Good morning, and welcome to the Magellan Health Third Quarter 2020 Earnings Call. We apologize for the technical difficulties that led to the rescheduling of this call this morning and appreciate your patience in this matter. As a reminder, this call is being recorded.

We will be conducting a question-and-answer session after management's prepared remarks. It is my pleasure to now introduce you to your host, Darren Lehrich, Chief Investor Relations Officer for Magellan..

Good morning, and thank you for joining Magellan Health's third quarter 2020 earnings call. With me today are Magellan's CEO, Ken Fasola; and CFO, Dave Bourdon. The press release announcing our third quarter earnings was distributed this morning. A replay of this call will be available shortly after the conclusion through November 30, 2020.

The replay dial-in numbers can be found in the earnings release. For those who listen to the rebroadcast of this presentation, we remind you that the remarks made during this call are as of today, October 29, 2020, and have not been updated subsequent to the initial earnings call.

During this call, we will make forward-looking statements, including statements related to our 2020 outlook. Listeners are cautioned that these statements are subject to risk 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 Form 10-K filed on February 28, 2020, as well as in subsequent Form 10-Q filings, including our Form 10-Q to be filed today.

In addition, please note that Magellan uses certain non-GAAP financial measures when describing our financial results. Please refer to the tables included with this morning's press release, which is available on our website, for a reconciliation of non-GAAP financial measures to the corresponding GAAP financial measures.

Finally, as a reminder, Magellan Health's results reflect Magellan Complete Care's discontinued operations in our financial statements as a result of the planned divestiture to Molina Healthcare.

All references to Magellan Health's results on this call, unless noted otherwise, will be presented to exclude Magellan Complete Care from continuing operations. I will now turn the call over to our CEO, Ken Fasola.

Ken?.

the increasing burden of behavioral health and the impact of this burden on physical health, substance use disorders and suicide; the concentration of spending within the most complex health care populations; the escalating cost of prescription drugs and especially specialty medications; and the health and well-being of our military and their families.

Magellan's current and reimagined suite of solutions are designed to help payers, whether employers, health plans, ACOs or governments, address these common areas of focus. In addition, our strategies, combined with our experienced team, clinical expertise and financial strength position us for strong growth in the future.

We'll continue to serve as a thought leader while health care remains in focus beyond the election and into 2021. Now, let me turn the call over to Dave Bourdon for our financial review.

Dave?.

Thanks, Ken, and good morning, everyone. I'm very excited to be at Magellan, and I look forward to interacting with our investors and analysts going forward. I'm grateful to Jon Rubin for his partnership and support during the transition, and I want to echo Ken's remarks of wishing him the best in his retirement from Magellan.

I was attracted to the Magellan opportunity and have become a big believer in the connection between mind and body and consider Magellan to have disruptive potential as more health care participants focus on the importance of this connection in an effort to manage better outcomes for patients while achieving lower cost to the system overall.

I've now been at Magellan for approximately two months, and I'm impressed with the talent, experience and energy of our organization. In my comments this morning, I'll review the third quarter results, discuss our reaffirmed outlook for the full year and provide some initial thoughts about 2021.

For the quarter, revenue was $1.2 billion, representing an increase of 1% versus the same period in 2019, largely attributable to growth in our Pharmacy segment offset by net contract losses within our Healthcare segment. Total segment profit for the quarter was $34.1 million compared to $45.6 million for the third quarter of 2019.

The net loss from continuing operations for the quarter was $17.3 million or a loss of $0.68 per share. This compares to net income of $4.1 million and earnings per share of $0.17 for the third quarter of 2019. For the third quarter of 2020, adjusted net income was $2.1 million or $0.08 per share.

For our Healthcare business, segment profit for the third quarter of 2020 was $21.2 million, representing a decrease of $5 million from the third quarter of 2019. The year-over-year quarterly decline in Healthcare results is primarily driven by net contract losses as well as minimum MLR thresholds in certain contracts.

As previously contemplated in 2020 guidance, we experienced higher levels of utilization in the third quarter in comparison to the first half of the year, which was suppressed due to the pandemic.

Turning to Pharmacy Management; we reported segment profit of $31.4 million for the third quarter of 2020, representing a decrease of $4 million from the third quarter of 2019.

This year-over-year decrease was largely a result of a previously disclosed contract loss and start-up costs associated with the Medi-Cal contract partially offset by strong results from specialty operations as well as favorable customer settlements.

Regarding other financial results, corporate segment costs, inclusive of eliminations, totaled $18.6 million versus $16 million in the third quarter of 2019. The increase in corporate costs is driven primarily by higher discretionary benefits and the timing of investments for transformation and growth initiatives relative to the savings offsets.

Corporate segment costs include overhead previously allocated to the MCC business of $7.2 million and $8 million for the quarters ending September 30, 2020 and 2019, respectively.

During the third quarter, we recorded additional special charges of $16.6 million primarily related to noncash lease abandonment charges associated with reducing our real estate footprint. We've been decisive about rationalizing our real estate footprint to align with our associates' needs and work preferences.

As a result, we have plans in place to reduce our leased office space from approximately 5,500 seats to 1,000 seats by the end of 2021. The savings from the work site strategy initiatives are well defined and expected to contribute approximately 1/3 of the net transformation savings targeted for 2021.

We expect additional charges in the fourth quarter of approximately $10 million related to further business transformation activity. Our cash flow provided by operating activities from continuing operations for the nine months ending September 30, 2020, was $54.1 million.

This compares to cash flow from continuing operations of $119.3 million for the prior year period. This decrease is mainly attributable to the timing of accounts receivable and other working capital charges.

We continue to expect that approximately $100 million of working capital on our balance sheet will be freed up following our Medicare PDP, exit effective January 1, 2021, and the majority of that will be received within 12 to 18 months.

As of September 30, 2020, the company's unrestricted cash and investments totaled $120.9 million as compared to $161.5 million at June 30, 2020. Restricted cash and investments at September 30, 2020, was $129.5 million as compared to $76.9 million at June 30, 2020. These amounts exclude discontinued operations, which I'll cover in the MCC update.

During the third quarter, we paid down $80 million of debt, leaving $400 million of undrawn capacity under our revolving credit facility at September 30, 2020. In October, our Board extended our share repurchase program through November 15, 2021. As of September 30, 2020, we had $186 million of buyback authority remaining under this program.

Now I'll move to an update on MCC. We continue to make progress on securing the necessary regulatory approvals to close the MCC divestiture to Molina prior to the end of the first quarter of 2021, as previously contemplated, with the possibility of closing towards the end of the fourth quarter of 2020.

MCC's results within discontinued operations reflect strong third quarter performance, primarily due to lower utilization offset somewhat by rate adjustments in certain markets, primarily related to COVID.

MCC segment profit for the third quarter of 2020 was $40.4 million, and on a year-to-date basis for the nine months ending September 30, 2020, MCC segment profit was $144 million. Excess capital and undistributed earnings related to MCC totaled approximately $165 million on September 30.

This amount is net of distributions totaling $37.5 million out of MCC's excess capital to Magellan during the third quarter. Including the $37.5 million distribution, MCC's excess capital increased by more than $42 million from $160 million on June 30, 2020, due to the strong year-to-date earnings performance of MCC.

It is important to note that excess capital and undistributed earnings related to MCC, including any additional amounts generated by MCC through the closing date, will remain with Magellan at closing. I will now discuss our 2020 guidance and provide some directional commentary regarding 2021.

We are reaffirming our 2020 guidance ranges for revenue of between $4.4 billion to $4.6 billion, segment profit of between $145 million to $165 million, adjusted net income of between $16 million and $28 million and adjusted earnings between $0.63 to $1.10 per share.

We have modified our guidance ranges for GAAP net income and GAAP earnings per share, as noted in our press release, to reflect higher year-to-date and anticipated fourth quarter special charges as previously mentioned.

Turning to next year; we are still in the planning process for 2021, and we expect to provide detailed guidance in conjunction with our fourth quarter earnings release.

In advance of the 2021 guidance, I would like to provide some high-level commentary about next year as well as some thoughts about our capital deployment strategy following the close of the MCC divestiture from Molina. Overall, we expect revenue and segment profit growth in 2021, and we have confidence in our business and strategic initiatives.

As we finalize our view of 2021 in the coming months, we will be considering uncertainties in the environment related to the economic outlook, the pandemic and future utilization patterns, including potentially higher demand for behavioral health care services.

From a segment profit perspective, the midpoint of our 2020 guidance range is $155 million. We are executing against our business transformation cost savings initiatives, the Medi-Cal PBA implementation and our Medicare PDP exit and believe these items collectively contribute approximately $70 million year-over-year of segment profit growth.

Separate from the $70 million, our team also remains focused on the elimination of stranded overhead from the sale of MCC. The savings from this activity, in combination with the transition service agreement fees we will receive from Molina, should allow us to offset the majority of the $25 million to $30 million of stranded overhead during 2021.

There are uncertainties in the macro environment which are difficult to quantify as well as a few known headwinds we can quantify at this point in our planning, which amounts to approximately $15 million to $20 million, including the elimination of the HIF and the increased IT security investments.

As far as the HIF goes for 2021, this item will be negative to segment profit but neutral to net income due to the income tax offset.

Regarding the IT security investments, this is new from a planning perspective based on our decision to invest even more next year in cybersecurity due to the current environment for health care companies with respect to cyber threats. From a P&L perspective, there are a few other items to consider in 2021 and beyond for the company.

Our preliminary view on effective tax rate for the enterprise excluding MCC is now in a range of 31% to 33%, exclusive of any potential future tax reform. When thinking about adjusted EPS calculations in your models on a go-forward basis, also bear in mind two additional items.

First, in terms of the amortization of acquired intangibles, which is an add-back item to derive adjusted net income, we expect there to be a pretax step-down of $13 million to $15 million per year over the next few years in comparison to the $39 million baseline in 2020.

And second, our fully diluted share count is expected to increase 3% to 4% next year due to management equity awards. In connection with our business transformation, we are reaffirming our expectation for this cost savings initiative to yield $30 million of net savings in 2021 and $75 million of net run rate savings during 2022.

Finally, we've received numerous investor questions with respect to our capital deployment plans following the MCC divestiture. Until the transaction closes, it would be premature to provide detailed comments on this subject, but we want to share a few thoughts at this point.

First, we'll prioritize investments to support business growth from both an organic and inorganic perspective. Second, we plan to reduce our debt level. Third, we may also choose to repurchase shares opportunistically.

Regarding our debt level, we plan to establish an interim gross leverage policy post MCC while still maintaining our long-term net leverage target of 2.5 times or less.

We believe establishing a gross leverage target that is generally consistent with peer averages is a practical approach due to the potential for us to retain higher cash balances immediately following the transaction close.

We want to emphasize that we do not expect to deploy all of the proceeds right away in an effort to preserve flexibility for strategic acquisitions that fit well within our core businesses over time.

We plan to remain disciplined and focused in how we pursue acquisitions, concentrating on assets with compelling strategic rationale and strong long-term risk-adjusted return.

In closing, we are very pleased with the solid third quarter results and believe we are positioned for future growth driven by net new business and by executing on opportunities to improve our cost structure.

We will have significant financial flexibility to add shareholder value following the completion of the MCC divestiture, and we remain committed to deploying capital in a disciplined manner. With that, I'll turn it back over to Ken..

first, robust data analytics and insights. This capability enables us to identify and predict impactful intervention opportunities, quantify the impact of those interventions, create value-based partnerships with providers and pharmacists and identify opportunities for new products and solutions.

Second, digital tools and capabilities; this capability enables us to improve member, provider and client engagement to drive behavior changes through user-friendly digital tools that create utility for all stakeholders, automate and streamline data collection and sharing that drives effective intervention and deliver care through digital assets.

Third, personalized clinical programs and solutions; this capability enables us to move to personalized evidence-based high-quality care, partner with the provider community to drive adoption of clinical protocols, leverage key opinion leader think tank as an asset to realize continuous improvement on clinical standards.

And fourth, market-leading availability and access to high-quality care; this capability enables us to become the partner of choice for providers, develop high-performance networks, deliver care through both digital and community-based assets.

Implied in this differentiation will be a relentless focus on execution, data and insights and superior strategic relationship management that's embraced by the entire Magellan organization. We're making great progress on this journey, and I look forward to updating you again when we report our fourth quarter results.

With that, I'll now turn the call back over to the operator for your questions..

Thank you. [Operator Instructions] Our first question is from Kevin Fischbeck with Bank of America..

Okay, great, thanks. So I just wanted to kind of go to your 2021 commentary here. So if I'm doing it right, I heard $155 million at the base, adding in $70 million from cost saves, California, Part D, the stranded overhead cost is basically going to be zero as it's mitigated and then minus $15 million to $20 million.

So that kind of is a starting point of kind of $205 million to $210 million. You made a separate comment that you expected revenue and profit growth in your businesses.

I wasn't sure if you meant that to be a separate add-on as kind of there's going to be organic growth on top of that or whether that profit growth was kind of incorporated into those dynamics that you outlined..

Kevin, this is Ken. Thanks for the question, and I hope you're well. I'll let Dave jump in and give you his thoughts for that, and then I'll build as necessary..

Kevin, thanks for the question. So as far as that macro statement on revenue and segment profit growth, just think of that as that's a macro statement. Don't think of that as in addition -- like for the earnings to be necessarily in addition to. We'll update you on more detail as we -- on 2021 once we get to fourth quarter.

In regards to your math, maybe one adjustment. So if you think about, yes, the $155 million as the midpoint of our guide for this year, you'd add about $25 million for the stranded overhead that we'll take out. And then you add the net of those tailwinds and headwinds..

Okay. So that's actually $25 million more than what I was saying.

That's actually $230 million to $235 million?.

Correct..

Okay, perfect. Okay. And then as far as the quarter itself goes, were there new contract losses in the Healthcare segment? You mentioned that -- on the Pharmacy side, it was previously disclosed, but you didn't have that same wording in the Healthcare segment side of things.

So just wanted to see if there's any update on how contracts have been trending in that business..

Yes. I can start, and Dave can certainly jump in. I would probably draw you more to some of the MLR provisions embedded in some of those agreements, which put a little downward pressure. So there wasn't any extraordinary losses and offset by, I think, good growth considering where we came from, and we're building real momentum there.

So I'd point you more towards provisions inside of some existing contracts, which put downward pressure on revenue as opposed to any substantial losses that weren't previously talked about..

Okay. And then, I guess, maybe last question now anyway.

When you -- do you guys have any kind of long-term kind of guardrails for how to think about the business after 2021? Is there any way that we should be thinking about? Or if not today, then when should we kind of expect an update on those kind of long-term growth targets?.

Yes. Kevin, you're breaking up a little bit, but I assume -- let me pare it back and make sure I captured the essence of your question. So you're asking about longer-term outlook beyond 2021 with respect to growth trajectory. And I'm assuming that's across all of our businesses..

Correct, yes..

Yes. So I -- one of the things I know we've committed to and we're building, I think, a good business case around proof points with respect to the progress we're making around reimagining our businesses. I'll take them each individually.

So as you think about behavioral health, obviously, the pandemic has intensified the impact on behavioral and mental health, and the conversations we're having are really important, with large payers, around ways to energize this recognition that managing the whole person.

And the impact behavioral health is having on that, I think, is creating an opportunity for us to get more granular with respect to the kind of things we're doing, not only in Virginia, which we branded Magellan Connect, but that we're beginning to build the capabilities to expand more rapidly nationwide.

And so I also think the work Jim Murray did to quickly consolidate our behavioral health and EAP businesses is providing a forum for us to talk to Fortune 500 and Fortune 50 customers particularly, around their growing concern about the impact on their employees of the elongated pandemic, the challenges of societal issues are impacting and the growing concern that has on their own employee well-being.

And so the program I mentioned that we're building quickly, leveraging our experience with -- in the military in Magellan Federal. Just another example, I think of some things that we can do where the pipeline and the procurement cycle is a little more accelerated than what we've normally seen in traditional BH RFPs.

And so -- and then with the advent of what we're doing with the digital front door, Livongo and Kaden to strengthen our vMAT, telehealth and another extension of our collaborative care capabilities I think help make that narrative even stronger.

Specialty health business, we're knee-deep in a couple of big implementations right now as we lean into the first of the year, a really well-run business for us, where I think we've got some real momentum as well.

And then if I pivot to Pharmacy, we've had really strong new business performance in our specialty Rx business this year, including formulary management, the medical pharmacy management, so -- driven by new logos. And we're up-selling inside of existing client relationships.

So I think that continued focus and a new focus around oncology and oncology support products are going to provide an increased opportunity to build the kind of momentum as we move into 2022. And so while we point to 2022 -- the 2022 selling season, remember, that builds all through 2021 given the procurement cycles in each of these businesses.

And lastly, we had said in earlier calls that we were actually pleased to see that the pipeline with respect to our BSH businesses was -- or the RFP processes weren't as delayed versus pharmacy, where we think there was a three-four-month lag, let's say, in procurement tied to the pandemic.

And I guess I'd add one more point, which is the -- and we mentioned this in the call script. I'm extremely pleased that our PBA renewed 100% of the cases. And there's some new RFPs that are out there as well, and I think we're really positioned well to compete.

So those are just a couple of proof points and -- that we hope demonstrate that we're keenly focused on growth into '21 and '22..

And just to pile on to that. Look, we know the investor community would like us to provide long-term strategic growth targets on revenue, segment profit and EPS. And that's consistent with how we'd like to operate, and we're working towards that.

And we'll do that at an appropriate time, which will be after we get through this transitional phase and have demonstrated on some of the key areas that Ken just noted..

Thanks, Dave..

Thanks, Kevin. Appreciate your questions..

[Operator Instructions] Our next question is from Dave Styblo with Jefferies..

Good morning, thanks for the question. I think I understand all the 2021 bridge comment, but I do have a follow-up on the new cost for security and IT.

I'm just curious if those are something that you'd expect to persist after 2021? Or would they rise? Would they decline? Is it something of a onetime-in-nature investment on that front?.

Okay. First of all, good morning and appreciate your question. I can -- I'll start, and I'll let Dave jump in. One of the things that I'm excited about is -- and I talked about the things that are going to be differentiating for us going forward, is the advance in digital tools and capabilities and robust analytics and insight.

And if you step back and think about the whole cybersecurity area is an arms race. So making sure that we're best in class and investing hard in our systems to enable the confident connections that are necessary to advance the strategy anchored around data analytics is really key to us.

So the investments we're making are in concert with investments we're making in our underlying platform to enable the seamless implementation of these new digital tools, and so those go hand in hand. A lot of this is contemplated in the work that we were doing with respect to transformation and identified early.

So -- but we -- when we think about the security piece of that, there's just no reason not to be extra diligent and vigilant.

Dave?.

Yes. I mean just to reinforce what Ken said. I mean we take protecting our members' and clients' information very seriously, and that's why we're making the investment to harden our environment. Dave, I'd have you think of this as, while there's certainly some onetime charges in there, I would -- I'd consider this to be run rate going forward..

Okay, that's helpful. And then I know you guys are building up the sales force this year towards your 30-person goal.

Can you just give us an update on how conversations and the pipeline is shaping up as you talk to employers and the clients about better integrating behavioral with medical pharmacy and the early reads on where you are in that process? Is it still going to be a few months away before you'd be in a position to share any of that information, given where we are in the cycle? Or are some of those conversations more advanced at this point?.

Actually, I'll make a couple of comments there. And I -- this has been really not only important, but really exciting as we think about the pivot we're making.

As I said on the earlier calls, one of the things we don't have to do is to prove that our payer partners are challenged by the growing impact of behavioral and mental health on total cost of care. And so it saves a lot of time when you walk in and start those conversations.

We've pivoted to having more C-suite and more strategic conversations with existing, prior and what we hope will be future payer customers around this growing challenge and again, the fact that it's been intensified by the pandemic. And so we're on -- we're actually right where we wanted to be with respect to the addition of new sales talent.

We've probably -- we filled 1/3 already. We've got 1/3 that offers are in hand. We started the first training program actually last week.

And we're hiring experienced professionals, not only domain-specific experience with respect to our solution sets and lines of business, but also really experienced and deep with -- individuals with deep relationships in very specific channels.

And those include really direct outreach to a lot of our largest customers who, again, are eager to look for creative ways and -- to deal with the growing total cost of care challenge. And integrating, again, the behavioral health, specialty health and EAP capabilities that exist in the company has really been well received.

And so again, some of those conversations are starting off cycle, which we're encouraged by. And I think that's just a function of existing challenges and demand among those large employers. And there's -- I recently saw there was an RFP that came out in one of our larger states targeted directly at child mental health.

And I think you're going to see more of that as people begin to step back and reflect on some of these, again the challenges of both suicidal and pandemic-oriented issues with respect to substance use disorder and related mental health issues..

Okay. And then, just a couple of housekeeping questions on both of the segments. So for Pharmacy, results were a lot better than we were looking for. Is there any material puts or takes there? I think there might have been some contract settlements that were positive.

And then on the flip side, can you quantify how much the start-up costs for California were in the third quarter and what those might look like for the fourth quarter? And then on the -- similar question on the Healthcare side.

Any start-up costs there for things like the Molina contract or the transformation costs that are going on as you build into next year?.

Yes. I'll start, and Dave can add the additional mathematical color. But as we think about the revenue beat, it's driven really probably in the following order, new business in the PBM and the specialty performance that I talked about earlier in the call.

And Dave, you want to build on that?.

Sure, yes. Dave, I'll unpack that a little bit. There were a few questions in there. So let's start with the pharmacy piece. So as you noted, big step-up sequentially in segment profit. We're really pleased with the performance of the pharmacy business. Having said that, that result is consistent with our expectations.

Within the Pharmacy segment, our 2020 guidance contemplated a higher weighting of segment earnings, like almost 60% of the year to be in the second half, with the third quarter being the highest because we are going to see a ramp in the Medi-Cal implementation costs as we get closer to the start of that contract.

To your question around the specifics in the quarter, we -- on a sequential basis, we had highlighted in the second quarter a few unusual onetime items related to PDP claims and some unfavorable customer settlements. And in the third quarter, we experienced stronger specialty trends, which Ken noted and also received benefit from some new business.

So those are the primary drivers as you think about it from a sequential basis in Pharmacy. In regards to start-ups -- start-up costs for Medi-Cal, I think in the $5 million to $10 million range is what we'll see in fourth quarter and one of the reasons why the -- sequentially, the segment profit will be going down from Q3 to Q4.

In regards to Healthcare, a big step-down in segment profit sequentially. And that was -- having said that, it was generally consistent with our expectations as well.

The sequential decline was largely driven by higher utilization in both specialty and behavioral care as compared to the second quarter as well as the impact of some minimum MLR thresholds in some of our contracts.

On specialty utilization, as you're aware, we saw a lot of favorability in the first half of the year, and we've now seen that return to normal level in the third quarter, and we expect that to continue throughout the remainder of the year. From a behavioral perspective, we did not see that same level of favorable utilization in the first half.

As a matter of fact, it ran pretty much at normal pre-COVID levels. We were expecting or our -- we were expecting it to move up to levels higher than pre COVID. And we did experience that in the third quarter, and we expect that to continue into the fourth quarter.

So those were the primary reasons why we had a step-up -- or a step-down for that matter in segment profits from second quarter to third quarter..

Got it. Thanks much. All have been asked. All right, thank you..

Ladies and gentlemen, we have reached the end of the question-and-answer session. I would like to turn the call back to management for closing remarks..

Yes. Listen, thank you very much. We apologize for the need to delay today's call, and we continue to wish everyone the best as we continue to power through these unique times in and around the pandemic. We continue to appreciate your support, and stay well..

This concludes today's conference. Magellan Health thanks you for your participation, You may disconnect your lines at this time..