Jul 26, 2013
Executives
Renie Shapiro – SVP, Corporate Finance Barry Smith – CEO Jon Rubin – CFO
Analysts
Dave Styblo – Jefferies Carl McDonald – Citigroup Josh Raskin – Barclays Capital Ana Gupte – Dowling & Partners Scott Fidel – Deutsche Bank Michael Baker – Raymond James
Operator
Welcome and thank you for standing for the second quarter 2013 earnings call. At this time, all participants are in a listen-only mode.
(Operator instructions) Today’s conference is being recorded. If you have any objections, you may disconnect at this time.
I will now turn the meeting over to Ms. Renie Shapiro.
Go ahead, ma’am. You may begin.
Renie Shapiro
Good morning, and thank you for joining us today. This is Renie Shapiro, Senior Vice President of Corporate Finance for Magellan Health Services.
With me today are Magellan’s Chief Executive Officer, Barry Smith, and our Chief Financial Officer, Jon Rubin. They will discuss the financial and operational results of our second quarter ended June 30th, 2013.
Certain of the statements that will be made during this conference call are forward-looking statements contemplated under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to known and unknown uncertainties and risks which could cause actual results to differ materially from those discussed.
These forward-looking statements are qualified in their entirety by the complete discussion of risks set forth under the caption risk factors in Magellan’s annual report on Form 10-K for the year ended December 31st, 2012 and in the current quarter’s Form 10-Q, which will be filed with the SEC later today and will subsequently be available on our website. In addition, please note that in this call, we refer to segment profits.
Segment profit is disclosed and defined in our annual report on Form 10-K and is equal to net revenues less the sum of cost of care, cost of goods sold, direct service costs and other operating expenses excluding stock compensation expense. Segment profit information referred to in this call may be considered a non-GAAP financial measure.
Included in the tables issued with this morning’s press release is the reconciliation from segment profit to the line item income before income taxes. We encourage you to review such reconciliation for an understanding of how segment profit compares to that GAAP measure.
I will now turn our call over to our CEO, Barry Smith.
Barry Smith
Thank you, Renie. Good morning and thank you for joining us.
I am pleased to report that Magellan had a strong second quarter and had several notable accomplishments during the quarter including important strides in our Magellan Complete Care and Magellan Pharmacy Solutions growth initiatives. I will discuss our high-level financial metrics for the quarter, progress and our growth strategy, and offer an update on the Maricopa County contract.
Jon Rubin will then discuss detailed financial and operating information on each of our segments before we take your questions. With respect to the financial milestones, for the second quarter of 2013, we produced net income of $31.5 million, EPS of $1.15, and segment profit of $75 million.
For the six-month year-to-date period, we produced an income of $59.5 million, EPS of $2.17, and segment profit of $144.3 million. As of June the 30th, 2013, we had $281.9 million of unrestricted cash and investments.
Year-to-date through July the 24th, 2013, we deployed capital to repurchase approximately 956,000 shares at a cost of $48 million. Through that date, we repurchased approximately 2.1 million shares at an average price of $49.75, completing approximately 52% of the current 200 million authorization.
This week, our Board of Directors approved a $100 million increase to this authorization and extended it for two years until October the 25th, 2015. The total remaining under the increased authorization is $196.2 million.
The shares may be purchased from time to time on the open market under 10b5-1 plans or in privately negotiated transactions. There are a number of factors that affect the timing and pace of purchases, such as our stock price, projected capital needs, M&A prospects, and determination of opened and closed trading windows.
Since we began repurchasing shares in August of 2008, we have repurchased 19.5 million shares at a total cost of $853.8 million, an average price of $43.73. As of July 24th, we have approximately 27.0 million shares outstanding.
Our priorities related to capital deployment have not changed. We will use capital to grow our business organically and through acquisitions, and look for opportunities to return capital to shareholders.
We continue to assess acquisition opportunities that would advance our Magellan Complete Care and Magellan Pharmacy Solutions initiatives. This is a time of continued growth and transformation of Magellan as we build on the solid foundation developed over the past several years.
We’ve moved from being a market leader in behavioral health management to a multiline specialty healthcare management company. In response to opportunities that we see in the marketplace, we are further transforming into what I often referred to as Magellan 2.0, a business with sharp focus, leveraging our expertise managing special populations.
The most critical component of this transformation is the ongoing development of our Magellan complete care and Magellan Pharmacy Solutions initiatives to address these opportunities and to be our primary growth engines for the future. In addition to these growth opportunities, Magellan 2.0 includes a focused effort to redesign our business to ensure that we are competitive in the staging healthcare marketplace.
It includes leveraging technology and processes to drive new levels of efficiency, reassessing our current and future product offerings, and ensuring our administrative expenses are market competitive. As we bring Magellan 2.0 to fruition, we will continue to maximize opportunities in our existing businesses.
Our Core Behavioral Health, Radiology, and Pharmacy businesses are performing well and we continue to develop innovative products and services to meet the changing needs of our customers and the healthcare marketplace. A great example of this is our Radiology Benefits Management business where we have several implementations underway this year with a diversified portfolio including a new pain management product.
It is important to acknowledge the significant contribution that all of our businesses are making to our results. These core businesses have fueled our past growth and, going forward, will provide the clinical capabilities to holistically manage enrollees in our Magellan Complete Care programs.
With our new health plan, MCC Florida, we are leveraging the assets of our entire product portfolio – Behavioral Health, Radiology, and Pharmacy. Let me highlight some of this quarter’s accomplishments.
We continue to make progress in our Magellan Complete Care business. Key events occurred in two states where we went live in the past two months, and we’ve also had a change in direction in a third state.
I’m delighted to tell you that we began operating in Florida as a general Medicaid HMO on June the 1st, taking full risk on all medical, behavioral, and pharmaceutical care, integrating both physical and behavioral healthcare. We are extremely pleased that we are now enrolling members in Broward County, with plans to expand to other regions later this year.
This accomplishment is the result of over 18 months of work to obtain licenses, build provided networks, develop coordinated models of care, set up infrastructures, and educate providers, community based organizations and advocates about the value we will provide to this vulnerable population. In addition, earlier this year, the state of Florida released an invitation to negotiate, soliciting proposals from general Medicaid HMOs and Medicaid Specialty Plans to participate in the state’s new mandatory Medicaid Managed Care program.
In March, we responded with a proposal to establish a specialty plan in eight of the state’s 11 regions for the management of Medicaid recipients with serious mental illness, or SMI. We’ve been invited to negotiate for plans in all regions that we proposed and, if successful, we expect the plans to be up and running some time in 2014.
While others submitted responses to manage specialty populations for child welfare and individuals with HIV/AIDS, we were the only the respondent to propose an SMI specialty plan. There are approximately 100,000 individuals with SMI in the regions we proposed, whose estimated total integrated healthcare spend is significantly higher than that of a standard Medicaid individual.
We would expect to penetrate this market over time dependent upon the market and state-enrolment policies. The opportunity in Florida could be quite material depending on the rates and the counties at which we participate.
Since 1995, we have worked with the state of Iowa to manage behavioral health for their Medicaid recipients. For the past two years, we have piloted integrated health homes in five counties for individuals with SMI, and our results demonstrate the value of this program in driving better health outcomes.
Recently, Iowa received CMS approval for a State Plan Amendment to fund statewide behavioral-led health homes for approximately 26,000 adults with SMI and 16,000 children with serious emotional disturbances. Under this ASO contract, Magellan will manage a team of healthcare professionals who provide comprehensive care coordination for our health home members.
The new program went live in our existing five locations in July the 1st and will expand in stages across the state, with surrounding counties going live on January the 1st, 2014, and rural counties on July the 1st, 2014. The contract which provides enhanced Medicaid funding from CMS to the state runs for a rolling two years from the implementation date in each county.
We do not anticipate material revenues in 2013, but estimate that 2014 revenues will be approximately $30 million. We decided to end our participation in Fallon Total Care, the drug venture to manage the dual eligible population of Massachusetts under age 65.
Given the network costs and the complex healthcare needs of these individuals, the rates offered were not sufficient to sustain profitable operations over the three-year term of the program. As a result, we have transferred our 49% interest in the joint venture to Fallon Community Health Plan, who’s now the sole owner of Fallon Total Care.
Fallon has been an outstanding partner and we’ve learned a great deal from this experience that could be helpful as we move forward with our MCC strategy. The termination of our participation in Fallon Total Care will not have a material effect on our 2013 guidance.
Every state is unique and the fact that Massachusetts was not financial viable does not impact our overall Magellan Complete Care strategy. We remain enthusiastic about our offering and the opportunities that exist in the market.
We continue to assess the market and prioritize our targets for entry. For example, the SMI and dual eligible populations are complex and require our high-touch expertise.
There are many different ways to address management of these populations in individual states. While many states are experiencing delays with their dual demonstration programs, we are continually evaluating ways to manage the dual eligibles.
In adding to pursuing integrated demonstration programs, we are looking at programs funded separately through Medicaid or Medicare. In states where we believe these opportunities exist, we are proactively taking steps to be able to participate.
Bases where we currently have existing Medicaid business and a proven track record are a high priority for us. We can leverage existing relationships much like we did in Florida and with the integrated health homes in Iowa.
We are also looking at ways to expand our programs to target populations with intellectual and developmental disabilities, those needing long-term care institutionalized persons and others with chronic illnesses. Our goal remains to manage the entire healthcare spend for special population in a limited number of states that will generate no less than $2.5 billion of revenue by 2017 either directly or in partnerships.
We will seek to achieve that objective through organic growth or through acquisitions that will provide capabilities, licensure, scale, or infrastructures to complement our existing scales, and accelerate our strategy. Our Pharmacy Solution strategy, in which we offer a suite of clinical and cost management solutions that integrate our specialty, medical pharmacy and PBM capabilities, continues to gain traction.
We believe this strategy will be an exciting growth opportunity for Magellan, capable of generating pharmacy revenues of $2.5 billion over the next five years. Our first commercial PBM client, implemented for an employer customer on January the 1st, expanded the program to include more of their employees and retirees this quarter.
Our strong operating performance and effective care management have made this a referenceable customer. We implemented two key contracts this quarter which continue to solidify our established position as the market leader in specialty and medical pharmacy, while simultaneously reinforcing Magellan’s overall capabilities as a pharmacy-benefit management company.
Our new 10-care PBM contract went live on June the 1st, covering 1.2 million Medicaid recipients in Tennessee. During implementation, we reached out to over 1,200 pharmacies to provide education and support, and within the first 24 hours, we successfully processed over 72,000 claims.
On July the 1st, we fully implemented a significant medical pharmacy account, bringing a number of lives managed under this product to approximately 9 million. There were also new sales this quarter, including a new medical pharmacy contract with an existing rebate customer; again, proving the concept that an integrated product is a very attractive option for the market.
In addition, we are building our sales infrastructure. We’re expanding our sales capabilities to address the long PBM sale cycle and position ourselves for a July the 1st, 2014 and January the 1st, 2015 best of plan dates.
Outreach to the broker and consultant community is vital to reach our target market. We’ve had positive feedback from them regarding the value proposition for integrated pharmacy solution.
Our products fill an important gap in today’s pharmacy market, providing flexible, channel-neutral solutions that address complex issues with a focus on clinical excellence, member engagement, and improve outcomes. We’ll update you on the current status of our protest of the Maricopa contract award.
On May the 9th, we filed an appeal and a motion to stay the award and implementation of the contract with the Arizona Department of Administration, the agency responsible for considering appeals of procurement protest in Iowa. On May the 21st, a stay of the award and implementation of the contract was granted while the department considers the merits of our protest and appeal.
On June the 13th, the Department of Administration ordered a continuation of the stay as well as a hearing before an independent administrative law judge in the Arizona Office of Administrative Hearings, which is currently scheduled for the week of August the 12. You should be aware that there is no assurance that we will prevail in our appeal or that the stay will remain in effect.
We continue to focus our efforts on our members and ensuring the highest quality of service delivery and outcomes. We are working with providers to ensure continuity and consistency of care, continued movement towards health and wellness, and promoting recovery and resiliency.
Jon Rubin will now discuss each segment’s details, after which we’ll take your questions. Jon?
Jon Rubin
Thanks, Barry, and good morning, everyone. Net income for the second quarter of 2013 was $31.5 million or a $1.15 per share on a diluted basis.
For the second quarter of 2012, net income was $27 million or $0.97 per share in a diluted basis. The increase in net income between periods was mainly attributable to higher segment profit.
Revenue in the second quarter of 2013 was $842.7 million, which was $37.3 million higher than in the second quarter of 2012. The revenue increase resulted primarily from new business and rate increase which were partially offset by lost revenues associated with terminated contracts.
Our segment profit for the second quarter of 2013 was $75 million compared to $64.8 million for the second quarter of 2012. I’ll now review each of the segment’s results and growth opportunities.
Our commercial behavioral health segment had a strong second quarter, producing $35 million of segment profit, an increase of $9.9 million over the second quarter of 2012. The increase includes the impact of favorable customer settlements in the current year quarter of $6.7 million, and also reflect the benefit of revenue associated with new business and same-store growth.
The prior year quarter included higher performance-based revenue of $2.3 million. During the quarter, an expansion was approved in the military and family life counseling program.
The expansion began on July 1st and is expected to be completed by the fourth quarter of this year. While the impact on 2013 is not material, we anticipate additional annualized revenue of approximately $15 million in 2014.
There’s a steady pipeline of 2014 commercial behavioral health opportunities, including interest from regional plans, Medicaid MCOs, and other health plans we can support in their Medicaid expansion, ACO, and exchange initiatives. We’re also seeing an active pipeline of employer opportunities for 2014 plan dates.
Segment profit for Public Sector was $28.8 million, a decrease of $3.2 million from the prior year second quarter. The decrease was mainly due to the inclusion in the prior year quarter of a favorable contractual settlement of $2.2 million, care trends in excess of rate increases, and the inclusion in the current year quarter of investments in Magellan Complete Care, which are included in Public Sector’s results in 2013.
Partially offsetting these items is favorable prior period care development in the current year quarter of $6.2 million. In addition to the health home initiative that Barry described earlier, our Iowa Medicaid business expanded on July 1st to include a program that manages services to those members who need support for daily living.
These services including the health home initiative went fully implemented in mid-2014 will generate approximately $100 million of additional annualized revenue. In June, the Commonwealth of Virginia awarded Magellan an ASO contract as the state’s behavioral health services administrator.
Under the terms of the contract, we will manage all behavioral healthcare that is currently fee-for-service for both the Medicaid program and the state’s Children’s Health Concerns program. The combined program will cover approximately 900,000 recipients.
This three-year contract, which includes two additional one-year optional period, will be effective December 1st, 2013 and is expected to generate annualized revenue of approximately $20 million. As we discussed in our last call, we were awarded the state of Nebraska’s risk-based behavioral health contract with annual revenues of approximately $100 million.
We remain on track for a go-live date of September 1st, 2013. Regarding the Public Sector pipeline, there have been some delays, but we still anticipate RFPs for the state of New Jersey ASO Adult Behavioral Health program as well as programs in Texas and Maryland, all in early 2014, with 2015 implementation dates for all three of these contracts.
In our Radiology Benefits Management segment, second quarter 2013 segment profit was $20.6 million, an increase of $2.8 million over the second quarter of 2012. This increase was mainly due to net favorable prior period care development recorded in the current year quarter of $2.3 million, as well as the net impact of new business and favorable care trends.
These increases were partially offset by favorable contract settlements recorded in the prior year quarter of $4.4 million. We continue to see growth in our radiology segment, including market and product expansion for our key commercial risk customer, which were implemented on July 1st.
Momentum around cardiac product expansion continues. We have produced very strong results for our initial customer in the management of outpatient left heart catheterization, and we implemented this program in two additional markets for this customer on July 1st.
Second quarter segment profit for the Pharmacy Solutions segment was $16.2 million, a decrease of $4.5 million over the second quarter of 2012. This decrease is primarily due to retroactive revenue adjustments recorded in the prior year quarter of $2 million, as well as implementation cost incurred in the current year quarter to support new business.
Our pharmacy pipeline is robust with many opportunities in both the Medicaid and commercial segments. Specifically for the PBM product, we continue to see interest in our services from Medicaid MCOs and employers and we are currently in advanced discussions with a number of potential customers.
For our fee-for-service Medicaid product, the procurement processes for several state Medicaid POS program have been delayed until late 2013 or early 2014. Regarding other financial results, corporate costs excluding stock compensation expense were $5.3 million less than in the second quarter of 2012.
This decrease is primarily due to investments in our growth initiative which were included in corporate expenses in 2012 that are now reflected in the individual business segment in 2013. Excluding stock compensation expense, total direct service and operating expenses as a percentage of revenue were 16.6% in the current year quarter as compared to 16.9% for the prior year quarter.
This year-over-year decrease is mainly due to our ability to hold increases in administrative expenses below our revenue growth rate. The effective income tax rate for the quarter ended June 30th, 2013 was 40.7%, which is comparable to the prior year quarter.
Turning to cash flow and balance sheet highlights. Our cash flow from operations for the six-month ended June 30th, 2013 was $86.9 million compared to cash flow from operations of $75 million for the prior year period.
Cash flow for the current year period includes the positive impact of a shift of restricted cash into restricted investments in the amount of $31.2 million, which is reflected as a source of cash from operations and the use of cash from investing activities. Cash flow for the prior year period included the negative impact of a shift of restricted investments to restricted cash in the amount of $19.5 million.
Absent these transfers, cash flow from operations for the current year period totaled $55.7 million compared to $94.5 million for the prior year period, representing a decrease in cash flow from operations of $38.8 million. The decrease in cash flow is primarily attributable to net unfavorable working capital changes between periods of $48.7 million, and an increase in cash tax payments of $14.2 million, partially offset by the increase in segment profit between periods of $24.1 million.
The net unfavorable impact of working capital changes between periods is largely due to increases in management incentive payments, accounts receivable and pharmacy inventory levels, as well as the net increase in restricted cash requirements associated with the company’s regulated entities. As of June 30th, 2013, the company’s unrestricted cash and investments totaled $281.9 million, which represents the decrease of $20.3 million from the balance at December 31st, 2012.
Approximately $54.1 million of the total unrestricted cash and investments at June 30th, 2013 related to excess capital and undistributed earnings held at regulated subsidiaries. The company’s restricted cash and investment balance at June 30th, 2013 of $341.6 million reflect a decrease of $5.8 million from the balance at December 31st, 2012.
Relative to full year 2013, we are maintaining our guidance for net revenue in the range of $3.3 billion to $3.5 billion, net income of $90 million to $108 million, and segment profit of $245 million and $265 million. Taking into account the impact of share repurchase activity through July 24th, 2013, but not considering any potential future share repurchases, our guidance for fully diluted EPS is still a range of $3.27 to $3.93.
We continue to expect same-store normalized cost of care trends for the 12-month forward period of 6% to 8% for commercial behavioral health, 0% to 2% for Public Sector, and 3% to 5% for Radiology Benefits Management. In summary, we’re pleased with our results for the second quarter and our continued progress on a strategy growth initiative.
Barry and I are now available to answer questions. And I’ll turn the call back over to the operator.
Operator?
Operator
Thank you. We will now begin the question-and-answer session (Operator instructions) Our first question comes from Dave Styblo of Jefferies.
Go ahead, sir. Your line is open.
Dave Styblo – Jefferies
Good morning, guys. Thanks for the color on the call.
Had a couple of questions. The first one was just a follow-up on Maricopa.
I think you had mentioned the hearing is set for August 12. Wondering what should we expect out of that.
Is there going to be some sort of definitive answer or is it something where the process could continue to drag on for several months after that?
Barry Smith
The hearing is scheduled for August the 12th and that we don’t know at this point in time what the outcome of that event will be. There is a lot of discussions that will be had, and we’re putting together materials right now.
But it’s really unclear at this point what the – how long this will take to resolve. It could be resolved in a short time or it could take a very long time.
We just don’t know at this point.
Dave Styblo – Jefferies
Okay. As a follow up to that, just wondering a little bit more about the second quarter, how that compared to your internal expectations and if you can help us reconcile.
Obviously, the beat was – the 2Q earnings was well above consensus. Curious how that reconciles with EPS for the full year remaining the same.
I know you guys called out a few different items moving back and forth between investments, but if you guys just help us understand. If the Street was just not properly modeling the second quarter or if there was additional expenses kind of being lumped in that took out some of the 2Q outperformance.
Jon Rubin
Well, I mean first of all, Dave, we don’t give quarterly guidance. So I can’t specifically comment on any specific expectations from the quarter.
But I will note that, quarter-by-quarter, there are always going to be puts and takes that impact the results and make the quarter-to-quarter comparisons difficult when you look at things sequentially. I would, in answering your question on that and also commenting about the second half of the year, note a couple of things that are important.
One being that, we did in the first half of the year, both in the first and second quarter, have a number of issues that I’d characterize as non-recurring or being out-of-period. And these issues include prior year development and other things we’ve noted in the call including some contractual settlements and retrospective care adjustments.
Order of magnitude for the first half of the year, those amount to about $20 million in total. So that’s one thing to consider.
The other thing that we’ve talked about is our model at this point still assumes that the Maricopa County Behavioral Health contract will transition away on October 1st. And as I noted in the first quarter call, the impact of that, including projecting expected severance level is approximately $19 million.
So those are some of the items I’d consider as you’re sort of reflecting on the results and guidance.
Dave Styblo – Jefferies
Okay. Thanks guys.
Barry Smith
Great. Thanks, Dave.
Operator
Our next question comes from Carl McDonald of Citigroup. Go ahead, sir.
Your line is open.
Carl McDonald – Citigroup
Great, thank you. First question is just clarification.
Barry, in your comments on the Ohio Behavioral Health Medical Homes, you talked about $30 million in potential ‘14 revenue. And then, Jon, I think when you were talking about Iowa you mentioned $100 million incremental revenue numbers.
So if you could just straighten me out on what those were.
Barry Smith
Yeah, that was the Iowa program, not Ohio, but to Jon.
Carl McDonald – Citigroup
Sorry.
Jon Rubin
Yes. Really, Carl, so there are two separate initiatives that we commented on.
The first was what Barry commented on, which is the integrated behavioral health-led home initiative, and that was around $30 million in annualized revenue. The $100 million includes that plus an additional program that manages services for members who need support for daily living, so home-based services, which is the incremental amount.
So the two of those add to the $100 million.
Barry Smith
It’s a significant contract expansion and so we couldn’t be more delighted with that. But importantly, it demonstrates the same operating capabilities as we now or now are demonstrating in Florida and yet in other states.
So it’s an exciting expansion for us.
Carl McDonald – Citigroup
Okay. Then more of a big picture question in case you’re interested in going there.
In the press release, you talked about positioning the company for continued growth. Assuming the Maricopa situation doesn’t change.
Do you see any scenario where you could grow EBITDA in 2014 or would the right way to think about next year, be it with the two big contract losses or the EBITDA will be down to some extent?
Jon Rubin
Carl, it’s Jon. At this point, we’re not prepared to talk in any specifics or even directionally about 2014.
We’ll certainly do that as we always do on the October call to give some directional color. So at this point, I wouldn’t comment beyond just saying we’ve highlighted what we know at this point about 2014 both in terms of some of the areas of growth like what we just talked about in Iowa and have talked about losses.
But we’ll get more specific as we go to next quarter’s call.
Carl McDonald – Citigroup
Okay, thank you.
Barry Smith
Great, thank you.
Operator
Our next question comes from Josh Raskin of Barclays. Go ahead, sir.
Your line is open.
Josh Raskin – Barclays Capital
Hi, thanks. Good morning guys.
First question is just on the MCC plan down in Florida. You got started enrolling in Broward, I know, in June.
First question is this, what sort of membership base did you start off with and how do we think about the ramp-up in membership there?
Barry Smith
Thanks, Josh, and good morning. We’re starting off in Florida with a very small base and we’ll grow into it incrementally.
We likely won’t see a lot of traction until 2014. But it was important to get that start because it allows us to participate in the ITM process and hopefully receive a good result later this year in that, to start those specialty plans for next year.
So again, starting out very minimally, but growing and it’s performing almost exactly as we anticipated it would at the beginning here.
Josh Raskin – Barclays Capital
Okay. And I know you’re saying minimal.
But obviously, there’s huge revenue per member per month and, obviously, per member per year. So would you think about 1,000 lives as sort of success before we turn the calendar page or how do we even put sort of a parameter around that?
Barry Smith
Yes. Well, we haven’t really indicated what we believe the growth will be through the end of the year.
For these initial lives, we do have – they’re largely TANF lives to start with. So the revenues won’t be material through this year.
We would expect to see a significant ramp-up in 2014. But again, we haven’t indicated our given guidance on that growth or the revenues for this year.
Josh Raskin – Barclays Capital
Okay. And you said performing largely in line.
Does that just mean in terms of contracting and building out or have you actually processed a couple of claims and see sort of the early week or two mainly on pharmacy or something like that that’s giving an indication that even costs are in line with what you saw?
Barry Smith
Yes, Josh. All of the above.
We had to go through the entire build out of virtually every aspect of a health plan to get to the licensee procedure, including all the ACA reviews, ACA 1 and ACA 2. That required us – those were all required to be able to take our first enrollees, which we’ve done.
And we’ve already started to process claims and do all the things the health plan would do to manage utilization and to process claim. So we do have that data now and we’re beginning to build that, which is just great experience as we’re going through the ITM process there in Florida and get ready to launch in a pretty significant way in 2014.
So, yes, all of the above.
Josh Raskin – Barclays Capital
And then just a separate question on the Massachusetts experience. Obviously you guys had to walk away due to inadequate rates.
Maybe just a two-part around that, is one, does that change the way you prepare for other state opportunities, i.e. are you going to do more diligence around providers and negotiations, et cetera, first up?
And two, what was the state’s reaction when you came to ask them and said, "Hey, look, we thought we could build a network at a cost of X, but it’s really going to be a cost of Y"? I mean, clearly, their end result was, we’re still going to pay you for X.
But I’m just curious, was there any negotiating sort of at the end there when you let Massachusetts know what your cost for coming in at?
Barry Smith
Let me answer that last part of the question first, Josh. I think that, number one the rates were a combination of both the state Medicaid program and CMS.
And both clearly have a strong desire to see the program be successful. And we are going to face with both the state officials as well as with CMS and we get extensive discussions.
We’re all very positive and I think we all wanted to see the same positive result. The reality is, and again, it’s different from state to state, you’ve seen one state, you’ve seen one state, is that the provider network contracting environment was simply – turned out not to be very positive in the state of Massachusetts.
I think that with the expertise of Fallon Total Care or the Fallon Community Health Plans, Hughes is the CEO there, has become and good friend. These are good high quality players who know the state well.
We went into the joint venture with Fallon because they understand the state and understand the nature of those networks. Early on, I think with these duals programs it’s challenging to understand the ultimate result.
I think that in the state of Massachusetts, we were asked, as well as all the other entities that were bidding, to provide the network prior to having the finalized rates. So I think it put people in kind of a difficult situation of committing to a program or not fully committing to a program, but indicating the network prior to having really the clout of having a finalized rate to negotiate against.
So in this particular case, a number of those who won the right to participate in each of these counties have dropped out of the program because they’ve seen similar network challenges as we did with Fallon. And these are very significant healthcare knowledgeable managed care entities in the state of Massachusetts.
So I think that the net result here is that, going forward, I don’t know that we would’ve done anything differently knowing what we know today, simply because it was not knowable until we went through that process. Other states, there’ll be some challenges in other states, not necessarily that we’re participating in.
But I think there might be some challenges in California and in other states, maybe in Illinois that will be similar in terms of the network challenge. Where they’ll end up we don’t know.
But it’s a game of chicken when it comes right down to it with the network providers and the rates that are established. So will CMS put more pressure on some of the provider networks, will that be effective?
We just don’t know. But it will be an interesting thing to see play out.
Josh Raskin – Barclays Capital
Barry, on that point, are you recommending to new state partners that maybe they publish final rates before all contract negotiations, et cetera, in state or do – I mean, it sounds like that would be a helpful tool for you to go to the providers and say, "Hey, look, here’s what the rate’s we’re assuming," right? Is that something that you see more important?
Barry Smith
Yes. That guidance would certainly be very, very helpful to us.
And the project reality is typically you’ll build out a network with a proviso that you can go back to the network when you receive the final rates to renegotiate, to fine-tune those rates to make sure there are the proper economics in place to be successful over the long term.
Jon Rubin
The other thing Carl that I’d add is that – I’m sorry, Josh, that I’d add is that with the benefit of having gone through the process with Massachusetts particularly with CMS, our actuaries have a much better understanding now of how the CMS rating process works, which is pretty predictable as we go forward. So I think that will help us a lot to make those up for an assessment as well.
Josh Raskin – Barclays Capital
Right. Okay, very helpful, thanks guys.
Barry Smith
Great. Thanks, Josh.
Our next question comes from Ana Gupte of Dowling & Partners. Go ahead, your line is open.
Ana Gupte – Dowling & Partners
Yes, thanks, good morning. So just following up on the last question again.
It sounds like a piece of it was the network rates you were getting in Massachusetts, a piece of it was the overall actuary or the soundness of the rate against that network. What was sort of the margin implication of what netted out in Massachusetts and what are your target margins in the initial phase and then in steady state for the complete care type business?
Jon Rubin
Hi, Ana, it’s Jon. First in terms of margins.
I mean, it is going to differ by state in many cases that we approach, Medicaid, and they all have their own nuances. But as we’ve talked about before, we’re largely talking mid-single digits in terms of profit.
Relative to Massachusetts, there is always a range because these are new programs. But our projections were that we couldn’t get it to a profitable position over the three-year period.
So obviously, that means there was a gap, at least, in that mid-single digit range.
Ana Gupte – Dowling & Partners
Okay, so it’s still a positive contribution margin though, but not in your mid-single? Is that how I should read that?
Jon Rubin
No, I’m saying, I’m sort of an all-in basis. We weren’t able to get it to a profitable position.
So, no, there was not a positive outlook.
Ana Gupte – Dowling & Partners
And then in Florida for the SMI, how is that looking, how is that shaping up to you, you think?
Barry Smith
Florida looks significantly different from two perspectives. Number one, there isn’t the kind of provider density in terms of negotiating power.
It’s far more diverse in Florida. And we already have relationships clearly on the BH side in Florida, and it built out very successfully the provider network.
So we’re in a fundamentally different position, I think, in Florida from those two perspectives. We are working through the provider, the ITM.
And so, we would anticipate the rates to be based upon the unique care characteristics of that SMI population. Thus far, from what we’ve seen in Florida, our expectations of network performance are right in line.
And so, again, our experience is still very limited because we’re just schooling up the enrollee base, but we’ve seen no surprises in Florida thus far. So we wouldn’t expect similar circumstances we’ve seen in Massachusetts, although we don’t have the final rates for the ITM for the final special needs population established yet.
Ana Gupte – Dowling & Partners
Got it, thanks. Just switching then to the Maricopa, understood that August 12 is someone uncertain.
Could you give us any color on what factors might swing the decision one way or the other? And let’s just say it does not go your way and stay is vacated, what recourse do you have going forward then?
Is that something you’re just going to use delay tactics for a while?
Barry Smith
Well, our arguments have remained the same at the very beginning. We believe very strongly that the entity that was awarded the contract is not qualified legally since they have an [inaudible] there.
One of the sponsors of that plan that won is actually a provider of care and that is not legally – was not legally permitted in the RFP process. The process was changed during the RFP time and they also didn’t adhere to the requirement to be licensed as an HMO by the date specified in the RFP.
There are numerous issues there legally that we feel are very valid today and we remain as enthusiastic as we were from the very start about the basis for our protest. In terms of the process, again, we have the hearing set for August the 12th.
We’re busily preparing for that important date. Again, we have no understanding of what will result yet until we go through that process.
But let me just take you through the process here that might give some additional light. We’ll have that hearing on the August 12th.
This is with an independent administrative judge by the Department of Administration. So we believe it will be a fairly – we hope that it will be a fairly unbiased judgment of the protest arguments.
If for whatever reason that does not go our way, we do have another opportunity to go to appeals, to the Superior Court of Arizona, in Arizona there and go through the same argument process with those folks. Then if the superior court denies the protest, we then have the right to appeal to the Arizona Supreme Court.
And given our argument and the strengths of our arguments, we’re prepared to go all the way to the Supreme Court if required because we believe that we should have won that award. There is also an issue of ongoing bias in favor of the winning bidder and that goes through both the process, as well as these legal arguments and scoring errors in the RFP evaluation.
We believe that we are on very strong and solid ground. But again, we won’t know the result until we go through the process.
So hopefully that’s helpful, Ana.
Ana Gupte – Dowling & Partners
Yes, that’s helpful. Thanks.
So it sounds like you’re pretty optimistic and then you do have the process of appeal all the way to Supreme Court. So you sound like you could even run through the duration of the contract.
Is that fair –
Barry Smith
Well, no, no. I don’t mean to indicate that.
We really have no – we express no sentiment whatsoever, positive or negative. We simply believe our arguments are very sound and we’re hopeful that we’re going to win in this process, but we really don’t know.
So we don’t want to convey optimism nor negativity. We just don’t know at this point.
Ana Gupte – Dowling & Partners
Okay. Well, thank you.
Appreciate it.
Barry Smith
You bet. Thank you.
Operator
Our next question comes from Scott Fidel of Deutsche Bank. Go ahead.
Your line is open.
Scott Fidel – Deutsche Bank
Thanks. First question.
Just wanted to ask about how you’re thinking about potential exchange driven enrolment in 2014, particularly relative to a number of your Blues customer and given that the Blues are going more aggressively into the exchanges. And then, how are you thinking about sort of pricing with the Blues customers with those commercial customers for 2014, just given the potential that we could see some higher utilization amongst the new enrollees into the exchanges?
Sort of similar to what you saw with some of those young adults that came on to the parents’ plans, aged under 26, initially, earlier last year.
Barry Smith
Sure. We are working very closely with our Big Blues clients, in particular, all of our health plan clients, to engineer the proper product and levels of product given the various middle plans.
One of our big clients as you know is Blue Shield with California and we’ve had a team working extensively with Blue Shield, and we believe that they’re going to be very successful on that, the individual and small group product, exchange product they have. In terms of the underwriting and kind of risk assessment, we do have also our underwriting team very actively engaged with them to make sure that it’s priced properly given the anticipated utilization.
The product, interestingly, will evolve we believe overtime to be more automated, deliver very high value dependent upon the level, the middle plan level. So again, a lot of extensive work has got into this.
Clearly, over the next year, when we see the activity level in the exchanges, that product will likely continue to evolve and it will evolve pricing as we have the experience. But we feel quite comfortable and confident in what we put forward with Shield and others in terms of both pricing experience and product desirability in the market.
Scott Fidel – Deutsche Bank
Okay. So the bottom line is you’re definitely thinking about some of those initial utilization patterns as you’re rating those products for the first year.
Barry Smith
Absolutely, absolutely. And clearly, it’s going to be different from area to area, but you raised a good point.
We’re watching it very closely.
Scott Fidel – Deutsche Bank
Okay. I just wanted to ask a second question just on the Radiology segment.
And the margins there just continue to defy gravity even after you had repriced some of that business last year. And just if you can talk about some of the factors that are driving such favorable results and how is this affecting renewal pricing at this point just given that you continue to way exceed your long-term margin target in the Radiology Benefits Management business?
Jon Rubin
Yes, Scott, it’s Jon. I mentioned a couple things.
One is you’re correct. The trends in Radiology as we outlined last quarter have continued to run favorable even to our internal expectations.
And I don’t know if I’d say it’s gravity-defying, but certainly they’re saying. As you think about the drivers of that, it’s really been twofold and both have worked to our advantage.
One, we’ve seen the presentations, meaning the utilization or request for services continue to be low. It’s upticked a little bit, but still has been low.
In addition though, our team has been working over the last couple years to improve the effectiveness of our care management processes and we measure that by clinical yield, meaning, how much impact do we have on the request that come in. And that has actually trended very favorably as a result of the great work that the radiology team has initiated.
So both of those have worked to our advantages as we move forward. As we talked about or as I talked about a little earlier, we still are pricing at the same level in terms of trends based on our forward-looking view.
We’re serving at 3% to 5% range for our trend as we look forward. And while we do anticipate that the trends will come back to a more normalized levels going forward, as we pointed out, they have not yet, and we continue to see the favorability.
Scott Fidel – Deutsche Bank
Okay. And I just have one last question.
And just thinking about the potential here for interest rates to start rising from the historically low levels over the next couple of years, and just the current capital structure, dynamic. Just interested in your thinking about, have you considered being more opportunistic around the capital structure just given the continued favorable interest environment and that may not continue for that much longer?
Or would you think about adding that onto the balance sheet being more – having a prerequisite first of having visible M&A or something like that before you’d want to take that type of approach? Thanks.
Jon Rubin
Scott, a couple things, just following on to your question. One being, if you recall, we did extend our credit facility over the past year, really, to give us the flexibility and take advantage of the favorable interest rate environment.
So that’s one. Two, we absolutely will factor in the interest rates and availability of funds as we think about our capital decisions going forward.
At the same time today, we really wanted to reserve our debt capacity to give us the financial flexibility that we think we’ll need with the opportunities we have ahead, to invest in growth and potentially to pursue acquisition. So that’s been our strategy and we’re maintaining it.
Scott Fidel – Deutsche Bank
Okay. Thank you.
Operator
And our last question comes from Michael Baker of Raymond James. Go ahead, sir.
Your line is open.
Michael Baker – Raymond James
Thanks a lot. Looks like there’s been some pickup in PBM M&A activity.
I was wondering if you’ve seen any impacts on pricing or timing relative to your plans there.
Barry Smith
Yes. We are as focused as ever on the acquisition front in the PBM world.
There has been some recent action. We’re following those things closely.
There was a recent announcing of Envision with TPG. We believe that it is a segment that is still very, very attractive and we remain very optimistic.
We believe that with both capital structure and with our internal expertise, we are uniquely positioned to look at these acquisitions and have them be synergistic as we acquire them. And so, we’re in active discussions and will remain so in this arena.
So we’re enthusiastic about it. It’s full throttle forward.
Michael Baker – Raymond James
And then in terms of your communications with the PBM consultant community, which points of differentiation are you highlighting?
Barry Smith
The real difference between the traditional PBM market and what we have to offer is far more in-depth, sophisticated clinical content and interfaced with both the patient and with the prescriber. Historically, the PBM world is operated kind of in a vacuum with great operating systems and great capabilities, but unless you interface directly with a provider and with a patient in a very meaningful way, particularly for these very high cost medications that are in the specialty world, you really can’t have the best possible impact.
And so when we talk about Magellan Total Drug Solutions, we’re talking about being able to manage the cost of a drug no matter if it had been historically in the medical claims spin or in the PBM world, no matter where that individual received that medication, either in the physician’s office or through their home. And we also interface very closely with the plan sponsors to aggregate their medical data so that we can more easily evaluate the clinical appropriateness of the medication for the individual.
We also, from a cost standpoint, don’t just look at the unit cost of a drug by itself. We consider the rebate potential, the ability to shift within a therapeutic class, along with the appropriateness in a therapeutic class of drug, as well as unit cost.
So it’s a combination of very sophisticated protocols for unit cost including rebate and other economic incentives, appropriateness from a therapeutic standpoint, but also appropriateness from a distribution channel. What’s the best channel to get that drug?
We’re agnostic, whether it’s mail service or through the network, chain store network, an independent network.
Michael Baker – Raymond James
And do the consultants at this point seem willing to adjust their scoring mechanisms to give credit for that different approach?
Barry Smith
Yes. The consultants that we’ve interfaced with – and we’re expanding that even as we speak by hiring new folks who focus on the consultant/broker market, we think they’re critical in selling to employers and somehow plans.
And so they do seem to be very receptive to that message. It’s fundamentally a different kind of product that they have seen historically.
So again, I wouldn’t say that we’ve got massive exposure yet, we’re just building up that sales force to be able to tell our story more effectively.
Michael Baker – Raymond James
Thanks for the update.
Barry Smith
You bet. Thanks, Michael.
Well, we’d like to thank you today for your participation in today’s conference call. We look forward to speak with you in October when we discuss our third quarter 2013 results.
Take care. Bye-bye.
Operator
This concludes today’s conference. Thank you for your participation.
You may now disconnect.