Centene Corp (CNC) 2018 Q2 法說會逐字稿

Good day, everyone, and welcome to the Centene Corporation 2018 Second Quarter Earnings Conference Call.

(Operator Instructions) And please note that today's 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, William, and good morning, everyone.

Thank you for joining us on our 2018 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 code for both of those dial-ins is 10121638.

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 24, 2018, the 10-K -- most recent 10-K we filed on February 20, 2018, 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.

This call will also refer to certain non-GAAP measures, that's generally accepted accounting principles, non-GAAP measures.

A reconciliation of these measures with the most directly comparable GAAP measures can be found on our second quarter 2018 press release, which is available on our website at centene.com under the Investor section.

Finally, a reminder that our third quarter earnings results call will be held on Tuesday, October 23 at 8:30 Eastern time, followed by our next investor day on Friday, December 14, which, as always, will be held 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 Second Quarter 2018 Earnings Call.

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

We will also discuss the recent Fidelis Care acquisition closing.

And additionally, we will provide commentary around the health care legislation -- legislative and regulatory environment.

Let me begin with Fidelis.

We are very pleased to have closed the acquisition effective July 1. I would like to remind you of the strategic and financial benefits of the transaction.

Fidelis is a diversified leader in government-sponsored programs across the State of New York.

Fidelis takes a local approach to providing high quality, affordable health care to low income, vulnerable population.

New York is the second largest Medicaid-managed care state.

With Fidelis, our New York health plan, Centene is now a leader in 4 of the largest Medicaid-managed care states.

Fidelis is ranked #1 in state-sponsored programs in New York.

It is the fastest-growing New York Medicaid and managed long-term care plan as well as the second fastest-growing New York Medicare Advantage plan.

It is the only plan to operate Medicaid, CHIP and managed long-term care plans in all 62 counties in the state.

Through the incorporation of our data analytics tools, such as Interpreta and RxAdvance, as well as case management and clinical programs, we will be able to further build upon the quality of care and enhance the existing capabilities of Fidelis.

We expect the transaction to be immediately accretive to GAAP EPS.

We anticipate high single-digit percentage accretion to adjusted EPS in the first 12 months following the close and low to mid-teens percentage accretion to adjusted EPS in the second full year following the close.

We also anticipate generating approximately $25 million in pretax net synergies in the first 12 months and $100 million in pretax net synergies in year 2. These synergies will primarily be attributable to our medical managing programs and specialty services.

On a run rate basis, we expect Fidelis to add over $11 billion in revenue and over $500 million in adjusted EBITDA, including net synergies.

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

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

We were able to hit the ground running the day of the close, and the integration is progressing as expected or better than expected.

Next, I will provide an update on the health care legislative and regulatory environments.

In early July, pursuant to discussions with the Department of Justice, the administration took the position to freeze the risk adjustment payments for 2017 and 2018.

This is pending its appeal of the New Mexico Federal Court's position.

The administration, along with congressional leadership, has made it clear that they are seeking a timely resolution of this matter.

We expect that CMS will bring clarity and a fair resolution to the issue.

Last week, we were pleased to see that CMS had an interim final rule to the OMB that would allow for the resumption of risk adjustment payments.

Consistent with our approach to sound public policy, Centene will continue to advocate for the risk adjustment program to continue in the manner for which it was designed.

Now on to second quarter 2018 financials.

We are pleased to report another strong quarter marked by solid top and bottom line growth.

Membership at quarter end was 12.8 million recipients.

This represents an increase of approximately 585,000 beneficiaries over the second quarter of 2017.

Second quarter revenues increased 19% year-over-year to $14.2 billion.

The HBR decreased 60 basis points year-over-year to 85.7%.

This was attributable to growth in the marketplace business and the reinstatement of the health insurer's fee.

The adjusted SG&A expense ratio increased 30 basis points year-over-year to 9.6%.

This was primarily related to the growth in our marketplace business.

We reported adjusted second quarter diluted earnings per share of $1.80.

As previewed at our June Investor Day, this excludes the $0.12 charge to reflect a retroactive charge in California's minimum MLR.

Consistent with our expectation, adjusted net earnings have developed in a quarterly pattern similar to last year.

Jeff will provide further financial details, including updated 2018 guidance in his prepared remarks.

A quick comment on medical cost.

We continue to see, as well as anticipate, overall stable medical cost trends.

This is consistent with our expectations in the low single digits.

Moving on to market and product updates.

First, we'll discuss recent Medicaid activity.

During 2018, we began operating under a statewide contract with Illinois Medicaid managed care program.

Implementation dates vary by region, and most of the membership came on during April.

This expanded contract significantly increased Centene's footprint in the state.

At quarter end, we served approximately 330,000 beneficiaries, representing a sequential increase of approximately 120,000 members.

Additionally, Centene will be the sole plan serving the state's foster care program.

This contract is expected to commence in the fourth quarter of 2018.

This membership will be incremental to the 330,000 beneficiaries I just noted.

Florida.

In May, Centene successfully re-procured its contracts, providing physical and behavioral health care services through Florida's statewide Medicaid managed care program.

We have expanded our presence under the new contract and will now be operating statewide, providing comprehensive MMA and long-term care solutions through all 11 regions in the state.

Additionally, Centene will remain as Florida's sole child welfare specialty plan in all 11 regions.

The new contract is expected to commence December 1, 2018, and runs through September of 2023.

Iowa.

Also in May, Centene was awarded a statewide contract for Iowa's Medicaid managed care program.

We are pleased to have won this contract as there was a re-procurement of an existing contract, and Centene was not an incumbent.

The Iowa Health Link program provides integrated Medicaid managed care coverage, including long-term care and behavioral health to over 600,000 beneficiaries in the state.

This contract is expected to commence on July 1, 2019.

Washington.

As part of the state's re-procurement process, Centene was selected to serve Medicaid beneficiaries under the Apple Health managed care program in 4 regional service areas.

We will be serving a total of 5 RSAs once it is fully implemented.

This new program now initiates physical and behavioral health.

The contract will be phased in 2 stages, the first commencing on January 1, 2019, and the second on January 1, 2020.

Centene continues to serve all regions through our foster care program in Washington.

Kansas.

In June, Centene successfully re-procured its contract to serve Medicaid beneficiaries under the KanCare program statewide.

This new contract is expected to begin January 1, 2019.

Next, Centurion, Arizona.

In May, Centurion was awarded a contract to provide comprehensive health care services to detainees of adult and juvenile detention facilities in Pima County, Arizona that commenced on July 1. We are providing a wide array of medical, dental, behavioral health services to the county's daily population of approximately 1,900 detainees.

Additionally, Centene renewed correctional contracts in Florida, New Hampshire and Tennessee.

These new contracts all commenced on July 1.

Now Health Net Federal Services.

In July, Health Net Federal Services was awarded next-generation military and family life counseling program contract.

Under this contract, we will deploy licensed behavioral health counselors on assignments throughout United States, U.S. territories and countries where U.S. military is deployed.

The contract term is up to 10 years, including multiple 1-year option periods.

On to Medicare.

At June 30, we served approximately 344,000 Medicare and MMP beneficiaries.

This represents a year-over-year increase of more than 16,000 members.

With the close of the Fidelis acquisition, we are now serving Medicare Advantage members in New York.

We remain focused on building a successful Medicare business over the long term.

We expect this business to be a significant driver of our annual growth rate.

Next, Health Insurance Marketplaces.

The marketplace business continued to perform well in the second quarter, consistent with our expectations.

At June 30, we served over 1.5 million exchange members, representing sequential decline of approximately 100,000 beneficiaries.

This is due to normal attrition and is in line with our expectations.

Including Fidelis, we now serve and offer exchange products in 16 states.

Shifting gears to our rate outlook.

We continue to expect a composite Medicaid rate adjustment of an increase of approximately 1% in 2018.

In conclusion, our strong second quarter results are continued evidence of Centene's financial strength and operational capabilities.

The acquisition of Fidelis further enhances our scale and position as a diversified health care enterprise and leader in government-sponsored health care.

Our pipeline of growth opportunities remains robust.

We are positioning Centene for the future by continuing to invest in systems, people and other capabilities.

This will enable us to sustain our growth as well as continue to expand our margins.

We thank you for your continued interest in Centene, and I will now turn the call over to Jeff.

Thank you, Michael, and good morning.

This morning, we reported strong second quarter 2018 results with total revenues of $14.2 billion, an increase of 19% over 2017, and adjusted diluted earnings per share of $1.80, an increase of 13% over last year.

Earnings for the quarter were driven by the performance in the 2018 marketplace business, providing a favorable HBR.

Additionally, we had higher investment income during the quarter due to the funds associated with the Fidelis acquisition and higher interest rates that was offset by slightly higher tax rate as a result of revisions to our share of the health insurer fee.

I will provide more details on this in a minute.

Additionally, during the second quarter, we completed the previously announced MHM acquisition and completed the financing transactions for the Fidelis acquisition, which closed July 1.

Let me provide some more details for the quarter.

Total revenues grew by approximately $2.2 billion year-over-year, primarily as a result of growth in the health insurance marketplace business, the expansion and new programs in many of our states in 2017 and 2018, including the Illinois contract expansion and -- excuse me, the Pennsylvania LTSS program; acquisitions, including MHM, CMG and Foundation Care; the return of the health insurer fees for 2018; and as highlighted at our June Investor Day, approximately $500 million of passthrough payments from the State of California received in the second quarter that were recorded in premium tax revenue and premium tax expense.

This growth was partially offset by lower revenues in California associated with the removal of the in-home support services program from managed care, which took effect in January of 2018.

Moving on to HBR.

Our health benefits ratio was 85.7% in the second quarter this year compared to 86.3% in last year's second quarter and 84.3% in the first quarter of 2018.

The decrease year-over-year is primarily driven by the growth in the marketplace business and the reinstatement of the health insurer fee in 2018.

This was partially offset by recognition of the changes associated with the California Medicaid expansion MLR rebates.

As we highlighted at our investor day in June, we recorded a reduction in revenue and earnings of approximately $30 million pretax associated with the changes in the MLR rebate.

This increased our HBR for the quarter by approximately 20 basis points.

Sequentially, the 140 basis point increase in HBR from the first quarter of 2018 is primarily attributable to the seasonality of the marketplace product, which has a lower HBR in the first quarter due to the effect of deductibles and the recognition of the California MLR changes, which I previously mentioned.

These HBR increases were partially offset by the decrease in flu-related cost over the first quarter of 2018.

Before I get into SG&A, let me provide an update on the marketplace business.

The reconciliation of the 2017 risk adjustment benefited the quarter by approximately $79 million pretax and was in line with our expectations, consistent from a percentage perspective to prior year and, as such, was included in our guidance.

As widely publicized, the risk adjustment transfer for 2017 had been suspended.

We did not change our accounting for the risk adjustment program and continued to utilize the statewide average premiums to record our risk adjustment estimates for 2017 and 2018.

We will await final determination on the issue before we consider any potential adjustment to our accounting.

Just besides the potential effect, if the risk adjustment program were to use each carrier-specific premiums versus the statewide average premiums, our net risk adjust -- adjustment payable would decrease by approximately $100 million pretax for the 2017 benefit year.

Again, our second quarter accounting remains consistent with prior periods.

Now onto SG&A.

Our adjusted selling and general administrative expense ratio was 9.6% in the second quarter this year compared to 9.3% last year and 10.3% in the first quarter of 2018.

The year-over-year increase was primarily a result of growth in the Health Insurance Marketplace business, which operates at a higher SG&A expense ratio.

The sequential decrease is primarily due to the open enrollment cost incurred in the marketplace product in the first quarter, lower acquisition-related expenses and lower variable compensation cost.

Additionally, we spent $0.04 per diluted share on business expansion cost during the quarter compared to $0.07 per diluted share last year.

Our effective income tax rate for the second quarter was 36.9% compared to 40.1% in the second quarter of 2017.

The lower tax weight -- rate was driven by the effective income tax reform in 2018, partially offset by the return of the health insurer fee.

Additionally, as mentioned earlier, our tax rate was negatively affected during the quarter by a true-up associated with our estimated portion of the health insurer fee.

Now on to the balance sheet.

Cash and investments totaled $15 billion at quarter end, including $3.5 billion held by unregulated subsidiaries.

As a reminder, total cash and investments at the end of the quarter included the capital raised to complete the Fidelis acquisition, which closed on July 1.

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

Debt at quarter end was $6.3 billion, and there were no borrowings on our revolving credit facility at quarter end.

Our debt to capital ratio was 36.7%, excluding our nonrecourse mortgage note and construction loan, compared to 42.1% at the second quarter last year and 40.3% at the first quarter of 2018.

Consistent with our past practice, we used equity as a significant component to fund various investments and acquisitions completed in the second quarter as well as to fund the Fidelis acquisition, which closed earlier this month.

We ended the second quarter with a debt to capital ratio that was 360 basis points lower than the first quarter of 2018, excluding our nonrecourse debt.

Our medical claims liability totaled $5 billion at quarter end and represents 44 days in claims payable compared to 43 days for the first quarter of 2018.

The increase in DCP is a result of growth in the Health Insurance Marketplace business, growth in new and existing markets and the timing of claims payments.

Cash flow used in operations was $526 million in the second quarter.

As expected and highlighted during our investor day in June, cash flow for the quarter was negatively impacted by the repayment of approximately $630 million to the State of California for rate overpayments.

In addition, we expect approximately $400 million to be paid to the State of California during the remainder of the year for the Medicaid expansion MLR rebates.

Before we discuss the changes to our 2018 annual guidance, let me spend a few minutes updating you on the Fidelis acquisition.

As Michael mentioned in his comments, on July 1, 2018, we acquired substantially all the assets of Fidelis Care for approximately $3.75 billion of cash.

The integration is well underway, and we expect to achieve half of the $25 million year 1 synergies in 2018.

Additionally, we continue to expect the transaction to deliver our previously communicated accretion targets.

Now onto our annual guidance.

We have increased our 2018 annual adjusted diluted earnings per share guidance by $0.03 to reflect the performance in the second quarter.

And we have updated our annual GAAP EPS guidance for the following items: first, an increase of $0.03 per diluted share, reflecting the performance for the second quarter; second, a decrease of $0.12 per diluted share to reflect the impact of the retroactive minimum medical loss ratio changes recognized in the second quarter under California's Medicaid expansion program that we previewed at our June investor day; finally, a decrease of $0.03 per diluted share to reflect an increase in acquisition-related expenses associated with the Fidelis Care acquisition.

In summary, our updated full year 2018 guidance is as follows: total revenues of $59.2 billion to $60 billion; GAAP diluted earnings per share of $4.25 to $4.57; adjusted diluted earnings per share of $6.80 to $7.16; HBR of 85.9% to 86.4%; SG&A ratio of 10.2% to 10.7%; adjusted SG&A ratio of 9.4% to 9.9%; and effective tax rate of 34% to 36%; and diluted shares outstanding of 198.7 million to 199.7 million shares.

Just to note that the share count is for the full year and not the third and fourth quarters.

The third and fourth quarters will include the shares issued to fund the Fidelis acquisition and will be closer to 209 million to 210 million shares.

Additionally, adjusted net earnings has continued to trend similar to last year.

In summary, we were pleased with the strong performance in the second quarter and the completion of the Fidelis acquisition that we expect to continue to drive long-term growth and margin expansion.

That concludes my remarks.

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

(Operator Instructions) And our first questioner today will be Steven Valiquette with Barclays.

And so we're getting a few questions around the risk adjustment payments.

And I guess, as you mentioned, you had a benefit of $79 million, but also last year $48 million and $70 million the year before that.

So from my point of view, it doesn't really seem to be a trend out of the ordinary.

I can imagine it would suggest that it was in your guidance.

So just to me, it seems like it had a pretty consistent trend and there's no change in accounting, but maybe just more color around why people maybe seemed to be kind of concern about this -- to me, it seems like a pretty consistent trend.

Well, I'll have Jeff give you a little more detail, but you got it precisely right.

Though the accounting has been consistent, margin, percentages, this is something we've been doing in this business for 5 years now.

And our accounting group understands and knows how to book it.

And it is in the guidance.

And Jeff, you may want to give a little more color around that.

Yes, yes.

Just -- I mean, I agree with your comments.

I mean, I guess, our view is, to Michael's point, it's been consistent.

We've been doing this program for 5 years.

There is, I think, more stability.

You have to go back to last year and remember that we had added conservatism to our guidance last year for the exchange because it was postelection.

So fast forward to where we are today, there's more stability in the program.

And we have a track record and, certainly, a history of having development on this estimate just like we have on IBNR and any other estimate that we have on the business.

And our next questioner today will be Steve Tanal with Goldman Sachs.

Just, I guess, following up on that, just a broader question on the exchanges in '19.

With respect to the risk adjustment program as well as the mandate going away, how is that affecting your approach, if at all?

What do you expect to see on the exchanges in terms of market share shifts or competition?

Any comments there would be helpful.

Kevin, do you want to comment on that?

Sure.

We remain very bullish about the exchange business, both for ourselves and also the stability of the market.

So we're expecting ongoing growth in our business.

We think it remains very, very stable.

And we're very enthusiastic about open enrollment coming up.

Yes.

Remember, the past couple of years, we retained 80% of the previous year's enrollees, which, I think, speaks for itself.

Perfect.

But I guess, just a separate question.

Just 2 of the deals that were done in the quarter, MHM Services and Community Medical Group, would be curious if you could break out.

Bigger than a quarter, I guess.

Just to be -- it would be helpful to know what kind of revenue and earnings to expect from those 2 companies going forward.

Jeff?

Yes.

We didn't give any specific revenue or earnings guidance on those.

Just a couple of things I can tell you on where those revenues show up.

For CMG, there's some risk-based revenue there, so that shows up in our premium revenue.

MHM is going to be on the service line.

And our next questioner today will be Josh Raskin with Nephron Research.

First question just around the timing of Texas STAR+

PLUS.

It sounds like there's a resubmission that you guys have been asked to give 30 days as of a week ago or so.

So is that a full resubmission?

You've got to resubmit responses to the entire RFP.

Or is that just going to be responding to the updates?

Just trying to get a better sense of the timing.

Yes.

Chris, I'll ask you to respond to that.

Thanks, Michael.

Josh, as far as we know, the RFP was reissued late yesterday.

We do, as you mentioned, have 30 days.

It's due on August 22.

and as far as I know, it is a full resubmission of the RFP at this point in time.

And they have moved the projected implementation date from 1/1/20 to 6/1/20 as well.

So...

Okay.

It sounds pretty -- I mean, it sounds like a full-blown RFP resubmission in 30 days sounds tough.

So I guess, I was also surprised to hear that.

Well, I think one has to be prepared to deal with those kinds of issues, and we are.

Right, right.

I guess, you guys are in good shape.

You've already submitted, so really probably have most of the answers.

The second question, I'm just curious around more clinic-based model for Centene and what the benefits would be to have more sort of brick-and-mortar type centers even if they were leased or partnered or whatever and how that would impact the Medicaid business specifically.

And then, I guess, if there's other commentary around the exchanges or MA for clinic-based model, that'd be helpful as well.

Yes.

I think I've commented on investor days and other conferences that we're not allowed to buy in all the practices we can and all the clinics that we can.

We said that the group in -- we brought in Florida, CMG, is scalable, if we need it.

And it will serve, as well, to be able to move into underserved areas, where there's not a -- an adequacy of physician.

Pick a county in Texas or somewhere that's more rural.

This gives us that opportunity to open up a clinic.

And they could do it efficiently and quickly and protect our membership and that concept.

And they have a very efficient operation.

They operate with highest of quality, low MLRs.

And so we saw that as an opportunity to have an asset that we can apply where needed versus just simply saying it's a national strategy.

They serve all the government services, Medicaid, Medicare and the exchanges.

Okay, So Michael, you would say you don't really need broad-based clinic help across all of your markets and some sort of retail strategy isn't what you're looking for in there.

No, we're not trying to buy clinics and have clinics in every market.

We're focused where they're needed or where there's a group of physicians that are now going to work with you, we have the capability to go in and protect the access that our membership needs.

And our next questioner today will be Kevin Fischbeck with Bank of America Merrill Lynch.

So just wanted to go back to the risk adjusted for a second.

So you're saying that you're -- the way you're accruing for it is the way that you've always been accruing for it, but if this lawsuit was to go, I guess, be upheld and your thought is the risk adjusted methodology would change in a way that would essentially be favorable to you to about $100 million to last year.

Is that the way to think about it?

Yes, yes.

We quantified 2017.

It's really what we've quantified.

I mean, who knows how the ultimate resolution is going to come out.

But I think what we've quantified is the difference between using the statewide average and carrier-specific premiums on the 2017 benefit year, and that was the $100 million pretax that I gave you.

And your point is that 2017, you were probably a little bit more conservative just because of all the uncertainty there.

So if you were to think about a 2018 or 2019 run rate number, it might be a little bit less than that $100 million.

No, no.

What I'm saying is if you look at 2017, the $79 million that's disclosed in our 10-Q, I think it was $48 million the prior year.

And you take that as a percentage of the year-end balance, it's roughly 10%.

So it's very consistent year to year.

And we are using that same methodology for 2018, and the business has actually grown.

Okay.

All right.

That's helpful.

And then I guess, I wasn't sure you responded to this in your commentary on the exchanges.

If you did, I apologize.

But with the risk-adjusted methodology, I guess, payments being withheld, does that change at all how you're submitting your rates for next year or how you think about next year?

Is there anything in the conversation with the states about kind of a dual submission process with risk adjusters about risk adjuster's old methodology, new methodology?

Kevin?

It's Kevin.

No, it's not.

We're very confident that we'll be able to maintain as other carriers are the rate time line submission deadline.

We're tracking to that.

And so we feel comfortable with it.

And our next questioner today will be Lance Wilkes with Sanford Bernstein.

Two questions for you kind of DC policy related.

One of them is as you're hearing about drug policy and drug pricing policy, be interested in your thoughts as to what the implications might be to the -- to your Medicaid business and the public exchange business of a range of approaches that might include elimination of rebates or shift to, like, a fixed discount model.

And the second question was kind of the -- just trying to understand if you thought there were any policy responses to risk adjustment or corrections there as opposed to just an appeal on the court case.

Yes, I think there's 2 of them.

So on your first question with our RxAdvance, we're moving ahead with our Rx program, which, we believe, will be proven to be much more efficient.

And it's all predicated on what the pricing is.

If they come up with a program without rebates, we have the capability to deal with that very efficiently and effectively.

And we're becoming a large-enough supplier of pharmaceutical products and purchaser of them that we'll be able to buy quality -- quantity very effectively and efficiently and put that together with RxAdvance.

And I think we'll be in a very strong position versus just a traditional PBM where -- so that part, I think, will work fairly well.

We also -- as it relates to the risk adjusters, we have the stated policy that we're comfortable with where it is, where we believe, we will advocate for maintaining it as it is and not to look for any short-term benefit for ourselves, but saying this is a matter of public policy.

It's been working.

Let's leave it alone.

Got you.

That's helpful.

And just to be clear on the rebates aspect of it.

I would think that from -- in the businesses you're in, which are more fully insured businesses, if there was a conversion to sort of a net pricing business model as opposed to the current rebate model that you would be relatively indifferent.

But I wasn't certain if that's exactly how it would work on the Medicaid and on the public exchange side.

Is that a fair way to think of your exposure?

I think it is.

I think, with the system capability we have, we can be indifferent to it because we can very quickly adjust to whatever methodology they are using.

So we're very comfortable with either one and had planned for it, recognizing this could easily happen.

The next questioner today will be David Windley with Jefferies.

It's Dave Styblo in for Windley.

First question just a little bit more about the exchange outlook for next year.

We've seen a number of new entrants to market in some of those -- in some of the areas that are in your footprint.

Just curious to get a sense of how much of your footprint you have visibility on for new competitors.

And in terms of pricing, I think the market has become a little bit more aggressive this year and perhaps, that's just because their MLR -- they're reaching their MLR for it.

Curious if you had any comments about what you're seeing broadly across the landscape.

Yes.

I'll start off and then let Kevin comment.

I've always thought it was a positive thing to have competition.

And I learned a long time ago, as in consumer package goods, when there's one in the market, it's incumbent on them to grow the category in the market.

When there's 2 or 3, you end up with more noise in the market, more awareness of it and not one company trying to build a category.

So I welcome the competition.

We've demonstrated that we can deal with the competition effectively and continue to grow and really -- we tend to use these opportunities to show just capabilities versus theirs.

Anything you want to add, Kevin?

Just to completely agree with what Michael said.

We welcome the competition.

We think that it's an example of the ongoing growth and stability of the marketplace.

As you guys are probably aware, we have expansion plans going into next year, both in adding new states as well as expanding in existing states.

So again, we think the increased new entrants is a very good sign for the marketplace, and we're ready to bring it on.

Great.

That's helpful.

And then you guys have provided some additional disclosure for the books of business just in terms of revenue.

When we try to triangulate the math around that, it looks like we get to government net margin that might be just under 2.5%.

Would you roughly agree with that?

And then is there a room to expand margins on that business, excluding M&A accretion from Fidelis?

You're talking about the Medicaid -- when you say the government, you're talking about the Medicaid line, right?

Yes, exactly, not the commercial line.

Yes.

I mean, I'm not going to comment about our specific net margins.

There's always rooms -- room to expand margins.

Scale, I think, helps.

Additionally, all the states are different, right, so it's a portfolio approach for us.

So there's always room for improvement, and we always look to do that over time.

And we have the same goal of expanding margins, so...

And our next questioner today will be Sarah James with Piper Jaffray.

I was hoping you could walk us through some of the sequential tailwinds between 2Q and 3Q.

It'd be really helpful if you could break that out into M&A related and other areas that you're looking for improvement.

You mean from this quarter to our third quarter, is that what you're specifically asking about?

Yes, I am.

Yes.

I mean, I think the biggest thing you have to realize going from Q2 to Q3, and this is the same from Q1 to Q4, is just how the marketplace business performs, right?

So it's always the lowest in the first quarter and it pretty much trends up from there all the way to the fourth quarter.

And then you have the fourth quarter, which includes all the open enrollment cost.

And it also includes the enrollment cost for Medicare, as well.

So I guess, what I would expect is HBRs would increase from here, consistent, I think, with what Michael said and what I said in my prepared remarks, which is this year, from an adjustment earnings perspective, is developing pretty much consistent with last year.

Any other tailwinds that you're looking for, either from M&A or from medical management on (inaudible)?

Yes.

Obviously, the Fidelis acquisition, right, comes in on July 1, so that's significant, and we're glad to have that.

The other thing is as we mentioned the CMG, MHM and some of the other transactions that we did.

Those are -- obviously, will benefit the P&L.

But from a size perspective, it's less of a needle mover.

So Fidelis interest rates have also continued to increase, which has been favorable as well.

Then where is Centene looking to expand to in 2019 for exchanges?

And can you help us size the impact on pricing for the -- did that when you include the removal of risk adjusters?

There's been some reports that's in the 20% range, and I just was interested to hear how you're thinking about that.

Well, I think we -- one, we have to see what happening in these adjusters.

So we deal as we typically deal with the here and now.

And I hate to say this, Sarah, but we'll talk more about '19 in our December guidance call, which is when we typically talk about the next year.

But as it relates to the other part of the question, we just say, we're going to treat it as it is now because there's no basis.

If you start to go over the what ifs, I think that's where you get turned sideways.

And our success has been just that.

Look at it, make a decision and go forward.

Does that help?

It does.

And our next questioner today will be Matt Borsch with BMO Capital Markets.

I was hoping you could comment on the enrollment drop in group commercial.

I know I asked about that business on the recent investor event, and I'm sorry if I missed something that you'd previously said about that.

(inaudible), go ahead.

Sure.

Yes, the enrollment drop in the group business, which you've just alluded to, is really a reflection of pricing discipline and market discipline that we've been bringing to that business.

Frankly, as you guys know, that's a philosophy that we bring to all our products in all our markets.

And obviously, we all need to make choices and figure out the right pricing and the right discipline to bring.

So it's a manifestation of that.

I -- maybe just to add on to that question, my own comment is we heard that California is seeing somewhat more intense price competition.

Would that then -- can I infer that would dovetail with what you're talking about?

Kevin?

Yes.

And again, but that discipline is not limited to any specific state.

It's something that we bring to all our markets and all our products.

Okay.

And can you just -- as we now step closer to Medicare Advantage open enrollment, are you getting any sense for -- we're hearing snippets of information, maybe rumor that -- are you getting any sense for where you may be positioned relative to competitors?

Well, I think we're looking at it on an ongoing basis, but it's probably too early to make a specific comment.

Our next questioner today will be Peter Costa with Wells Fargo.

I think we've beaten the risk adjusters to death here, so I won't talk about...

There always has to be -- we had -- there always has to be one issue, Peter, that we beat to death.

Glad it will be the risk adjusters.

Go ahead.

Okay.

So I want to move on down to the income statement a little bit and understand about the health insurance fee true-up a little bit.

How much of that is a true-up just in this quarter?

It went up $12 million from the first quarter.

Should we be thinking about that going up every quarter the same amount?

Or -- and so $183 million each quarter from here?

And then how much of that is offset in terms of Medicaid picking up the tab for the premium -- in premiums versus what's in commercial or, say, Medicare where that would be headwind into earnings?

Yes.

So that's specifically what I commented on my prepared remarks.

You're exactly right.

There was a true-up this quarter.

And how that true-up comes about is we're estimating how much our fee is compared to the entire industry, right?

So we're using information from third parties to figure out what the denominator is in that.

And we got new information that the denominator changed a little bit.

And so we increased the health insurer fee.

Now on the Medicaid side, that's a pass through -- predominately a pass through.

That's how we treat it.

So you're recording the additional revenue and expense, and it offsets the net earnings line.

On the commercial side, that is not.

Our premiums don't change.

We've -- we bid premiums, and so those don't change.

So that was a little bit of a bad guy in the tax line, if you will.

And that's what we mentioned in our prepared remarks.

And that really offset, what I would call, the additional investment income that we had, really, from the capital that we had on the books for the financing of the Fidelis transaction.

So what I would say is I think, going forward, Q2 -- or Q3, Q4, I think would be relatively consistent with what it was in the past, a little bit less than what you saw this quarter.

So a little bit less than this quarter, meaning down to $171 million or meaning...

Right around -- yes, I'd say north -- a little north of $175 million.

Okay.

And then in terms of the interest income item that you mentioned, that was up quite a bit in the quarter.

You said most of that was related to the Fidelis Care cash balance.

But how much was interest rates?

And how much of that will continue going forward?

I think there -- I mean, I'm -- there's a little more than $10 million that was just on the Fidelis capital, so that can give you an idea of what it was.

Our next questioner today will be Mike Newshel with Evercore ISI.

Just I think -- I mean, you already clarified, but just to make sure, it sounds like that you're framing the annual second quarter risk adjustment true-up as more of a recurring benefit relative to the size of the exchange premium base that we shouldn't treat as a nonrecurring item.

That's right.

So basically -- yes, so basically, that -- the 2017 benefit you're recognizing in 2018, should we think of that as being offset by conservatism and embedded into the payables you're accruing for the 2018 plan?

Yes, absolutely.

And that should flow through the earnings next year and the second quarter or 2019, assuming, of course, there's no change in the program.

Is that the right way to think about it?

That's exactly right.

And we -- and I anticipate they will be as close to accurate next year as they were this year.

Got it.

And then maybe just a second one then.

So the -- when you closed the Fidelis acquisition, was there any evaluation on the reserves or adjustments made in the asset purchase?

Well, we haven't.

So that closed July, so we haven't -- we're not reporting our accounting for that yet.

But yes, we will go through a entire fair valuation exercise associated with the Fidelis transaction.

We have -- the first time we'll see that is when we report Q3, so we've begun our procedures on that.

Obviously, we did a lot of planning for that, but we've kicked that off, and that will be the beginning of the fair valuation exercise that we'll complete within 1 year from the balance sheet.

And our next questioner today will be A.J. Rice with Crédit Suisse.

Continuing to beat the dead horse on the risk adjusters.

Is your 5% pretax margin outlook for the exchanges in 2018 inclusive of the $79 million risk adjuster accrual?

Yes.

I believe we've said it's -- I think my commentary specifically was higher than 5% and below 10% at one of our investor days.

So yes, it is.

When we look at the margins -- when we're giving those margins, that's what I would call a fully complete reconcile with the government margin number.

But you have to do it when you include it in guidance.

You have to be...

That's right.

Right.

So I know, originally, you guys had talked about -- and for some time had talked about long-term profitability on the exchanges being in the 3% to 5% range.

If -- or it sounds like you're running 5% or north of that now.

Is there any updated thought on what the long-term profitability of the exchanges might be?

No, I think you're right.

We've had a lot of history with the product.

And it's performed consistently year-over-year.

That's why we ultimately changed our 3% to 5% and updated that to north of 5%.

For competitive reasons, I'm not going to get into the actual margin number, but it's a very good product for us.

Okay.

But you're saying you think the north of 5% is sustainable basically.

Yes.

Okay.

And then just -- this is a technical cleanup.

On the California Medicaid expansion, MLR retroactive adjustment, I think you're saying that the $0.20 headwind was in the reported 85.7% MLR, but you're taking that out when you -- on the EPS -- adjusted EPS calculation of $1.80.

I just wanted to confirm that.

Yes, that's true.

In my prepared comments, I mentioned that it was a 20 basis point increase to the HBR for the quarter.

We don't provide an adjusted HBR number, so I just gave you the 20 basis points.

And our next questioner today would be Zack Sopcak with Morgan Stanley.

I just wanted to go back to the contribution from Fidelis for the second half of the year.

Is it fair to think that the cadence of the contribution is going to follow the same path as Centene historically has in 3Q and 4Q?

Yes, excluding the exchange business, the marketplace business, right?

You're talking Centene historically prior to the marketplace business.

Yes.

I guess, I'm talking about -- when adding Fidelis I think of the contribution being the same as your general cadence between 3Q and 4Q.

Or is there something that's going to change the overall timing due to the accretion from Fidelis?

No, no.

I would say that, yes, they would follow, what I call, a traditional Medicaid earnings path for a year.

So you have flu season, which kicks off in Q1 -- or Q4 and can go into Q1.

And so those months are usually -- or those quarters are usually the highest HBR quarters.

The summer months, a little better.

So yes, I think it would follow that same seasonality path because they're predominantly Medicaid.

Okay.

Got it.

And a question back to the marketplace.

So with CMS adjusting again the amount that they invest in navigators, are you thinking again about how you're going to invest in advertising, in general, for the marketplace going into next year?

And should we think about that at a similar level as we saw coming into this year?

Yes, that's -- yes, similar level.

I would say, it's larger actually because the business is larger for us, right?

And we're planning for growth in 2019.

But that kind of goes back to the whole risk adjustment comment.

If you go back to last year, in the second quarter, we had the risk adjustment that was pretty much offset by the additional costs that we loaded into the fourth quarter of 2017 because of the government limiting marketing.

Those costs are already included in our 2018 guidance, which is one of the reasons why we included the risk adjustment favorability as well.

Both items are in.

And those costs are actually higher than they were last year because of the size of the business.

And the next questioner today will be Justin Lake with Wolfe Research.

So on risk adjustment, I want to make sure I've got it completely correct.

So it sounds like I'm almost completely and exactly wrong in that you're saying that you put up a pretty significant reserve or adverse deviation every year on this thing.

Yes, just for the record before Jeff responds, you said that.

I didn't.

But it's always fun to be publicly incorrect, so let's just make sure I have this straight.

So Jeff, you put up the same reserve.

It looks It's north of 10% of your -- of what you-- what the spot number ends up being, you're putting up 10%, plus.

Yes.

What I will tell you is that's an actuarial estimate, of course, and it's done by state.

That's also net of minimum MLRs, so the calculation is actually more complicated than just aggregating the business altogether and taking one.

And obviously, there are a lot of carriers that have had problems with this in the past.

So yes, we have had a, what I call.

a consistent reserve for adverse deviation.

And that's been -- you can see that in the actual results and how it's played out over the last 3 years.

And where it's interesting is because the business is actually growing.

The deviation reserve you're putting up for this year for '18 is actually even bigger on the -- from a headwind perspective than the tailwind you're getting for last year.

That would be an accurate statement.

We are using the same methodology that we have used since the beginning of the program.

The only thing that's happened is we've gotten more states, and the business is growing.

All right.

And then let me just -- you said this isn't guidance and, obviously, I take you guys at your word.

The thing that was confusing is last year, was it in guidance for '17 because you beat the 2Q when you had this true-up benefit?

You beat by $0.30 versus consensus.

And you had it very clearly in the write-off that you had this $0.17 beat.

And that's where, I think, at least, I got confused because it looks like it was upside last year.

And this year, it wasn't.

So can you -- it -- was it consistent?

Or was this the first year you didn't -- you decided to put it in guidance?

Can you clear that up for me?

Yes, yes.

I mean, I hate to go all the way back to December of 2016, but you have to remember where we were in December 2016.

It was postelection.

And if you recall, we actually added $0.20 of conservatism for the whole marketplace product as a result of the election.

So at that point in time, we did not include the risk adjustment in the number -- in the guidance.

But post that, we've seen stability in the market.

We have a consistent level of development.

So heading into this year because we have the cost, right, remember, in 2017, when we had the favorability in Q2, we added the cost to Q4, pretty much offsetting that, because the government was limiting its marketing.

So fast forward to this year, the cost we're in, the benefit of the risk adjustment in, really driven by stability and the program, and we were comfortable enough with our estimates and what the costs were going to be for the year.

So it was in guidance, yes.

Got it.

So in '17, it wasn't in guidance.

And you did that from a conservatism perspective because of everything going on.

And in '18, it was in guidance.

And going forward, it will be in guidance, so we should expect and comparing this is -- you'll basically just assume that this occurs at 10% or plus of whatever the reserve is each and every year.

Yes, yes.

And I -- and there has been consistency in the past.

I want -- I do want to be careful.

It's an estimate, right?

We're estimating it.

We've had a very consistent track record of estimating it, but we are using the same methodology that we have used since the beginning of the program.

And I just want to emphasize what Jeff said earlier that it's not a 10%.

It's market by market evaluation that really gets rolled up by our accounting folks.

The next questioner today will be David MacDonald with SunTrust.

Just a couple of quick questions.

One, wanted to come back to RxAdvance.

You've obviously had that relationship now for a handful of months.

Can you just talk for a minute about -- are you already starting to see some of the efficiencies around administrative costs?

And also has it noticeably improved your visibility around gaps in care and the ability to decrease some of these drug-impacted medical costs?

Yes.

I'll start off and Jesse can pick it up.

But no, it's been a couple of months and that would be a lot to see in a couple of months.

But -- Jesse?

Yes.

I think there's plenty of -- couple of kind of pieces of context around that.

One is, to Michael's point, we're in the kind of the rollout process, so It wouldn't be fair to comment on kind of specific visibility.

But we've continued to have confidence that the efficiencies that we have referenced are there.

And those benefits will continue to accrue as we expand the offering in the future.

And then guys, just one quick follow-up.

How do we think about, with regards to Fidelis, the pacing of the expansion of services at Fidelis, how quickly you expect to roll out some of these additional services and just any visibility around that?

Well, I think it's going to be a function of -- we've worked out the medical management.

And we've already been planning for it through the -- prior to close, we've planned the rollout.

I'm not going to add the whole plan of when medical management is coming, case management, interpreter and the other things.

Jeff?

Yes, yes.

I mean, obviously, we're trying to -- it's a big component of the synergy capture, so we've been planning on this for quite some time.

And we are accelerating those as fast as we can.

And by the way, we have a very willing recipient.

They've been sitting there waiting and biting it to bits, so to speak, to get at it.

And our next questioner today will be Gary Taylor with JPMorgan.

One clarification and then two questions.

The first, Jeff, when you talked about the $400 million for the California MLR rebate remainder of year, that's simply a cash flow item already accrued.

Correct?

It's actually -- it's regulated capital.

It is already accrued, so it's already on the balance sheet of the statutory entities.

So there's really no revolver borrowing or any free cash flow implications.

That's regulated capital going back to the state that's been accrued since the Fidelis acquisition -- or since the Health Net acquisition, sorry.

Okay.

Question.

Was there a material outpatient provider rate increase under the Florida Medicaid program during the quarter?

A couple of things.

I will always say there's retroactivity in the business.

We're operating, obviously, in several states across the country.

And I would say this is common in Medicaid programs where there's retroactivity.

Some are positive.

Some are negative.

But we always see a certain level of retroactivity.

That's the benefit of scale and diversification, is that the you're matching those things up and you're using a portfolio or approach.

So what I would say is yes, there was some fee schedule changes.

But I would say, across the Centene enterprise in total, nothing out of the ordinary.

Okay.

Understood, so not material enough to call out given the portfolio's performance.

That's a positive.

And then last one is just specifically hospital trends.

So we came out of first quarter with hospitals -- at least, for profit hospital showing higher -- not just acuity but higher same-store revenue.

Most of the payers still saying overall hospital trend is fairly stable.

Is there any color on your overall hospital trend?

No.

I would agree with those comments.

I think it's pretty consistent.

And the next questioner today will be Ana Gupte with Leerink.

So the stocks, not just yours but Medicaid, in general, has been rebating back to growth status.

And my question was about your organic growth and then your priorities for your capital deployment on inorganic.

If you take a look at this year, it looks mostly like your growth is coming from exchanges and then to a smaller -- much smaller extent on ABD complex population and then also much smaller base on Medicare.

So inorganically speaking, where do you think the growth is going to come from?

Or is it going to stay more exchange driven, you think?

Or would it reaccelerate in other areas?

And then secondly on the -- looking at your inorganic approach because, initially, I felt like you were talking a lot about Medicare.

It's now very successfully.

You've done Health Net and Fidelis.

Might you be thinking more about roll-up as your priority or more tuck-ins on Medicare?

And then where does it play into your specialty and involve capabilities as far as cap deployment?

I -- from the organic standpoint, I think we laid out the number of RFPs we won, the expansions taking place there.

The new RFPs will be waiting to go live.

So you will see continued growth in the Medicaid business to that point of organic growth.

Relative to the inorganic growth and tuck-in things, I really can't talk too much about that.

That's from a competitive standpoint and all the reasons associated with it.

And very simply, there's always -- they say many (inaudible) left until a deal is done it's not done, so I want to be very cautious and conservative on that particular one.

And the third part that I heard is we continue to focus as well as on the current book of business, the Medicare, other things that we've talked about on the technology side of things.

Our RxAdvance is a good example of that, I'll tell you.

The technology that, I think, will materially help us grow that business and contribute significantly to reducing costs.

So we will continue that and to focus on those kinds of opportunities and the prison health, et cetera, just a very balanced portfolio of growth is our objective.

Helpful.

Mike, one follow-up on the technology piece.

So you very nicely showcased RxAdvance at the I Day I did see John Sculley at a public appearance, after Amazon announced PillPack and how they might need to get into cloud-based BBMs and so on.

And so as you think about your equity stake in your RxAdvance and tech players like Amazon potentially making a play into the drug value chain, might you see yourself driving partnerships with some of these so-called...

I think anybody that wants to purchase at a fair price our services, we'll be available to talk to.

And I think, really, as people understand some of these capabilities, they are going to recognize they really need it as they move ahead.

And I made some recent comments that, vis-à-vis, the things they're talking about and disruptors and -- I see that as a positive.

And we intend to be at limited extent a disruptors ourselves with some of these technologies.

And this will conclude our question-and-answer session.

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

Well, I want to thank you all for your time, attention, support.

And we look forward to the next call, not unlike this one.

Thank you, and have a good rest of the summer.

And the conference has now concluded.

Thank you for attending today's presentation.

You may now disconnect.