that the integration is going very well, it is at or ahead of schedule, that the teams are working well together, that the business is where we expect it to be and want it to be.

And we look forward to giving you an in-person report at our June conference in New York.

Have a good second quarter along with us.

Thanks.

The conference is now concluded.

Thank you for attending today's presentation.

You may now disconnect.