Centene Corporation

Good morning and welcome to the Centene 2018 fourth quarter and year-end financial results conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note that this event is being recorded. I would now like to turn the conference over to Ed Krall, Senior Vice President of Finance and Investor Relations. Mr. Krall, please go ahead.

Thank you, Anita, and good morning, everyone. Thank you for joining us on our 2018 Fourth Quarter and Full Year Earnings Results Conference Call. Michael Neidorf, Chairman and Chief Executive Officer, and Jeff Schwaneky, Executive Vice President and Chief Financial Officer of Centene, will host this morning's call, which can also be accessed through our website at centene.com. A replay will be available shortly after the call's completion, also at centene.com, or by dialing 877-344-7529 in the U.S. and Canada, or in other countries by dialing 412-317-0088. The playback code for both of those dial-ins is 10125. Any remarks that Centene may make about future expectations, plans, and prospects constitute forward-looking statements for purposes of the safe harbor provision under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in Centene's most recently filed Form 10-Q, which is dated October 23, 2018, Form 10-K, dated February 20, 2018, and other public SEC filings. Centene anticipates that subsequent events and developments will cause its estimates to change. While the company may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so. The call may also refer to certain non-GAAP that's generally accepted accounting principles A reconciliation of these measures with the most directly comparable gap measures can be found in our fourth quarter 2018 press release, which is available on the company's website at centene.com under the Investors section. Finally, a reminder that our next Investor Day will be on Friday, June 14th in New York City. With that, I'd like to turn it all over to our Chairman and CEO, Michael Neidorf. Michael?

Thank you, Ed. Good morning, everyone, and thank you for joining Centene's fourth quarter and full year 2018 earnings call. During the course of this morning's call, we will discuss our fourth quarter and full year 2018 financial results and provide updates on Centene's markets and products. We will also bring you up to date on the integration of Fidelis and the regulatory and legislative environment. First, let me provide commentary on healthcare legislation legal and regulatory environment. We are hopeful that the divided government leads to greater constructive dialogue from both parties when it comes to healthcare policy. It is clear Medicaid and the services we provide are needed more than ever. Clearly numerous governors from both parties strongly supported Medicaid managed care during the repeal and replace debate. We also have seen Utah, Nebraska, and Idaho by ballot initiative recently passing Medicaid expansion. It also appears from the most recent marketplace enrollment figures, there continues to be consistent demand for affordable, high-quality healthcare coverage. As stated in the 2020 proposed payment notice, we support CMS's goal in the 2020 proposed payment notice we support CMS's goal of maintaining a stable regulatory environment, allowing for greater product predictability. The payment notice is CMS's annual regulatory and financial guidance for the marketplace. Importantly, we support the administration's continued efforts to give states greater flexibility via 1332 and 1115 waivers. This works well with our local operating model where we have strong relationships with providers and regulators. We look forward to working with the states who are on the front lines in making sure all of their citizens have access to affordable, high-quality healthcare. Next, I'd like to recap Centene's highlights of 2018. 2018 was another year of strong growth and accomplishment for Centene, capped off by the robust fourth quarter results we reported this morning. In 2018, we added 1.8 million members, surpassing the 14 million mark. We grew revenues by 24% to $60.1 billion and adjusted EPS by 41% to $7.08. The HBR improved 140 basis points year over year to 85.9%. The adjusted net income margin improved 50 basis points to 2.5%. Cash flows from operations remain strong at 1.4 times net earnings. During the year, we stuck to our business as usual approach. We have not been distracted by ACA legal headlines. As we agree with all the legal experts, it will be reversed. While there has been chatter about possible disruption to the exchanges, Individuals like to have an insurance card with comprehensive coverage. We remain the leader in the AC marketplace. In 2018, Centene successfully entered three new exchange markets and expanded in six existing and better markets. I remind you, in 2018, year over year, our exchange membership increased by approximately 500,000 members, or 52%, to one and a half million. Please note, this is ahead of our initial expectations. In Medicaid, we successfully re-procured contracts in Arizona, Florida, Washington, and Kansas, and won two new Medicaid contracts in New Mexico and Iowa. Overall, our win rate in Medicaid RFPs remains an industry-leading 80%. Also, our medical management efforts and network initiatives continue to gain traction and help drive the improved HBR I previously noted. In addition, it is our strong organic growth we engaged in strategic M&A and investments throughout the year. In 2018, we closed the acquisition of Fidelis, the only statewide health plan in all 62 counties of New York. During the year, we began integrating Fidelis, now our New York health plan, into our enterprise. We are very pleased with how the integration is going. For example, on January 1, we moved all the Fidelis employees to Centene's HR systems without incident. Fidelis has also been on our general ledger since the day we closed the transaction. We remain on track to achieve the accretion and synergy targets. We anticipate high single-digit percentage accretion to adjusted EPS in the first 12 months following the closure and low to mid-teens percentage accretion to adjusted EPS in the second full year following the close. We are also anticipating generating approximately $25 million in pre-tax net synergies in the first 12 months following the close and $100 million in total pre-tax net synergies in year two. On a run rate basis, we expect Fidelis to add approximately $12 billion in revenue and over $515 million in adjusted EBITDA, including net synergies. In addition to Fidelis, we completed the acquisition of MHS Services, a national provider in healthcare and staffing, to correctional systems and other government agencies. MHM was previously our joint venture partner in Centurion. We are now providing correctional services in 15 states with 32 contracts. We also completed the acquisition of Community Medical Group, CMG, a leading at-risk primary care provider in Miami-Dade, Florida. CMG has 15 clinics that focus on low-income beneficiaries with an expertise in social determinants. We increased our ownership in Interpreter, a technology company focused on clinical and geomic data, as well as real-time analytics. Our total ownership is now 80%. We made an investment in RxAdvanced technology-based pharmacy benefits management platform. We support a shift towards a more transparent PBM model that is sustainable with higher quality and lower cost for consumers. Over the past year, we have been advocating for net pricing versus rebates. Lastly, Centene purchased a controlling stake in University Hospital of Torreon in Madrid. This is an important addition to our Rivera Salud model, which sets the standard for successful public-private partnerships in healthcare. As a final point, we introduced Centene Forward a transformative program to enhance key parts of our enterprise. We expect Centene Forward to realize up to $500 million in savings over a multi-year period. It is important to note that this is not a short-term effort to have savings immediately go to the bottom line in 2019. Rather, it is a self-generating effort to reinvest capital into additional capabilities and technologies that better position-setting for long-term growth, increased margins, and profitability. Moving on to market product updates. First, we'll discuss Medicaid activity. Florida. In December, as part of a successful re-procurement, we continued providing physical and behavioral health care services to the state's Medicaid program. We are now statewide in all 11 regions, Importantly, this large geographic footprint results in additional membership and revenue from our previous contracts. Kansas. On January 1, our Kansas health plan renewed its contract to continue providing managed care services for the state's Medicaid program. This was a successful re-procurement of an existing contract. We currently serve approximately 130,000 recipients in the state. New Mexico. Last month, Santum began serving recipients enrolled in New Mexico's Medicaid Managed Care Program. We currently have approximately 65,000 members while still early in the process. The launch is progressing as expected. Pennsylvania. In January, we began serving over 30,000 beneficiaries enrolled in Pennsylvania's Long-Term Care Program in the Southeast Zone. We launched the Southwest Zone in January of 2018. We now serve over 50,000 long-term members in the state. The third and final zone will be implemented by January of 2020. Our participation in this major program reinforces our national leadership position in long-term care. North Carolina. We are pleased to be selected in two regions in the North Carolina Medicaid Managed Care Program. These two regions are among the largest in the state. Our joint venture Carolina Complete Health is the only provider-sponsored winner in the RFP. This will result in better health outcomes for members at a lower cost for the state. The contract is set to commence February 1, 2020, as this was only awarded yesterday, we will provide more details on our first quarter earnings call. I do want to highlight, however, that we believe that the state did not fully understand our innovative approach with providers in North Carolina. However, we believe our partnership with the North Carolina Medical Society and the FQHCs will be proven to be the right model for success in that market. We are a believer in a provider-led entity approach for growth and quality, and we expect to be the best partner the state has in its Medicaid program. We are currently considering an appeal and helping them to understand what this innovative model means and how we can help manage costs and improve quality. Next, Centurion. Florida in December In December, Centurion began operating under an additional new contract, providing comprehensive healthcare services. Operating under an additional new contract, providing comprehensive healthcare services. This new contract covers an average of 1,425 detainees in Valencia County detention facilities. With the addition of this new contract, Centurion is now statewide in Florida. New Mexico. In February, Centurion began providing comprehensive healthcare services to detainees in the Metropolitan Detention Center in Albuquerque. Centurion is providing a wider range of healthcare services to an average detainee population of 1,550. Arizona. In late January, Centurion was notified by the state of Arizona of its intent to award a contract to provide healthcare services to inmates housed in the state's prison system. The contract is expected to begin in July of 2019. Under the agreement, Centroia will provide healthcare services to an average daily population of approximately 34,000. Now, health insurance marketplaces. Our marketplace business continued to perform well in the fourth quarter. At year-end 2018, we served approximately $1.5 million exchange members in 16 states for 2019 our continued focus on providing high quality affordable health care led to a very successful open enrollment in a national market that shrunk almost three percent and better grew approximately 15 percent and now has approximately 20 percent national market share we achieved this while maintaining our pricing disciplines we began offering exchange products in four new states in 2019. We also expanded our footprint in six of our existing Ambetter states. In January, we had almost 2 million paid members across 20 states. This represents a year-over-year increase of 250,000 legacy Ambetter members, as well as 80,000 Fidelis members. The $250,000 increase is well ahead of our most recent estimate of $150,000 to $200,000. As you recall, the initial estimate we provided on December Investor Day was $50,000 to $150,000. The key demographics of these members remain consistent with the comments we made on December Investor Day, excluding Fidelis, approximately 90% are eligible for subsidiaries. Meadowtier and other demographics are consistent with prior years. Our retention rate is maintained at 80%. We expect to have another strong year of operations in our industry-leading marketplace business. On to Medicare. At year-end, we served approximately 417,000 Medicare and MMP beneficiaries. This represents year-over-year growth of approximately 83,000, or 25%. Consistent with our growth strategy, we have expanded our geographic footprint and are in 21 states in 2019. We continue to take targeted approach to growing our Medicare Advantage business. As we commented on December Investor Day, we priced for margin stability in 2019, recognizing the headwinds that came with a lower star rate. As a reminder, we expect first quarter 2019 MA membership. to decrease by approximately 20,000 members. This is due to a reposition in Fidelis to get back its four-star rating. We continue to expect 2019 MA revenue and membership to be flat compared to 2018. We will return to a four-star MA parent rating for the 2020 plan year. We expect this will have a positive impact on multiple new plans, including the joint venture we announced with Ascension Healthcare. This should allow us, along with other product enhancement efforts, to accelerate growth in MA in 2020 and beyond. I remind you, it is not how fast, but how well one grows. Shifting gears to our rate outlook. For 2018, our composite Medicaid rate increase was 1%. We are expecting a composite Medicaid rate increase of 1.5% in 2019. Separately, CMS issued the 2020 advance notice last week, and preliminary Medicare advantage rates appear to be in line with our expectations. We continue to see, as well as anticipate, overall stable medical cost trends, including flu, consistent with overall stable medical cost trends, including flu, consistent with our expectations in the low single digits. In conclusion, 2018 was another successful year for Centene. Our strong 2018 results reaffirmed our growth momentum for 2019 and beyond. Our pipeline of growth opportunities is robust, and we remain focused on margin expansion. We are raising our 2019 guidance to reflect a higher than expected open enrollment for Marketplace, the Centurion win in Arizona, and the win in Madrid or the acquisition of the Madrid Hospital. Before I turn the call over to Jeff, I would like to remind you that the approved two-for-one stock split will be distributed tomorrow, February 6th. The split stock enhances liquidity for shareholders in line with Centene's market cap growth. Importantly, it moves our float to a level appropriate for an enterprise of our size. Thank you for your interest in Centene. Jeff will now provide you further details on fourth quarter and full year 2018 financial results as well as our increased 2019 guidance.

Jeff? Thank you, Michael, and good morning. This morning we reported strong fourth quarter and full year 2018 results. Fourth quarter revenues were $16.6 billion, an increase of 29% over the fourth quarter of 2017. and adjusted diluted earnings per share was $1.38 this quarter compared to 97 cents last year. Both the fourth quarter and full year results include additional costs associated with the marketplace open enrollment period. During the fourth quarter, we invested an additional 4 cents per diluted share into growth-related initiatives, including member outreach efforts associated with the marketplace business. This was above our forecast and previous business expansion cost guidance range. The strong fourth quarter caps off a very successful year for the company. Total revenues grew 24% in 2018 to $60.1 billion, driven by the acquisition of FidelisCare, continued growth in the health insurance marketplace business, product and market expansions, and the return of the health insurer fee in 2018. This growth led to record adjusted earnings in 2018, with adjusted diluted earnings per share of $7.08 an increase of 41% over 2017. The growth in earnings year-over-year was driven by the Fidelis acquisition and the growth in the marketplace business. Before I get into the details, I want to remind everyone of the upcoming stock split. The split was declared by the Board of Directors on December 12, 2018, to be distributed on February 6, 2019, to stockholders of record as of December 24, 2018. The split is not reflected in this morning's earnings release unless otherwise noted. Now let me provide some more details for the fourth quarter. Total revenues grew by approximately $3.8 billion year-over-year, primarily as a result of the acquisition of FidelisCare, growth in the health insurance marketplace business, the expansions in new programs in many of our states in 2018, including the Illinois contract expansion and the Pennsylvania LTSS program, other acquisitions, including MHM and CMG, and the return of the health insurer fee in 2018. This growth was partially offset by lower revenues in California associated with a reduction in pass-through payments and the impact of the removal of the in-home support services program from managed care, which took effect in January 2018. Moving on to HBR, our health benefits ratio was 86.8% in the fourth quarter this year, compared to 87.3% in last year's fourth quarter and 86.3% in the third quarter of 2018. The decrease year-over-year is primarily driven by growth in the health insurance marketplace business and the reinstatement of the health insurer fee in 2018. These decreases were partially offset by the acquisition of Fidelis Care, which operates at a higher HBR. Sequentially, the 50 basis point increase in HBR from the third quarter of 2018 is primarily attributable to the impact of the IHSS reconciliation in the third quarter of 2018 and normal seasonality in the health insurance marketplace business. These HBR increases were partially offset by improved Medicaid performance over the third quarter of 2018. The marketplace business continues to perform well and membership remains strong as we ended the year with 1.5 million members. We had a successful open enrollment season, adding approximately 250,000 members from our peak enrollment last year, excluding Fidelis. This growth, with the addition of the Fidelis membership, is expected to give us almost 2 million members for 2019 peak membership. The demographics of our membership remain consistent, and we ended 2018 with with approximately $930 million of risk adjustment payable and over $260 million associated with minimum MLR rebates. Now on to SG&A. Our adjusted selling general administrative expense ratio was 9.9% in the fourth quarter this year compared to 10.5% last year and 10% in the third quarter of 2018. The year-over-year decrease was primarily due to the acquisition of FidelisCare, which operates at a lower SG&A expense ratio. This decrease was partially offset by growth in the health insurance marketplace business, which operates at a higher SG&A expense ratio, and the impact of the removal of the IHSS program from California's Medicaid contract. The sequential decrease is primarily due to the costs associated with the end of our contract with the U.S. Department of Veterans Affairs and the contribution to our charitable foundation recognized in the third quarter of 2018. Additionally, as commented on earlier, We spent 20 cents per diluted share on business expansion costs during the fourth quarter, which was 4 cents higher than our previous expectations. For the full year 2018, we spent 38 cents per diluted share on business expansion costs compared to our previous guidance range of 30 to 34 cents per diluted share. Invested income was $67 million during the fourth quarter compared to $53 million last year and $80 million last quarter. The increase year-over-year is due to higher investment balances, mainly associated with Fidelis acquisition, as well as higher interest rates on short-term investments. Sequentially, investment income decreased due to lower investable balances associated with the payment of the health insurer fee, risk adjustment, and the California Medicaid expansion minimum MLR rebate payments. Interest expense was $98 million in the fourth quarter of 2018, compared to $66 million last year and $97 million last quarter. The increase year over year was driven by additional debt to fund the Fidelis acquisition and higher interest rates on our debt associated with our interest rate swaps. Our effective tax rate for the fourth quarter was 32.5% and in line with our expectations. The fourth quarter tax rate is lower than the full year, driven by the vesting of our employee stock awards, which lowers the rate in the fourth quarter. Now on to the balance sheet. Cash and investments totaled $13.5 billion at quarter end, including $478 million held by unregulated subsidiaries. Our risk-based capital percentage for NAIC filers continues to be in excess of 350% of the authorized control level. Debt at quarter end was $6.7 billion, which includes $284 million of borrowings on our revolving credit facility. Our debt-to-capital ratio was 37.4%, excluding our non-recourse mortgage note and construction loan, compared to 40.3% at fourth quarter last year and 36.9% at the third quarter of 2018. Our medical claims liability totaled $6.8 billion at quarter end and represents 48 days in claims payable compared to 51 days for the third quarter of 2018. As expected and highlighted on our third quarter earnings call and investor day in December, The DCP decreased during the quarter associated with timing items and the Fidelis acquisition from the third quarter. We continue to expect days and claims payable to be in the mid-40s range on a long-term basis. Cash flow used in operations was $634 million in the fourth quarter, and cash flow provided by operations was $1.2 billion for the full year 2018, or 1.4 times net earnings. Cash flow for the quarter was negatively impacted by the payment of the 2018 health insurer fee of approximately $700 million and the repayment of approximately $370 million of Medicaid expansion MLR rebate payments in California, which was previously accrued. Before we discuss 2019 guidance, let me provide an update on the Fidelis acquisitions. Through the first six months, Fidelis has performed in line with expectations, including the realization of anticipated synergies. The integration continues to go well, and we expect to achieve our previously communicated synergy targets for the first and second years post-acquisition. Now on to our 2019 annual guidance. Our updated 2019 annual guidance is included in our press release issued this morning. We have provided our earnings per share guidance on a split-adjusted basis for convenience. In summary, we have increased both our 2019 total revenues guidance at the midpoint by $600 million and adjusted earnings per share by 4 cents at the midpoint on a split adjusted basis to reflect the additional membership growth in the marketplace business which came in above our expectations, the acquisition of Torrijon in Spain, and the new contract win for Centurion in Arizona. In summary, Our full year 2019 guidance on a split adjusted basis is as follows. Total revenues is $70.3 to $71.1 billion. Gap diluted earnings per share of $3.65 to $3.83. Adjusted diluted earnings per share of $4.11 to $4.31. An HBR of 86.5 to 87%. An SG&A ratio of 9.3 to 9.8%. An adjusted SG&A ratio of 9.3 to 9.8%. an effective tax rate of 25% to 27%, and diluted shares outstanding of 421.5 to 422.5 million shares split adjusted. In conclusion, 2018 was a successful year for the company, led by strong top and bottom line growth. The performance in the fourth quarter and continued growth in the marketplace business provide tailwinds heading into 2019, where we expect to continue to drive long-term growth and margin expansion. That concludes my remarks, and operators, you may now open the line for questions. Thank you.

We will now begin the question and answer session. To ask a question, you may press star, then 1 on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. The first question today comes from Kevin Fishbeck with Bank of America Merrill Lynch. Please go ahead.

Great, thanks. I wanted to focus on the exchanges. I guess the first question there is, you mentioned retention is similar and the demographic is similar. Any markets in particular that you would highlight as kind of faster growing than average?

I think we have a very balanced approach to our markets. Of course, different markets have different sizes, so you have different penetration, but it's very balanced across our markets. And the demographics across markets are the same. The metal tiers, everything about it, Kevin, is just consistent with what we have historically seen.

I was going to ask also, Jeff, your comment there where you said at the very end, you said the growth in the marketplace business provides tailwinds for 2019, and you expect to drive long-term growth and margin expansion. I wasn't sure if You were saying that you expect additional margin expansion in the exchanges, or whether that was a broader comment about the overall business seeing margin expansion?

No, that was an overall broader comment. I mean, I think the tailwinds comment is evident by, obviously, we haven't even closed the books for January, and we're raising guidance, right? So membership came in higher than we expected, and we have, obviously, the new win in Centurion in Arizona and the acquisition, and we're updating guidance for those items.

Great.

Thank you.

The next question comes from Josh Raskin with Nefron. Please go ahead.

Hi. Thanks. Good morning. I want to stick with the exchanges as well. Good morning, Michael. Two questions, I guess, related to exchanges. One is, can we get an updated revenue contribution in terms of your total top line of that $70 billion or so? How much of that is actually exchanges? And then Is there any assumed margin reset? It doesn't sound like there's any reason to think that. I know you've talked about conservatism in the past in certain years, so curious on that. And then just on new competition, I don't know, are you seeing any traction from the Oscars or even new competitors in any of your markets? So sorry for a bunch of questions on exchanges, but that's it.

Go ahead, Jeff. Yeah, so, Josh, a couple things. I think you could probably, you know, bridge our Investor Day slide to get there, but for 2019, I would say, you know, around the $10 billion mark would be for the exchange product. As far as margins, I think, you know, what we mentioned in our Investor Day in December was kind of the margin you know, what we're projecting margins for 2019 to be similar to 17, 16, 15, which was between the 5 and 10% range. And I think that's exactly what we're expecting for 2019.

And from a competitive standpoint, we're not seeing activity that in any way affects us.

Okay. You're not seeing any, you know, pockets of growth from some new entrants or anything like that in any of the specific markets?

No. If anything, I mean, we like to see more people out there because it creates more noise and more activity. And in a competitive environment, we tend to do very well. Gotcha.

And then just one last one. I just want to ask on North Carolina. Could you size sort of the startup and development costs? I know you guys have been in the state. You guys were one of the earliest in there. I know you've entered the exchanges as well. Any way to size what that total cost of market entry was for North Carolina?

Recognizing we just got the information yesterday, I'd like to suggest that we delay that comment to the first quarter call, if I may, Josh. I mean, we have some ballpark numbers with Something like that, we want to be fairly specific. We are talking about an appeal. So I don't want to put anything out there that can in any way mislead.

Do you agree to that? Yeah, I would agree on the specific number. I would say that included in our guidance that we gave today are costs. We're refining those estimates obviously based on what we learned yesterday.

All right, that's fair.

Thank you.

Thank you.

The next question comes from Scott Fidel with Stevens. Please go ahead.

Hi, thanks. Good morning. I just wanted to follow up on North Carolina and just as you continue to do the postmortem today on the results yesterday, just interested in as you evaluate the awards, what you think were the key reasons why the state didn't award Centene a statewide contract? And then, Michael, as you mentioned, you're considering the appeal. maybe help us think about some of the key sort of substantive points that you think that Centene can raise around the appeal.

Yeah, I think, one, I want to back off. I mean, we're not unhappy. When you win the largest service region and the third largest, it's meaningful numbers, and I have them here somewhere I could quote them. So it's not a, I don't see this as a loss. I see it as a win. I think, as I said in my comments, that the state did not fully understand the innovative approach we had working with providers, which I've personally done before. And I think as they understand that, and this was something that was in the legislation that they wanted, and we have worked very hard, and we do believe that the partnership, when they understand it with the FQHCs, the Medical Society, and others, will prove to be a very successful model in North Carolina when you look at the history of what their models have looked like. So, you know, I think we're going to be a strong provider in those two regions. We're going to take them through what happened and we're going to understand their decision making because, you know, you win two, you say if it works there, this model, maybe they're trying to understand it more and they don't want to go too far with it until they do. I can see lots of reasons. So we'll work with them, we'll appeal it, but regardless of what happens, we believe in being a strong partner with states and work with them, and I think it's going to have a short and longer term, very positive outlook for quality and cost effectiveness in their state.

Got it. If I could just ask a related follow-up, too, just on, I know you're not ready to size the revenue impact from North Carolina, but I think from all of our end, we're trying to sort of sort out just what the margin profile of the North Carolina business can look like because you've got some different dynamics in terms of the JV with providers and the minimum MLRs in North Carolina and some other factors. Just sort of, I guess, conceptually, how do you guys think about sort of the margin profile of North Carolina business? more broadly relative to, let's say, sort of the more broader normalized margins that you target in the Medicaid book?

I expect our margins over time because, as you know, we have always taken conservatism and said that for the first three, four quarters, there's an investment period. In the MRR, we book high until we see that the system is understanding what's involved in the managed care profile and system that we use. And so, I mean, I don't expect great, great margins in the first three, four quarters. But I do believe that these margins will be consistent to better. And I think working with the providers effectively, and you have to keep in mind, we have some pretty good systems with Integra, Interpreter, and CaseNet and other things that will help make these providers particularly successful. And so, I see an opportunity for... you know, in 20, because, I mean, we're not going to start immediately. I do see over, as the year unfolds, 20, because, I mean, we're not going to start immediately. I do see over, as the year unfolds, some opportunity for some upside on it. And I think we're going to be putting together a model here that others will want to emulate over time.

Okay.

Thanks.

The next question comes from Michael Neuschell with Evercore ISI. Please go ahead.

Thanks. Michael, can you address the contract extension disclosed last night and what it means for succession planning? Did the board ask you to stay longer or did the impetus come from you?

No, I would say when succession planning continues as originally planned with the board, we continue to work through that. And as we were talking about succession planning, the board asked me if I'd be willing to extend it. And I said that... I would. I mean, we're having fun. We're having success. I don't want to jinx it, but we're blessed with good health. And so we have a great team here that it's fund the lead that's taking on more and more of the load. So I can continue what I'm doing and maybe even add a couple rounds of golf.

So succession planning still kind of continues in the meantime?

Or it's pushed off now? No, no, the succession planning, you know, one, succession planning can be a point in time, but it can also be a process that can be implemented any time one feels it's appropriate to do so. So I'd rather take that approach, and it's business as usual, and, you know, it was their idea to extend it, because I've had a lot of questions about it, and to give a sense to all of you and everyone and the people in the company, there is... There will be continuity, and we'll continue down the line.

Got it. And if I can just squeeze one more in. Can you just also confirm whether you're buying the QualChoice health plan in Arkansas from CHI and what the financial impact in time you might be?

Yeah, we have the terms decided. We have not closed on it yet. And I will close, Jesse, when later this –

Yep, so we have executed the contract on that, Mike, so we would expect to close in the second quarter, and I would just say this is an in-market transaction, so we tend to like those and look for those, so not material in the macro scheme, but certainly Arkansas has been a good market, and we're excited to expand our presence there.

Great. Thank you very much.

The next question comes from Peter Costa with Wells Fargo Securities. Please go ahead.

Thanks, and congratulations on the quarter. I wanted to ask you about going forward. First off, in North Carolina, what do you expect the startup costs will be in 2019 and 2020? Because your business doesn't start until 2020. And then also in 2020, can you talk about what's going to happen with silver loading and the cost-sharing subsidies and what might change there?

Yeah, so this is Jeff. I'll handle the first question on the cost. I think what we said was we have some costs in for our 2019 guidance, but since we just got this information yesterday, it's a little early, and we're reevaluating those costs, I guess is what I would say. So early for us to give a pinpoint number on that, given the information that came out yesterday. And on the second, I mean, we're not talking about 2020 guidance here today.

I'm curious if you want to talk about what might happen in Washington this year regarding the cost-sharing subsidies and the way silver loading works and if that may change for 2020 relative to HHS is allowing it for 2019, but it seems to be more up in the air for 2020.

Hey, Peter, it's Kevin. Yeah, you're right. If you look at the 19 payment notice, they make allusion to that. I think, again, it's premature to think about what that might actually look like into 2020. You know, we're going to be prepared to pivot irrespective of what the policy decides. And, again, as you know, within CMS a year is a long time. So we'll see what happens.

Yeah, I think also, you know, we do have two sides to the government now looking at these issues. And our feeling is that that can be positive if we get some good constructive discussion going. And we're going to play every part we can to move it to policy versus politics. There may be some real opportunities there, Peter.

Okay, thank you.

Next question comes from Sarah James with Piper Jaffrey. Please go ahead.

Thank you. In North Carolina, Did Centene submit a bid as a... Thank you. In North Carolina, did Centene submit a bid as a health plan also or only a PLE? And I'm wondering, since the provider-led entities could be awarded regions and health plans statewide, can you speak a little bit to the strategy around deciding to submit a bid as a PLE?

Well, we actually did submit... on both sides of it, but we emphasize the PRE. You have to go back and look at the historic programs they've had in the state and the role providers have had, and I think working with the state medical society, and they've been great constructive partners, and they really want to deliver high-quality care. They understand the cost issues, and they want to work with us because of our systems and how we can support them doing a better job and everybody doing well, we decided that's a good place to be. And I still believe that Sarah. And, uh, I think over time, it's going to prove to be, uh, a very effective model, uh, in markets like, uh, North Carolina with the history they had. So, uh, no, this is one of those things that, uh, I think time will, uh, prove to be on our side. And, uh, So it's going to be business as usual. We did do both, but we felt a real need to emphasize this side of it. And I think the state just, I think they understood some value in it, and that's why they did give us the largest and third largest regions, as opposed to saying, no, we're not going to do any of this provider-led organizations. But we're going to go back and talk to them and see if that can't be expanded some. through the appeal process. If not, we'll still be a good partner no matter how it comes out. It's going to be a sizable business, which we'll size for you on the Q1 call.

That makes a lot of sense. And one more question, if I can. If I look back at 2018, there were points of 2Q and 3Q where consensus didn't really get seasonality right on a couple of different lines, and that caused some confusion. So I'm wondering if there's any commentary you can offer around 2019 seasonality or cadence and how you see that differing from 2018.

I want to make an opening comment and let Jeff take it up. Of course, we don't look at consensus. We look at the business and how it's developing. But, Jess, do you want to talk about seasonality?

Yeah, I think what we said in our December Investor Day, we've been trying to give more insight, I guess, to the seasonality of the business, giving a first half, second half view as far as how earnings progression goes. And I would say the comment we made there, I think we're consistent. So over 60% in the first half of the year. And again, As we continue to grow the marketplace business, that shift continues to happen. The real driver of our change in seasonality is really the product mix. It's the diversification of the product mix. To the extent that you have a higher mix of exchange, then you will pull more earnings forward to the first half of the year. Number one, that's when we have the highest level of membership. And number two, that's when we have the lowest HBR as a result of deductibles.

Okay, so even though you guys are doing much better on exchange growth than you thought at Investor Day, you still think the 60-40 mix is an appropriate way to think about the year?

Yeah, yeah, I would think that's a good place to start.

Thank you.

Thank you.

The next question comes from A.J. Rice with Credits List. Please go ahead.

Thanks. Hi, everybody. First of all, just to ask about Fidelis a little more. It sounds like generally on a broad sense everything is tracking. Are there any pockets as you drill down where you've seen new opportunities now that you've had it for a while? Are there any areas where you're seeing challenges that weren't anticipated?

I'll start off, and others can add as they feel. I think it's an incredibly well-run company. We're pleased with what we've had. Father Frawley will continue to work with us in social responsibility for some obvious legal reasons. It was important that he appoint a new CEO, and we did. Great continuity there. The whole team's in place. In fact, he commented to me not too long ago when he was in that the turnover rate since we announced the acquisition has been the lowest they've seen historically. So people are very pleased with it. I think there are opportunities to continue to grow. People are very pleased with it. I think there are opportunities to continue to grow. There's opportunities to help them with their medical loss ratio using our systems. But they're hitting all their numbers. They're They're functioning on all eight or 12 cylinders, depending on how many you have in your automobile. And so I think from every aspect of it, I made the comment one day that if we could find more businesses like that, I'd want to do one in the morning and one in the afternoon. They're really a well-run company.

Okay. I was going to also ask about in Mississippi in the press release, you highlight that you completed the implementation of the new PBM model. Can you update us on your thought about rolling it out to other markets, and will you wait for sort of proof of concept in Mississippi to play out for a little while, or how should we think about that?

We're actively rolling it out now, and I'd like to roll it out as fast as we can, but once again, I want to make sure it's well implemented. Proof of concept's there. It's working incredibly well in Mississippi. And we're confident we're going to roll it out into additional markets. We are right now as we speak. And by the end of 2020, we will be in all the markets. And if I can pick it up in some way, we will. But, you know, once again, I'm not going to overload it. But it's a great system. It's going to prove to be, I think, where... pharmacy benefits should be headed.

Okay. What's this most significant economic benefit of making that transition that you're seeing in Mississippi?

Well, there's administrative expenses. It's cloud-based. We can reduce the admin costs significantly. And we're working with, I mean, John Scully and Ravi and the people there are really innovative and creative. And I'm working with them now to, cause I have a commitment to figure out, is there some way to move to net pricing as opposed to rebates? And, uh, I think they have the system skills and capabilities that, uh, we can start talking about those kinds of, we are talking about those kinds of things with them. It's not going to be instant, but, uh, so there's a lot of significance in what they're doing. It's, uh, it's very innovative. And as, uh, We're able to demonstrate more and more, but you'll see it.

Okay. All right. Thanks a lot.

The next question comes from Lance Wilkes with Sanford Bernstein. Please go ahead.

Yeah, good morning. Could you talk a little bit about, in the Medicaid book, medical cost trend and management? In particular, if you could just kind of hit upon some color on what's doing better than expected, what's doing worse, how important steerage and restrictive networks are, and what's going on with risk profile at the state level with some of the re-enrollment efforts that are taking place at those levels.

Jeff, do you want to comment on that? Yeah, a couple of things. We did see the Medicaid improvement over the third quarter. Really, it's a combination of many things, you know, a combination of the med management, network improvement, initiatives, premium rate adjustments, combined with, I think, what we saw was stable cost trends in the fourth quarter. So your comment about risk profile, I mean, you really have to go on a state-by-state basis. So if you aggregate the business, I mean, that's one of the benefits of diversification. If you aggregate the business, I would say that the risk profile has remained relatively consistent.

Yeah, I'd like to add that If you look at the scale and size we have in most markets, albeit in the newest markets, 65,000 in Mexico now grow. But when you have the size we do, you get a balanced book of business. And we're expecting to have some that are acutely ill and some that are healthier. And we look across the whole book and we're seeing that. And that's really the law of large numbers as much as anything else coming into play. So that's part of the benefit of our size. being the largest Medicaid provider. But also, as Jeff highlighted, you have 31 states. It puts you in a strong position because, as I tell investors, it's no different than their portfolios. At any given time, they might have one stock that's not performing well or two. Well, we can have a market that has a couple issues, but we have others doing well in the offset while we correct the one that has an issue. So it's a balance that gives us a certain comfort.

And can you just talk to the, or just clarify on the behavioral membership for the quarter? What was the decrease in that, and did it go into an integrated medical offering?

It's moving, and we're moving more and more to the integrated medical offering. It's moving, and we're moving more and more to the integrated medical, and I want to do that as quickly as we can. I really believe that's an important place to be. I have used publicly the example that if somebody's diagnosed as a new diabetic, I sure want them to talk to a behavioral person as quickly as they can because it gives you more control of the total medical condition.

Yeah, the membership decreased. We previewed this at our Investor Day. It was really a behavioral health-only program in Arizona that was integrated with the traditional Medicaid program. And so while the membership decreased, quite a bit, the revenues are up on a consolidated basis. So lower membership, higher revenue because it's been integrated with the physical health.

Gotcha. Thanks.

The next question comes from Steve Tennell with Goldman Sachs. Please go ahead.

Morning, guys. Thanks for the question. Morning. Just one quick one on the marketplace. I missed the minimum MLR accrual number. If you could just give us that once more and then maybe just let us know where 2018 margins ended for the business.

Yeah, so I think 260, approximately $260 million. And, you know, as I said, you know, in our December investor day, you know, we're not going to give it. It's a competitively priced product. We're not going to give a specific margin number.

Okay. All right. Fair enough. And then the other question that I had, you know, we're hearing a little bit more sort of anecdotally around the eligibility redeterminations in Medicaid potentially affecting risk pools and making for a bit of a short-term blip as some of the, you know, the MCOs go back to the states for better rates. What are your views on whether or not that's happening? And if it is, maybe is this part of sort of the uptick in Medicaid rates where you're looking for a one-and-a-half composite increase in 19 versus one in 18, or... How should we think about that if that's not really behind that?

Again, I think you have to go on a state-by-state basis. We have seen where redeterminations have changed the risk pool, and states have been relatively quick to react. I wouldn't necessarily call that meaningful. It's certainly helpful, but it's not a meaningful driver of the medical cost. If you look at the actual volume of redeterminations, But we actually have had states do adjustments, I would say, relatively quickly after the redeterminations. And, you know, when you look at acuity mix, it's different by state. Some states have had redeterminations that had no effect on acuity.

Yeah. So once again, it's the law of large numbers, large number of states in the mix.

That's helpful. And so then the acceleration and the rate, is there anything specific we could sort of think about as driving that?

The acceleration in what rate? The composite?

Yeah, the composite rate going to 1.5 versus 1.18.

Yeah, I mean, I think I mentioned at our December investor day, you know, we do have certain states which aren't performing at the long-term margin. Some of that is a rating issue. So we have seen and are projecting some improvement in rates into 2019. Perfect. Thank you.

The next question comes from Dave Winley with Jefferies. Please go ahead.

Hi, good morning. It's Dave for Dave Winley. First question I had was just on the Medicaid business. It seems like that that's driving the MLR movement to the bottom end of your 2018 guidance range. I'd be curious just to get a better sense of where the margins are at this point. And we're hearing peers obviously talk about net margins getting close to 3% over the next couple of years. Do you think that's something possible for Centene, or is there some business mix or other structural considerations that might make it hard for you guys to replicate that type of profile?

Yeah, I commented on this in our December Investor Day where, you know, we've also grown faster than anybody else in the industry on the Medicaid side. And as Michael mentioned before, when you're starting up these new markets, you have compressed margins versus, you know, what you would say is your long-term margin growth. So I think from our standpoint, we still think 3% to 5% is a good margin target. And just because of the mix and the growth that we've had, it's probably different than our competitors.

And I would add something else. If you look at it, I know we showed the net margin of 50 basis points with what we gave you today. It's easy to say what you think is going to happen in the future. We prefer to say we have a continued focus on margin expansion and growing the business. And we tend to deliver against it versus saying, I'm going to get it to X number. I mean, that's easy. I used to learn that they used to say in Brazil and other Latin American countries, I used to learn that they used to say in Brazil and other Latin American countries, that paper will accept anything. I'm going to simply say that we're going to continue to grow this business, and it's dramatic in my opinion, and we're going to work hard at margin expansion. using systems and other capabilities we have to improve outcomes and reduce costs.

Sure. And, Jeff, I think I heard you mention that the risk adjustment payables was at $930 million at the fourth quarter. I think that's up about 37% year-over-year. Compared to exchange enrollment, that's up a little bit over 50%. Can you just help us understand maybe the delta there, why those don't look a little bit more comparable in terms of growth?

Yeah, I mean, you have to look at member months, I think, is one of the first things in total. But, I mean, it wasn't out of line with our expectations. And I did give you it's $930 million. And the reason I'm giving those is because typically what we file in the quarters, we file the 10-Q, and you can pull those from the 10-Q. Obviously, here the annual report comes later, so I'm just giving those to you now. Sure. Thanks.

The next question comes from Matt Borsh with BMO. Please go ahead.

Oh, thanks for fitting me in. Thank you. I have a question about as you look out with the various providers that you're working with, do you anticipate shortages as you look ahead the next five years or maybe even beyond that? And I'll ask the question in the context of a hypothetical that, if you had one of the big drug retailers, let's say, you know, with sort of ancillary personnel providing primary care services, would that be something that would be an attractive model for Centene to contract with?

You know, I think we tend to kind of march our own drum. And, you know, we work well with primary care. We work well with specialists. And sometimes some of you... have a chance to come to the office. We'll take you through our case net and our interpreter. We've shown some of it in the investor days. But there are systems that help physicians become very successful in treating their patients and give them the data and give them real-time heated scores and things that they can get on. We're moving to where they can get on their iPhone. And so I believe that there are effective contracts available in equity. You can have equity in contracts, is what I'm trying to say. That tends to be the direction. If we see, and I said this in Investor Days, if we saw an area where there's not enough positions for access, and we're working with some governmental agencies in just that issue, well, we have CMG now that has the capability to open up very successful clinics that deal with this population, social determinants, etc., And we'd ask Luis, who runs it, to move into Region X and put together a little multi-specialty clinic. So we think we have the capability to meet our members' needs. And once again, we all know who you're thinking of. That's a big operation, but they also have a lot of commercial and other membership. And we're very focused in the government services area.

Thank you.

The next question comes from Anna Gupta with SCB Lyric. Please go ahead.

Hi, thanks. Good morning. Thanks for sending me in. You know, I just wanted some color as you go into 2020 on a couple of drivers, growth drivers. Firstly, on exchanges, can you talk about, you know, what your growth profile might be there as you look at the demand and then, you know, the underpenetration, the moves to short-term plans and anything else in the competitive environment as you go into the selling season?

I'll start and Jeff, you can pick up. The short-term plans, I mean, short-term plans through manufacturing associations have been around forever. The benefits have matured less. The majority of our membership has subsidies. So why jump out of something else that gives them a lot less benefits to go into it? And those things still have to be proven out and And they are just that, they're short-term. And I think over time, costs of short-term plans go up because you have such a turnover that you have different disease states. And they've tried to overcome that by being able to underwrite health risk. And that in itself, I think, is going to long-term be a problem. Not for us, but just for health states in general. It's a problem. Not for us, but just for health states in general. So I think it's a long way. It's an attempt to be disruptive, but I'm not sure how disruptive to be our particular model. So I think that's it. So looking forward, I mean, um, I'll just remind any, not you, but others have talked about our growth rate. You know, as we got bigger, well, it's, we're still maintaining a significant growth rate. They talk about the exchanges and all the disruption and how it is. And we're up, uh, what, 15% this year when the market is declining. So, uh, We're just going to continue to business as usual and deal with the facts as we have them now. And the facts say it's a good business, it's a strong business, and we know how to manage it. We have the systems to manage it. Does that help?

That's helpful. Yes, thanks, Mike. On the MA side then for 2020, and I think it's really thought leading on the Ascension JV, but you do also have the four-star contract at this point. Are you planning to do two different products, one that's co-branded and then one that's, you know, with Ascension and then one Centene, or how are you thinking about 2020 as an opportunity for both?

I think that's going to depend by market. You know, it depends on the size of the market, where we are, our network. You know, we're going to work, we're going to first work effectively with our partners at Ascension. And, you know, and they, we're not the only health plan they work with. So, I mean, so it's, it's, It will be a mix depending on the size of market, scale, and what makes sense. I mean, we have some markets we've had historically more than one product, so that's not a bad thing. I go back to my consumer package goods days. There was a time in Canada we had three different soap pads, and it worked very well. I don't want to have to do it out there. Pardon me?

Yes. No, I think that makes sense. They're not customized. You'll be more customized by local market and depending.

Right. I think what's key is you have to have the systems and the overall capability to manage that multiplicity of opportunities. That's where we're focused. I've made comments. We're going to continue to invest in technology. I think we've demonstrated that we have the the wherewithal to do it in a very mean way goes back to the $500 million we're going to generate internally so as to be able to invest in new technologies and new opportunities without affecting margins and the overall growth of the business.

Yeah, truly, that's a competitive advantage. Yeah, that makes a lot of sense on the systems.

Thank you.

The next question comes from Steven Valicuete with Barclays. Please go ahead.

Great, thanks. Good morning, everybody. Good morning. So there were some moving parts in Medicaid costs throughout 2018 for really Centene and really a lot of companies in the overall MCO sector. But just given all the drivers you mentioned earlier that led to your sequential improvement in Medicaid costs in 4Q18 and also just exiting the year, I guess when you add it all up, is there any extra color you can provide just on your expected Medicaid MLR assumptions for 2019 overall versus 2018 overall, just when comparing on an apples-to-apples basis? Thanks.

Yeah, no, I commented on this at our investor day. I mean, we do expect Medicaid margins to improve in 2019 over 2018. And a lot of that's driven by a lot of actions that we've, you know, taken this year, which will have a full year run rate heading into 2019. But we do anticipate improvement in the Medicaid margins in 19. Yeah.

The bottom line is that the trends in 4Q18 are certainly very suggestive as you're on track to achieve that. So that's, I guess, kind of the key takeaway, at least from my point of view.

Yeah. Yes. It was a good quarter.

Yep. Got it. Okay. All right. Thanks, guys.

The next question comes from Gary Taylor with JP Morgan. Please go ahead.

Hi, good morning. Just a couple questions left. The first is on the 2019 exchange enrollment. Have you guys disclosed or be willing to help us with on the four new states, how much does that contribute to the 250,000 increase ex fidelis? Jeff?

Yeah, I guess what I would say is consistent with what we've done historically, It's not the largest driver of membership growth. You know, typically when we go into new markets, it's a test and learn approach, and I think we've followed that for the new markets this year. So it's not the majority of the driver of the membership growth. It's this year. So it's not the majority of the driver of the membership growth. It really is coming from existing markets that we've had.

Okay. And then my second question is cash from ops for 2018 was weighed by about a billion dollars, I think, with some of these California accruals that you ended up paying this year. If you normalize that, free cash flow looks quite good compared to earnings. As we head into 2019, just remind us, I don't recall from Investor Day you called out anything, but versus kind of your long-term guidance of one and a half to two times cash mobs versus earnings, are there any material variances to that for 2019?

No, I mean, I think the one and a half to two times would apply. There's always timing issues, right? There can always be a timing of a state payment that you don't get at the end of the quarter or the end of the year that is subsequently paid within the next few days. And given our size in some states, those can be meaningful. So you always have timing items that come up, but nothing that I can think of similar to what we experienced in the over a billion dollars of MLR payables in California.

Okay. Thank you very much.

The next question comes from Ralph Jacoby with Citi. Please go ahead.

Thanks. Good morning. So you ended with 1.46 million HICS members. You mentioned the 2 million, which I understand is sort of the peak number. And I think you also said 250,000 year over year. So I just want to clarify that sort of year-end membership on the HICS, somewhere in that kind of 1.7 to 1.8, is that the right way to think about it?

We don't actually provide the year-end. Obviously, there's attrition from the peak membership. So what we're talking about If you go back to our Investor Day slides, we would have said 2018 peak was $1,650,000. You're growing $250,000 on top of that, plus the addition of $80,000 with Fidelis gets you close to the $2 million, right? But we're not providing a year-end 2019 number.

Okay. Is there any reason to think that it wouldn't just be similar to prior years in terms of ending versus peak?

Yeah, I would expect a normal attrition rate. That's certainly what we have forecasted.

Okay, that's helpful. And then just real quick, Jeff, effective tax rate we should use for 2019?

It's in the guidance. I provided that in the guidance this morning.

Okay, apologies, I missed that.

Yeah, yeah, it's in the press release.

Okay. And one more, if I could. Can you just remind us of the level of incremental, maybe strategic investment that you called out and just framing on sort of the ongoing expense or if you see that pace flowing? Thanks.

Strategic investment for which year, 2018 or 19? What specifically are you? Yes. I think we said start what we call business expansion, business expansion costs. I think what we said, now this is on a split adjusted basis, obviously, 12 to 14 cents. Okay.

All right. Thank you.

This concludes our question and answer session. I would like to turn the conference back over to Michael Neidorf for any closing remarks.

Well, I just want to thank everybody for the questions, the time, and we look forward to continuing discussions the record of year after year. So have a good first quarter. We'll talk to you soon.

This conference has now concluded. Thank you for attending today's presentation. You may now disconnect.