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Centene Corporation (CNC) CEO Michael Neidorff on Q2 2021 Results - Earnings Call Transcript

Think of the HBR pressure caused by our Marketplace business and our short-term variable compensation as somewhat offsetting toggles. You’ll also see this in our full year guidance elements. If the deferred demand bubble in Marketplace causes us to land toward the high end of our consolidated HBR guidance range, we would be toward the low end of our SGA range because of a reduction in our short-term incentive plan for 2021. Think of this as a potential 35 basis point swing in those metrics. On the other hand, if pent-up demand and high new member utilization settles quickly and we come in toward the bottom of our HBR range, we would incur typical short-term incentives, which would have a corresponding effect of putting us toward the top of our SGA range, and the outcome could be in between those bookend scenarios. While we recognize the current challenges in Marketplace, we have implemented a slate of mitigating initiatives, including operational, clinical and available pricing actions. Current performance does not change our perspective as we look out to our long-term margin goals.

Continuing on highlights of the quarter, cash flow provided by operations was $1.7 billion in the second quarter, primarily driven by net earnings before the legal settlement reserve, which is expected to be paid in future periods. We continue to maintain a strong liquidity position of $1.1 billion of unregulated cash on our balance sheet at quarter end. Approximately $700 million of that was deployed on July 1, as we completed the acquisition of the remainder of Circle Health. Recall, we acquired 40% of Circle in 2019 and 2020 with the intention to subsequently acquire the remaining portion. Circle is a very well-positioned and leading ambulatory surgery center business in the UK and comes with a strong management team. We expect Circle to be above our company-targeted adjusted net income margin by 2023.

Debt at quarter end was $16.8 billion. Our debt-to-cap ratio was 38.9%, excluding our non-recourse debt. Our medical claims liability totaled $12.8 billion at quarter end and represents 48 days in claims payable compared to 49 in Q1. DCP was mechanically impacted by the timing of state-directed payments.

We updated a few of the 2021 guidance elements based upon what we’ve seen through the second quarter and for the items we just discussed. While we are maintaining the same wide adjusted EPS range of $5.05 to $5.35, you will notice some changes in the underlying metrics, including higher revenue from continued growth in Medicare and Marketplace; delayed state pharmacy carve-outs; higher state pass-throughs of approximately $1 billion and a continued suspension of redeterminations; a higher HBR range, as we just discussed, solely due to our Marketplace business; a lower SGA range due to the potential reduction of the short-term incentive plan, depending on how Marketplace pent-up demand plays out. But in addition, we are also getting some leverage on the higher revenue base.

Overall, this continues to be a relatively wide range as we referenced at Investor Day, given the choppiness in our Marketplace product. We still have 6 months of the year to play out, especially with varying scenarios around the subsidence of pent-up demand and the unknowns with COVID. The guidance continues to exclude Magellan. It excludes our recent Magellan financing and Circle Health. We are determined to execute on our multiyear value-creation plan laid out at the recent Investor Day and achieve our long-term adjusted net income margin target of at least 3.3%. We have launched a formal program internally, encompassing all aspects of the organization marching in unison toward pulling the necessary levers to achieve the value-creation plan. We have developed some of these muscles over the past couple of years, such as the Centene Forward program for discrete initiatives, our HBR office for clinical quality and cost initiatives and the integration skills from past large acquisitions.

As I said at Investor Day, this journey won’t be a straight line, and the fruits of our labor are expected to show up more so in 2023 and 2024 than in 2022. But we know how to do this, and we are committed on taking the actions to deliver value creation to shareholders. What matters most is pulling the levers in the next 12 to 18 months to bear fruit in 2023 and 2024. Our balance sheet remains strong, and we expect it to strengthen even further as we improve margins and generate cash flow.

Thank you for your interest. Operator, you may now open the line for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Today’s first question comes from Justin Lake of Wolfe Research. Please go ahead.

Justin Lake

Thanks. Good morning. Appreciate all the detail. Wanted to touch on two questions, one, Drew, at the Investor Day, you talked about EPS probably seemed to indicate you expected EPS to be closer to the low end of the range. Can you – of the – from a – from the $5.05 to $5.35. Can you reconfirm whether that’s kind of the expectation for the second quarter? And then can you talk to where the exchange margin profitability? I remember you’ve taken down the targets there. But where is the profitability coming out this year and do you expect to get back to normalized exchange profitability next year? Thanks.

Drew Asher

Yes. Thanks, Justin. So at Investor Day, you’re right, we revised the long-term pretax margin to 5% to 7.5% for the Marketplace business. And that is unchanged even with a little bit of choppiness in the near-term. I can’t give you an exact date when we’re going to get there and stay there. But we’re below that now, obviously, with the pressure that we outlined in Q2 and some of the pent-up demand. And then with respect to the guidance range, I’d say my comments are the same from Investor Day. We kept the range wide for a reason. And there is clearly paths to get into that guidance range. So we maintain that despite some of the pressure that we outlined for Q2.

Michael Neidorff

And I might just add that – My focus upfront is we’re going through what could be another real surge in pandemic. And so to try and call it, recognizing that which way it could go will have an impact, and we will see how it plays out. But it’s something we have to be very cognizant of.

Justin Lake

Understood. Thanks.

Operator

And our next question today comes from Josh Raskin of Nephron Research. Please go ahead.

Josh Raskin

Thanks. Good morning. So I know we spoke a little bit about this at the Investor Day, but what gives you the confidence that these HICS costs are just pent-up demand issues, right and not new members coming through the SCP or even old members that are using higher levels of services now that they understand the benefits? And maybe you could help us what types of services we’re running above expectations, types of procedures, etcetera. And then lastly, I think last quarter, you talked – I think it was at the Investor Day, you talked about this could potentially positively impact the risk adjustment. So I wonder if there is any offset there.

Michael Neidorff

I’ll ask Drew to start, and then Brad, you might add to it?

Drew Asher

Okay. Let’s start with risk adjustment. Like I said in the prepared remarks, the Wakely data, that’s a third-party actuarial firm that aggregates for most carriers data came in. That’s date of service through April. That was consistent with our expectations, and that largely represents, Josh, the members that rolled into this year and incurred claims during the first 4 months. So that’s consistent with our expectations. On the pent-up demand, certainly, it’s the nature of the services, the outpatient nature. We’ve seen orthopedics, joint degeneration, unfortunately, some psychiatry and chemical dependency drivers in marketplace. And really, the outpatient pressure coming into a little bit in March and then April and May, and then it popped in June. The SCP members, I think I mentioned this in my script as well, we’re seeing them access inpatient services and then quickly – while it’s early, quickly returning to a more normalized utilization. It’s early, so we’re tracking that, and we’re sort of managing this in those four cohorts.

Josh Raskin

Got it. Do you know, Drew, if these members came from other plans or if these were coming from different segments, Medicaid or uninsured, etcetera and I’m just curious if those previously insured versus previously uninsured are acting differently?

Brent Layton

Josh, this is Brent Layton. In the new members that we’re seeing, the vast majority have been uninsured. There is been very few called switchers. So this has been uninsured. And I’ll echo what Drew said because that is what we’re seeing in the separation and really of the utilization that he talked about.

Josh Raskin

Okay, thanks.

Operator

Thank you. Our next question today comes from Kevin Fischbeck of Bank of America. Please go ahead.

Kevin Fischbeck

Great, thanks. Maybe just to follow-up on this concept of pent-up demand, I mean it’s interesting because in general, it seems like the commercial utilization was less impacted during COVID than the other cohorts. Are you at all worried that it will be a similar potentially delayed type of pent-up demand in Medicaid and Medicare over the next 12 to 18 months? And if so, I guess, how are you treating that from a pricing perspective?

Michael Neidorff

I think Drew referred to before, where possible, we build it into pricing. But particularly in Medicaid, we have a younger population, and it’s mostly children. And to-date, they were not as affected, but the way to see with this new COVID as the Delta, but they have not been affected, so we don’t see a lot of pent-up demand there. Medicare, once again, they have been a little more sensitive to getting to their position because of age and other health factors. So we don’t see as much pent-up demand there as we have in the Marketplace, which had new members in it.

Kevin Fischbeck

Okay. And I guess as far as the Medicare days, you mentioned that the 6 75 of rate cuts, is that something that’s temporary? Does that reverse next year? Or should we be thinking this as you can get to normalized margins even with this new lower rate outlook?

Michael Neidorff

Well, I think as Drew said, we anticipate returning to a normalized rate structure. I just want to add, all this has an overlay of what happens with this new Delta, which is so much more contagious than with the unvaccinated population, particularly. So I mean that’s why we put the emphasis upfront. This could change how the whole dynamics of it, as we saw a year ago. So we’re going to continue to watch and monitor and manage through it as we have historically.

Kevin Fischbeck

Thanks.

Michael Neidorff

Thank you.

Operator

And the next question today comes from A.J. Rice at Credit Suisse. Please go ahead.

A.J. Rice

Thanks. Hi everybody. I guess two things. One, I think in the prepared remarks, you mentioned that there is a possibility that redeterminations, holiday get extended into 2022. I know at the Investor Day, you gave a guidance range for – on revenues for 2022, your current expectations. Would the delay in redeterminations materially impact that revenue outlook if indeed that happened? And then the other thing I was going to just ask about is, as you’re talking about this variation, and because of the Delta variant, on your risk corridors on the Medicaid side, are you well into those now so that if there is a little variation in utilization, it’s not going to really matter because you’re sort of already at a point where you’ve given back to the state or those risk corridors not really lengthy to provide much protection in the back half of the year?

Michael Neidorff

I think there is – first, let me do with the redetermination. We just gave you some insight as to what some discussions are taking place. And I think the time to talk about the revenue and how it may or may not be impacted will be at the end of the year when we see where they are. And I’m just trying to give people an insight that these are things that it could be a tailwind, but we have to wait and see. On the risk adjusted, some of them are starting to drop off, and Drew can probably give you more detail on that.

Drew Asher

Sure, A.J. Yes, you’re right. In some states, we are into the risk corridors, even the standard ones or the minimum MBR depending on state-by-state, which you’re right, that would give us a cover for increased costs, but not everywhere. It’s sort of a mixed bag across our portfolio.

A.J. Rice

Okay, thanks.

Operator

Thank you. Our next question today comes from Matt Borsch with BMO Capital Markets. Please go ahead.

Matt Borsch

Yes. Thank you. If I could just ask a question on the Marketplace dynamics, so if you look at the medical costs, and forgive me if you mentioned this, but can you give us a pickup of how much is COVID, direct COVID care and how much is everything else? And maybe how that compares this quarter to what you saw previously?

Drew Asher

I’ll take that one, Michael.

Michael Neidorff

Go ahead.

Drew Asher

So COVID, the COVID costs going back to April and May, we had budgeted or we had forecast some, but it was on an absolute basis higher. And then with our revised view coming out of Investor Day, the June number continued to fall on an absolute basis, and it was sort of right on our forecast. So COVID really wasn’t – while that pushed us based on our Investor Day discussion, there is really no major change in our view on that. Obviously, the elephant in the room is what happens going forward with the Delta strain, as Michael covered. That’s a much smaller component relative to sort of non-COVID utilization, whether it’s the outpatient utilization on the majority of our block or the inpatient utilization on sort of the 20% SCP membership.

Matt Borsch

So for now, this is all that pent-up demand really? I mean it could be about COVID if – depending on how things develop. But for now, it’s not a pent-up demand?

Drew Asher

Correct.

Michael Neidorff

And I think I want to add one thing. I think you heard Drew talk about the cost for claim. Some of that pent-up demand is where individuals delayed services. And we see that in cancer treatments and diagnosis. So, there is a little higher acuity. But once again, these are transitory things and not something that we see as fundamental and something will continue. And that’s the COVID really spikes again and people end up not going to hospital and doctors as we historically saw. So, there are unknowns out there. Hence, some of the caution or more cautious approach we are taking until it becomes clearer.

Matt Borsch

Great. Thank you.

Operator

And our next question today comes from Ricky Goldwasser with Morgan Stanley. Please go ahead.

Ricky Goldwasser

Yes. Hi, good morning. So, with Delta impacting the non-vaccinated population, do you have a sense of what percent of your membership are vaccinated?

Michael Neidorff

Boy, it’s – I want to say the last I saw was somewhere around 50%.

Ricky Goldwasser

Okay. So, when we should think about kind of the risk there, we should think 50% of the membership and then as we think about…

Michael Neidorff

Now remember, let me back up, a lot of them are children who are not eligibly vaccinated. So, I mean the Medicaid is women and children. And so I need to clarify that.

Ricky Goldwasser

So should we think about the 50% as 50% of eligible population and then you have the children?

Michael Neidorff

No, that’s total, including the children.

Ricky Goldwasser

Okay, great. And then just when we think about sort of the Delta variant, from what you have experienced to-date and you are seeing, any sense of how to compare the hospitalization rates versus what we have seen earlier in COVID? And really, as we think about kind of like your HBR assumption, are you assuming that members might refrain from going back to core utilization because of that Delta risk, but then the expenses that are related to COVID are lower than what we have seen at the beginning of this year or end of 2020, just trying to understand the dynamic?

Michael Neidorff

I think – I know I think the answer is it’s not clear, and that’s what we are trying to say. That’s – those are things we are going to continue to monitor. We can assure we can manage through COVID-type issues. And so we have that positive feeling of in terms of our ability to deal with it, but we wanted investors to understand that it is out there. It’s not business as usual as everybody had hoped. We wish everybody was vaccinated. And we now see that even those who were not as forceful and encouraging are now moving to it. And so I think what – always we want people to understand is COVID is not over. And I think for us, I think it’s just business as usual. I think that will be a mistake. Now, I am not saying it’s going to necessarily impacted the point that our guidance changes, but we just maintained it, as I said in my prepared remarks, while we monitor it, keep you informed, how it unfolds and the impact it has on not just us, but everybody. I mean, it’s just how we return to work. We see them reinstating masks things of that nature. So, it’s a variable.

Ricky Goldwasser

Thank you.

Michael Neidorff

Thank you.

Operator

And our next question today comes from Stephen Baxter of Wells Fargo. Please go ahead.

Stephen Baxter

Hey, good morning. Thanks for the question. Just wanted to ask another one in exchanges, just hoping you can help a little bit with quantification as we can kind of think about what that means for your pricing next year. I guess how much higher was core medical costs relative to baseline in Q2? Like how does that compare for the special enrollment population? And I guess then what does that mean for the non-SCP membership? Thanks.

Michael Neidorff

Drew?

Drew Asher

Sure. As I said at Investor Day, you might recall that with what we saw through April and May, we were able to reflect that in pricing. So literally, during those months, came in, made some adjustments to pricing, meaning pushed pricing to reflect what we thought would continue into 2022. Recall, we expect a lot of this to sort of settle out during 2021. It’s just during which month in 2021 is the question. With what we saw in June, we did have about half of our marketplace bids and pricing open for various reasons, and we could make judgments on what we wanted to change, if anything, and the other half, though are sort of submitted and baked.

Stephen Baxter

Anything that you can add on just sort of on a relative basis, like what Q2 was versus what you might have priced for, is it 1% higher, is it 3% higher, anything like that?

Drew Asher

Yes. I mean, given the competitive nature of the marketplace and the fact that none of that’s public, I think we will keep our pricing decisions close to the best.

Stephen Baxter

Got it. Okay. Thanks.

Operator

Our next question today comes from Lance Wilkes with Bernstein. Please go ahead.

Lance Wilkes

Yes. Just two more Delta variant sort of questions, first one is on redetermination suspension. And just kind of if you can give some color into the mechanisms that could cause delay or push out that at a State or Federal level? And then the second was just any further color on July utilization in outpatient and invasion. If you are seeing anything that’s reflective of people slowing down use as a result of mask mandates or Delta?

Michael Neidorff

Yes. I want to be careful now when we are talking about July, it’s still early. And while we have good data in that, we don’t get ahead of ourselves on that one. But as it relates to the Delta and your concern there, it’s real, but we don’t know to what extent people are going to use the – their good senses and do what they can to protect against it. And so we have to kind of – that’s why we are calling it out to say it’s a variable, and it’s a less predictable variable, particularly when you look at the intensity of it, and it’s so much stronger than the original. And the bad part is that we are trying to tell everybody who listen that if we don’t deal with this effectively and get vaccinated and the things that prevent it, the next one is even worse, our epidemiologists were telling us. So, this is something that continues to progress. And it’s not just the Centene population. It’s everyone in total. So, that’s why we are calling it out. We want to keep it in front of people, so that everybody is aware that we are dealing with it. We are doing the PSAs. We are doing everything we can to get people vaccinated, we – the phone calls, the robo calls and everything else. So, it’s not where you stand, but where you are moving in and we are working hard to be preemptive in it.

Lance Wilkes

Redeterminations, is that just an extension of public health emergency that would be…

Michael Neidorff

Yes. I am sorry. I was trying to – yes, you are right. That’s where we determine where we are with the COVID. It will just be an extension of it.

Operator

Thank you. Our next question today comes from Scott Fidel with Stephens. Please go ahead.

Scott Fidel

Hi. Thank you. Good morning everyone. First question, just wanted to go back to HICS again and just on the 2022 pricing strategy and couple of interesting dynamics in the HICS market because it looks like utilization is certainly pretty hot in the market, but there is also some competitors out there, including some of these newer public companies that are pricing very aggressively and don’t seem to have the same type of margin targets that some of the more established companies traditionally have had in the market. So, I am interested if you are going to approach 2022 pricing really sort of based on actual expected cost trends and you are willing to sacrifice memberships, if necessary to do that. With the risk adjustment, do you feel that, that would be able to protect you against potential adverse selection that could occur? Traditionally, when we think about a company pricing conservatively well, there is a pricing aggressively, there are some concerns around adverse selection. Just interested if you are comfortable that risk adjustment could help offset that type of traditional risk?

Michael Neidorff

Yes. I will take that one. I think, one, I am not going into a great deal of detail on 2022 because that’s – we save that for December. I think what Drew tried to cover was that we did take into consideration to the extent we could, and as we always do and where positively, we took some steps. I will say the same thing that I said last year, and it proved to be an appropriate way to do it. And we are not going to do any races to the bottom because if you are losing on every member, you don’t make it up on volume. And so we are very sensitive to that particular approach. And we do believe that the risk adjusted, that’s what it’s there for. So, somebody rushes in and they get adversely selected against because of it, then that will provide protection for those that have the higher acuity patients. So, I think that’s about as much as we can say about it for now. But we are going to continue to stay the course, which we think we have demonstrated is the appropriate course.

Scott Fidel

Okay. And then I just had a follow-up on – just interested if you have had any updates just on the Ohio situation and on the contract renewal just post the PBM legal settlement with the state.

Michael Neidorff

Yes. We continue to be very optimistic on it and expect a resolution in the very near future. They wanted some additional data, which we have had. Our consultants provide them, and they are analyzing that. And as we said, with the settlement and the no harm and all court cases, we moved everything. There is no reason for them not to reinstitute our bid. We did come in number two. And so I am very optimistic on it.

Operator

And our next question today comes from Mike Newshel with Evercore ISI. Please go ahead.

Mike Newshel

Thanks. So, CMS recently proposed a monthly special enrollment period on exchanges, but just for people below 150% of the poverty level. I am just wondering if you are expecting any meaningful impact on your exchange business since you do focus on lower income and then both from like an enrollment and revenue perspective and also any potential adverse selection problems for margin?

Michael Neidorff

Go ahead, Kevin.

Kevin Counihan

Sure. Yes. Thanks for the question. First of all, as you know that, that is a proposed policy change as you underscored, and we are in the comment period right now. So, I think it may be just a bit premature to say that this is going to be policy. We do have some concerns about this with respect to potential adverse selection, particularly since there were some states where the APTC is not going to fully cover the cost of the premium. And in that instance, there is that risk of that for selection. We think there are ways to ameliorate that in pricing, as Drew has acknowledged. And so we will see how CMS ends up ruling.

Michael Neidorff

I think that would be particularly adverse selection and for those that have the very low prices pushing to gain membership on pricing.

Kevin Counihan

Yes, that’s true.

Operator

Thank you. And today’s final question comes from George Hill at Deutsche Bank. Please go ahead.

George Hill

Hey, good morning guys and thanks for taking the questions. I guess, Michael, just as you look forward to the closing of the Magellan transaction, I guess can you talk about how you are thinking about the PBM business and the pharmacy business, both as it relates to the government businesses that you serve now and the opportunity to maybe enter some of the non-government businesses?

Michael Neidorff

Yes. I think I will ask Sarah to respond that. She is close to it of working through it.

Sarah London

Yes. Thanks for the question. We have been making really good progress on our integration planning. And as we said at Investor Day, we are focused on the restructuring of our involved pharmacy business to focus on member services and clinical operations and relying on an external PBM. And so the goal is to position Magellan, as we have said before, within healthcare enterprises, where it will remain independent and focus on its third-party business. So, I think you should expect an update from us once we get through that transaction and how we are specifically thinking about the Magellan Rx business.

George Hill

Maybe then as a quick follow-up, I guess could you talk about how you feel about the segment’s competitiveness ex the government business?

Sarah London

Sorry. Can you repeat the question, if you don’t mind?

George Hill

I said just like how do you guys feel like you will be positioned competitively once the transaction closes ex-supporting the government business?

Sarah London

Well, we think the Magellan PBM business has a lot of opportunity for growth. We also think there is really interesting synergies relative to our existing specialty pharmacy assets with their portfolio. So, that’s been the major focus of the integration planning.

George Hill

Okay. Thank you.

Operator

And ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Neidorff for closing remarks.

Michael Neidorff

I just want to thank you all, and we will continue to focus on our margin expansion and our capital allocations, as we have talked about, while managing through what could be a difficult pandemic, but I would think we have what it takes to get through it. So, we look forward to it, and we maintain an optimistic attitude. So, thank you very much.

Operator

Thank you, sir. This concludes today’s conference call. We thank you all for attending today’s presentation. You may now disconnect your lines and have a wonderful day.