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Edited Transcript of MGLN earnings conference call or presentation 1-Nov-19 12:00pm GMT

Q3 2019 Magellan Health Inc Earnings Call

AVON Nov 19, 2019 (Thomson StreetEvents) -- Edited Transcript of Magellan Health Inc earnings conference call or presentation Friday, November 1, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Barry Smith;CEO

* Joe Bogdan

Magellan Health, Inc. - SVP of Corporate Finance

* Jonathan Neal Rubin

Magellan Health, Inc. - CFO

* Ken Fasola

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Conference Call Participants

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* David Anthony Styblo

Jefferies LLC, Research Division - Equity Analyst

* Kevin Mark Fischbeck

BofA Merrill Lynch, Research Division - MD in Equity Research

* Scott J. Fidel

Stephens Inc., Research Division - MD & Analyst

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Presentation

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Operator [1]

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Welcome, and thank you for standing by for the third quarter 2019 earnings call. (Operator Instructions) Today's conference is being recorded. If you have any objections, you may disconnect at this time.

Now I will turn the meeting over to Joe Bogdan. Thank you. You may begin.

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Joe Bogdan, Magellan Health, Inc. - SVP of Corporate Finance [2]

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Good morning, and thank you for joining Magellan Health's Third Quarter 2019 Earnings Call. With me today are Magellan's CEO, Barry Smith; and our CFO, Jon Rubin. We're also fortunate to have our incoming CEO, Ken Fasola on the call as well. While he won't be taking any questions today, his first day at Magellan will be November 14, and he'll be on our 2020 guidance call in December.

The press release announcing our third quarter earnings was distributed this morning. A replay of this call will be available shortly after the conclusion of the call through December 1. The numbers to access the replay are in the earnings release. For those who listen to the rebroadcast of this presentation, we remind you that the remarks made herein are as of today, Friday, November 1, 2019, and have not been updated subsequent to the initial earnings call.

During our call, we'll make forward-looking statements, including statements related to our growth prospects and our 2019 outlook. Listeners are cautioned that these statements are subject to certain risks and uncertainties, many of which are difficult to predict and generally beyond our control. These risks and uncertainties can cause actual results to differ materially from our current expectations, and we advise listeners to review the risk factors discussed in our press release this morning and documents we filed with or furnished to the SEC.

In addition, please note that Magellan uses certain non-GAAP financial measures when describing our financial results. Specifically, we refer to segment profit, adjusted net income and adjusted EPS, which are defined in our SEC filings and in today's press release.

Segment profit is equal to net revenues less the sum of cost of care, cost of goods sold, direct service costs and other operating expenses and includes income from unconsolidated subsidiaries but excludes segment profit from noncontrolling interests held by other parties, stock compensation expense, special charges or benefits as well as changes in the fair value of contingent consideration recorded in relation to acquisitions.

Adjusted net income and adjusted EPS reflect certain adjustments made for acquisitions completed after January 1, 2013, to exclude noncash stock compensation expense resulting from restricted stock purchases by sellers, changes in the fair value of contingent consideration, amortization of identified acquisition intangibles as well as impairment of identified acquisition intangibles. Please refer to the tables included with this morning's press release, which is available on our website for a reconciliation of these non-GAAP financial measures to the corresponding GAAP measures.

I will now turn the call over to our CEO, Barry Smith.

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Barry Smith;CEO, [3]

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Thank you, Joe. Good morning, and thank you all for joining us today. On our call this morning, I will comment on the financial results for the quarter and a reduction to 2019 guidance. I'll also highlight business and operational developments, including progress on our margin improvement initiatives.

For the third quarter of 2019, we reported net revenue of $1.8 billion, net income of $21.3 million and EPS of $0.86 per share. Our adjusted net income was $30.2 million or $1.23 per share, and we achieved segment profit of $72.2 million. Results for the quarter were solid in MCC and Pharmacy, but we are lowering our 2019 earnings guidance, primarily due to the following 2 factors: cost of care pressure in our behavioral and specialty health business and severance charges related to our operational improvement initiatives. As I'll discuss, these pressures are short-term in nature and should not affect progress towards our margin goal of at least 2% adjusted net income by 2021.

Later in the call, Jon will provide additional details on our quarterly financial results, our updated 2019's earnings guidance and some initial commentary on our outlook for 2020. Now let me highlight some specific developments within our business during the third quarter and the progress we are making towards our margin improvement plan. Within our Magellan Complete Care portfolio of managed Medicaid health plans, we continue to execute against our medical action plans towards the goal of achieving industry competitive margins. In addition to reducing costs, our team remains focused on improving the quality and associated outcomes from the medical services provided to our members.

In Virginia, I am pleased to report that our efforts to improve the cost of care continue to show progress. Our medical loss ratio for the quarter was in the low 90s. The focus of our medical action plans has not changed to Virginia. We continue to drive value through the appropriate management of inpatient, outpatient and personal care services as well as claim payment integrity reviews.

For example, we've been successful in managing outpatient behavioral health services, where we approach care coordination on a member-centric basis. The key is understanding what's best for the member and proactively connecting them to the appropriate care, while avoiding waste and duplicative services. These upfront interventions also prevent increases in inpatient hospitalizations and ER visits. While we still have work to do to reach our target margin in Virginia, we feel good about the continued progress we've made to date in 2019.

Regarding our New York plan, we highlighted our second quarter earnings call -- in our call that we were awaiting updated capitation rates for the current fiscal year. I'm pleased to report that we've received these new rates, and they are largely in line with our expectations, including an update to our risk scores to reflect the increased security of our population.

Now turning to our behavioral and specialty health business, we have experienced an increase in cost of care, particularly for inpatient admissions within our behavioral health business. We are currently working on action plans to mitigate the impact. I'd also note that our customer contracts allow for annual resetting of capitation rates to reflect emerging experience and anticipated future trend. So while these cost pressures affect our 2019's earnings outlook, we do not expect a material ongoing impact in 2020.

With respect to product development, we have recently deployed an industry-leading automated prior authorization solutions called Decision Point. The tool will provide clinical guidelines for determining the medical necessity of certain imaging procedures to inform providers and enable authorization determinations in real-time through full integration at the point of care. Because providers are increasingly accountable for the cost of care of their patients. We see this as a new growth channel and are currently piloting the program with a number of provider groups.

Now let me provide you with some quarterly operational highlights for Magellan Rx. Throughout 2019, we have been actively working towards our strategic priority of lowering the cost of goods sold through negotiations with our network pharmacies, manufacturers and wholesaler. I'm pleased to report that, to date, we have renegotiated a 98% of the supply chain, creating savings for our customers while also improving our gross margin. Our pharmacy team has also been broadening and deepening our specialty carve-out services to retain existing and attract new customers. We continue to evaluate therapeutic classes of drugs where there is an increase in competition, which enhances our opportunity to develop management strategies that create savings while maintaining or improving quality of care.

The U.S. Food and Drug Administration has recently reported that biologics are the fastest-growing class of therapeutics. Earlier this year, in response to the growing biologic spend, we expanded our formulary management program into therapeutic classes such as oncology biosimilars and medical management biologics -- medical benefit biologics to treat asthma. In preparation for the expanded market entry of oncology biosimilars, we have also expanded our medical pharmacy management program into a comprehensive solution that aims to educate consumers, customers, members and providers. These expanded products and services are already gaining solid traction with our client base.

In our PBM book of business, we continue to see traction with larger employer accounts in our core middle-market employer business. We feel good about our prospects for 2020 organic growth and retention rate. We will share more details, since our plan was finalized in early December.

In addition, we are pleased to share that Magellan Rx Management was recently accredited by NCQA for utilization management. This recognition reflects the high quality of medical management that we provide to our customers and their members. In our Part D business, our bid rates were below the benchmarks in 3 out of 4 regions that we bid, and as a result, we estimate to retain 80% to 90% of our current membership in 2020. As we've mentioned in the past, our entry into the PDP business was primarily designed to gain the necessary experience to serve the Managed Care PBM market.

One of the key elements to our multi-year margin improvement strategy is reducing our administrative costs. We continue to review and execute against opportunities to improve efficiency across all of our businesses through our efforts to consolidate platforms, remove redundancy and rightsize operations. As I noted earlier, we plan to incur severance charges later this year, which reflect the anticipated 2020 implementation of several of these initiatives. Some of these savings will contribute to our future margin expansion target, and others will be used for funding investments for our business. We'll provide more details during our 2020 guidance call in December.

Before turning the call over to Jon, I'd like to emphasize that the headwinds facing us this year are short-term in nature and should not affect the pace of our margin improvement plan. We continue to see significant long-term opportunity for both growth in our health care and pharmacy businesses, and we remain focused on improving the adjusted net income margin for the company to at least 2% by 2021.

Now I'll turn the call over to our Chief Financial Officer, Jon Rubin. Jon?

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Jonathan Neal Rubin, Magellan Health, Inc. - CFO [4]

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Thank you, Barry, and good morning, everyone. On today's call, I'll review the third quarter results, discuss our revised outlook for 2019 and provide some initial commentary on our 2020 business plan.

For the quarter, revenue was approximately $1.8 billion, which is relatively consistent with the same period in 2018. Growth in MCC Virginia and new business were essentially offset by MCC Florida and Medicare Part D footprint reductions as well as the previously discussed PBM health plan contract loss due to an acquisition.

Net income was $21.3 million and EPS was $0.86. This compares to net income and EPS of $27.1 million and $1.09, respectively, for the third quarter of 2018. Adjusted net income was $30.2 million and adjusted EPS was $1.23. This compares to adjusted net income of $36.2 million and adjusted EPS of $1.45 for the prior year quarter. Segment profit was $72.2 million for the third quarter compared to $88.3 million in the prior year quarter.

Now for our health care business, segment profit for the third quarter of 2019, was $44.7 million versus $61.7 million in the third quarter of 2018. Health care results for the current quarter include net favorable out-of-period adjustments of approximately $4 million compared to $22 million of net favorable out-of-period adjustments in the prior year quarter. Adjusting for these out-of-period items, segment profit was $1 million higher than in the prior year quarter. This net increase in segment profit is driven by progress on our cost of care initiatives in Virginia, offset by cost of care pressure in the behavioral and specialty health care business as well as lower discretionary benefit expenses in 2018. As Barry mentioned, we're seeing an increase in demand for behavioral inpatient services this year. We're currently in negotiations with key behavioral customers on our 2020 rate renewals, which will incorporate this recent experience, so we don't expect significant earnings pressure to continue into 2020. In addition, we're continuing to strengthen and execute our care management program, particularly inpatient concurrent stay reviews and targeted network initiatives.

Turning to pharmacy management. We reported segment profit of $35.4 million for the quarter ended September 30, 2019, which was an increase of 5.2% from the third quarter of 2018. This year-over-year increase was primarily driven by growth and improved profitability in our Magellan Rx specialty division.

Regarding other financial results, corporate costs, inclusive of eliminations but excluding stock compensation expense, totaled $8 million compared to $7 million in the third quarter of 2018.

Total direct service and operating expenses, excluding stock compensation expense and changes in fair value of contingent consideration, were 14.3% of revenue in the current quarter compared to 13.8% in the prior year quarter. This increase is primarily due to lower discretionary benefit expenses in the prior year quarter and a change in business mix.

Stock compensation expense for the current quarter was $4.8 million, a decrease of $4.5 million from the prior year's quarter. This reduction is primarily due to timing related to vesting of certain equity awards.

The effective income tax rate for the 9 months ended September 30, 2019, was 31.2% versus 26.3% in the prior year. The 2019 year-to-date tax rate is higher than the comparable 2018 rate, mainly due to book to tax differences related to stock compensation expense, partially offset by the suspension of the health insurer fee in 2019. We anticipate a full year effective income tax rate of approximately 31%.

Our cash flow from operations for the 9 months ended September 30, 2019, was $144.4 million. This compares to cash flow from operations of $34 million for the prior year period. This year-over-year improvement is primarily related to favorable working capital changes and lower tax payments.

As of September 30, 2019, the company's unrestricted cash and investments totaled $220.3 million compared to $130.4 million at December 31, 2018. Approximately $105.4 million of the unrestricted cash and investments at September 30, 2019, is related to excess capital and undistributed earnings held at regulated entities. Restricted cash and investments at September 30, 2019, decreased to $500 million from $527.7 million at December 31, 2018. This decrease was primarily due to changes in working capital of our regulated subsidiaries.

Now as Barry mentioned, we're lowering our earnings guidance, and the primary drivers for the reduction are: first, pressure in our behavioral and specialty health care business, primarily related to higher-than-anticipated demand for behavioral inpatient services; and second, an estimate of severance and other costs that we expect to recognize later in 2019. Specifically, we're revising our 2019 full year earnings guidance ranges to the following: net income of $47 million to $65 million, EPS in the range of $1.92 to $2.65, adjusted net income of $82 million to $98 million, adjusted EPS in the range of $3.35 to $4 and segment profit of $245 million to $260 million. We're maintaining our current revenue guidance range of $7 billion to $7.2 billion.

As I noted previously, with key rate renewals and progress for our behavioral health customer contracts, we believe we'll mitigate the majority of this earnings pressure in 2020.

We're in the process of finalizing our business plan for 2020, and we'll provide detailed guidance in early December. In advance to the 2020 guidance call, I'll now provide some high-level commentary. To start, the midpoint of our revised 2019 guidance range for segment profit needs to be adjusted by 2 factors to arrive at a run rate: first, approximately $22 million of combined net favorable year-to-date out-of-period adjustments and estimated fourth quarter severance charges; and second, approximately $12 million of additional segment profit in 2020 related to the provision for nondeductibility of the health insurer fee, which we expect to be reinstated. After adjusting for these 2 items, our 2019 normalized segment profit run rate would be in the range of $235 million to $250 million. We expect that 2020 segment profit will be significantly higher than this normally -- than this normalized 2019 segment profit range. And key drivers of the segment profit increase in 2020 are continued execution against cost of care initiatives for MCC Virginia and other health care contracts, rate increases in our health care business in excess of care trend and net business growth.

In closing, our results for the quarter in MCC and Pharmacy were solid. Despite the short-term pressure we're seeing in our behavioral and specialty health care business, we're making good progress on our profitability improvement initiatives and are well positioned to achieve earnings growth in 2020 and beyond.

And with that, I'll now turn the call back over to Barry. Barry?

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Barry Smith;CEO, [5]

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Thanks, Jon. As we end today's call, I am delighted to introduce Ken Fasola as Magellan's new Chief Executive Officer to succeed me, effective November 14, 2019. The Board and I are all pleased that we're able to have -- to attract such a capable individual of Ken's caliber, who has broad health care experience and a proven leadership track record. Ken has had a successful leadership career spanning 3 decades in the health care industry. He's held key executive roles at Humana, UnitedHealth Group and the blues in business operations, marketing and sales. Most importantly, he has served as President and Chief Executive Officer of HealthMarkets, one of the largest health insurance agencies in the U.S., which was acquired earlier this year by UnitedHealth Group. I know the Board is looking forward to working closely with Ken and Magellan's executive leadership team to continue the next phase of growth for the company, I've agreed to assist with the transition as needed.

On a personal note, I am grateful to the Board and our executive leadership team and Magellan's 10,000 employees for their commitment and dedication to Magellan Health, its members, customers and investors. Over the past 7 years, the company experienced a period of expansion through organic growth and strategic acquisitions. Magellan's portfolio of businesses, Magellan Complete Care, Magellan behavioral and specialty health and Magellan Rx Management are poised for future success.

I'd like to welcome Ken to the call and ask that he share a few comments. Ken?

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Ken Fasola, [6]

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Thank you, Barry, and good morning. I appreciate Barry's and the Board's confidence, and I'm honored to be named Magellan's CEO. I'm looking forward to leading Magellan and would highlight several distinct advantages we'll build from. It's been said that great companies, while defined by their leaders, are in fact built by their people. Magellan has a team of highly skilled, committed, mission-driven employees, anchored around a culture that values respect and caring and proven expertise in managing complex population health across our 3 business lines. These advantages will serve us well in today's rapidly evolving health care marketplace. Over the coming months, I plan to dedicate time with key stakeholders, the Board of Directors and Magellan's executive leadership team to refine our strategy and lead this company into its next phase of growth. I look forward to meeting those of you on the call in the very near future.

And with that, Barry, I'll turn it back over to you.

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Barry Smith;CEO, [7]

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Great. Thank you, Ken. And with that now, I'll also turn the call back over to the operator, and we'll be happy to take your questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question or comment comes from Kevin Fischbeck from Bank of America.

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Kevin Mark Fischbeck, BofA Merrill Lynch, Research Division - MD in Equity Research [2]

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Just want to go into the behavioral issues in the quarter. Can you talk a little bit about -- you said that you don't really expect much of an impact in 2020. How much of that offset is coming in the form of rate increases versus some of the operational costs and network changes that you're making?

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Jonathan Neal Rubin, Magellan Health, Inc. - CFO [3]

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Kevin, it's Jon. Let me start on that. First, really, as we think about the pressures in behavioral, which were driven by demand for inpatient services and our means of addressing it, there's really 2 main things that we're doing. One is as noted on the call -- in our prepared remarks, working with customers as we're negotiating rates into 2020 to make sure that those rates reflect both the baseline experience that we've seen as a result of the increased demand and the trends that we're seeing in the business. So that's something, again, that's in progress now, and we expect to be completed, hopefully, by the end of the year and first quarter. Second really is the action plans on the care management side, both concurrent review for inpatient stays, contracts are generally per diem, although we have a mix of contracts, we are making progress on that and looking for further improvements and also on targeted network initiatives because we've identified some facilities that are outliers, and we've seen some change in mix of services to some of the higher cost facilities. So while I'd say the relative rate -- waiting on those things, the rates will likely have the bigger near-term impact, both will be important as we drive progress going forward.

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Barry Smith;CEO, [4]

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And the only other thing I would add to Jon's comment is that when we see these underlying shifts in the population, we do have agreements with our clients that we can renegotiate our rates based upon that increased demand because the population is fundamentally different. And in some of our accounts, we've seen it on the MCC side as well as the commercial side as well. When you have unanticipated populations that have different impacts on utilization and demand, we typically are able to renegotiate in a way that keeps us whole and allows us to have our normalized margins. And so we expect to see that in this case.

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Kevin Mark Fischbeck, BofA Merrill Lynch, Research Division - MD in Equity Research [5]

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And this ability to kind of recontract, is this that -- is this in the normal repricing cycle and you caught this in time for that? Or you're saying that your contracts kind of allow for even unexpected changes in utilization throughout the year, you have an ability to go back and recontract that?

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Jonathan Neal Rubin, Magellan Health, Inc. - CFO [6]

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Yes, Kevin, right now, we are in the normal cycle. So in a way, the timing is good for us because we're just heading into those negotiations. Like I said, in many cases, with some of the largest most critical customers, those are already ongoing. So while our contracts do allow reopeners under certain circumstances. In this case, we're actually in the normal cycle, which actually facilitates this.

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Kevin Mark Fischbeck, BofA Merrill Lynch, Research Division - MD in Equity Research [7]

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Okay. And then the Virginia contract, it sounds like you're doing well there. These are at low 90s MLR. I think the guidance you said was that you want to be at 90% MLR there. Is that still what you think the ultimate target is? Or is there still opportunity to go below that?

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Jonathan Neal Rubin, Magellan Health, Inc. - CFO [8]

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Yes, I'd say there's some opportunity to go below that. I'd say 90% would be where we think we need to at least get to, to get into the normal profit margin range. But our objective would be to do 90% or better. But we think based on where we are 90% over the foreseeable future is very reasonable.

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Barry Smith;CEO, [9]

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And Kevin, we've had great success this year in managing costs appropriately with both the inpatient utilization management, claims integrity, outpatient costs. So we've seen the kinds of initiatives have material impact. The other thing is, is that many of the initiatives that we deployed even in late 2018, we haven't seen fully yet, the positive impact of those. They're still emerging in a positive way. So we expect to see value throughout this year, but also into 2020, which gives us great hope for normalized margins in the near future there.

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Kevin Mark Fischbeck, BofA Merrill Lynch, Research Division - MD in Equity Research [10]

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Great. And then on the Magellan Rx side, I guess, you said you've gone to 98% of the supply chain. How do we think about this? This is something that I think you guys do kind of annually, and it felt like maybe you're a little bit later to that process this year than normal. How do we think about the ability to go back next year and get additional savings? Is it going to be kind of the same pace and timing? Or should we see it be a little bit more front-end loaded?

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Jonathan Neal Rubin, Magellan Health, Inc. - CFO [11]

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Yes. I would say -- I mean, Kevin, what you said is true. I mean, it is a continuous process and that you're never done. What I would say, though, is that some of the initiatives we undertook this year, we're beyond just the normal annual recontracting. We actually did a full RFP for our wholesaler contract, for example, and did change wholesalers to affect cost improvement and get the best possible terms. So you're right that it is an annual process. And what I'd say is, we'll get the full benefit next year of what we implemented this year, much of which wasn't implemented until second quarter, this year. So we'll get some annualization of that next year. And then next year, like you said, we'll go through the normal process of -- as we grow the business and as we have opportunities to affect additional savings.

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Barry Smith;CEO, [12]

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The fact is -- kind of building on Jon's comment there, we've seen greater and greater success with larger and larger clients, both in the MCO world, but also on the commercial side as well. And because of that incremental volume, we're able to go back to networks, particularly we have density in certain geographic areas and negotiate better pricing with our network. And also on the specialty side, negotiate better deals for both our clients, which enhance our margins as well. So it works well. And we've seen that progress over the last several years, but it really continues. And it's kicking into higher gear now than I think I've seen it in the past.

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Kevin Mark Fischbeck, BofA Merrill Lynch, Research Division - MD in Equity Research [13]

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And then maybe last question on the severance initiatives and operational improvements. So I'm just trying to understand kind of how that impacts this year's numbers versus next year's numbers because it sounds like you've got extra costs in this year's numbers that you're not really excluding from the core results, which would go away to some degree next year, plus you'd be generating savings, some of which gets reinvested, but some of which bolstered the bottom line. So I'm just trying to understand is there any way to quantify at the very least, kind of the severance costs that you're taking on this year versus kind of the return on those investments as you'd expect over the next year or 2?

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Jonathan Neal Rubin, Magellan Health, Inc. - CFO [14]

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Yes, this is Jon. So 2 general comments. Again, we'll provide more detail on next year's budget in December. We're still finalizing the plan. So I don't have precise numbers for you. But in terms of severance, we currently -- what we're currently expecting order of magnitude is about $5 million of severance in the fourth quarter. And that number, we will refine as we kind of complete our plans and go through the next month or so, but that's the least ballpark what we're expecting at this point. In terms of next year and exactly how much of these savings will be reinvested versus will accrue to our benefit short term, those things we're still working out and we'll kind of have a updated view on as we go to guidance call. The only other note I'd make is, if you recall, last year, when we talked or even earlier this year, we said we have about $35 million of incremental expense savings opportunities beyond what we signed up for and achieved in 2019. Now that won't be necessarily in 2020, but that -- if you think about our 2- or 3-year path to getting to fully competitive margins, that's order of magnitude, the amount that we believe, we have left and have the opportunity to achieve over the next couple of years.

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Kevin Mark Fischbeck, BofA Merrill Lynch, Research Division - MD in Equity Research [15]

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Okay. And then just to make sure that $235 million to $250 million kind of normalized base, which you talked about for 2019, does that exclude the severance cost? Or does that still includes the severance cost?

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Jonathan Neal Rubin, Magellan Health, Inc. - CFO [16]

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Yes, that excluded. So it was one of the things we adjusted out.

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Kevin Mark Fischbeck, BofA Merrill Lynch, Research Division - MD in Equity Research [17]

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Okay. Okay. So that $235 million is a good base. It has the severance out.

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Jonathan Neal Rubin, Magellan Health, Inc. - CFO [18]

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Yes.

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Operator [19]

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Our next question or comment comes from Dave Styblo from Jefferies.

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David Anthony Styblo, Jefferies LLC, Research Division - Equity Analyst [20]

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And I guess, to start with, Ken, welcome on over, I'm looking forward to working with you. And Barry, I guess, maybe this is the last time we'll probably hear from you on the call. So I just want to say thanks for perspectives and enjoyed working with you over the years. I want just to come back to understand the guidance. So it sounds like based on Kevin -- the response to Kevin's question, of the $25 million to $30 million segment profit, about $5 million of that is related to severance. I know you guys talked about other costs in there. I just want to make sure that I'm thinking about that right, that it's $5 million there and, call it, $20 million-plus related to the health care earnings that are dampened. Is that sort of the right split?

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Jonathan Neal Rubin, Magellan Health, Inc. - CFO [21]

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Yes. I'd say, ballpark, Dave, it's right. I would say that of the 2 items I specifically noted, it's around $5 million on severance and around $15 million on the behavioral specialty cost of care side. But you're right. I mean, there's a handful of other things, smaller things that add up. And as well, we did have some pressure in the first half of the year, which while we were still in the guidance range, it would have potentially pulled us a little bit below midpoint, so -- but round numbers, again, I do $5 million and $15 million and then the rest, again, either rounding in terms of where we were versus midpoint or a handful of other smaller things.

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David Anthony Styblo, Jefferies LLC, Research Division - Equity Analyst [22]

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Okay. And then on the severance, I guess, you guys had announced this initially, thinking there's extra savings back in December a year ago at the guidance call. Just curious what may have changed as you've evaluated the year to include some more severance costs. I would have thought that these would have originally been baked into guidance, knowing sort of the plans that you guys have. Is there something that got pulled forward or changed that is now causing the severance cost to land in the fourth quarter of this year?

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Jonathan Neal Rubin, Magellan Health, Inc. - CFO [23]

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Yes, I would say, Dave, just having increased specificity now in terms of the plans and timing. And also, as you can imagine, as we go into the planning phase, we're also looking at the volumes that we have to deal with in the following year. So whether we're able to achieve the expense reductions with or without further reductions in workforce or requiring additional severance, would be based on what growth looks like in the following year as well. So I wouldn't look at it as materially different. I would just look at it as fine-tuning of kind of our multiyear plan and the timing of it.

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David Anthony Styblo, Jefferies LLC, Research Division - Equity Analyst [24]

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Okay, got it. And then on the behavioral and specialty issues, can you -- Jon, maybe can you elaborate a little bit more on how widespread the increased utilization is, as it's related to certain pockets of employer groups or into a certain geography? Or is this very broadly spread across the book? And why do you guys think you're all of a sudden seeing this now?

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Jonathan Neal Rubin, Magellan Health, Inc. - CFO [25]

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Yes. I mean -- and that's a great question, Dave, and one that honestly, we're spending a lot of time trying to gain further understanding of. It is relatively widespread, meaning it's not just one account. I mean, obviously, there are certain large accounts where it adds up to more, but we are seeing this increased demand for inpatient and the -- and it's really primarily behavioral health. We're seeing that across a variety of accounts and population. So it does seem like it's more of a sort of broad market phenomenon rather than either anything specific to things we're doing or in a particular customer. But in terms of really trying to get down and understand, are there any sort of specific causes versus just general demand or industry trends, right now, we're seeing it be more widespread in nature.

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Barry Smith;CEO, [26]

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And Dave, the only thing I would add to that is that in some accounts, given the fact that you see churn in populations, you're bringing on new populations who may not have been covered in the past, particularly in the Medicaid world or on the MCC side, again, individuals, new populations you're bringing on, may not have had access. The fact that we're well known and there's a relationship already in place of Magellan being a provider for the behavioral health, we do believe that does have an impact on the populations that we typically attract or receive. And so those are underlying trends that we're trying to understand better, but they do seem to have an impact.

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David Anthony Styblo, Jefferies LLC, Research Division - Equity Analyst [27]

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Okay. And I'm sure from a competitive standpoint, negotiation, you probably don't want to say too much, but can you give us a sense of the -- I guess, about $15 million cost drag on this, how much revenue is related against that $15 million? And just trying to get a sense of, okay, how much of a rate increase ballpark do you guys need next year as you go through to feel good about getting back to kind of a normalized profit on the business? And is there -- I was going to say, and is there any sort of restrictions in terms of regulators that may cap you on how much you can increase the rates for next year?

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Jonathan Neal Rubin, Magellan Health, Inc. - CFO [28]

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Yes. I would say, Dave, it's really much more of a negotiation. I mean, these, again, are primarily health plan customers in the behavioral specialty segment and behavioral health, we're talking about. And I looked at it really more sort of the normal course of negotiating. So no regulatory constraints because, again, these are commercial customers and we're a subcontractor, really more arm’s length negotiations. And from a contract standpoint, we often have sort of defined rate methodologies, which take into account both the underlying baseline experience over the period and the actual trends. Now having said that, it is a negotiation. So while there are no hard constraints, it is something that we're working hard to educate customers on and get to the right place on. I'd rather not speak at a customer level about what rates are required and it does vary by customer, but we think it is manageable to make up the vast majority of the current shortfall. And again, those discussions are well underway.

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David Anthony Styblo, Jefferies LLC, Research Division - Equity Analyst [29]

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All right. Good. And last one, I'll let others. But what for -- the 2019 guidance now, what does that assume for the Virginia margin? What's embedded in there?

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Jonathan Neal Rubin, Magellan Health, Inc. - CFO [30]

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For the full year?

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David Anthony Styblo, Jefferies LLC, Research Division - Equity Analyst [31]

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Right. Yes.

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Jonathan Neal Rubin, Magellan Health, Inc. - CFO [32]

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It's still what we talked about earlier in sort of the low 90s, but it would be really, really a continuation of the type of experience we've seen to date. And again, we're feeling pretty good based on where we are right now.

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David Anthony Styblo, Jefferies LLC, Research Division - Equity Analyst [33]

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To be more specific pretax margin, what is the assumption?

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Jonathan Neal Rubin, Magellan Health, Inc. - CFO [34]

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It's pretty close to breakeven when you're running in the low 90s, if that was the question.

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Barry Smith;CEO, [35]

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Great. Thanks, Dave, and it's been wonderful working with you as well. And all I can tell you, you're getting a great big upgrade with Ken coming on board. So we're all thrilled to have him, and I'm sure you'll enjoy working with him as well.

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Operator [36]

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(Operator Instructions) Our next question or comment comes from Scott Fidel from Stephens.

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Scott J. Fidel, Stephens Inc., Research Division - MD & Analyst [37]

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And first of all, Barry, best wishes on your retirement, and congrats to Ken on coming on board as CEO, looking forward to catching up with you soon and hearing your thoughts on the future strategy. So first question, just on sort of keeping on the new sort of behavioral cost issues, how would you guys sort of describe the sequencing of how that emerged during the third quarter? Did that start picking up earlier in the quarter or later? And then just in terms of -- from the claims experience and reserve development side, what have you seen on sort of a look back basis in terms of claims coming in, in terms of what that's implying for maybe how -- when these issues may be started emerging in the first half of the year or not as well?

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Jonathan Neal Rubin, Magellan Health, Inc. - CFO [38]

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Yes. Scott, great question. The way I describe it is, we saw some pressure emerging in the first half of the year, but it seemed within sort of normal range of seasonal volatility. So we had assumed that the modest increase in demand we saw in the first half of the year was more sort of seasonal in nature and wasn't -- and we expected things to return normal in the second half of the year. In third quarter, we saw claims come in high. And we also had about $3 million in this particular segment of unfavorable development related to the first half of the year. So we saw the first half actually restate unfavorably and then additional pressure in third quarter. I mean, now we've kind of incorporated the new run rate into the full year outlook. So in terms of the progression, that's how I'd best describe it.

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Scott J. Fidel, Stephens Inc., Research Division - MD & Analyst [39]

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Got it. And Jon, do you feel, at this point, just in terms of keeping the reserving up-to-date with these emerging trends, maybe talk about on the reserve side, sort of, your confidence that you are building in enough conservatism into the reserves, if you do see these trends continue? Are you building in and that they are essentially leveling out? Or are you building some additional conservatism that some of these trends may potentially continue to accelerate?

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Jonathan Neal Rubin, Magellan Health, Inc. - CFO [40]

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Yes. No, I mean, we have refined our methodology based on what we know and based on the emerging trends. And again, if you look at second quarter restated and you look at third quarter now, they're relatively level. So in fact, going into fourth quarter, it's not like we're seeing a huge uptick, it's -- now we've got a much better picture of both second quarter and third quarter and feel like we've appropriately reserved and forecast now for the fourth quarter. I mean, I hope it ends up being conservative, but we think we've got a pretty good beat now on the full year.

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Scott J. Fidel, Stephens Inc., Research Division - MD & Analyst [41]

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Got it. And then just on the New York side of things, just to level set on that. Did the -- in terms of the rate increases and the updated risk scores, did that pretty much come in pretty much spot on with what you had built into the guidance for the year? Or was there any sort of variance in terms of either a little bit more favorable or negative relative to what you had in the plan?

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Jonathan Neal Rubin, Magellan Health, Inc. - CFO [42]

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No, actually, it was pretty much what we expected. I mean, if you recall, we said we expect that the rate changes to be worth sort of $20 million to $25 million over the second half of the year. That was what we originally expected. I mean, I'd say, ballpark, we came in pretty close to that in terms of New York, overall. The base rates were a little bit lower than expected and the risk adjusted is a little bit higher in terms of the components. But the -- overall, we came in pretty close. And obviously, some of that was retroactive to second quarter. If you recall, it was a [4 1] effective date. So we did have some out-of-period favorability as well as, obviously, the benefit in the third quarter.

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Scott J. Fidel, Stephens Inc., Research Division - MD & Analyst [43]

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Got it. And then just one last one for me. Just relative to the updated guide. And so it's still has a pretty wide implied range in the Q4, so maybe you want to sort of highlight sort of key swing factors in terms of what you're building in at higher end relative to the lower end. I'd assume that maybe some of that relates to how much rate you start getting for the behavioral and specialty issues? And then maybe also within that dynamic, sort of what's embedded sequentially around pharmacy margins, clearly, that was a bright spot in the quarter in terms of the pharmacy business continuing to improve and just sort of interested in sort of what you're thinking in terms of margins for the Rx business in Q4? And that's it for me.

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Jonathan Neal Rubin, Magellan Health, Inc. - CFO [44]

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Okay. Yes, in terms of the pharmacy piece of it, we did see good margins in the quarter. What I'd say is if you look at the last couple of quarters in pharmacy, we run reasonably well, and we'd expect to continue at that general level of margins. So I think that should be pretty stable as we complete this year and as well as we go into next year. I'm sorry, Scott, can you repeat the first part of the question again?

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Scott J. Fidel, Stephens Inc., Research Division - MD & Analyst [45]

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Sure, Jon. Just in terms of the wide range still on sort of the implied Q4 guide and sort of the swing factors to the high end and the low end. My assumption was maybe that sort of reflects how much rate you get on to reflect some of the cost issues seeing and the behavioral and specialty, but just interested in sort of what some of those swing factors are that drive a pretty wide range still on the implied Q4 guide?

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Jonathan Neal Rubin, Magellan Health, Inc. - CFO [46]

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Okay, got it. Sorry, but that -- yes, so -- no, it's not the behavioral range. Those are really 2020 negotiations that we're going through now, so really won't have an impact on 2019. I wouldn't read a whole lot into the range kind of being plus or minus $7 million, $7.5 million. I would just look at it as -- there are factors that there's always some level of volatility and obviously, cost of care is one. On the rate side, there's always things we're negotiating. Generally, those are more favorable in nature with states around risk scores and rates for different facets of the population that have some opportunity. We talked about severance charges, those are things we'll fine-tune as we go through the balance of the year. I'd say those are really the key items. And again, the further you get in the years, the more confidence we have, and we have narrowed the range some. But like I said, I wouldn't attach a whole lot of significance to the width of the range other than we try to make sure we're forecasting in a way that we've got confidence of being within the range.

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Scott J. Fidel, Stephens Inc., Research Division - MD & Analyst [47]

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Yes, got it. And probably, I guess, that wide range is more related to EPS actually than the segment profit dynamics. So again, probably just the reality is with smaller share count as well. So I appreciate that clarification.

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Operator [48]

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Thank you. And I'm currently showing no further questions or comments at this time. I would now like to turn the call back over to Barry Smith for closing comments.

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Barry Smith;CEO, [49]

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We thank you all today for attending our third quarter earnings conference call. Take care.

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Operator [50]

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That concludes today's conference call. Thank you for your participation. You may disconnect at this time.