Centene Corp (CNC) 2017 Q2 法說會逐字稿

Good morning, and welcome to the Centene Corporation 2017 Second Quarter 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, Anita, and good morning, everyone.

Thank you for joining us on our 2017 second quarter earnings results conference call.

Michael Neidorff, Chairman and Chief Executive Officer; and Jeff Schwaneke, Executive Vice President and Chief Financial Officer of Centene, will host this morning's call, which can also be accessed through our website at centene.com.

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

The playback number for both of those dial-ins is 10110042.

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 dated today, July 25, 2017, the form 10-K dated February 21, 2017, 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.

The call will also refer to certain non-GAAP measures.

A reconciliation of these measures with the most directly comparable GAAP measures can be found in our second quarter 2017 press release, which is available on the company's website at centene.com, under the Investors section.

Finally, a reminder that our next investor day will be on Friday, December 15, 2017, in New York City.

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

Michael?

Thank you, Ed.

Good morning, everyone, and thank you for joining Centene's Second Quarter 2017 Earnings Call.

During the course of this morning's call, we will discuss our second quarter financial results and provide updates on Centene's markets and products.

Additionally, we'll provide commentary around our understanding of the status of the Affordable Care Act.

I'd like to begin with comments on the health care legislation landscape.

It is a moving target with a long way to play out.

But you know that.

Centene's priority has always been to ensure this country's most vulnerable populations have access to high-quality affordable healthcare.

We remain committed to working closely with federal and state regulators and policymakers to collaborate on actions needed to stabilize the market.

Whether or not members of Congress believe a Medicaid design or a commercial design is the best way to deliver high-quality health care to low-income individuals, Centene is the market leader in both platforms.

We have the credibility as well as the experience to work with Congress on ways to address the challenges associated with the current law.

We believe some improvements have need to be included in any fix are: eliminate the taxes, which will drive down premiums; maintaining CSRs or some similar mechanism to make coverage affordable for low-income, non-Medicaid eligible recipients; and reinsurance with COB, as estimated, will result in significant premium reductions.

We believe it is important for health brands to take some risks to ensure care continues to be managed appropriately.

It is important to note that every repeal and replaced proposal in the House and Senate as well as the House budget has included CSRs as a necessary component to stabilize the market [price].

Republicans and Democrats alike have shown how integral CSRs are to the stability of the marketplace.

At times, we can all get wrapped up in the political debate going on in Washington.

However, any intentional act to stop these CSR payments does not advance the debate on how to fix our healthcare delivery system.

It only hurts the millions of Americans who currently have affordable health care insurance in the marketplace.

The leadership in Washington bears the responsibility to ensure that does not happen.

In the meantime, we are focused on business fundamentals as evidenced by another strong quarterly financial performance and positive operating momentum.

Now on to second quarter financials.

We were pleased to report a strong second quarter marked by solid top and bottom line growth.

Membership at quarter-end was 12.2 million individuals, representing an increase of approximately 790,000 recipients compared to the second quarter of 2016.

Total revenues increased 10% year-over-year to $12 billion.

The HBR improved 30 basis points year-over-year to 86.3%.

This was primarily attributable to growth in our insurance exchange business in 2017.

Lastly, we reported second quarter adjusted diluted earnings per share of $1.59.

This includes a $0.17 benefit related to the 2016 risk adjustment reconciliation under the ACA.

This compares to $1.29 reported in the same period last year, which included a $0.19 benefit related to the 2015 risk adjustment.

Jeff will provide further financial details, including updated 2017 guidance.

A quick comment on medicals cost.

We continue to see as well as anticipate overall stable medical cost trends consistent with our expectations in the low single digits.

Moving in -- onto markets and product updates.

First, Medicaid.

We are pleased to have grown our overall Medicaid book by over 400,000 beneficiaries compared to the same period last year.

Recent Medicaid state updates include Missouri.

In May, we commenced operations in the Missouri statewide expansion of its Medicaid program.

Centene now provides healthcare services to over 278,000 Medicaid recipients in all 114 counties in the state.

This represents a sequential increase of over 172,000 members.

State of Washington.

Also in May, Centene successfully reprocured its Apple Health contract in the North Central region of the state.

The new contract integrates behavioral health into the program.

It is expected to commence in the first quarter of 2018.

Mississippi.

In June, Centene successfully reprocured its contract to serve Medicaid recipients under the state's MississippiCAN program.

The new contract is expected to begin mid-year 2018.

Georgia.

In July, we commenced operations under a new statewide Medicaid contract in Georgia.

This was a successful reprocurement of our previous contract with that state.

Nevada.

Also in July, we began providing healthcare services to Medicaid beneficiaries enrolled in the state's Medicaid managed care program.

While this is initially a small market for Centene, it should continue to grow over time.

Nevada marks Centene's 28th state of operations.

Next, Centurion.

In June, Centurion began operating under an expanded contract to provide correctional healthcare services to over 15,000 inmates in South Florida.

We now provide services to over 85,000 inmates in the state.

Centene currently serves over 160,000 inmates across 8 states.

Now Medicare.

At quarter end, we served approximately 328,000 Medicare and dual beneficiaries.

As I have previously stated, we are applying a test-and-learn approach to our first year of Medicare Advantage operations in our 4 Centene Medicaid states.

We are applying the insights we have gained thus far this year to Centene's 2018 Medicare Advantage plans.

Consistent with our overall strategy, we are focused on providing high-quality affordable Medicare Advantage products to low-income beneficiaries.

It is important to note that the low-income Medicare opportunity across Centene's existing states is in excess of $150 billion.

For 2018, we have filed bids for new Medicare Advantage contracts in 6 markets as well as bids in 2 additional markets focused on [D-SNP] products.

These will be launched under the Centene's new national Medicare Advantage grant, Allwell.

They are eligible for a premium bonus under our 4-star parent rating.

This rating allows Allwell to be marked in as a high-quality Medicare Advantage grant.

Over the long-term, we expect our Medicare Advantage product to drive over 20% of our annual growth rate.

Next on to Health Insurance Marketplaces.

At June 30, we served approximately 1.1 million exchange members.

This represents a sequential decline of approximately 100,000 beneficiaries, in line with our expectations.

The key demographics of these members including age, gender, financial assistance and metal tier remain consistent.

This highlights Centene's continued success in attracting and retaining our targeted customer seg.

This has been done through effective sales marketing and member engagement activity.

Our exchange business continues to perform well in 2017.

We now have reasons to believe our margins will be at the high end of our guidance range.

As a result, we have removed the conservatism that was previously included in our 2017 financial guidance.

Jeff will provide further detail on this topic.

For 2018, we intend to grow this profitable segment of our business.

We remain focused on providing high-quality affordable healthcare to low-income individuals.

Next year, we plan to enter Kansas, Missouri and Nevada; and expand our footprint in Florida, Georgia, Indiana, Ohio, Texas and Washington.

International.

Our international business continues to perform as expected, and we are encouraged by its long-term growth prospects.

Lastly, Envolve.

In July, our specialty solutions subsidiary, Envolve, began providing a comprehensive management services for approximately 200,000 Medicaid members of a health plan in Maryland.

Shifting gears to our rate outlook.

We continue to expect a 2017 net composite Medicaid rate adjustment of 0 to 1%, consistent with the past few years.

In summary, we delivered another strong quarter and raised 2017 financial guidance.

This was achieved while increasing our investment in growth opportunities as evidenced by the increase in our expected business development cost.

Headline noise regarding repeal and replace efforts in Congress will persist.

It is important to remember, despite political or industry distractions, the need for high-quality affordable healthcare remains constant.

In the past, we have demonstrated our ability and capacity to navigate industry changes to the benefit of our members, shareholders and government partners.

As such, we continue to follow our business-as-usual approach from an execution standpoint.

We are a growth company and our pipeline of opportunity across all lines of our business remain robust.

We are optimistic about our future and ability to extend Centene's leadership position in government sponsors health care.

We thank you for your continued interest in Centene.

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

Thank you, Michael, and good morning.

Earlier this morning, we reported strong second quarter 2017 results with both top and bottom line growth.

Total revenues were $12 billion, an increase of 10% over the second quarter of 2016, and GAAP diluted earnings per share was $1.44.

Adjusted diluted earnings per share was $1.59 compared to $1.29 last year.

We had strong performance across our products and markets during the quarter with the marketplace business performing exceptionally well.

The performance in marketplace was driven by a pretax net benefit of $48 million or $0.17 per diluted share, associated with the reconciliation of the 2016 risk adjustment provisions under the ACA.

As a result of the strong second quarter performance, we have increased the midpoint of our GAAP and adjusted diluted earnings per share guidance range by $0.18 while increasing our business expansion cost by $0.17 per diluted share at the midpoint to fund further growth in 2018.

Let me provide some of the performance highlights for the quarter.

Total revenues grew by $1.1 billion year-over-year, primarily as a result of growth in the Health Insurance Marketplace business, a full quarter of business expansions in 2016 in Texas and Louisiana, the expansion of the Missouri contract in May of 2017 and the start-up of our Nebraska health plan on January 1, 2017.

This growth was partially offset by the 1-year moratorium of the health insurer fee, lower specialty pharmacy revenue and lower membership in the commercial business in California as a result of margin improvement actions taken last year.

Sequentially, total revenues for the second quarter increased by $230 million from the first quarter of 2017.

The increase was driven by favorable risk adjustment in our marketplace business recorded in the second quarter of 2017 as well as the expansion of our contract in Missouri.

We expect total revenues to be lower in the third and fourth quarter compared to the second quarter 2017 due to the addition of a competitor in Georgia and the normal membership attrition on the marketplace business.

Moving on to HBR.

Our health benefits ratio was 86.3% in the second quarter this year compared to 86.6% in last year's second quarter and 87.6% in the first quarter.

The decrease year-over-year is primarily driven by the growth in the Health Insurance Marketplace business, which operates at a lower HBR.

Sequentially, the 130 basis point decrease in the first quarter is primarily attributable to the favorable risk adjustment in our marketplace business recorded in the second quarter of 2017 and normal seasonality of the business in the first quarter as a result of flu-related costs.

As I mentioned earlier, during the second quarter, CMS released reconciliation information related to the risk adjustment provisions associated with the 2016 marketplace business.

The reconciliation of the risk adjustment provisions for 2016 improved our results for the second quarter by approximately $0.17 per diluted share.

This is after considering the risk-sharing contracts primarily in California, the risk corridor and the minimum MOR, Turning to our 2018 -- or 2017 marketplace business.

The metal tier's enrolled demographics and profiles of our membership continues to be in line with our expectations.

Additionally, the claims experience and the initial information we received in the second quarter from the data aggregators associated with the 2017 risk adjustment estimates, have provided additional comfort regarding our margin expectations for the year.

As a result, we have removed all of the initial $0.20 per diluted share conservatism from our annual GAAP and adjusted diluted earnings per share guidance.

This includes $0.04 per diluted share that was related to the first quarter, $0.12 per diluted share related to the second quarter and the remaining $0.04 per diluted share related to the second half of 2017.

We continue to utilize our consistent reserving methodology for the risk adjustment program as we have done since the inception of the marketplace business.

Moving on, our selling, general and administrative expense ratio was 9.3% in Q2 this year excluding the Health Net merger cost, compared to 9% last year and 9.3% in the first quarter of 2017.

The increase in the ratio as compared to the prior year is primarily due to the increased business expansion cost and higher variable compensation expense based on the performance of the business in the first half of 2017.

Interest expense was $62 million in the second quarter compared to $52 million in the second quarter of 2016 and $62 million in the first quarter of 2017.

The increase year-over-year is due to the increase in senior notes over 2016.

Our effective income tax rate was 40.1% in the second quarter of 2017.

The lower tax rate compared to the prior year is due to the 1-year moratorium of the health insurer fee.

Now on to the balance sheet.

Cash and investments totaled $10 billion at quarter-end, including $291 million held by unregulated subsidiaries.

Our risk-based capital percentage for NAIC filers continues to be in excess of 350% of the authorized control level.

Debt on June 30th was $4.7 billion, including $150 million of borrowings on our revolving credit facility.

Our debt-to-capital ratio is 42.1%, excluding our nonrecourse mortgage note, compared to 43.7% last year-end and 43% at the end of the first quarter 2017.

Our medical claims liability totaled $4.2 billion at June 30 and represents 40 days in claims payable compared to 41 days last quarter.

The decrease in the days and claims payable is due to the timing of payments associated with improved auto-adjudication rates on the legacy Health Net business.

As we highlighted at our midyear Investor Day, we have improved the auto-adjudication rates by over 10% since the fourth quarter of 2016.

Cash flow used in operations was $306 million in the second quarter.

Operating cash flows for the second quarter was negatively affected by approximately $750 million of delayed payments, primarily from several of our states as a result of their fiscal year-ends.

We expect to receive the majority of these delayed payments by the end of July 2017.

Turning to guidance.

We have adjusted our 2017 annual guidance to reflect the following items: The strong performance for the second quarter; an increase in our business expansion costs to $0.42 to $0.47 per diluted share, reflecting the shortening of the open-enrollment period for the marketplace business and additional investments and growth initiatives in Medicare marketplace for 2018; and an increase in our 2017 margin expectations for the Marketplace business.

Our updated full year 2017 guidance is as follows: total revenues between $46.4 and $47.2 billion; an HBR ratio of 87% to 87.4%; SG&A expense ratio of 9.4% to 9.8%; adjusted SG&A expense ratio of 9.3% to 9.7%; GAAP earnings per share of $3.96 to $4.29; adjusted diluted earnings per share of $4.70 to $5.06; effective tax rate between 39% and 41%; and diluted shares outstanding between 176.3 million and 177.3 million.

The increase in the SG&A and the adjusted SG&A expense ratios is due to the increase in business expansion cost, which we expect to occur primarily in the fourth quarter.

In summary, we are pleased with the second quarter results and the operating momentum heading into the remainder of the year.

That concludes my remarks.

And operator, you may now open the line for questions.

(Operator Instructions) Our first question comes from Gary Taylor with JPMorgan.

I just wondered if you could go into a little more detail on the additional G&A spending, which I guess calculates out to almost a couple hundred million dollars.

Maybe just explain why the shorter open-enrollment period drives some increased spending and a little more detail on those investments for '18.

I don't think it's that much, but Jeff?

Yes, I'm not sure of the math there on the couple hundred million.

But ultimately, we are investing in further growth initiatives.

The shortening of the enrollment period is that you have cost that you incur to enroll members and that used to go for a longer period and some of those costs would end up in the next fiscal year.

But they've shortened that cycle so all those costs will end up in the fourth quarter of this year.

And then we are making additional investments in the expansion states which Michael mentioned for exchange as well as Medicare.

Medicare.

And Medicare marketing is not inexpensive.

I did have a math error on my -- You increased the G&A ratio by 20 to 30 bps, I had a math error there.

But I appreciate the detail.

The next question comes from Sarah James with Piper Jaffray.

I'm trying to bridge the guidance change here.

If I take the prior guidance and adjust for the HIX reconciliation, the outperformance in exchanges, the carve-in of conservatism, which I was estimating to be about $0.06 and then the SG&A headwind.

I'm still getting about another $0.27 benefit between where that math leads me to the current guidance.

So I'm wondering if there's some other improvements going on maybe on the Medicaid side?

Or if that delta really is just even more outperformance to come on exchanges.

Yes.

Again, I'm not certain of your math there.

I understand that you're picking up the 25 or the change in the mid-points of the G&A ratio.

But that would assume that our guidance was at the midpoint initially.

So -- but I follow your math with the outperformance of the second quarter.

I think the way we've laid it out in the press release is the outperformance -- you have the $0.17 on the exchange 2016 reconciliation, which is really offset by the additional investments that we have.

So I think that's the roll-forward that we've done in the press release.

Got it.

And you mentioned expanding into more bare counties for the exchanges.

How do you get comfortable with the margin profile on that business?

And are there any similarities between those markets in Arizona which seems to be performing well?

I think it's the same principle.

I mean, these are markets that were -- you say if you take Missouri were involved in the Medicaid products and expanding there, and so it's -- we have the networks in place, the medical management in place.

And it's very success is -- a great deal of our success is the medical management programs and our systems that allow us to do that effectively.

Sarah, so I think we're comfortable, we have it in the new counties.

And you pointed out, as we did in Maricopa when that opened up last year.

The next question comes from Zack Sopcak with Morgan Stanley.

Wanted to ask a question about drug trend for a second, and if there's anything you see that could impact costs this year or next year such as the SPINRAZA drug by Biogen?

Hi, this is Ken Yamaguchi, I'm the CMO.

No, SPINRAZA exposure for us has been very, very low.

The indications for that medication are also very, very tight.

So at this point, we're watching it carefully, but really our exposure has been low, and we really haven't seen any drug trends that are concerning right now.

Yes, I don't -- this is Jeff.

I don't think there's anything outside of our expectations right now what we're looking at.

The next question comes from Lance Wilkes with Bernstein.

Wanted to hear a little more color on pipeline, in particular, the higher-acuity populations and how you're seeing that pipeline develop?

And then are you seeing any slowdown or delay in the pipeline as a result of political uncertainty?

Yes, Lance.

Jesse Hunter here.

So the answer to your second question first.

No, we're definitely not seeing a slowdown.

We're quite active on multiple fronts, as you've seen by some recent announcements in reprocurements and I would say more to come there.

And I think to your first question, we've seen this trend initiate a number of years ago and if anything, I'd say it's accelerating as you look at the impact that these programs, higher-acuity managed-care programs have had in both cost and quality.

So we continue to see that as a significant growth opportunity going forward.

I might comment that -- I have, for years, commented that the higher-acuity programs is where the states get the greatest benefit.

Our systems in medical management is really mature.

You can expect the medical loss ratio to be higher but the G&A to be lower.

So it's something that we are very comfortable with.

Great.

And on the higher-acuity programs.

Can you just talk a little bit about your value propositions, especially with the breadth of specialty programs that you've got?

And how that compares with some of your rivals in that space?

Oh, I'm going to let the others talk about their programs.

We kind of focus on ours.

I'm sure you understand that.

But -- so we have Casenet.

We have a series of programs that we're -- we saw it coming which -- for a long time and we built the systems, the predictive models, the case management, medical management programs and systems to deal very effectively with it.

It's not an accident that we are the largest in long-term care.

And we -- I think we've continued to do that for states to recognize the capabilities there.

So it's something that we anticipated for years and we built on it and it's a very local type approach and that is something that has also serves us very well.

Jesse, anything you want to add?

Yes, just to Michael's last point around the local approach.

I mean that's obviously been a hallmark of our orientation, how we serve these populations, I think particularly on the higher-acuity programs, including LTSS.

These are not just medical programs.

So you really have to understand the social determinants and the environmental factors and having a high-touch local approach really is a differentiator for us there.

The next question comes from Kevin Fischbeck with Bank of America Merrill Lynch.

Just wanted to ask a couple questions on MA.

You mentioned that some of the business expansion costs are related to MA.

Is this a sign that you're going to push a little bit faster into Medicare Advantage in 2018 than you had previously been thinking?

Yes.

I mean, I think those additional costs are representative of that.

I mean, I think we had a targeted approach, and I think we're comfortable with adding some extra dollars there.

We did have a baseline of costs in our original guidance.

And I think we're just increasing those.

I think, Kevin, if you recall, we said we viewed '17 as a learning year when we went into it.

So we see expanding the states we're in as well as the 6 new markets that we're looking at, a couple D-SNP markets we're adding.

So now it's just time to put that learning to work.

And we're taking the same approach we did on the exchanges [over the] last year.

It's not how fast but how well.

And as it continues to do well, then you start building momentum.

So it's not just what '18 bears but '19 and on out, and we -- at the time we did the health [ends], we said that we see growing to the end of this decade and the next decade material growth out of the Medicare Advantage products.

Okay.

I think in the past, you guys have said that you expected MA in 2017 to be [profitably] as large as your 2 existing California businesses.

Is that at still on track I assume given this?

Yes, it is.

And as far as Health Net goes, you mentioned that DCPs were down because of an improvement in the adjudication.

Is that largely now run rate?

Or is there still room for that to go?

Where should we expect DCPs to go from here?

No.

I think there's still room for that to go, specifically, because we haven't done all the operational systems conversions.

So the Centene platform has a higher auto-adjudication rate.

And so I think there's more room to go on the legacy system.

And I think there's additional room even further out in the future on -- after the system -- post-system conversion.

And Mark, we're looking at early '18 for that conversion at this point, right?

That's correct, Michael.

Okay.

And then I guess, this is the last question.

So this, hopefully, will be the last time I ask about health -- I guess we'll call it the California Health plan.

Just wanted to make sure that, that business continues to have come in line with your expectations.

I would say, clearly within our expectations.

We're very pleased with it.

The integration is where it should be.

The synergies are being delivered.

The team out there is incredibly strong.

I think they're enjoying the business more that they have some of the system support were giving them, Casenet and others.

So it's proving to be a very worthwhile move.

The next question comes from Chris Rigg with Deutsche Bank.

Just wanted to get your view midyear.

Coming into 2017, people were concerned about a county like Maricopa where you're the only insurer.

I guess with 6 months under your belt, how do you feel about it conceptually when you're the only insurer to market?

Does that make you feel more comfortable or less comfortable about serving that population?

Well, it's kind of a two-edged sword.

One, we like being the only one, because then we get the full population.

Then we get the sick, the wells, the full mix.

When there is a second player in there, we get the benefit of showing how good we are by comparing to the others.

So you know that -- it's kind of a mix.

But having the full risk is consistent with sound insurance policy.

So we're very comfortable with it.

Okay.

And then just to come back to the higher SG&A outlook.

I mean, by my math, the increase is about $0.40 of headwind.

You've talked about $0.17 of incremental investment spending or business expansion costs.

I know we're all trying to get to a sort of an exact number here.

But the $0.23 delta, is that compensation expense?

Or is there something else in there?

I think there's some in the variable compensation category because obviously we did increase our guidance substantially, but in general, you're assuming that our internal forecast was at the midpoint.

And so if you noticed, we did actually take the HBR range (technical difficulty) meaning (technical difficulty)

The next question comes from Dave Windley with Jefferies.

I wanted to clarify, Jeff, some comments you made in your prepared remarks about the -- taking the conservatism on the exchange marketplace business that was previously in there.

You said $0.04 in 1Q, $0.12 in 2Q and $0.04 in the second half.

Is that when you are taking those amounts into earnings?

Or is that where they were mapped out to benefit you in guidance or to be kind of gated in the guidance?

Well, actually, there is -- you're not really taking in to your earnings, right?

Because it was -- we took our, if you will, our forecast and added the conservatism on top of the forecast.

So when we say that we beat the expectations in the 2017 marketplace for this quarter by $0.12, that's effectively a piece of that original $0.20 of the conservatism.

Right.

Okay.

And so the...

So I guess the way I'd look at it is we originally had $0.20 of conservatism when we talked to everybody in December.

That's all out of the -- it's all out now.

We've taken all that conservatism out of our current guidance.

Yes, understood.

So it's not so much that the exchanges were in line and then -- in line in the second quarter and then you took the additional $0.12 out of the conservatism?

I would say that the exchange performance was stronger than the numbers with the conservatism in it, right?

We had better performance, I would say, more in line with how the exchange performed in 2016.

Got you.

And then a follow-up question here on the risk adjustment.

You had positive settlement impact of $0.17.

For '17, it sounds like you needed to increase your payable.

Is that -- am I thinking about that right that those are moving in, kind of, opposite directions?

And was that based on a different set of assumptions for '17 or a different methodology in '17 than you had applied in '16?

No.

No, we did not have to increase our payable.

What I'd say is, I guess our payable is, kind of, consistent as it was in 2016.

But obviously the business has grown, so it's going to be a larger dollar amount.

So I guess what I would say is the exchange performed, kind of, better than we anticipated with the conservatism and in line with 2016, and I think that's where it is.

I think I might just add, I think that (inaudible) -- today they understand how it works and we've booked the appropriate levels.

Yes.

Yes, I would say -- again, my comment was we are using the same reserving methodology for risk adjustment that we have for the past 3 years.

Exact statement.

Nothing is different there.

The next question comes from Peter Costa with Wells Fargo.

Can you explain to me a little bit about what you think the direction of your margins will be going forward?

If you're at the high-end of your prior margins on the exchange business, I think that was a 3% to 5% targeted margins at the high-end of that or -- and then your Medicare business is still, sort of growing and so I imagine you are on the lower side of your targeted margins there.

Where do you think your overall margins will go over the next few years?

Hopefully up.

Yes, I mean obviously, we're refocused on improving the margins on a going forward basis, but again, I think I mentioned this at our Investor Day.

I think the largest driver of our margins going forward is going to be the business mix.

So the exchange is at the higher-end of the margins, the Medicaid's a little bit lower than that.

There's obviously opportunity for additional interest income and investment income depending on what interest rates do.

So I think we would like to see margin expansion in the future.

But what's going to be driving that is how much Medicare and exchange and long-term care.

It's a mix of contracts and business that we have that's going to drive, I would say, the bottom line margin number.

I think with the growth that we anticipated and have been demonstrating, you don't get the -- you're not leveraging the overhead quite as much when you're growing at the rate that we're growing, so -- but we expect it to expand.

And then can you break that down by business line in terms of which direction you think the margins will go?

Well...

Detail of what we...

Yes, I think you highlighted, for example, Medicare.

I mean, we would not anticipate to operate long term at a lower end of the margin range on that.

But we're on investment mode.

So I think what you said earlier is probably what the expectations are.

The next question comes from Scott Fidel of Credit Suisse.

Just on the -- do you have any update on if there's been developments just on that LTSS carve-out situation in California?

I know you had put the $1 billion sort of placeholder on the 2018, but it sounded like that situation was still a little fluid at the Investor Day?

Yes.

I think it was in the government's budget, and the government's budget was approved.

So I believe that's done.

I think it's carved out.

Chris, do you want to add to that?

Sure.

I just have one point to that, Michael.

I think that as Jeff said, it did get past the governor's budget but we continue to work with the counties and the state to look for ways to work together on the in-home support services.

Okay, got it.

Then just -- on second question.

Just I know on the services that revenue is -- can be heavily sensitive to changes in the specialty business.

But looks like it was down around 10% year-over-year.

So was that all just relating to the specialty biz?

And then how should we think about, I guess, revenue growth in that business in the back half of the year?

I mean I can comment initially on -- it's down in the specialty pharmacy business and it's related to Hep C, I think that's a macro trend and then as far as growth going forward on -- Jesse, if you want to comment on that?

Yes, I think it’s got one of things that we've seen.

We talked about a few times with the variability in that line as trended with, as Jeff referenced, more of the macro Hep C trends.

So I think we're at certainly a more stable point and we view that as a growth part of the business, so you shouldn't expect to see that going forward.

I think that, as we look at the business, it's large, it's $46 billion.

And you're going to have some products that are up and some that are down.

So that's -- we see it as the benefit of the diversity that we have and are continuing to build into the business that -- Hep C might be down because of the trends, but there's other things that will pick it up, and so we tend to manage at the macro level of the overall trends and say it's headed where we expected.

Got it.

Just one last quick numbers one.

Just -- do you have where the Georgia lives ended up settling out in July with the fourth vendor coming in?

Yes.

We don't really comment on, I would say, interquarter membership so -- but it was in line with our expectations.

When you look at the total, we had a good quarter, a year-over-year growth in [Medicaid].

Go ahead, I am sorry, operator.

The next question comes from Justin Lake from Wolfe Research.

First, just kind of following up on one of the last questions.

Given the strength in the exchange margins, would you expect this is a reasonable run rate for this business going forward?

Or would you expect and [did] some -- embed similar conservatism in 2018 than you did this year on exchanges?

Well, I mean, I think if you recall why we put the conservatism in is that really is a result of the presidential election.

And so I guess I'm not giving 2018 guidance now.

But there's a lot of things that have to play out between now and December.

Okay, that's helpful.

And then just in terms of the -- your 2018 revenue outlook.

Was hoping you might be able to give us some color on what kind of exchange membership growth was kind of built into that revenue outlook you gave us at the Investor Day.

And can you tell us what percentage of your membership this year gets CSRs?

I think -- Justin, I want to be careful.

We're not going to give specific guidance until December 15.

I mean, that's always been our policy and practice.

So please bear with us on that.

We give -- in June, we give a trend and a directional thing.

And we've expressed historically that 90% or more tends to have subsidies at different levels.

It's not all full subsidies.

That depends on the tiers and the income of the individuals.

Okay, that's helpful.

If I could just sneak in one last numbers question.

Is there -- the variable comp that you talked about this year, the increase there than ran for SG&A.

Can you put some numbers around that so that we can understand how much might normalize out next year?

I'm not going to get that specific.

I mean, we had a very strong quarter.

I think you all recognize.

And so therefore, the variable comp will be booked accordingly.

That add avoids any one quarter taking an inappropriate hit because it's up or down.

So we balance it out.

But I don't want to get into the specifics because of the changes that can take place from quarter to quarter.

The next question comes from Ralph Giacobbe with Citi.

I just wanted to go back to the business expansion cost, the $0.42 to $0.47.

I think the cost was $0.05 in the first quarter.

I may have missed it.

Did you give the impact in the second quarter?

It's $0.07.

$0.07, okay.

We did not give that, but it was $0.07 in the second quarter.

And again, I think my comment was the increase is going to be more in the fourth quarter.

So this increase that we put in, the $0.17 at the midpoint, I think most of that, the majority of that's going to be in the Q4 because that's when...

So the way to think about it, I mean, $0.05 in the first, $0.07 in the second.

It looks like it's going to be close to a $0.30 impact in the fourth quarter.

Is that fair?

Yes, yes.

That's close enough.

Good.

And do you get any of that back on sort of an ongoing -- like when we think ahead to next year.

Does some of that come back?

Or is that just an embedded cost, sort of, going forward?

If you're comparing it to 2017, yes.

Because in 2017, in the first quarter, there were exchange open-enrollment costs.

So when you go to 2018, in theory, there wouldn't be, but the cost would be higher in the fourth quarter.

So I think -- we're not going to quantify that, but I don't know how much that difference is.

Okay, all right.

And then is the underlying base case for HIX enrollment next year to be flat?

Can you just sort of level set, like where do you think the overall pool is?

I'll go back to Michael's comment.

I think we're not going to -- consistent with what we've done in the past, we're not going to get into 2018 membership.

I mean, we're still in pricing cycles and those things to sort, so...

Yes.

And we did comment that we're entering new markets and expanding the existing markets.

So that would probably give a sense that there will be some growth, which we'll detail in December.

Okay, that's helpful.

And then -- but I guess, just to help sort of frame a little bit.

Just given sort of the -- and you've certainly done well in the exchanges to this point.

There's obviously a lot of headline risks still as we think about next year.

There's a lot of questions around sort of a mandate that may not be enforced and the potential sort of for drop off of healthier lives given some of the rhetoric out of the administration currently.

I guess how do you get comfort with that in terms of how you price the business as you think about 2018?

I think when we have a little (inaudible) at the price 2018 too, we've articulated again and again that we'll make our decisions based on the facts as they are today.

And to try and do the what ifs, that's where you end up with what I'd call paralysis by analysis.

And so as we get closer, we'll continue to look at the facts and we'll make those decisions based on where we are.

And as I said in my opening remarks, this has a long way to play out and I genuinely believe, in the time I spent in Washington, there is not the appetite across the broad perspective of both houses to take the most vulnerable populations and leave them without insurance when there are programs that are working very well.

It's a matter of how they cover it to exchange it, how they cover it through Medicaid, to what level.

And we have been giving some very constructive programs and I was quoted last week on a -- that the bill had been moving in the right direction.

And we think that in the end, they will do the right thing for the part -- for this vulnerable population.

Okay, fair enough.

And then one more if I could squeeze it in.

Can you just remind us if there's any tailwind or earnings this year from the HIF moratorium?

And maybe frame the size of potential headwind next year?

Or is it full pass-through with maybe more marginal impact from the Health Net commercial book?

Yes.

I mean, for us, I mean we're still heavily weighted towards the Medicaid side.

So that's the predominantly pass-through side, and then commercially, to some extent, pricing that in.

So I think the margin impact will be very small, if any.

(Operator Instructions) The next question comes from Ana Gupte with Leerink Partners.

The first question I had was on the Florida RFP that came out earlier this month.

And can you talk about your views on the consolidation of suppliers by reach?

No.

I -- when there's an active RFP, we're prohibited from commenting on it by law.

And I'm not going to give people a [BO] opportunity.

All right, understood, okay.

The second question I -- and some of it's been asked already.

But in terms of the CSRs, what types of conversations are you having with the state insurance commissioners?

Where some of the states are offering a within/without type scenario?

And do you think at the end of the day, they don't want to leave a whole bunch of low-income citizens uninsured that they will at least come in at the right time?

I think there's 2 elements, Ana.

First of all, most of the conversations we have at the state in federal level have been very quiet.

And we find it really works much better when you're not out front in specifics.

We are left clearly with the feeling that, at the state and federal level, leadership understands that to eliminate the CSRs is to create havoc to the insured marketplace.

And if you read too many of the comments made by the people and listen to it, they talk about stabilizing the insurance markets, not destroying them.

So I am -- personally, I think we're corporately convinced that when all the dust settles, there will be subsidies in some form.

CSRs, tax credits, what have you, pass-through tax credits that will protect the low-income vulnerable citizens.

Got it.

Yes.

One last question, and I agree with you on that.

The last question is on your announcement about Schnucks and the clinic in Ferguson.

Do you think this a one-off because you're trying it as a community outreach?

Or is it more business-oriented around your Medicare population and/or third-party services?

Yes, I think we'll learn from this.

But I'm National Chairman of the Urban League.

In fact, our convention is here, national convention is here this week.

As soon as my board meeting is over, I put on a different hat.

But Ferguson, we decided 2 years ago as a community -- and as the business community, the largest companies, that we would -- we had an obligation to show what to do and how to correct the kinds of issues that were reflected in Ferguson.

There are 150 cities in this country where that same thing could have happened.

And we're showing the road path, that it's creating jobs, small businesses supporting them.

The Save our Sons program that the Urban League has put together.

So in this -- when Schnucks opened up a supermarket there, [when there are] great civic leaders in this community as well, and what they did.

I know their Chairman, we know each other.

And I said, "Why don't we put a health center in there that's going to be manned by the federally qualified health centers?" So that, that population now has access to high-quality healthcare.

But it has another advantage.

Not only can they get urgent care, but if they see something that's more chronic, they can then refer to the health center where they can get continued continuity care.

So it's a combination of doing what's right for the community and getting some learning that may or may not apply in some other environment.

But thank you for your question.

You gave me a chance to get on my hobby horse.

This concludes our question-and-answer session.

I would like to turn the conference back over to Michael Neidorff, Chairman and CEO, for any closing comments.

I just want to thank everybody for the time in the call, and we look forward to continuing success throughout the balance of the year in 2018.

Have a -- enjoy the rest of the summer and stay warm.

Take care.

This conference has now concluded.

Thank you for attending today's presentation.

You may now disconnect.