Centene Corp (CNC) 2018 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Centene Corporation Third Quarter 2018 Earnings Conference Call.

(Operator Instructions) Please note this event is being recorded.

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

Please go ahead, sir.

Thank you, Denise, and good morning, everyone.

Thank you for joining us on our 2018 third quarter earnings results conference call.

Michael Neidorff, Chairman and Chief Executive Officer of Centene; 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 number for both dial-ins is 10123967.

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, October 23, 2018, and our Form 10-K dated 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.

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 third quarter 2018 press release, which is also available on our website at centene.com under the Investors section.

Finally, a reminder that our next Investor Day will be held on Friday, December 14 in New York City.

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 Third Quarter 2018 Earnings Call.

During the course of this call, we will discuss third quarter financial results and provide update on Centene's markets and products.

We will also bring you up-to-date on the integration of Fidelis.

Let me begin with Fidelis.

The third quarter was our first full quarter with Fidelis operating as our New York state health plan.

The integration is going very well, progressing as expected.

We will further enhance the quality of care and current capabilities of Fidelis as we add case management and clinical programs and incorporate our data analytics tools.

We are on track to achieve the synergy and increasing targets.

On a run rate basis, we expect Fidelis to add approximately $11.5 billion in revenue and over $500 million in adjusted EBITDA, including net synergies.

Now on to the third quarter financial results.

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

It is important to clarify that the operating metrics in the quarter were strong as this may have been obscured by 3 offsetting adjustments booked in the quarter.

2 of the adjustments relate to contracts that have expired.

These were $140 million benefit related to California IHSS program reconciliation and $110 million charge related to the expiration of our Veterans Affairs contract.

The third adjustment related to a $30 million contribution to our charitable foundation.

Membership at quarter-end was 14.4 million recipients.

This represents an increase of approximately 2.1 million beneficiaries over the third quarter of 2017.

This growth is in part a result of the acquisition of Fidelis, which closed effective July 1.

Third quarter revenues increased 36% year-over-year to $16.2 billion.

The HBR decreased 170 basis points year-over-year to 86.3%.

This was primarily attributable to the benefit of the IHSS program reconciliation and membership growth in the exchange business.

The adjusted SG&A expense ratio increased 110 points year-over-year to 10%.

This was a result of the growth in the exchange business, which operates at a higher SG&A expense ratio and one-time costs associated with the expiration of our VA contract.

We reported adjusted third quarter diluted earnings per share of $1.79 compared to $1.35 in the same period last year.

This represents growth of 33%.

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

Please note, we reiterate our comments regarding visibility into $69 billion-plus in total revenue for 2019.

As is our practice, we will provide full details and updates of 2019 guidance at our December 14 Investor Day.

We are still finalizing our annual planning process.

But based on reviews to date, the current adjusted earnings per share consensus for 2019 would be within our guidance range.

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

A quick comment on medical cost trends.

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

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

I would also like to make comment on pharmaceutical costs and the evolution of the PBM model.

There have been some recent media articles regarding this topic and our Ohio Medicaid health plan, Buckeye Community Health.

To clarify, Buckeye is not charging the state more than any other MCO per script.

Health plans are paid a flat per member rate and cannot charge the state $0.01 more, even if that member has more prescriptions.

As you know, CVS has rescinded their original comment on this matter.

And there are no duplicative services by CVS and Envolve.

In fact, Buckeye's per member spend on pharmacy services of $83.79 per month is below the all plan average in Ohio of $87.96 according to the NAIC filings for 2017.

We support a shift towards a more transparent PBM model that is sustainable with higher quality and lower costs for consumers.

Our recent investment in RxAdvance is the latest evidence of our approach.

As a matter of fact, our first state will go live with RxAdvance before year-end.

And we have a national rollout for RxAdvance throughout 2017 -- 2019.

We look forward to working with the state of Ohio and others to enhance and evolve the PBM model.

Moving on to market and product updates.

First, we'll discuss Medicaid activity, Mississippi.

In October of 2018, as part of a successful reprocurement, we entered into a new agreement to continue to provide services to Medicaid recipients enrolled in the Mississippi Medicaid program.

Note that the state added a third vendor as part of the reprocurement process.

Arizona.

In October of 2018, our Arizona subsidiary, Health Net Access, began a new contract that integrates physical and behavioral health services through the state's Medicaid program in the Central and South regions.

We now have over 180,000 integrated lives in this program, representing an increase of 120,000.

North Carolina.

In early August of 2018, North Carolina released an RFP for the state's first time transition of Medicaid members out of fee-for-service into managed care.

We have been planning for this RFP for several years.

In January of 2017, we established a joint venture with the North Carolina State Medical Society to collaborate on a statewide member-focused approach to Medicaid managed care.

The joint venture, Carolina Complete Health, was established as a physician-led health plan to provide Medicaid managed care services in the state.

Carolina Complete Health submitted its RFP response this past Friday.

We feel we are well-positioned due to our joint venture, which is consistent with our local approach.

Furthermore, our participation in North Carolina marketplace will be recognized in the Medicaid RFP scoring.

The state expects to announce winners in early February of 2019.

Next, Centurion.

In August, Centurion announced that the Volusia County Florida Council voted to award Centurion a contract.

Centurion will provide comprehensive health care services to an average of 1,425 detainees of the county's detention facilities located near Daytona, Florida.

The contract is expected to commence January 1, 2019.

Additionally, Centurion was awarded a contract to provide compressive health care services to detainees of the Metropolitan Detention Center in Albuquerque, New Mexico.

The average detainee population for this service area is 1,550.

This contract is expected to commence in February of 2019.

Note, these 2 recent correctional contract wins offer further evidence that we have gained traction in growing this relatively new product line.

Now on to Medicare, where we remain focused on building a successful Medicare business.

At quarter-end, we served over 417,000 Medicare and MMP beneficiaries.

This represents a year-over-year increase of more than 86,000 recipients in 2016.

Consistent with our Medicare growth strategy, we have expanded our geographic footprint and expect to be in 21 states in 2019.

The annual enrollment for the 2019 plan year began on October 15.

We continued to take a targeted approach to growing our Medicare Advantage business in markets that we are focused on.

And we are pleased with the competitive position of the Allwell products.

Further, we are encouraged by CMS's recently released data suggesting we will return to a 4-star MA parent rating with the 2020 plan year.

We expect this will have a positive impact on multiple new plans, including the joint venture recently established with Ascension health care.

Please note, we expect to have 68% of our MA members, excluding Fidelis, in 4-star plans in 2020.

With Fidelis, it will be 53%.

Next, Health Insurance Marketplaces.

At September 30, we served 1,535,000 exchange beneficiaries.

This represents a sequential increase of over 26,000 individuals.

The addition of Fidelis offsets the sequential loss of members from normal attrition.

On a year-over-year basis, membership grew 49%.

Our exchange businesses continued to perform well in the third quarter.

We expect 2019 to be another strong year for Ambetter.

In addition to expanding our footprint in 6 existing markets next year, Florida, Georgia, Indiana, Kansas, Missouri and Texas, we're in 4 new states, Pennsylvania, North Carolina, South Carolina and Tennessee.

In 2019, we will be offering exchange products in 20 states.

Our strategy remains consistent, focusing on low-income subsidized populations.

We do not see a significant change in the competitive dynamics of our markets and pricing appears to be appropriate.

I would like to speak to the elimination of the individual mandate in 2019.

We do not expect this to have a meaningful impact on the overall performance of our marketplace product.

Open enrollment starts November 1. Our guidance includes incremental marketing and other outreach efforts to offset the federal government's continued reduced efforts.

Shifting gears to our rate offering, we continue to expect a composite Medicaid adjustment of an increase of approximately 1% for 2018.

In conclusion, third quarter results offer further evidence of Centene's financial strength and operating capabilities.

Centene's pipeline of further growth opportunities remains robust.

We continue to score new growth and diversification prospects while maintaining our focus on margins.

We are optimistic about our future and the leading role that Centene will continue to play in the evolving health care industry.

As a reminder, our next Investor Day is on December 14 in New York City.

We look forward to seeing you there.

We thank you for your continued interest in Centene.

Jeff will now provide you with further details on our third quarter financial results.

Jeff?

Thank you, Michael, and good morning.

This morning, we reported strong third quarter results with total revenues of $16.2 billion, an increase of 36% over 2017, and adjusted diluted earnings per share of $1.79, an increase of 33% over last year.

Earnings for the quarter were driven by the completion of the Fidelis acquisition and the continued strong performance of the marketplace business.

Additionally, the third quarter results include the following items, which in aggregate, had no effect on diluted earnings per share.

First, during the third quarter, we received cost reconciliation information from the state of California associated with the IHSS program, which ended last year.

The information allowed us to estimate the effect of the reconciliation.

And we recorded a pretax benefit of $140 million during the quarter.

Second, the Veteran Affairs contract expired this quarter.

In connection with the conclusion of the contract, we recorded a pretax charge of $110 million for negotiated settlements and severance costs.

Lastly, as an offset to the first 2 items, we recorded a pretax charge of $30 million associated with the contribution commitment to the company's charitable foundation to continue to support the communities that we serve.

Let me provide some more details for the quarter.

Total revenues grew by approximately $4.3 billion year-over-year primarily as a result of the acquisition of Fidelis Care; growth in the Health Insurance Marketplace business; expansion and new programs in many of our states, including the Illinois contract expansion and the Pennsylvania LTSS program; other acquisitions, including MHM, CMG and Foundation Care; and the return of the health insurer fee in 2018.

This growth was partially offset by lower revenues in California associated with the removal of the IHSS program for managed care, which took effect January 2018, and lower membership and revenue in the Medicaid business due to eligibility redeterminations in many of our states as a result of the strengthening economy and lower unemployment.

Additionally, the IHSS adjustment this quarter lowered premium revenues by a little over $100 million.

Moving on to HBR.

Our health benefits ratio was 86.3% in the third quarter this year compared to 88% in last year's third quarter and 85.7% in the second quarter of 2018.

The decrease year-over-year is primarily driven by the benefit of the recognition of the IHSS program reconciliation, which reduced the HBR by approximately 100 basis points.

Additionally, the year-over-year membership growth in the Health Insurance Marketplace business and the reinstatement of the health insurer fee in 2018 also decreased the HBR.

These decreases were partially offset by the acquisition of Fidelis, which operates at a higher HBR.

Sequentially, the 60-basis-point increase in HBR from the second quarter of 2018 is primarily attributable to normal seasonality in the commercial business and the acquisition of Fidelis Care.

These increases were partially offset by the IHSS program reconciliation I previously mentioned.

Now on to SG&A.

Our adjusted selling, general and administrative expense ratio was 10% in the third quarter this year compared to 8.9% last year and 9.6% in the second quarter 2018.

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

The SG&A expense ratio was also negatively impacted by approximately 70 basis points related to the cost associated with the conclusion of our contract with the U.S. Department of Veterans Affairs and the contribution commitment to our charitable foundation.

These increases were partially offset by the acquisition of Fidelis Care.

The sequential increase is primarily due to cost associated with the VA contract expiration and the charitable contribution previously mentioned.

These increases were partially offset by the acquisition of Fidelis Care, which operates at a lower SG&A expense ratio.

Additionally, we spent $0.06 per diluted share on business expansion cost during the third quarter compared to $0.12 per diluted share last year.

Investment income was $80 million during the third quarter compared to $51 million last year and $65 million last quarter.

The increase year-over-year is due to higher investment balances mainly associated with the Fidelis acquisition as well as higher interest rates on short-term investments.

Sequentially, investment income increased due to the acquisition of Fidelis.

We expect interest income to be lower in the fourth quarter due to lower investable balances associated with the payment of the health insurer fee, risk adjustment and the California rate overpayments mentioned in the second quarter.

Interest expense was $97 million for the third quarter 2018 compared to $65 million last year and $80 million for the second quarter of 2018.

The increase year-over-year was driven by the additional debt to fund the Fidelis acquisition and higher interest rates on our debt associated with our interest rate swaps.

The increase sequentially is driven by a full quarter of the senior notes issued to fund the Fidelis acquisition.

Our effective tax rate for the third quarter was 33.3% compared to 38.3% in the third quarter of 2017.

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

Now on to the balance sheet.

Cash, investments and restricted deposits totaled $14.3 billion at quarter-end, including approximately $500 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 at quarter-end was $6.4 billion, which includes $100 million of borrowings on a revolving credit facility.

Our debt-to-capital ratio was 36.9%, excluding our nonrecourse debt, compared to 41.2% at the third quarter last year and 36.7% at the second quarter of 2018.

We continue to target the debt-to-capital ratio in the mid- to upper 30% range.

Our medical claims liability totaled $7 billion at quarter-end and represents 51 days in claims payable compared to 44 days for the second quarter of 2018.

The increase in DCP is a result of the addition of the Fidelis business, which accounts for 4 days, timing of claims payments and business expansions which accounts for 2 days and the impact of the IHSS program reconciliation for 1 day.

Several of the items influencing the DCP increase this quarter are timing-related and are expected to reverse.

We expect the DCP to be in the mid-40 range on a run rate basis with the inclusion of Fidelis.

Cash flow provided by operations was $548 million in the third quarter.

Cash flow was positively impacted by approximately $350 million due to the timing of Fidelis Care claims payments and $175 million due to increases in experienced rebate payables primarily related to the performance of the Health Insurance Marketplace business and the previously mentioned IHSS program reconciliation.

Before we discuss the changes to our 2018 annual guidance, let me spend a few minutes to update you on the Fidelis acquisition and the effect on the third quarter 2018 results.

On July 1, 2018, we acquired substantially all the assets of Fidelis Care for approximately $3.5 billion of cash consideration, net of the preliminary working capital adjustment.

The integration is in process.

And we expect to achieve the previously communicated synergy targets.

In connection with the completion of the acquisition, during the third quarter, we incurred approximately $401 million or $1.46 per diluted share of transaction costs, including investment banking fees, legal costs and $324 million, representing the present value of the contribution to the state of New York as part of the undertakings associated with regulatory approval.

Now on to our annual guidance.

We have increased our 2018 annual adjusted diluted earnings per share guidance by $0.02 at the midpoint to reflect the performance in the third quarter and narrowed the ranges of several other guidance metrics.

In summary, our updated full year 2018 guidance is as follows: total revenues of $59.8 billion to $60.3 billion; GAAP diluted earnings per share of $4.34 to $4.50; adjusted diluted earnings per share of $6.90 to $7.10; and HBR of 85.9% to 86.3%; SG&A ratio of 10.5% to 10.9%; adjusted SG&A ratio of 9.7% to 10.1%; an effective tax rate of 34% to 36%; and diluted shares outstanding of 198.8 million to 199.8 million shares.

Additionally, we are increasing our full year 2018 business expansion costs from $0.28 to $0.32 per diluted share to $0.30 to $0.34 per diluted share.

In summary, we were pleased with the strong performance in the third 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 your first question will be from Kevin Fischbeck of Bank of America Merrill Lynch.

Wanted to ask about the exchanges and how you thought about 2019.

I guess, you mentioned that the competitive landscape hasn't really changed that much.

But it does seem like that there's a number of counties that last year only had one option and this year at least have 2. And you guys often stepped in there to be that one option.

I think initially the market was concerned that being the only one there was going to be a bad thing.

You guys have really outperformed.

Wondering now whether there's potential risk on the other side if a new competitor comes in, does that potentially change the risk pool for you in that market?

Let me respond.

Kevin, I don't see a change in the risk pool.

So we have had the last 2, 3 years, 80% reenrollment of our membership.

So we expect that to continue.

There's a great deal of satisfaction with it.

And we continue to focus on the subsidized markets.

And some of the others are coming in at higher levels than that, so I don't really see any material changes within the marketplace.

Okay.

And then I guess, a question on the MA side.

It looks like you guys expect now to have the parent rating back for 2020.

How did you think about the 2019 pricing for Stars, particularly on some of the new contracts?

You have this issue where you fell off on the Star ratings for 2019, but you expected to show improvement going forward.

Did you kind of think about it and price to the actual Star rating that you had in 2019?

Or did you kind of take the longer-term view that it's better to grow the business and we may see some margin impact in 2019 but then getting back...

Right.

I'm going to ask Kevin to join in.

But I, last year, said we are committed to growing the business.

But I'll let Kevin pick that up.

I just would restate what Michael had said.

Our position has been to take the longer-term view.

I think when you look at both our expansion strategies, the states we focus on, the potential Ascension alliance, I think it all reflects that.

The next question will be from Josh Raskin of Nephron Research.

First question, just on the exchanges and sort of just how you guys think about the bidding process and resetting your plans.

We've talked about a margin, I guess, above 5% this year.

As you think about '19, is there a reset to your bid margin?

Or do you think sort of where you are sustainable?

And again, you've been sort of a sole operator in a lot of counties.

So my guess is there's no need to make major revisions there.

But just how are you thinking about long-term margins?

And is there any reset we should expect for 2019?

Yes.

I'll let Jeff and some others comment.

But as I said in my -- on the previous answer, we see our position in the marketplace not changing.

But all up to the -- give Jeff some...

Yes, not to get into too much details about '19, but we are certainly not planning for a margin reset in 2019.

That's certainly not our view.

Okay, that's perfect.

And then just on North Carolina, as they released the set of bidders, I was actually a little surprised there were only 8 plans that were listed.

And so I don't how to think about that.

Is that, "Hey, there's a little bit of fear around the ability to earn a reasonable return on that contract and it's a big contract, so there's risk"?

Or is it, "No, but it's just such a large contract that there's only a few plans that can realistically win this"?

I guess, I'm just curious on your perspective on the competitive landscape in North Carolina.

It's Kevin.

I think one potential factor, contributing factor to what you've just said is that the -- as you probably know is that it was a complicated bid.

And when one looks at the requirements on an MCO with respect to care management requirements, network and such, the mix between how provider organizations would be implemented as well as outside MCOs, it is a complicated bid.

So again, we're very excited about our bid.

We believe we have a strong one.

But that may be a contributing factor.

Yes, I would just add to it.

I think when you look at the scale, the size, the expectations, the technology required to do it, a lot of people would initially get excited but would sit back and say, "I think maybe I may have to sit this one out." And so we're comfortable with our position, our partnership and think and expect to do well with it.

Okay.

And just to clarify, there was nothing in the bid or the RFP that came out that changed your view on the ability to earn a reasonable return, nothing around rates or continuity of care, anything like that, that's going to make it onerous in the early periods?

No, I don't think so.

I think that you always looked at how bifurcated it is, how many members, how many plans they have in a particular region.

But I think when you look at it in total, I think it's going to be fine.

You always have your first year where you're educating people.

And we have planned for that accordingly.

And we've always said new plans, you want to go through 3, 4 quarters so that same metric applies.

And we're planning accordingly.

The next question will be from Steven Valiquette of Barclays.

So just quickly for the California IHSS payment, I think you guys mentioned this at your Analyst Meeting back in June.

So it seems like it was included in guidance.

But just to clarify, so $140 million, is it still subject to any material adjustments, depending on minimum MLR calculations in California for those prior periods?

And also are these California risk corridors, are they all finalized now?

I just want to get more clarity around all that.

Yes, a couple things.

This was not in guidance.

So it's never been in guidance.

But the real issue here is they're reconciling the program from the beginning, its inception, all the way back to 2014.

And this is really the first quarter that we had cost and I would say member eligibility information from the state in order to perform the reconciliation.

So the state has the data, not the MCO.

So obviously, this is the first time we had a look at it.

It is not done.

I think in the press release, you'll find that it says that we expect the '14 through '16 information to potentially get reconciled late this year or early next year.

And then there's still the 2017 year, which would come later, maybe in 2019.

So what I will tell you is that it could get adjusted.

And if it does, we would disclose it accordingly.

As far as the breakdown of $140 million though, how much of it relates to 2014 to 2016 versus 2017?

Is there any just rough breakdown of it that way just to help us get a sense of the magnitude for how much it could be adjusted?

I think there were rate changes in the program in the later years.

So I think a significant piece of that relates to '14, '15 time periods with a little bit less in 2017.

So I would say it probably starts larger at the beginning and gets smaller as the years go on.

And our next question will be from Ralph Giacobbe of Citi.

Obviously, a lot of moving parts in MLR and SG&A.

Any reason why you wouldn't exclude some of those sort of one-time items from the adjusted figures?

Well, we've never historically done, if you will, an adjusted HBR, an adjusted SG&A ratio.

But I think our preference in general is to disclose and not have an adjustment section that's very long in the filing.

I think that makes it confusing.

And so I think our view was this was a much more easier way to just disclose the information.

And I just want to add to that.

I think what's really important, as we change lenses to a $60 billion company versus what a lot of people remembers us historically, you're going to have a lot of adjustments that come through in a given quarter.

That's just the nature of the business.

And what we did this time, we wanted to ensure that we had the offsets.

And to ensure that there was no income taken into it, we took the $30 million and put it in the foundation because we wanted to really even it out.

And so I agree with Jeff, obviously.

We decided to keep the adjustment simple, so people understand it.

And we believe that most people, when we say, "Here's a one-time change," one way or the other, tend to discount it.

I'm used to an environment where they say, "That's to be expected in a business this size," that at any given quarter, any given time, there's going to be adjustments that are good and bad.

But you have to treat them just as one-time events and not part of the ongoing.

What I'm pleased with in this quarter is the ongoing business is performing well and consistent with our expectations.

Okay.

All right, fair enough.

And then just to follow up, the administration was out yesterday with sort of more flexibility to states around waivers and the like.

Any initial thoughts around that and maybe implications of that, whether it's even a consideration for '19 as opposed to maybe '20?

Kevin?

Yes, it's a good question.

I just finished reading the guidance last night.

Clearly, I think we support the ability for states to have additional flexibility.

I think it plays well into both our business model and also our strategy.

With respect some of the nuances in the guidance, I think we're all still studying that.

The next question will be from Steve Tanal of Goldman Sachs.

Wanted to just to follow up on a couple of the ratios.

Specifically, first, the HBR, at 87.3%, I mean, just looking at typical -- and that's kind of ex the IHSS item, the typical seasonality and thinking through kind of the impact of Fidelis, really trying to understand, I guess, the question will be what was the impact of Fidelis, if you can spike that out?

Because I think this HBR looked pretty decent ex it.

Yes, I want to comment that as we go forward, we've always had the policy, we look at it on a consolidated basis versus bifurcating it.

Because we think it's too confusing, the next quarter, what about this or that?

So we want to look at it in totality.

But you can give some kind of directional...

Yes, I think you're exactly right.

Obviously, you have 2 things, one's been here the whole year, the HIF, right, the health insurer fee pulls down the HBR, if you're comparing to last year, right, because last year, there was no health insurer fee.

And then you have the IHSS adjustments.

So those 2 I would kind of put on a separate category.

And then you're correct, you do have an increase for the Fidelis business because it does run a higher HBR.

And that was predominantly offset by the marketplace because a lot of the growth -- organic growth this year has been in the marketplace business.

So the increased volume of that business as a percentage of the total company pulls down the HBR.

Okay, so not quantifying Fidelis.

And I guess, just on the SG&A side, came in a bit higher than we were thinking.

And I guess, one thing that I heard on the call so far was just the increased business expansion cost.

And that, I guess, stepped up about $0.02 or so.

Was that in the third quarter?

Or is that to come in the fourth quarter?

And then just a step-back on that, like should we think about that $0.32 number as kind of a run rate number at this point?

Some of that is in the third quarter related to our -- as Michael mentioned in his script, related to the open enrollment period.

And so what you have to remember is in order -- what we do with the business expansion costs are incremental, so incremental to the prior year when you look at, for example, the marketplace business.

So I would say it's a pretty good run rate.

But it can be lumpy from time-to-time, depending on Medicaid RFPs, right?

Because a lot of times, for example, if we had a 1/1 start date, we'd have a lot of start-up costs in the fourth quarter for that.

So I would say it's a pretty good run rate.

I think that's where we've been in that range for the last several years.

But obviously, depending on the timing of awards and how many awards are in a specific year, it could change.

The next question will be from Sarah James of Piper Jaffray.

I was hoping that you could walk us through capital deployment priorities.

As you think about the business model going forward, are there certain areas that would make sense for Centene to add assets or expand their exposure?

Yes, I mean, I think, obviously you've seen a lot of the capital that we continue to deploy and have deployed over a long period of time is really related to growth and adding capabilities.

And I think you've seen some of that this year with the addition of CMG, our investment in RxAdvance, Interpreta.

So we've continued to add capabilities to the business as well as grow the business.

So every new market requires statutory capital.

That's capital deployment, increasing the marketplace growth in that business.

So I think it's a consistent strategy going forward.

We're looking for ways to add capabilities that in the long term will continue to grow the business successfully.

Okay.

And can you talk about the rate outlook in a little bit more detail?

So you mentioned reiterating the 1% for 2018.

But we've had a couple of updates recently that would put -- that were higher than that.

So I'm just wondering as you're looking for the rest of '18, focusing on 4Q or kind of rolling out of the year, are you still thinking that 1% is accurate for 4Q?

Or could the recent update provide some upside to that?

Yes.

I think we've been -- and I may get this a little bit off.

But I think we've been close to 1% for the last 3 years.

And just to give you the idea about what we're giving you as far as what the 1% is, it's the annualized effect of rate adjustments in this year.

So it's not just as they occur, it's the annualized effect of those.

And other thing is it's a net rate adjustment, meaning if the state changes the fee schedule and provides a premium adjustment for that, we've excluded those.

We've netted those together because typically those are 1:1.

So we're still comfortable with the 1%.

We've been in the 1% range for the last several years.

And I think I wouldn't see anything different going forward at this point in time.

And I think what is important, Sarah, is to what Jeff said there is it's easy to say we've got a 5% increase or something.

But if they raise other fees comparable to that, then that's a mislead.

So I think we want, in interest of clarity, report the net number.

The next question will be from Matt Borsch of BMO Capital Markets.

Can I just ask about the tax rate?

The rate looked quite low in this quarter.

And I think you're maintaining your tax rate guidance for the full year.

Is that implying something pretty high for the fourth quarter?

I'm just wondering if you can talk to what's going on there.

And apologies if I missed something you already said.

Yes.

No, Matt, that's a good question.

I think what's driving the tax rate obviously for the quarter is the significance of the adjustments related to the closing of -- it's really the transaction cost associated with the Fidelis transaction.

Those are deductible at a statutory tax rate that's roughly around 24%.

So we've known about these cost for some time and our guidance has always included those.

So again, that's why you didn't see a revision to the tax rate range is for the full year, on a GAAP basis, we're going to get back to in between our guidance ranges that we've provided today.

Okay, got it.

And that's also, Matt, a good example of what I said earlier in terms of in any given quarter, you can have a particular effect that impacts it.

Just to give you a little more detail, Matt.

We've always had, I would say, a lower back half tax rate because of the addition of Fidelis.

Because Fidelis is not subject to the health insurer fee this year, so their tax rate is much, much lower.

But for the full year, we're comfortable with our guidance range.

Got it.

And could I just ask a question on if you look at the organic growth going into 2019 and above $69 billion, am I correct that implies a high single-digit range for organic growth if you sort of broad side of the barn adjust out for Fidelis?

I think once again for consistency, we've always -- when there's a partial year on something, we've always had to adjust for it the next year.

So if you go year-over-year, that's consistent.

We look for consistency in how we do this.

But any way you look at it, I mean, it's a lot of significant growth for that.

And then that reflects what the visibility we had last June.

And we'll update it in more detail and give you more detail in December.

The next question will be from Peter Costa of Wells Fargo Securities.

Was any of the guidance change -- the metrics changing due to the performance at Fidelis being different than you expected?

And what things will be seen at Fidelis that's been different from your expectations, either positive or negative?

I think it's been very consistent with our expectations.

And the reaffirmation of the revenue and the EBITDA, I think, reflects that.

It's a well-run company, and we're very pleased with that.

I mean, we really were -- you talk about integration, day 1, they are on our general ledger.

So I mean, this is a company that has their act together, and it's everything we could have expected.

And just as a follow-up.

Why was Fidelis Care view of the individual mandate going away, which caused them to initially seek much higher rates from the exchange business, so different from your view of the individual mandate going away?

Is New York somehow different?

And are you seeing what they initially saw now that you're seeing what's going on in New York?

Okay.

So I think you're right, New York is different.

New York has a basic health plan, as I think you're probably aware of.

It's 1 of 2 states, that and Minnesota, that have that.

So just by definition, they're going to have different underwriting issues and risk management issues and selection issues than states without the BHP.

So that's what's caused them to seek much higher rates in New York than you were seeking rate increases for next year?

Yes.

If you're a state with a basic health plan like those 2, there are definitely different underwriting issues that one has versus a state without that.

And we, of course, could not get involved in any discussions on their rate adjustments until after closing.

That would have been inappropriate.

The next question will be from Michael Newshel of Evercore ISI.

So when we're looking at the RFP pipeline, is there any update on expected timing of the STAR, CHIP and STAR+PLUS contracts in Texas after the cancellation repost of the RFP a few weeks ago?

I think you see it's a moving -- it's a movable feast.

But Chris, what's the best...

I'll give you my best shot, Michael.

Right now, it looks like the -- well, as you know, both of the RFPs have been reissued and are due in mid-November.

We expect that the awards are going to come Q2, Q3 of 2019.

And right now, the projected start dates for both of these are STAR+

PLUS will be 6/1 of 2020, and the CHIP and Star RFP will be 9/1 of 2020.

Okay, great.

And how about -- and also what's the latest on Pennsylvania, whether the HealthChoices contract will go through another bidding process?

Have the courts vacated that?

We haven't -- I haven't heard anything.

I mean it's been very silent.

And so we will continue to focus on a long-term territory and a great job there in the East in a way to bring that up.

And that's going well.

But I've decided not -- it's something that I'm just going to wait for them to call and say, "It's time to try a third time." So we've done one or twice.

So we'll see what happens this time.

Got it.

And the existing focus will just continue in the meantime?

Well, yes.

Actually, yes, I'm sure.

I mean, that's -- there's no -- I mean, they need the help.

They want it.

And well, there's a -- you have an election coming up.

The new governor will be in place potentially.

So let's wait and see what happens there.

And I'm not forecasting the election come this week.

But -- so there's a lot of variables.

So we have so much going on now that if anyone will wait a little bit, that's okay.

We have a full plate.

The next question will be from Lance Wilkes of Sanford Bernstein.

Just a quick question on the days claims payable and the timing issue, more predominantly on the non-Fidelis.

Was that related to any particular product?

Or if you can just give a little more color on that, that'd be helpful.

Yes.

No, nothing specific.

I mean when you look at the days in claims payable, some of this depends on which day of the month the actual quarter ends on and when our check runs are scheduled.

Obviously, we're fairly large, so we're making a lot of payments every single day.

So it just depends on that.

That's what most of the timing items are related to.

And I think I was pretty clear in my script that, long term, we think in the mid-40s is a good proxy for where we're going to be with the addition of Fidelis.

Okay.

And then on RxAdvance, so you made additional investment in convertible preferred, and you talked a little bit about the rollout in 2019.

If you could talk a little bit more about both how you're thinking about rolling out that capability, how it replaces existing capabilities.

And what would be the impact to a state's kind of pricing model as a result of this?

Is it -- do you frequently have like separate computation rates related to pharmacy, and this is going to transfer it to more transparent pricing?

Or maybe just some more color around that.

Yes.

What I'm going to do is Jesse's been leading that.

And so I'm going to ask him to bring us to speed on that.

Yes.

And it's a good combination of questions there related to RxAdvance.

I think as Michael referenced in his comments, I think the important starting point here is we're really investing in the future kind of more transparent version of the PBM model.

So that includes making investments in the technology platform, which is really where RxAdvance is today.

So we're rolling that out on a market-by-market basis, as we referenced that rollout.

That's been in process since the initial investments, and we'll initiate in the end of 2018 and continue to occur market-by-market through 2019.

In conjunction with those new -- the implementation of the platform, we will be moving to a different operating model, which is built around transparency and more focused on cost sharing for total cost of care.

So integration of pharmacy costs with a more comprehensive total medical cost.

And we do believe that over time, delivering those services more efficiently will provide both higher quality and lower costs for all of our customers, including states.

Yes, this is going to be a game-changer.

The next question will be from Dave Windley of Jefferies.

It looked to us that you added something like 110 counties to Medicare Advantage for 2019.

You've got the Ascension JV, the STARs that were discussed earlier in the call.

Michael, I'm just interested in your kind of longer-term view aspiration for Medicare Advantage in the business mix for Centene?

Yes.

I think I've said that -- when we talk about our growth, that I view the Medicare Advantage product as continuing to fuel our growth into the next decade.

And we've been using last year and a little bit of this year as the learning process, then gradually expanding it.

I keep telling you, it's not how fast, it's how well we get the fundamentals right.

And that's what we're doing.

But I see it as a very important part of what we're doing.

And you will continue to see it.

And we've built systems capability for it.

And I think that's also very important, whether it be the RxAdvance, the interpreter, things that help improve outcomes.

So we see it as a very important part going forward.

And then at the top of the call, you talked about Fidelis and the adding of case management and clinical programs and things like that, that I think you've been fairly transparent about targeting their HBR as your synergy target.

How quickly can those things happen?

And do you think the benefits of those things are fully captured in the synergy targets that you've laid out?

Or can those be exceeded over time?

Well, I think, one, we'll be implementing them as we speak.

And it's something that we got ready for it during the extended period before we could close.

So those are the kinds of things we could talk about and did.

So I think it will.

And we're very careful from the standpoint of GAAP reporting and how we do things that, from a conservative standpoint, has to be consistent with appropriate GAAP accounting.

I would always hope that we can underpromise and overdeliver a little bit.

And so we want to keep the expectations real and the timing real, but we're very hopeful on the benefits of all these as they are.

And I know they were looking forward to our systems and their capabilities.

So -- and these things we're learning from them.

So it's really great to put 2 great companies together like that.

The next question will be from Zack Sopcak of Morgan Stanley.

I wanted to ask first about just your turnaround in MA STARs.

And from your perspective, what really drove the improvement?

And were there any incremental investments involved to get you up for 2020?

Well, I'll ask Kevin later to jump in.

But I think that's something that's a priority.

And we've been focusing on it, and we're not satisfied with where we are.

We're going to keep pushing it, to increase it, to make it better.

And that's just when it -- we're happy we got involved with it.

We made it a priority to make the investments to get there.

And then we caught a few breaks along the way as well.

So Kevin, you want to take...

I think Michael said it.

It is clearly a priority.

Michael's made it pretty clear to us where those expectations are.

We've got a strong team that's focused in on STARs as well as RA and other quality activities.

So it's about execution.

And then just to clarify on your charitable contribution.

So if I look back at your '17 and '16 numbers, you excluded them from adjusted net earnings.

And -- but now you are including in an adjusted net earnings.

Going forward, should I just consider your charitable contribution to be included into it in adjusted net earnings?

Yes.

I think this goes back to what Michael had mentioned earlier, was that this was really the offset for the other 2 items.

So to the extent that you see one like this, I think it would be disclosed similarly to what we did this quarter.

And our next question will be from Justin Lake of Wolfe Research.

Just wanted to come back on the tax rate.

The -- first of all, is there -- you're saying that the one-time costs from Fidelis were deductible in the adjusted number?

Well, no.

They're deductible on your tax return, right?

They're deductible on your tax return at their -- effectively, their statutory rate, which is around 23 and change, I guess, is what I would say.

So they're -- I mean, those are actual costs that we burden, that when we file our tax return, we'll take a deduction for them.

Right.

But you -- So I guess, what I'm just a little bit confused by, if I'm understanding this correctly, is you one-time the cost of the Fidelis integration, right?

Those are not included in the adjusted, correct?

In the adjusted earnings, right.

That's exactly right.

So we have the costs that we're -- we're effectively backing those out at the applicable tax rate, at which they will be on our federal tax return.

Right.

Did you also one-time the tax benefit or the tax shield?

Or are you saying you ran that...

Yes, yes, yes.

If you -- yes.

If you look at the press release, the tax, it's -- actually, they're combined.

The tax benefit of those deductions is disclosed in the press release, but it's aggregated into one line.

Right.

that's what I would've thought.

So...

Yes.

It's the 65 -- or it's the amortization and the transaction cost.

The tax benefit of both of those are aggregated into one line in the press release.

I think it was, yes, $110 million, I think, for the quarter, right?

Okay.

So the adjusted tax rate, right, when we look at adjusted pretax income and then adjusted after-tax income and look at the tax rate, that tax rate doesn't see the benefit.

Just -- it just looked somewhat low, lower than expected.

And it kind of implies the fourth quarter's going to be pretty meaningful, given you guys didn't change the guidance?

So I'm a little bit confused.

Well, I think this is -- yes, yes.

It's the magnitude to some extent because GAAP net earnings were so low.

But I mean, we're guiding to a GAAP number, right?

So if you look at the GAAP number for the quarter is roughly 33%.

I know it has a small amount of earnings because of the significance of the adjustment, right, of the transaction costs.

But we're guiding to a GAAP range, which is -- that's why we didn't actually change the range because we're going to get to that GAAP range.

So recalculate your math on the GAAP financial statements, and that'll give you what you're looking for.

Got it.

If the -- so maybe if I could just follow up, the adjusted tax rate we should be thinking about for the year, maybe that's another way to think about it?

Well, we don't really give an adjusted tax rate, right?

I mean, what I could tell you is those items specifically on the tax return are deductible at a statutory rate, which, by the way, the difference between the statutory rate and the rate that you see on our financials is -- has a large piece of it associated with the health insurer fee, the nondeductibility of the health insurer, yes.

So that is playing into the calculation, which is why the math is challenging to understand the way you're trying to do it.

I'll take a harder look.

I know there's a lot of moving parts in the quarter.

And then just lastly on the services business.

When I look back at the third quarter last year, obviously, it was -- it looked like it's better, at a pretty kind of strong margin in the quarter on the services business in 3Q '17.

Obviously, it looks like it's normalizing, more than anything, maybe in third quarter '18.

Is there a way to think about this services margin as we go forward?

Is this a good kind of run rate that's kind of low 80s kind of cost of services?

Yes.

I think I'll just give you a couple of pieces here, Justin.

I think the services line continues to change, specifically with some of the deals that we've done last year.

But the services margin that you see in the financials, it would have been a little bit lower because of the VA adjustments that we took this quarter.

So if you exclude those, it would have been lower and more consistent with last year.

And that's because the third quarter has a lower cost of services ratio because that's typically when we get the information on the USMM ACO programs.

And we have the reconciliation.

And that reconciliation is favorable to us, and it was favorable to us by a similar amount last year, third quarter.

So it's kind of being masked by a couple of things.

The wind-down of the VA program, that was not -- work was at full speed until September 30.

That wound down throughout the quarter.

And then these VA adjustments that we've mentioned also inflated the cost of service ratio a little bit.

So I would say the mix in that line continues to change, but I would say mid- to low 80s is probably a good estimate.

And that could fluctuate by quarter depending on when we have reconciliations in a lot of these programs.

And our next question will be from Ana Gupte of Leerink Partners.

A couple of questions.

The first one was -- as you think about your margins going forward, do you see any reason you couldn't expand margins.

Your mix shifting to exchanges in MA looks like trend is weak.

You have a better STAR ratings starting in 2020.

Investment income would go up with interest rates.

So what would your normalized margin expectations be?

Well, I think we'll talk more about margins in '19 in December.

But I mean, we have clearly stated -- we're demonstrating our interest in expanding margins.

And I think that's appropriate.

And the scale, the size, the activities we have going, the technology we're applying to improve medical costs over time all -- will tend, Ana, to give us the ability to expand margins.

And we can get more specific on our December call.

Okay, great.

That's what I would've thought.

The second one's on exchanges for 2019.

What are you expecting given on the subsidized book of business overall, I mean, for the exchanges, what types of assumptions are you all making?

And is your growth likely to come from secular growth?

Or are you thinking of it more from just your geographic expansions and share shifting within your existing markets?

Or a bit of both?

Well, I'm going to ask you to kind of stick with us in terms of not getting too granular on '19 until December.

That's a pattern we've -- that's well established over a lot of years.

I will say that from the standpoint, our focus continues to be on the supplements and that portion that has the premium supplement.

And we see that continuing, going into '19.

So it's going to be business as usual for us.

And we're comfortable with the attrition we had this year relative to previous years.

The reenrollment we had, everything says it's very much business as usual.

And I thought -- I think you heard Jeff comment earlier that from a margin standpoint, the business we see maintaining that.

So it's a business we understand.

And we've developed systems to continue to build it and maintain it.

Okay, great.

One final one.

Any update at all on the Texas RFP?

I believe they announced award...

I think, Chris, he can just give a little detail.

You want to repeat that?

Sure.

I'd be happy to, Michael.

Both of the RFPs that were canceled have been reissued and are due in mid-November.

The awards will be announced, we believe, in Q2 and Q3 of 2019.

Projected start dates for STAR+

PLUS will be 6/1/of 2020.

And CHIP and STAR RFP, our start date will be 9/1 of 2020.

The next question will be from Gary Taylor of JPMorgan.

Just a couple of questions.

And just sorry to go back to the tax rate again.

I think there's a perception that the quarter did benefit materially from a lower tax rate.

And I followed your discussion, but the nondeductibility of the HIF actually serves to increase the effective tax rate, right?

So 8 over 24% on a GAAP basis is 33%.

But including nondeductibility of the HIF, 8 over like a $202 million number is like a 4% number.

So it doesn't look like there was a tax benefit in the quarter different from what you've seen in the first half.

And Fidelis would just be a few hundred basis points, I think.

So do you follow where I'm going?

And where am I wrong on looking at that?

Yes.

I mean, I can understand your -- I can understand where you're coming from.

I guess, what I would say is this is nothing different than what we've already had in our guidance from -- when we had these costs associated with the Fidelis transaction.

So -- yes.

So Fidelis, lower tax rate, not subject to the health insurer fee.

You're pulling 1 item or 2 items, putting them down below the line, and you're pulling them out at a statutory rate versus your annual effective rate, which includes the nondeductibility of the health insurer fee.

So I think it's more complicated than that.

But we certainly don't view that there was any tax benefit in the quarter.

This has been our guidance for -- we're guiding to an adjusted number on a full year basis.

And we don't see any tax benefit to the quarter that way we've seen it since these costs associated with the regulatory undertakings were known.

Sure.

Maybe another way, just to sort of look at the quarter.

If we look at pretax earnings were up $262 million in the first quarter, $89 million in the second quarter.

Adjusted pretax earnings, up about $110 million this quarter, but Fidelis, if it ran a 4% origin, would have been over $100 million of that.

So it does look like the pretax earnings growth from the rest of Centene slowed this quarter.

Is that something that you'd acknowledge?

Does that make sense?

So you're adding back the -- which pieces are you adding back?

The merger costs and the amortization or just the merger costs or...

Yes, both.

It looks like the adjusted pretax would be $490 million, which is up like $110 million versus the prior year.

So I think it was...

Yes.

I think the piece you may be missing is the exchange business and how the profitability of the exchange business works, right?

Remember, it makes; yes, it makes a lot.

And the other thing is that remember the enrollment dates were accelerated this year, so the exchange business profile is actually a lot different.

And it's a more meaningful piece of the business.

That's what I figured.

That makes some sense.

Last question.

The specialty operating income was a $51 million loss.

It was $102 million year-over-year.

You called out the VA termination costs as the major factor there.

But it's still would have been about $40 million of OI versus $102 million when you said other federal contracts, and then some carved in of behavioral.

Is there any more color you could tell us on just the specialty operating income and where they might be some margin pressure?

Yes.

Actually, I think some of this is related to the integration of the physical and behavioral health.

So some of those behavioral health revenues and margin is now embedded with in our health plans because we've moved to an integrated approach.

The next question will be from A.J. Rice of Crédit Suisse.

First of all, maybe a numbers question, then one other broader question.

In the MLR when you x out for the unusual items, you're up -- you've improved 70 basis points year-to-year.

And I think in the prepared remarks, you said a lot of that was due to the HIF and the health insurance exchanges.

I just wondered -- I mean, it seems like you have -- and maybe I'm wrong, but 4 major things, your core Medicaid, your Fidelis, your HICs, and then the health impact.

Any way to sort of parse out where you're seeing improvement year-to-year in MBR and where this -- if there is any place where there's pressure?

Yes.

I mean, I think those are the items that we mentioned.

I mean, as we look at the business, I think the Medicaid business was pretty consistent.

That's why we didn't highlight it as a driver of the HBR metrics.

That's why we highlighted, obviously, Fidelis coming in would be an increase to the HBR and the marketplace.

The size of the business is a decrease on a year-over-year basis.

So we highlighted kind of the -- what I would call the drivers for the quarter.

And your...

Year-over-year, by the way.

I was just making sure.

Yes, right.

Yes.

Your HICs HBR, was it significantly better this year than last year?

No.

I think it was in line with our expectations.

I think it's volume -- the magnitude of the business, obviously, it's a lot larger.

Right.

Okay.

So it's mainly just the growth as opposed to the actual absolute ratio?

Yes, yes.

It's the growth on the business.

Okay.

And then my bigger picture question is, obviously, with the Fidelis now done, your balance sheet is still sort of within the range that you guys historically have targeted, I would say.

And acquisitions have been a big part of the growth story for the last couple years, even bigger acquisitions.

What's the appetite of the company to look at additional deals?

Do you need some time where you're settling in with Fidelis?

Or you've done a couple of big ones in pretty rapid succession.

Are you open to other things?

Well, I think Fidelis, the integration, it's well.

I mean, I'll put it in this context.

We know that the closing got delayed, which gave us a lot of time to prepare for a very effective integration.

So it is -- it's where it needs to be, and it's appropriate.

So if an opportunity came along, there is no reason for us not to do it.

We have a strong balance sheet.

We have a lot of capability, and we're in a position to do it.

But it has to be the right time, the right place and be, first, financially effective and strategically -- I'm not saying...

Would it reasonable to think that Medicare, given your focus on growing that, is a primary place to look?

Or are there other areas you'd highlight?

Well, I think -- I mean, look we're looking very broadly.

I mean, you've seen us with a focus on technology.

And there's some really effective technology that's going to provide it a lot of significant dividends, and already are.

Our technology committee meeting yesterday demonstrated that we're moving more and more to a leadership position there.

So there's a lot of very good opportunities there that -- stay tuned.

And ladies and gentlemen, that will conclude our question-and-answer session.

I would like to hand the conference back over to Mr. Neidorff for his closing remarks.

Well, I want to thank you for all your questions.

I hope we've clarified some of the outstanding issues because we -- I believe we had a strong quarter, and the metrics were right.

And what people refer to as noise and puts and takes, that's normal course of business in a company our size.

And what's important to us is that the fundamentals are strong.

It's headed the right way.

And we're looking forward to the fourth quarter, and we're looking forward to the December.

We can tell you how strong '19's going to be.

So we thank you very much for your time and attention, and great questions.

Have a good day.

Thank you, sir.

Ladies and gentlemen, the conference has concluded.

Thank you for attending today's presentation.

At this time, you may disconnect.