Welcome and thank you for standing by for the Third Quarter 2019 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. Now I will turn the meeting over to Joe Bogdan. Thank you. You may begin.

Good morning, and thank you for joining Magellan Health third quarter 2019 earnings call. 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 will 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 will 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 non-controlling 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 reflects certain adjustments made for acquisitions completed after January 1, 2013, to exclude non-cash 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.

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 two 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 income by 2021. Later in the call, John 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…

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 $1.9 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 healthcare business, segment profit for the third quarter of 2019 was $44.7 million versus $61.7 million in the third quarter of 2018. Healthcare 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 Healthcare 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 customer…

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 the 14th, 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 healthcare experience and a proven leadership track record. Ken has had a successful leadership career spanning three decades in the healthcare industry. He has held key executive roles at Humana, UnitedHealth Group and the Blue’s 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 in 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 seven 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 into the call and ask that he share a few comments. Ken?

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 have built from. It’s been said that great companies well defined by the 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 three business lines. These advantages will serve us well in today’s rapidly evolving healthcare 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 turn it back over to you.

Great, thank you, Ken. And with that, now I’ll also turn the call back over to the operator, who will be happy to take your questions. Operator?

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question or comment comes from Kevin Fischbeck from Bank of America. Your line is open.

Great, thanks. 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?

Hi, 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 two main things that we’re doing. One is as noted on the call – on 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 in 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 improvement. 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, well, I'd say, the relative rate weighting of those things, the rates will likely have a bigger near-term impact both will be important as we drive progress going forward.

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 it's some of our accounts we have 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 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.

And this ability to kind of re-contract is this that – is this in the normal re-pricing cycle and you got this some time for that or you're saying that your contracts kind of allow for even unexpected changes in the utilization throughout the year. You have an ability to go back and re-contract that?

Yes, Kevin, right now we are in the normal cycle. So, where 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 contract do allow re-openers under certain circumstances in this case, we are actually in the normal cycle, which actually facilitates this.

Okay. And then the Virginia contract. It sounds like you're doing well there these 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 are there still opportunity to go below that?

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 to get into the normal profit margin range, but our objective would be to do 90% or better. But we think we are based on where we are 90% over the foreseeable future is very reasonable.

And Kevin we've had great success this year in managing costs appropriately with both the in-patient utilization management, claims integrity, outpatient costs. So, we've seen the kinds of initiatives have material impact. The other thing is that many of the initiatives that we deployed even in late 2018 we haven't seen full yet the positive impact of those, they are 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.

Great. And then on the Magellan Rx side, I guess, you said you've gone to 98% in the supply chain. How do we think about this is something that you guys do kind of annually and it felt like maybe you are 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?

Yes, I would say, I mean, Kevin what you said is true. I mean it is a continuous process that you never done. What I would say though is that some of the initiatives we undertook this year were beyond just the normal annual re-contracting. We actually did a full RFP for a 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.

In fact as 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 are able to go back to network, 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, we've seen that progress over the last several years, but it really continues, it's kicking into higher gear now and then, I think, I've seen it in the past.

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 passed to the bottom line. So, just trying to understand is there any way that you can quantify at the very least kind of the severance cost that you're taking on this year versus kind of the return on those investments you expect over the next year or two?

Yes, this is Jon. So, two general comments. 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 what we're currently expecting order of magnitudes about $5 million of severance in 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. That won't be necessarily in 2020, but that if you think about our two or three 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.

Okay. And just to make sure that $230 million to $250 million kind of normalized base which you talked about for 2019, does that exclude the severance costs or is that still includes the severance costs?

Yes, that's excludes it. So, it was one of the things we adjusted out.

Okay, so, that $235 million is a good base, it has the severance out.

Yes.

Okay, thank you.

You bet.

Great. Thanks, Kevin.

Thank you. Our next question or comment comes from Dave Styblo from Jefferies. Your line is open.

Hi, there. Good morning. And I guess to start out with Ken welcome on over. I'm looking forward to working with you and Barry, I guess, maybe this is the last time we will probably hear from you on the call. So, I just want to say thanks for perspective and enjoyed working with you over the years. I want to just come back to understand the guidance. So, it sounds like based on 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 healthcare earnings that are dampened. Is that sort of the right split?

Yes, I'd say, ballpark, Dave that's right. I would say that of the two items I specifically noted it's around $5 million in severance and around $15 million on the behavioral specialty cost of care side. But you're right, I mean, there is handful of other things, smaller things that added 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 would have potentially pulled us a little bit below midpoint. But round numbers, again, I do five and fifteen and then the rest again either rounding in terms of where we were versus midpoint or a handful of other smaller things.

Okay. And then on the severance, I guess, you guys had announced this initially thinking this 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 cost. I would have thought that these would have originally been baked into guidance though and sort of the plans that you guys have. Is there something that got pulled forward or change that is now causing the severance cost to land in the four quarter of this year?

Yes, I would say, Dave it's just having increased specificity now in terms of the plans and timing, and also if you can imagine as we go into the planning phase, we're also looking at the volumes that we have to deal within 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 look at it as fine tuning of kind of our multi-year plan and the timing of it.

Okay, got it. And then on the behavioral specialty issues. Can you, Jon, maybe you can elaborate a little bit more on how widespread the increased utilization is? Is it related to a 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?

Yes, I mean, 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's certain large accounts where it adds up to more, but we are seeing this increased demand for inpatient 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 caused us versus just general demand or industry trends right now we're seeing it be more widespread in nature.

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 not have been covered in the past particularly in the Medicaid world, or on the MCC side again individuals new populations bringing on, may not have had access, the fact that we are well known and there is a relationship already in place and Magellan being a provider for 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 we're trying to understand better, but they do seem to have an impact.

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, 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? 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?

Yes, I would say, Dave it's really much more of a negotiation. We need to get our 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 arms length negotiations. And from a contract standpoint, we often have sort of defined rate methodology was taken 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. Yes, I'd rather not speak at a customer level about what rates are required. 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.

Alright, good. 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?

For the full year?

Right, yes.

Yes, it's still what we've talked about earlier and then sort of the low '90s. So, 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.

So, to be more specific, pre-tax margin, what is the assumption?

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

Yes, okay. Thanks, guys.

Great. Thanks, Dave. 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. Thank you.

Great. Thanks, Barry.

Thank you.

Thank you. [Operator Instructions] Our next question or comment comes from Scott Fidel from Stephens. Your line is open.

Hi, thanks. And first of all, Barry best wishes on your retirement. And congrats to Ken on coming on board as CEO. I'm 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 if 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 maybe started to emerge in the first half of the year or not as well?

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 to 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 in the first half actually restated 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 best describe it.

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 that they are essentially leveling out or are you building some additional conservatism that some of these trends may potentially continue to accelerate?

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 – the relatively level. So in fact, going in to fourth quarter, it's not like we're seeing a huge uptick. Now we've got a much better picture of both second quarter and third quarter and feel like we're 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.

Got it. And then just on the New York side of things. Just to level set on that. It has to be 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?

Yes, actually, it was pretty much what we expected. I mean if you recall, we said we expected 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 on the effective date. So we did have some out of period favorability, as well as obviously the benefit in the third quarter.

Got it. And then just one last one from me just relative to the updated guide. So it's still as a pretty wide implied range in the 4Q. So maybe you want to sort of highlight sort of key swing factors in terms of what you're building in at the 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 and sort of what you're thinking in terms of margins for the Rx business in 4Q. And that's it for me. Thanks.

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’ve run reasonably well. We'd expect to continue at that general level of margin. 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?

Sure, Jon. Just in terms of the wide range still on sort of the implied 4Q guide and sort of the swing factors to the high-end to the low-end. My assumption was maybe that's sort of reflects how much rate you get on to reflect some of the cost issues you’re seeing and the behavioral specialty, but just interested in sort of what some of those swing factors are that drive pretty wide range still on the implied 4Q guide?

Okay, got it. Sorry about that. Yes, so no it's not the behavioral rate. Those are really 2020 negotiations that we're going through now. So it 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 which states around restores and rates for different facets of the population that have some opportunity. We talked about severance charges. Those are things we will fine tune as we go through the balance of the year. I'd say those are really the key items. I mean again, the further you get in the years, the more confidence we have, and we have narrowed the range some. But like I said, it wouldn't attach a whole lot of significance to the width of the range other than we try to make sure we’re forecasting that we've got confidence of being within the range.

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. Thank you.

Got it.

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.

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

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