Centene Corp (CNC) 2019 Q1 法說會逐字稿

Good day, and welcome to the Centene Corporation First Quarter Earnings Conference Call.

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

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

Please go ahead.

Thank you, Nicole, and good morning, everyone.

Thank you for joining us on our First Quarter 2019 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 10129281.

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 recent Form 10-Q filed today, April 23, 2019 and the Form 10-K dated February 19, 2019 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 first quarter 2019 press release that we released this morning, which is also available on the company's website at centene.com under the Investors section.

Finally, a reminder that our next Investor Day will be on Friday, June 14, 2019, in New York City.

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

Michael?

Thank you, Ed.

Good morning, everyone, and thank you for joining Centene's First Quarter 2019 Earnings Call.

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

We will also provide commentary regarding the regulatory and legislative environment and our recently announced agreement to acquire WellCare.

I want to emphasize, while we have an experienced team working on the WellCare integration, our main focus continues to be the results of the core business.

This includes executing on our transformation project, Centene Forward.

Let me begin with first quarter 2019 financials.

We were pleased to begin 2019 with another strong quarter, marked by solid top and bottom line growth and robust operating cash flows.

Membership at quarter-end was 14.7 million recipients.

This represents an increase of 1.8 million beneficiaries over the first quarter of 2018.

First quarter revenues increased 40% year-over-year to $18.4 billion.

The HBR increased 140 basis points year-over-year to 85.7%.

This was primarily due to Fidelis Care, which we noted when we announced the acquisition operates at a higher HBR as well as the impact of the HIF moratorium in 2019.

We reported adjusted first quarter diluted earnings per share of $1.39 compared to $1.09 in the same period last year.

This represents 28% growth year-over-year.

We are pleased to report our adjusted net earnings margin improved 40 basis points year-over-year.

This improvement was due to better network management, leveraging our scale and enhanced medical management efforts.

We continue to see opportunity for further improvement.

Lastly, operating cash flows came in at $1.3 billion or 2.5x net earnings, above the high end of our previously stated range of 1.5x to 2x net earnings.

Jeff will provide further financial details, including increased 2019 guidance, in his prepared remarks.

A quick comment on medical cost.

Medical cost remains stable and in line with our expectations of low single digits.

Moving onto markets and product updates.

First, we'll discuss recent Medicaid activity.

Our Medicaid book of business performed well in the first quarter.

On March 31, we had 8.6 million recipients, representing a year-over-year growth of $1.5 million or 21%.

As we have previously mentioned, we see an opportunity to continue to improve our overall Medicaid margins.

Now onto state updates.

New Hampshire.

In March, we successfully reprocured our statewide Medicaid contract in New Hampshire.

The new program covers 180,000 recipients.

The new contract is expected to commence September 1, 2019.

At March 31, we served 83,000 beneficiaries in the state.

North Carolina.

I remind you that we won 2 large regions in the recent RFP and have an active appeal process for the balance of the state.

We remain cautiously optimistic regarding the appeal.

Iowa.

On July 1, 2019, Centene will commence operations under Iowa's managed Medicaid program.

The state is moving from 3 to 2 players, and beneficiaries will be split equally between the 2. We are confident the state is committed to operating a sustainable Medicaid managed care program.

I remind you, we booked a higher HBR in the initial quarters of any and all new Medicaid managed care contracts, and Iowa is no different.

As our medical management efforts gain traction over time, we will attain experience and knowledge with respect to our new members.

It is at this point that margins will begin to normalize.

We fully expect Iowa to match this pattern and believe we will be able to succeed in this progress.

Next, Medicare.

At March 31, we served 394,000 Medicare and MMP beneficiaries across 20 states.

This represents a year-over-year increase of over 50,000 recipients.

On a sequential basis, membership declined by approximately 23,000, as previously projected.

This is due to the repositioning of Fidelis to get back its 4-star rating.

We continue to expect 2019 MA revenue membership to be flat compared to 2018.

We believe, as previously discussed, 2020 will be an inflection point for our Medicare Advantage book of business.

Centene will return to a 4-star MA parent rating next year.

We expect this, along with the joint venture with Ascension and the addition of WellCare's top-performing MA platform, to accelerate profitable growth, as previously suggested in the 2020s and beyond.

Now Health Insurance Marketplaces.

The marketplace business put up another strong quarterly performance consistent with our expectations.

At March 31, we served approximately 2 million exchange members across 20 states.

This represents a sequential increase of 510,000 beneficiaries or 35% on a year-over-year basis.

Membership increased by 365,000 beneficiaries or 23%.

The key demographics of these members remain consistent with prior years.

Approximately 90% are enrolled in Silver tier plans and greater than 90% received subsidies.

Additionally, we see a slightly higher retention rate compared to last year, which is reflected in our updated guidance.

We expect to have another strong year of operations as the national leader of exchange products.

Next, I'll provide an update on health care legislation and regulatory environment.

At this time, we believe there is little appetite in Washington to revisit comprehensive health care reform.

With the political class turning its attention to the 2020 presidential and congressional elections, we welcome the discussion on ways to improve and expand government health programs.

States and federal government continue to seek private sector solutions to enhance quality and lower cost of health care.

This is evidenced by 68% of Medicaid beneficiaries and 34% of Medicare recipients in private managed care plans.

Centene will continue to work with both parties on a bipartisan solution and strengthens the Nation's health care delivery system.

We are pleased to see bipartisan efforts put forth on reducing prescription drug costs.

Centene will continue to advocate for greater price transparency.

This includes moving towards net pricing.

We've stressed these things in our recent response to the draft rule on PBM rebates.

We have been ahead of the curve with our equity interest in RxAdvance.

This is a national full-service crowd-based PBM that manages standard and specialty drug benefits with unmatched compliance and transparency.

Thus far, Centene has successfully migrated 2 states into the RxAdvance platform, Mississippi and Nebraska.

The implementation went seamlessly.

We expect the rollout of Centene's Medicaid in exchange states to be completed by the end of 2020.

We commend the administration's efforts on giving states greater flexibility via waivers.

This was most recently exemplified with CMS approval of Utah's waiver for partial Medicaid expansion.

Centene believes in allowing states to expand their Medicaid population up to 100% of the federal poverty level.

This would enable every American below 100% in the federal poverty level to obtain coverage through Medicaid.

Americans above 100% of the FPL would continue to be able to purchase affordable, comprehensive coverage to the marketplace with the help of advanced tax credit.

We look forward to working with the states that are on the front line in making sure all of their citizens have access to affordable, high-quality health care.

I'd like to remind you, with over 3 decades of experience, Centene and its predecessor company have demonstrated the ability to adapt and adjust to political and regulatory changes at any given time.

I would now like to make a few comments about our recently announced agreement to acquire WellCare.

This combination is expected to bring together 2 top-performing companies, creating a premier health care enterprise focused primarily on government-sponsored programs.

The addition of WellCare will bolster and diversify our product offering, significantly increase our scale and provide access to new markets.

WellCare has developed a strong portfolio of Medicare access -- assets, which is expected to provide Centene additional Medicare capabilities, including both Medicare Advantage and Part D. WellCare's Part D offering will significantly enhance and increase our scale in pharmacy.

On a combined basis, our pro forma annual drug spend will be approximately $30 billion and growing.

We also believe the addition of WellCare's Medicare expertise creates significant opportunities across Centene's existing markets, as it can both strengthen and accelerate the growth of our existing M&A portfolio.

WellCare's approach to Medicare Advantage is complementary to Centene's strategy.

Both companies focus on providing high-quality, low-cost health care to low-income seniors.

It is important to note that substantial opportunity this approach presents for the combined company.

More than 10,000 people a day in the U.S. turn 65, and 65% of seniors are at or below 40% of the federal poverty level, our target market.

The combination will also further extend Centene's robust Medicaid offerings.

Additionally, it will benefit from Centene's growing exchange presence, as we will be able to leverage our exchange platform in new markets.

Adding WellCare, we will expand our footprint from 32 to 50 states.

The combined company will provide health care services to 22 million recipients in the U.S. This consists of over 12 million Medicaid and 5 million Medicare beneficiaries, including Part D clients.

We will also be serving individuals on the exchanges, and those enrolled in the TRICARE program.

The addition of WellCare will extend our position as the largest Medicaid managed care organization in the country.

We will remain the largest provider of exchange offerings and become the fourth largest Medicare company.

We're already working on integration planning, and believe our similar values, including both companies' local approach and integrated care models, will help ensure we achieve a seamless transition.

We expect to hit the ground running when we post our integration priorities include delivering values for members, capturing synergies and retaining and attracting the best talent.

We have experienced integration leaders in both companies and are confident in the accretion and synergy targets that we outlined when we announced the transaction.

We believe Centene's leading technology platform will be essential to our success as a combined company as it provides a competitive advantage.

We will provide our platform, including our data analytic tool such as Integra, to further enhance the quality of care with the combined company recipients.

We will continue to invest in cutting-edge technology, systems and capabilities.

This will significantly enhance our ability to scale, coordinate and better manage care while leaning to lower cost.

Further, the integration of Centene's specialty platform across WellCare's membership base should also enhance quality and profit across sectors.

We recognize the importance of network adequacy.

We want to ensure access to high-quality, cost-effective providers.

We also want to ensure that these providers are appropriately and adequately compensated.

We have initiated appropriate preliminary regulatory discussions at the federal level with the Department of Justice.

We will describe these discussions as constructive and have laid out a timetable for submission.

At the state level, 5 Form Es have been filed and others are in the process of being filed.

Some preliminary discussions with appropriate regulatory authorities in our largest states have taken place.

It is our opinion these processes will protect recipients, providers and states.

As I have commented previously, there may be some form of divestitures in Nebraska and Missouri.

Based on our actions thus far, we continue to maintain our internal time lines with approval of the transaction.

The combined company will have estimated pro forma 2019 revenues of approximately $100 billion and pro forma EBITDA of $5 billion.

The pro forma revenue mix consists of 65% for Medicaid, 15% for Medicare and 15% from exchanges.

We are confident the combination will provide significant value to our collective shareholders, members, state partners and other stakeholders.

We look forward to providing updates as we move to the transactions process.

A quick note on Fidelis.

We continue to be very pleased with the performance of Fidelis.

Approximately 10 months since the closing of the transaction, integrations went smoothly.

We remain on track to realize our synergies and efficient targets.

Shifting gears to our rate outlook.

We continue to expect a composite Medicaid rate adjustment of an increase of approximately 1.5% for 2019.

Separately, CMS recently issued a 2020 Part D Medicare Advantage rate notice, and rates came in better than expected.

In summary, our strong first quarter results set the stage for us to maintain positive momentum throughout 2019 and beyond.

Our pipeline of opportunities across all lines of business remains robust.

We believe the additional scale and diversification that the WellCare acquisition provides will enhance the sustainability of Centene's long-term goal.

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

As Ed reminded you, our Investor Day is June 14 in New York City.

We look forward to seeing you there.

We thank you for your continued interest in Centene.

I will now turn the call over to Jeff.

Thank you, Michael, and good morning.

This morning, we reported strong first quarter 2019 results.

First quarter revenues were $18.4 billion, an increase of 40% over the first quarter of 2018, and adjusted diluted earnings per share was $1.39 this quarter compared to $1.09 last year.

Before I get into the details, I want to remind everyone that the company stock split was distributed on February 6, 2019 to stockholders of record as of December 24, 2018.

Now let me provide additional details for the first quarter.

Total revenues grew by approximately $5.3 billion year-over-year, primarily as a result of the acquisition of Fidelis Care; growth in the Health Insurance Marketplace business, expansions and new programs in many of our states in 2018 and 2019, including the Illinois contract expansion, another region going live for the Pennsylvania LTSS program and the beginning of operations in New Mexico; and approximately $500 million of pass-through payments from the state of California; and approximately $435 million of pass-through payments from the state of New York.

This growth was partially offset by the health insurer fee moratorium in 2019.

Moving on to HBR.

Health benefits ratio was 85.7% in the first quarter this year compared to 84.3% in last year's first quarter and 86.8% in the fourth quarter of 2018.

The increase was primarily due to the acquisition of Fidelis Care, which operates at a higher HBR, and the impact of the health insurer fee moratorium in 2019.

These items contributed to 130 basis points in the increase from last year.

Sequentially, the 110 basis point decrease in HBR from the fourth quarter of 2018 is primarily due to the performance and seasonality in the Health Insurance Marketplace business, partially offset by the impact of the health insurer fee moratorium in 2019.

The marketplace business continues to perform well, and membership remains strong as we ended the quarter with approximately 2 million members.

We continue to expect pretax margins for the year to be within our stated 5% to 10% range.

Now on to SG&A.

Our adjusted selling, general and administrative expense ratio was 9.5% in the first quarter this year compared to 10.3% last year and 9.9% in the fourth quarter of 2018.

The year-over-year decrease was primarily driven by the acquisition of Fidelis Care, which lowered the ratio by 70 basis points.

The sequential decrease is primarily due to seasonal open enrollment costs associated with the Health Insurance Marketplace and Medicare businesses that were recognized in the fourth quarter of 2018.

Additionally, we spent $0.02 per diluted share on business expansion costs during the first quarter.

Investment income was $99 million during the first quarter compared to $41 million last year and $67 million last quarter.

The increase year-over-year is due to higher investment balances, mainly associated with the Fidelis acquisition, higher interest rates on short-term investments and improved performance associated with our deferred compensation investment portfolio, which fluctuates with these underlying investments.

The earnings from our deferred compensation portfolio were substantially offset by increases in deferred compensation expense, which is recorded in SG&A.

Sequentially, investment income increased due to the previously mentioned improved earnings from our deferred compensation portfolio as well as higher average investment balances and higher interest rates on short-term investments.

Interest expense was $99 million for the first quarter of 2019 compared to $68 million last year and $98 million last quarter.

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

Our effective tax rate for the first quarter was 24.2% compared to 34.1% in the first quarter of 2018.

The lower tax rate was driven by the health insurer fee moratorium in 2019 and lower tax expense associated with a favorable outcome of a federal tax audit with respect to R&D tax credits.

This favorable outcome accounted for 150 basis points of the reduction in the first quarter 2019 tax rate.

Now on to the balance sheet.

Cash and investments totaled $14.8 billion at quarter-end, including $507 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 $6.8 billion, which includes $357 million of borrowings on our revolving credit facility at quarter-end.

Our debt to capital ratio was 36.5%, excluding our nonrecourse debt, compared to 40.3% last year and 37.4% at the fourth quarter of 2018.

Our medical claims liability totaled $7.4 billion at quarter-end and represents 48 days in claims payable, which is consistent with the fourth quarter of 2018.

We continue to 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 $1.3 billion in the first quarter or 2.5x net earnings.

The cash provided by operating activities in 2019 was due to net earnings; an increase in medical claims liabilities, primarily resulting from growth in the Health Insurance Marketplace business; and the commencement or expansion of the Arkansas, Florida, Pennsylvania and New Mexico health plans; and an increase in other long-term liabilities, driven by the recognition of the risk adjustment payable for the Health Insurance Marketplace business in 2019.

Cash flow from operations were partially offset by an increase in premium and trade receivables of $662 million, primarily due to a delay in payment from one of our state customers, which was received in early April.

Before I discuss our revised guidance, let me make a few comments on the WellCare acquisition.

As Michael commented, we are working through the regulatory approval process and have begun integration planning activities.

While it is still early in the integration planning and regulatory approval process, we continue to be comfortable with the synergy and accretion targets we communicated at transaction announcement.

As we progress through this process, we look forward to keeping you updated.

Now onto guidance.

We updated our 2019 annual guidance for the following items.

First, we are increasing the total revenue guidance at the midpoint by $2.5 billion, primarily driven by $1 billion of additional pass-through payments in New York and California, $700 million associated with the Health Insurance Marketplace business, driven by a combination of higher-than-expected member retention and risk adjustment and $500 million due to the proposed changes in the Iowa contract award.

Second, we are decreasing our full-year effective tax rate by 50 basis points to reflect the lower tax expense recognized in the first quarter associated with the favorable audit results.

Lastly, we are increasing our adjusted diluted earnings per share guidance at the midpoint by $0.13 per share.

This is the second increase so far this year and is driven by the first quarter results, $0.05 per diluted share for higher expected investment income and $0.05 per diluted share associated with increased Health Insurance Marketplace revenue I previously mentioned.

These increases are partially offset by increased business expansion cost of $0.02 per diluted share.

In summary, our full year updated 2019 guidance is as follows: total revenues of $72.8 billion to $73.6 billion; GAAP diluted earnings per share of $3.67 to $3.84; adjusted diluted earnings per share of $4.24 to $4.44; an HBR of 86.5% to 87%; an SG&A ratio of 9.4% to 9.9%; an adjusted SG&A ratio of 9.3% to 9.8%; an effective tax rate of 24.5% to 26.5%; and diluted shares outstanding of 421 million to 422 million shares.

Overall, we had a good start to the year with good performance across all of our business segments.

We believe the continued growth in revenue provides the opportunity for future earnings growth.

That concludes my remarks.

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

(Operator Instructions) Our first question comes from Josh Raskin of Nephron Research.

So my question, just it sounded like a little bit more excitement around the Medicare opportunity for next year, talking about the inflection point.

And so I was wondering if you could help sort of flesh out what gives you that confidence, how you guys are thinking about your bids with 1.5 months to go on that.

And then was there any thought as to waiting for the WellCare acquisition to close and giving yourself a little bit more time and information and management expertise in Part D plans, et cetera?

Or is it sort of now we've got the 4 stars for Centene and that's all we need?

And then just one quick one on the WellCare progress.

I understood the integration started, et cetera.

Any more updated thoughts on combined management team?

I think that'd be helpful as well.

Josh, I'll start off on the Medicare, and others can jump in, in a bit.

On the Medicare, we've said that the 2020 will be the year where it comes together.

We've been testing things.

We're recontracting with providers on this space, contracts and the things that create successful Medicare products.

So we will continue to move ahead on our own, recognizing that until we close, we can't work with WellCare.

Once we do close, they have a strong platform.

We have some -- we've added some real talent here.

And through the integration progress, we'll be putting those 2 talents together, and I think 2020 will be a very strong year for Medicare on that basis.

On the organization, I am not going to comment.

I think before I say too much on a call like this, first, the Centene people and as well as then the WellCare people need to know what the new organization would look like.

And we're not going to get into that until we get closer to the -- know when it's closing.

Simply, we have, as I said earlier, everybody focused on their respective businesses.

And then we'll move through that.

I'm sure you're going to say anything about it.

That's a better place to be.

But see you.

I will add this much.

Just we are working with some of the senior management at WellCare and have some very important responsible positions at -- they will be able to move in, in this -- into this new $100 billion company.

That's helpful, Michael.

And just one quick follow-up on the Medicare comment, 2020.

You've talked about Medicare contributing as much as 20% of growth in future years.

Is 2020 that year where we start thinking about as much as 20% of the growth coming from Medicare?

Look, I think I said during the course of a decade.

So I mean, we'll start to hit, Josh, and then you'll see it continue to ramp up.

It's not going to be adjusted, but thanks.

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

I wanted to have a question on the WellCare deal.

It sounds like you've already started the process with the states.

And again, you've identified a couple of states where you expect there to be divestitures.

Is it safe to say that based upon the conversations with the other states, where you have above average pro forma market share, you still feel confident that divestitures will not be required?

And then, I guess, how do you think about the sustainability of a state where you have pro forma 50% market share?

What -- how do you factor in the potential risk that in 2 years during a reprocurement, the state might add a new player in to replace the fact that you've consolidated WellCare?

I would say this, Kevin.

I think we try to plan ahead, and we've thought 2 of those kinds of issues in looking at this particular transaction.

I'm not going to front-run the states with a lot of discussion as to what our discussions with them.

They are very constructive.

And I will go this far and say the full we share are shares focused on worrying about the recipients and what's best for them.

Then we look at the provider networks ensuring that they're well taken care of in terms of provided for in this situation and protected and then they stay as customers.

So we're focused on all 3 of those things.

As far as divestitures are concerned, those are subject to discussion.

And even in Missouri and Nebraska, we're in discussions as to what, if anything, they want us to do.

I mentioned in the past, we had talked about in the past, that's why there are 3. And we -- 2 of the 3 are WellCare and Centene.

So we're working through and seeing what they want to do there and go from there.

I guess, in the past, you talked about the accretion, the synergy numbers, assuming a proven amount of divestitures.

Does it take into account potential issues a couple of years down the road when you give that 2-year accretion number?

Does that also factor in any kind of loss of membership if states were to [move] here?

Yes.

Sure.

It factors in a conservative position on that.

So we'll -- absolutely.

Okay.

And if I can just ask one more question.

You mentioned that the Medicaid margins have room for improvement.

Where -- how do we think about where we are in that process?

Is this a multiyear process?

Where are we versus your target margins?

And how long do you think it takes to get there?

Well, we'll never -- firstly, from a management standpoint, Jeff and all of us here, Chris, we'll never take the pressure off improving margins because the moment you stop trying to improve, they're going to bounce out.

So it's an ongoing process.

And -- but we want to do it in a way that's sustainable.

It's not -- we don't want a short-term big, huge improvement and then have something come up.

So what we're working on is the network, the contracts with various providers and keep it balanced with them.

Because we view them as part of our products that we don't want to -- you never want to hurt your products.

You want to maintain it.

So it's a total process we're going through.

And we're moving more and more to risk-based management, where the providers can do very well when they work with us and manage it.

So it's a longer-term thing, but what is important is that we see it on a sustained basis.

Hope that helps.

Our next question comes from Sarah James of Piper Jaffray.

I wanted to drill down on the services line.

It looked like cost of services increased about 250 basis points year-over-year, and we're estimating that was about a $0.04 headwind, which implies the underlying health plan results were strong.

So on the services line, I know there were some moving pieces with the VA contract and the MHS acquisition.

Can you help us bridge 1Q '19 to historical levels and speak to how we should think about revenue and gross margin on that product going forward?

I'm going to putt that one to Jeff.

Thanks, Michael.

Obviously, I think a couple of things.

First, I think you hit the nail on the head there, Sarah.

I think a few things.

It's a different mix of business than we had in the first quarter of last year.

So I guess, what I would say, as I would bridge from the fourth quarter to the first quarter, I think that's more appropriate, given the fact that we had the VA business that's no longer part of that line.

And then you also have a couple of acquisitions that we made that are changing the mix profile of that business.

And so, I guess, what I would say is I would look at the fourth quarter of last year bridging to Q1, and I think that's pretty consistent.

And I think that's what you would expect to see for the remainder of the year.

There is some lumpiness in those because there are certain -- like, for example, the home health business has some contract reconciliations that are normal and occur every year, either in the third or fourth quarter.

So it doesn't mean every quarter is going to have a consistent cost to service percentage.

But for the full year, we would expect it to look similar to the fourth quarter, maybe a little bit lower.

Got it.

And one clarification here on guidance.

Last quarter, you guys talked about 60% one half, 40% second half and, last year, you talked about a 10% or so historical average for the risk-adjusted true-up, which, based on today's Q, would be about $93 million benefit to 2Q '19.

So I just want to make sure, on those 2 aspects, that's still what guidance assumes, there's a 60/40 seasonality split and about a 10% risk-adjusted true-up benefit in 2Q.

Yes.

The 60/40 is consistent with what we said.

The true-up piece, you just have to make sure that when you do the true-up, it's really based on last year's.

It's on 2018 business, right?

You can't roll in the first quarter of 2019's risk adjustment in order to calculate the 10%.

So it's a state-by-state calculation that's really based on the business activity in the 2018 year.

Our next question comes from Peter Costa of Wells Fargo.

Can you tell us a little bit about what you're thinking about with the PBM at this point?

You've had a couple of states now convert to RxAdvance.

You're starting to see how that's performing.

Is that performing up to your expectations at this point?

Do you think you can do better by looking at what WellCare is doing, given that WellCare has the buying power of much bigger CVS behind it than what RxAdvance has, which maybe doesn't matter in the Medicaid space, but certainly matters in the Medicare space?

I think one -- the first part, the RxAdvance has been flawless in the implementation.

I expect that as we continue to enroll more states, we'll continue to find ways to improve and always do better.

Two, I think we are going to find that RxAdvance will provide some new useful tools to the WellCare and what they're doing with the purchasing they're doing, as this is really a very modern day PBM-type thing with a lot of transparency, a lot of great information, Peter, that this would serve everybody well.

So the combined -- the combination of the 2 will help.

Jesse, you want to add something?

Yes.

Yes.

Thanks, Michael.

So I think just to your point, Peter, I think as we're looking at the combined business, we do recognize the importance of pharmacy cost management on MA and PDP businesses.

And we think, as Michael referenced, the combination will certainly have the ability to leverage in the capabilities from the WellCare team and their experience.

So are you talking about some kind of a combination of RxAdvance and what WellCare's doing currently with CVS?

We're working through the integration now, and we'll determine what part each one should play in it.

So you're probably about 2 months ahead of us, but it's a good question, Peter.

All right.

And this is the last question.

The third quarter of last year, you had some reconciliation benefit from the California in-home services and sports program ending, and you talked about perhaps getting some more of that reconciliation completed in 2019.

Was there any of that in this quarter?

Or do you expect any for the remainder of the year?

There was not any of that in this quarter.

And as you're well aware, typically, what happens, you're waiting for the final reconciliation and the state notifies you.

So we don't have any of that included in our guidance.

And more to come.

I guess we're waiting to see what the results are.

Do you expect that to be positive when it happens?

I mean, we made our best estimates.

So it could go either way, but we've had a history of making relatively conservative estimates.

So that's -- I guess, I'll leave it at that.

Our next question comes from Scott Fidel of Stephens.

First question.

Just interested in your assessment on the final 2020 exchange reg that came out late Thursday.

Then just specifically also whether you think the subsidy tweak that CMS made will have any impact on exchange market fundamentals or it's just you don't see it as particularly being material.

Kevin, do you want to comment on that?

Sure.

Scott, I think, in general, we're pretty much supportive of the new final rule.

We think the lower user fee is definitely appropriate.

We support the fact that there's no change in either the silver loading or the automatic reenrollment.

We also are supportive of the exclusion of the manufacturer coupons for patient cost sharing, which we think is going to actually incent members to take more attractive generics.

And we think some of that offset -- that some of that headwind that you're talking about could be offset both by the lower user fee as well as the fact that manufacturer rebate change -- or manufacturer coupon change that I talked about is also going to create more incentives for people to take generics.

So we think some of that projected $980 million was APTC, which I think is what you're referring to, will be offset by those 2 items.

Got it.

So net-net, when you look at all the different variables, would you actually view the final exchange rule as more of a sort of neutral to slightly positive overall?

That's our view.

Okay.

And then just I had a follow-up question.

Just actually wanted to tack on to Sarah's question just about some of the moving pieces in the specialty segment.

I noticed in the Q, you guys mentioned how in the 2Q, we'll probably see more of a noticeable shift from earnings, from specialty over to managed care, as you continue to implement the new Rx pricing model.

Jeff, interested if you can maybe just walk us through sort of functionally how that plays out within the 2 P&Ls.

Is it basically you have a lower gross margin in the specialty segment and it benefits the MLR in the managed care segment?

Or just interested in the exact mechanics of how that works out.

Yes, you're exactly right.

That's what we preview, and we included that language in our 10-K.

You're exactly right.

There would be a lower gross margin in the segment results for the specialty that would, in turn, directly benefit the health plan results.

And just to make sure I clarify for everybody, that's -- only in the segment disclosure, and that's intercompany item.

So that gets eliminated in the consolidation.

So for -- we're not talking about the cost of service line, for example, that's reported on the GAAP financials.

Our next question comes from Dave Windley of Jefferies.

I wanted to ask a follow-up in pharmacy.

Michael, I believe I caught you saying in your prepared remarks that Centene would be supportive of a move to net pricing.

And if I'm interpreting that right, elimination of rebates and a reduction of manufacturer price to net.

If I'm interpreting that correctly, I'm curious what mechanism you would see as the governor to pharmaceutical price increases after that happens.

Well, I think, one, I said some time ago that that's something I believe we will work very hard to try to move to.

And if we're successful in it, the governor on price increases will obviously be the competitive world.

And we will be a -- we'll have the critical mass in drug purchasing that all the pharmaceutical companies will have to take it seriously.

We've said that 30 billion we see is a growing number.

And as that continues to grow, and as RxAdvance information becomes ever more credible, I think we'll have the data we need to encourage competitive pricing.

Got it.

If I come back to medical costs.

Appreciate the reconciling items that you provided.

I'm curious if there's any difference year-over-year in the contribution or lack thereof from flu.

And with a relatively, I guess, in-line expectation after those adjustments, if there were other moving part -- if flu was better this year, for example, were there other moving parts as an offset?

I'll let Jeff -- I'll cover the flu initially.

But I want to remind you, the flu -- we had a flu season it looked like 2 years ago, not last year.

But when you have the scale and size, it will be a $70 billion enterprise issue before -- that the medical costs associated to flu is really not a major factor and it's part of the total medical costs.

So that's something that we plan for, we book for, but a variation will not have a material effect.

Jeff?

Yes.

Thanks, Michael.

Dave, I think Michael's spot on.

We're obviously calling out the large drivers -- the largest drivers obviously which being Fidelis and the health insurer fee moratorium are the 2 largest pieces.

I would say we did see a lighter flu than we did in the first quarter a year ago, but we also had, I'd say, a lot of new businesses starting up, including the Pennsylvania LTSS, New Mexico.

And as Michael mentioned, we recorded a higher level of HBR in those because you're also building margin at the inception.

And then we had new members in both Illinois and Florida.

And so I think those were smaller drivers on an absolute basis, but you add all that together and they're kind of offsetting.

Our next question comes from Matt Borsch of BMO Capital.

Yes.

Maybe you could talk about the Iowa situation and how you expect that to unfold.

And what gives you confidence that unlike the peer company that exited the market, you can reach a mutually workable rate arrangement?

Well, I think, one, we've had discussions over a long period of time at the most senior levels of the state and in the regulatory environment.

And we have a real comfort in their commitment to have a very successful managed care program.

It's very obvious.

Historically, we've been offered contracts and have turned them down rather than -- and taking a new contract and filing a PDR before you even have your first member.

That's something we try to avoid.

So we -- but at this time, we looked at -- our actuaries looked at it.

The state just -- the legislature just voted additional $150 million variables to help sustain the program and improve it.

So everything we look at said that this will be a successful program.

And I know some peers have exited.

It was a different time.

If I had entered when they did, I might have a different feeling than I do coming in now with the new administration in place the past year or so.

And they're very aggressively looking at how they can have a successful program.

Michael, if I could just follow that with one question, partly related, which is, do you have a view on the optimal number of participants in a given state?

I know the question isn't quite as simple as that because you've got small states and large states, but...

Right.

Are 2 plans sufficient for some states like the size of Iowa?

Yes.

Let me put it this way.

Regardless of the size, I think the optimum is -- was just us.

Okay.

Now had we moved away -- when you move beyond that -- you kind of hit on it.

I think in Iowa, the size and scale, too, is appropriate.

It's really sweet.

You can deal with that.

We saw Georgia go from 3 to 4. So -- and that really did not have much of an impact.

And that's fine because you have choice.

And when you have the -- it always starts out with choice.

And we have the network.

We have the reputation we have in most of these states.

We tend to do well with this choice.

So we deal with it as it is.

In Florida, there's some counties -- I think Dade County has -- as many as 6 plans in it and that's okay.

But the way the algorithms work on auto assigns, the member of the families in and how the members get a size of the plan, it's the -- the states that have been doing it for a while understand and get it right.

And obviously, when you look at the growth we've had and how we're doing, we're very comfortable with the way it is.

And so you really hit on it.

It's really a function of the size of the state as to how many.

Our next question comes from Charles Rhyee of Cowen.

I'd like to go back to pharmacy a little bit.

And you talked on this idea of going to -- of supporting credit price transparency.

When it comes to pharmacy, my understanding, generally speaking, right, states have tended to like the current rebate model in part because rebates don't necessarily have to be from back to health care.

It can be used for general sort of budget purposes.

As you see the market moving maybe towards greater transparency and maybe even towards the net pricing model, how do you see states moving towards this as well?

And how do you see them sort of operating within this kind of this new world, I guess, as we think about the way pricing starts to evolve?

And sort of how you -- how do you think this would impact your pharmacy business, particularly as you try to roll out RxAdvance further?

I think that's where they are right now.

They -- I mean, they're pushing more and more for transparency on where it is for pass-throughs, the pricing and how they're doing it.

So they really have moved away from just a pure rebate type model.

And we're hearing more and more at the federal level about rebates at point-of-sale and that type of thing.

So that whole -- it's all in transition.

It's in flux right now.

And I think the things we can do, and if we can move to a net price type thing that everybody can do much better with the transparency, the competitive bidding, et cetera.

So as -- you're not playing with discounts and rebates and volumes and things, here's the drug cost -- and it's particularly important on specialty pharma.

So this is something that can apply to both.

So I think the states are really adapting to it and have been, in their own way, moving more towards it on an ongoing basis.

And then maybe following up on Dave's question in terms of sort of a governor for price increase in the future.

You talked about price competition from transparency, but what about that, in many cases, right, a lot of these, particularly in specialty, while these drugs are the only drug in their class, so there's really no competition, how do you look to manage costs in those particular drugs, where there is little to no competition?

So you manage it through effect by managing the utilization effectively.

I mean if you have only one drug, and it's a curative drug, you -- I mean you negotiate the best that you can, but rebates aren't going to help you there one way or the other.

I mean it's -- you're not going to get rebates because they're going to be the same.

So what you do is you manage the utilization and ensure that people are getting a specialty pharma drug, whether you use genome or other things, it's going to be supportive and health-performing.

If it's curative, you're going to get it for them, and that what's important.

When the hep C drugs first came out, they were expensive, and it didn't take long before a second one showed up.

So it's not -- usually not very long.

I used to be in the pharma side with Miles and eventually full time at Bayer.

And we learn very quickly.

If you take your margins up too high, you're just leaving room for somebody to come in under you.

And so you're going to get competition very quickly if the pricing gets too abusive.

Is that helping?

Our next question comes from Steve Tanal of Goldman Sachs.

I guess, the -- I wanted to follow up on just sort of the HBR, the new program, and then talk about DCPs for a second.

So I guess, the way I'd come at this is flattish HBR x Fidelis and HIF looks like a pretty solid outcome when you've expanded or entered into new programs in 4 new states.

So I guess, I'd first ask how those programs are shaping up in the early days.

But it seems like the numbers would suggest quite good.

And so maybe the real question is around Jeff's comment on DCPs returning to the mid-40s.

From 47.9 at the end of the first quarter to 2.9 days, 3 days to get to 45, let's say, is sort of like $450 million of excess reserves using Q1 claims per day.

So does that math sound right?

Is it fair to think about that as an excess?

Or are there seasonal fluctuations either in marketplace or otherwise we should be thinking of?

And just finally, is there anything you can tell us about sort of the path and time line to returning to mid-40s, if that's the right level?

Yes.

Certainly, Steve.

A lot in that question, but I'll start with the DCP in the first.

I mean what we're saying is that's our long-term range.

That doesn't mean by the end of this year.

There's a couple of things with Fidelis on the cash timing that we're still working through that could reduce that sometime this year.

So think of it as more like a day, maybe 2, by the end of this year.

Then, ultimately, when you look at DCP, a lot of that has to do all with timing of payments, right?

It's really a timing of payment measure, not necessarily how your reserves are.

We look at reserves differently as a percentage of medical expense, which we've been very consistent over the -- since the last 5, 10 years.

We've had a very consistent reserving methodology.

So I guess, what I would say is it's more timing-related to anything.

The other thing is we have obviously some risk-based contracts with some providers.

Those accruals are in the IBNR balance.

Some of those accruals are in the IBNR balance.

And when those get paid, the IBNR goes down.

So those are the things that we're dealing with and why we call out timing of payments from a quarter-to-quarter perspective.

Perfect.

Very helpful.

Is there any comments on those -- on the new state programs, Florida, Illinois and...

Yes.

Yes, sure.

On the HBR side, I guess, what I would say is it's in line with our expectations.

You have to remember Pennsylvania is an LTSS award.

So it's going to be in the 90% plus range from an HBR.

So it's really a mix of business that obviously impact on the total HBR of the company.

But in general, those programs are -- and the expansions are running exactly in line with our expectations.

And as Michael mentioned before, a lot of times, there's continuity of care periods.

And then obviously you have to build margin on that additional new business.

And that impacts the HBR early in the program, but nothing outside of our expectations.

I think, probably just to set that in a new plan, you don't have -- we use a date received methodology for calculating.

It's proved to be a very accurate way to do it versus creating claims.

But you need the history of quarters -- 2, 3 quarters to be able to do the accurate accounting of it.

That's -- I think we'll never say never, but we're proud of the fact you don't see a lot of prior-period adjustments.

And so it works.

So rather than take the chance, we typically will book it at 90% for the first 3 quarters or so, just not knowing if it's where it is.

And that has typically served us well.

So that's the approach we take to it.

Our next question comes from Ana Gupte of SVB Leerink.

Appreciate you taking the question.

On the deal again, as you're having conversations with the DOJ, which I'm assuming will be the arbiter here in the states, as you have like a broad platform now across Medicaid exchanges and Medicare, do they view that in a favorable context?

And what types of -- what type of feedback are you getting from the DOJ and states, if any?

And how does that dovetail with kind of this integrated -- not integrated duos, but states looking for players to be in Medicaid to participate in the special needs plans and so in cases like Florida?

I think the states recognize -- they recognize the systems and the capability we have to really improve outcomes and control costs on a very fair, balanced basis.

So that echoes a long way.

Now there has not been this kind of Medicaid acquisition.

Going back, I think they said it was, I guess, a miracle.

It was the last one that turned.

And so there's some new -- they're reestablishing grants.

But when you look at this, it's a different form of competition.

You have states setting rates.

You have things of that nature.

So it's working through and talking about all these elements.

And I don't want to get ahead of them, but we're finding that their questions are really the kind one should expect in this kind of transaction.

And it's constructive.

And as I said, it's really focused in 3 areas: one [where to push] what's best for the recipient.

Because we're dealing with a fragile population.

We emphasize that.

And it's important to think about them to the provider network.

This is not just gaining critical mass against them, but how do you get the kind of size and scale that allows you to do the risk-based contracting so many of them want.

And we show the data of what we can do and how we do that.

And thirdly to state how we're able to contain costs and how the benefit of large numbers everybody wins on.

So it's -- and it's been an enlightening process.

And I think I'll add one other thing.

And we've done other deals, but I'm finding that we have a lot of very smart regulators at the state level.

And they're asking the right questions.

They understand it, and they're able to think through it.

I find that positive.

And I think we're finding that the Justice Department is -- and the federal level, they're equally trying to get this right.

And so I'm very encouraged just by the provided question.

That doesn't guarantee the absolute maximum outcome.

I'm not trying to float on that, but I feel good about where it is at this point in time.

Thanks for the update.

And then one more on the taxes and the Louisiana reprocurements, any updates there?

With the Louisiana, it -- we're -- that just went in.

Yes.

Louisiana, I think, is due to be submitted next week, and no update on the Texas time line other than what we've previously discussed, I think May or June time frame.

Our next question comes from A.J. Rice of Crédit Suisse.

First, on the public exchange comments, you highlight member retention being better than favorable risk adjustment.

I wonder if you could flesh those out a little more, what you're talking about there.

And I think last call, when the -- or maybe it was on the Investor Day when you gave guidance about the exchange this year, you said you'd be in the 5% to 10% range as last year, but down slightly in margin within that range.

Is that still your thinking?

Or have you changed in the way you think about what the margin looks like this year versus last year?

Jeff?

Yes.

Thanks, A.J. It's Jeff.

Yes.

No, nothing different than what we said in our previous guidance with respect to exchange.

Yes.

We do expect it to be a little bit down from 2018, more similar to '17, '16, '15, the margin that we had there.

As far as the retention, I think we have a normal retention rate that we've assumed based on our historical experience, meaning how long a member stays with us and pays premiums.

Obviously, you can go back and look at the historical retention rate from beginning to end, and we've been obviously tracking that.

And what we're seeing is that members are actually staying and paying in premiums longer, which is obviously a good thing.

And that's driving, I guess, the additional revenue that we added to the guidance today.

The other piece is risk adjustment.

And on the risk adjustment side, we have certain geographical areas where we've got a lot of scale.

We've grown the business very successfully.

And as you continue to grow and capture a larger percentage of that market, you do see a little bit of a return to the mean on the risk scores, nothing significant.

But obviously, that was the other piece of the guidance increase on the revenue line.

Okay.

And then just taking a quick glance at your 10-Q.

I mean I hope I have this right.

It looks like you're up about $230 million in prior-year development, this year's first quarter versus last.

And I know that's a gross number.

Is that a function of the Fidelis and the exchange volume?

Or what's driving that?

And any comment about that?

Yes, that's pretty much all related to Fidelis.

We've put a note actually in the table of our press release kind of highlighting that the press release has a 12-month roll forward, which does not include the Fidelis business because that transaction happened July 1 of last year.

So the development is not included in that 12-month roll forward.

But in the 10-Q, that is a 3-month roll forward from December's number, which obviously does include Fidelis.

And so that's the difference there.

Our next question comes from Justin Lake of Wolfe Research.

A couple of follow-ups here.

One on the PBM side, the -- when you've looked at -- now that you've had some conversations -- I assume, some greater conversations with WellCare Group on the -- on their ability to drive cost savings, and they've talked a lot about how much they've been able to save at CVS and use their scale, is there any comparison you've been able to kind of make versus your kind of cost of goods on the PBM side of Centene?

Is -- and is it comparable?

Is WellCare greater?

Or are you guys greater?

Any kind of color you can give us there?

Yes.

Justin, this is Jesse.

So I think, just obviously there's a limited amount that we can comment on with respect to relative pricing on those things.

I mean that's -- obviously, we went through an appropriate process on that in the diligence phase.

And I think as we said, as part of the announcement of the deal, that there are kind of net synergies anticipated on the pharmacy front.

So I don't think it'd be appropriate to go into too much more detail than that at this point.

Okay.

And then just following up on the risk adjustment side.

Can you give us an idea of how big you expect that risk adjustment payable to be at this point, given the kind of shift and the risk you're talking about here?

And any impact or kind of update you can give us on margins that you're seeing kind of as you get a full look at the book?

Yes.

A couple of things, Justin.

I would say risk adjustment obviously we continually update that estimate every single quarter.

And so that changes, but I would say over $800 million is what we're anticipating on the risk adjustment payable for the year.

On the margin side, it was right in line with our expectations.

And obviously, we expect it, and we're expecting for the year a little bit lower in our margin range compared to last year.

So nothing out of the ordinary there.

The exchange business performed well, and it was right in line with our expectations for the quarter.

Our next question comes from Ralph Giacobbe of Citi.

I wanted to go back to Iowa quickly.

I think in your prepared remarks, you said that those [plans] would be split equally, but the $500 million boost in your guide for the back half seems a little bit lighter.

I thought the United business was closer to a $3 billion annualized number.

So is that related to mix?

Is it maybe timing?

Just hoping you can maybe reconcile that.

Yes.

No.

I mean I think if you look at United, they had a larger percentage of the business.

They didn't have just half.

And so we've previously given a range of membership, I think, of 180,000 to 200,000 members.

So we've updated that to half the market.

And obviously, we're only getting half the year.

So nothing unusual other than the mathematics behind that.

Okay.

And then you said you assume a higher MLR in new business as you've talked about, which certainly makes sense.

For this, just remind us, are you assuming a loss in year 1 or more breakeven?

And if it is, assuming a lot of breakeven?

Yes, more breakeven, which is why you didn't see any earnings flow through on the increase in the revenue line for the 6 months.

And we're not talking about '20.

So just for the 6 months in '19, we're assuming breakeven.

Our next question comes from Gary Taylor of JPMorgan.

Just three clarifications, nothing original at this point and all financials.

So sorry, Michael.

I'm going to go to Jeff.

Okay.

It's okay.

I understand financials, too.

So...

That's fair.

Well, you can take a shot at this.

Just on days claims payable, and I appreciate the comments about timing.

And in fact, when I look at the roll forward for the first quarter in the Q, it does look like the ratio of current paid versus incurred slipped about 300 basis points year-over-year from about 64 to 61.

So a lot of that -- a lot of the impact on days claims payable does look like it's sort of timing-related.

Is there anything to call out in that or just illustrating the point that you were making earlier?

Yes.

No, nothing to call out.

I mean I would say that this is a 3-month roll forward that's in the 10-Q.

And so that number -- I mean, we've only had 3 months of runout on those medical claims from December.

So that number will -- all things being considered, would, in theory, continue to grow.

So you have to -- it's only 3 months out.

And usually, in the press release, it's a full year roll-forward.

So that number will continue to change, I guess, is what I would say.

But no, nothing unusual, which is -- I mean, from our view, it's consistent.

It's consistent on a percentage of medical costs.

That's how we track it.

We show this information to our Audit Committee and Board every single quarter.

It's been very consistent for a long period of time.

The methodology hasn't changed, so we're comfortable where it is.

Got you.

And just trying to understand, on the investments, I caught what you said about -- a little bit higher balances and higher rates, but the investment income more than doubled year-over-year on about a 12% year-over-year increase in the investment balance.

You called out a little better investment income in the quarter, but you also guided for that continuing for the year and part of the guidance raise.

So is there any extra color on how you're doing so much better on investment income versus the growth investment?

Yes.

Sure.

Good question.

Two things.

Fidelis, so you have the impact of Fidelis.

We have their investments.

We didn't have those at the first quarter or second quarter of last year.

So you get the full effect of the Fidelis investments.

The other thing is, on the health insurer fee, we had received payments for the last year's health insurer fee reimbursement from a lot of our states earlier than we have historically.

So think of that number to $300 million to $400 million that we have earlier in the year than we've had in the past.

And so you're earning investment income on that.

And then obviously we had a strong cash flow generation for the quarter, and a lot of that cash goes to the balance sheet, and we earn a short-term interest rate on it.

So ultimately, you add up all those 3 things, and that's really driving the increase on a year-over-year basis.

Okay.

And then final one was I think Scott had mentioned the 10-K disclosure about move -- starting in the second quarter seeing some of those specialty earnings moving to MCO inter -- intracompany in the elimination.

Is the effect of that -- or is what driving that merely less retained rebate at the PBM more going to the health plan?

Or what's the dynamic that drives that?

It's nothing other than internal dynamics as far as the margin on -- as we move to transparent pricing, there used to be a margin there that's no longer going to be there.

There's going to be a small piece really on the administrative front, but the margin just moves into the health plan segments.

So nothing other than, I would say, internal company activity.

This concludes our question-and-answer session.

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

No.

Just thank you for your questions, your attention, your participation.

We're off to a strong start and looking forward to investment day and future quarter reports.

So have a good day.

Thank you.

The conference has now concluded.

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