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Magellan Health Inc  (NASDAQ:MGLN)
Q4 2018 Earnings Conference Call
Feb. 28, 2019, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Welcome and thank you for standing by for the fourth quarter 2018 earnings call. At this time, all participants are in a listen-only mode. (Operator Instructions) Today's conference is being recorded. (Operator Instructions)

Now I'll turn the meeting over to Joe Barton. You may begin, sir.

Joe Barton -- Senior Vice President, Investor Relations

Good morning, and thank you for joining Magellan Health's Fourth Quarter and Full Year 2018 Earnings Call. With me today are Magellan's Chairman and CEO, Barry Smith; and our CFO, Jon Rubin. The press release announcing our fourth quarter earnings was distributed this morning. A replay of this call will be available shortly after the conclusion of the call, through March 28, 2019. The numbers to access the replay can be found in the earnings release. For those who listen to the rebroadcast of this presentation, we remind you that the remarks made herein are as of today, Thursday, February 28, 2019 and have not been updated subsequent to the initial earnings call.

During our call, we will make forward-looking statements, including statements related to our 2019 outlook. Listeners are cautioned that these statements are subject to certain risks and uncertainties, many of which are difficult to predict and generally beyond our control. These risks and uncertainties can cause actual results to differ materially from our current expectations, and we advise listeners to review the risk factors discussed in our press release this morning and documents we filed with or furnished to the SEC.

In addition, please note that Magellan uses certain non-GAAP financial measures when describing our financial results. Specifically, we refer to segment profit, adjusted net income, and adjusted EPS, which are defined in our SEC filings and in today's press release. Segment profit is equal to net revenues less the sum of cost of care, cost of goods sold, direct service costs and other operating expenses, and includes income from unconsolidated subsidiaries, but excludes segment profit from non-controlling interest held by other parties, stock compensation expense, special charges or benefits as well as changes in the fair value of contingent consideration recorded in relation to acquisitions.

Adjusted net income and adjusted EPS reflect certain adjustments made for acquisitions completed after January 1, 2013 to exclude non-cash stock compensation expense resulting from restricted stock purchases by sellers, changes in the fair value of contingent consideration, amortization of identified acquisition intangibles, as well as impairment of identified acquisition intangibles. Please refer to the tables included with this morning's press release, which is available on our website for a reconciliation of GAAP financial measures to the corresponding non-GAAP financial measures.

I will now turn the call over to our Chairman and CEO, Barry Smith.

Barry M. Smith -- Chairman and Chief Executive Officer

Thank you, Joe. Since our 2019 guidance call, we've been focused on our earnings improvement plan that we detailed in December. One, we are confident, we'll position us for margin improvement this year and beyond. But first let me be clear, we are disappointed in the results we reported today. In my remarks, I'll touch on four general areas. First, I will review our full year financial performance and provide color on events that negatively impacted our results. Second, I'll review our guidance for the full year 2019. Third, I'll provide an update on the progress of our multi-year margin improvement initiatives, which we introduced in December. And last, I'll comment on the Health and Human Services proposed rule on rebates.

For the full year 2018, we recorded net revenue of $7.3 billion, net income of $24.2 million and EPS of $0.97 per share. Our adjusted net income was $61.7 million, or $2.46 per share and we achieved segment profit of $228 million. Relative to our previous expectations, the fourth quarter was negatively impacted by approximately $50 million, both of out-of-period and non-recurring items, primarily related to retrospective rate adjustments in New York, which occurred subsequent to our guidance call in December. We do not expect these items to have a material impact on 2019 earnings and therefore are confirming 2019 guidance. John will provide more details later in the call. While, the New York rate adjustments were unforeseeable, I'm disappointed to end the year in this manner, particularly as we are beginning to see a positive benefit from our investments in talent and progress in Virginia.

Looking forward, we are focused on our multi-year margin improvement plan we outlined in December, which has a long-term goal over 2% adjusted net income margin. The initiatives that are part of this plan include, first within healthcare, reduced our cost of care while improving quality with attention to Magellan Complete Care and in particular our Virginia plan. Second, within Magellan Rx continue to grow our PBM, while retaining specialty carve-out contracts and lowering our cost of goods sold. And third, drive operational improvements across the organization to enhance efficiency.

Let me provide you with an update to our progress in these areas over the last few months. In Virginia, our care management initiatives continue to drive high quality of care for our members at improved cost levels. For example, we are seeing a favorable shift in the balance between inpatient admissions and observation beds and a decline in readmission rates, also the behavioral health outpatient authorized service level is trending toward a more appropriate level of care for membership. During the fourth quarter, our claims integrity initiatives have recovered over $3 million in claims over payments using both internal and external resources. Additional recovery opportunities have also been identified.

As a result of our efforts of the Virginia team, our fourth quarter financial results for the market improved over the third quarter, consistent with our expectations and we have momentum heading into 2019. For context on projected revenue base of approximately $800 million achieving them with 2% or 3% to 5% segment profit margin would result in approximately $80 million of improved pre-tax earnings versus 2018. While approximately half of this improvement is expected this year, we still have significant opportunity beyond 2019.

With respect to Magellan Rx, we've been working to highlight the strengths and capabilities of our operations to serve larger clients. I'm pleased to report that we've added our first Fortune 100 employer client, further evidence that with our specialized offerings, we could compete and win against larger competitors. This represents a full service PBM win with 124,000 to new lives. In addition, we had a 100% retention rate in our specialty carve-out business during the fourth quarter. We are also working to lower our cost of goods sold through improvements in several areas, including our retail pharmacy network, formulary management and drug acquisition costs for our pharmacy.

We continue to make progress on our operational efficiency improvements. And in the fourth quarter, we recorded additional severance cost associated with headcount reductions. These actions combined with previously identified reductions are expected to have a favorable segment profit run rate benefit of $25 billion for 2019, consistent with what we communicated in our December guidance call. We've assembled a dedicated team to uncover additional opportunities for more industry competitive administrative cost structure in 2020 and beyond. We are targeting an additional 30 basis points to 40 basis points on our $1 billion of operating costs, resulting in $30 million to $40 million improvement in the next two to three years.

Now let me turn to the regulatory environment. Late last month, the US Department of Health and Human Services published draft regulations that remove the current Safe Harbor protection for prescription drug rebates under Medicare Part D and Medicaid managed care effective January 1, 2020. The proposed rule as currently written, does not have a material impact to our business. Magellan's formulary management and PBM business is largely concentrated within the commercial payer and the employer markets, which is outside the scope of the proposed rebate rule. In addition, Magellan supplemental rebates delivered to State Medicaid customers are not impacted by the draft regulation.

Finally, we do not expect any material financial impact to our Medicare PDP business, so as we would reflect any rebate changes in our bid premiums. We are committed to working with the administration and policy makers to achieve our shared goals of lower drug prices and reducing out-of-pocket costs. We are concerned that the proposed rule will only result in shifting the drug spend and it would actually increase overall pharmacy costs. Estimate suggest that the HHS proposal may increase premiums for Medicare beneficiaries by as much as 25%, states spending by $2 billion and federal spending by as much as $196 billion over a decade. We are encouraged that Congress and other stakeholders share our concern for potential negative impact on both consumers and taxpayers, if this proposal were to be finalized. We are hopeful that HHS will reconsider once it hears from the public in the coming weeks.

Before turning the call over to John. I want to briefly address the recent Director nominations from Starboard Value Fund. We value the views of our shareholders. And following Starboard's recent investment, members of the Magellan Health's Board and Management Team begin a dialog with Starboard to understand their perspectives. We take the composition of our Board seriously. As we've evolve, the diversified Magellan's business, we've added new Directors with relevant skills and experience to support the changes in our strategic direction.

Five new Independent Directors have been added to the Board in the past five years, representing more than half the Board's nine members. Two of these Directors joined just last year and are among the Directors up for election. The Magellan Board and Management Team have been and remain committed to acting in the best interest of the Company and all of Magellan's shareholders. We also remain open to reaching an agreement with Starboard that serves the interest of all Magellan shareholders. We will present the Board's recommendation with respect to the election of Directors in the Company's proxy statement.

With that said, I will hand the call over to John to discuss our results and outlook in more detail. John?

Jonathan N. Rubin -- Chief Financial Officer

Thanks, Barry and good morning, everyone. I'll begin by discussing full year 2018 results as well as key items affecting results for the fourth quarter. Then I'll provide more details surrounding our 2019 guidance. For the year ended December 31, 2018, revenue increased more than 25% over 2017 to $7.3 billion. This increase was mainly driven by the full year impact of the acquisition of Senior Whole Health and the impact of net business growth.

Net income for the year ended December 31, 2018 was $24.2 million and EPS was $0.97 per share. The decrease in net income was primarily due to lower segment profits and a higher effective income tax rate. Adjusted net income for the year ended December 31, 2018 was $61.7 million and adjusted EPS was $2.46 per share, compared to $144.8 million and $5.92 per share for the year ended December 31, 2017. Segment profit declined from $311 million to $228 million year-over-year.

As Barry noted, relative to our previous expectations fourth quarter segment profit was negatively impacted by approximately $50 million of both out-of-period and non-recurring items, which I'll now describe in more detail, as I review each of our segments results. For the full year, we reported 2018 Healthcare segment profit of $149.1 million versus $202.7 million in 2017. The 2018 decrease was primarily driven by cost of care pressure in MCC Virginia, rate reductions in MCC Florida and unfavorable revenue adjustments in New York, partially offset by a full year contribution of Massachusetts from the Senior Whole Health acquisition.

Results in the quarter were unfavorably impacted by significant out-of-period and non-recurring adjustments to revenue for our New York contract. We received communication from the state regarding several items impacting our rate. First, the state has delayed implementing the updated retroactive risk or adjustments for the 2018 contract year published in November. This would have been favorable to Magellan and would appropriately reflect the increase in acuity of our population. As such, we continue to discuss this matter with the state. We expect that the updated risk or adjustments will be included in the 2019 contract rates and therefore this is not materially affect our 2019 guidance.

In addition, there was a separate 2% risk adjustment pool exclusively for high cost, high needs individuals. In January, the state released a methodology and final calculation for the 2017 contract year, which was worse than we expected. Beyond the adjustment for the current year, we also have modified our estimates for the current contract year through March 2019 accordingly. We also received in January, the final settlement for the 2017 contract year on the supplemental capitation we received for members transitioning to a custodial nursing home setting, which was lower than we anticipated.

As a result, we also modified our estimate for the 2018 contract year. Since this population is scheduled to transition out of the MLTC program. We don't expect this to have a material impact in 2019. Finally, in February, the state modified the quality incentive payment methodology and communicated our relative ranking for the 2018 contract year. As a result, we've reduced our estimate for the bonus we'll receive. We've continued to improve our quality results since the baseline period used for the recent ranking and while the bonus is also affected by other plans results, we're not making any changes to our 2019 expectations.

The collective impact of all the changes for New York in the quarter was $43 million unfavorable to our previous revenue expectations. We still believe in the strength of our New York Medicaid plan and our ability to deliver long-term profitable growth at market competitive margins for this product. We reported pharmacy management segment profit of $104.4 million for the year ended December 31, 2018, which was a decrease from the $139.9 million in 2017. The year-over-year decrease was primarily due to the loss of specialty carve-out business during the first half of 2018, as well as $7 million of unfavorable non-recurring items in the fourth quarter, related to inventory rebate receivables and prior year customer settlements.

Regarding other financial results, corporate cost inclusive of eliminations, but excluding stock compensation expense totaled $25.6 million for the year compared to $31.8 million in 2017. The decrease is mainly due to lower discretionary benefits in 2018, higher corporate development costs in 2017 related to the Senior Whole Health acquisition and litigation settlement recorded in 2017. Excluding stock compensation expense and changes in fair value of contingent consideration, total direct service and operating expenses as a percentage of revenue were 14.2% in the current year, as compared to 15.5% for the prior year. The decrease is primarily due to economies of scale from growth and acquisitions, the impact of other business mix changes and lower discretionary benefits.

Stock compensation expense for the year ended December 31, 2018 was $29.5 million, a decrease of $9.6 million from the prior year. This change is primarily due to the vesting of stock related to the Armed Forces Services Corporation and CDMI acquisitions during 2017. The effective income tax rate for the year ended December 31, 2018 was 44% compared to 18.6% for the prior year. The increase was due to a number of factors including the reinstatement of the non-deductible Health Insurer Fee. The favorable impact of reducing the net deferred tax liabilities in the prior year for the lower future corporate tax rate. The reversal of valuation allowances related to AlphaCare net operating loss carryovers in the prior year and an increase in 2018 and the amount of non-deductible executive compensation as a result of the Tax Act. The effective tax rate was higher than our previous guidance, as a result of lower segment profit and the leverage impact of the non-deductibility of Health Insurer Fees and executive compensation.

Our cash flow from operations for the year ended December 31, 2018 was $164.8 million compared to $162.3 million for the prior year. As of December 31, 2018, the Company's unrestricted cash and investments totaled $130.4 million, which represents a decrease of $130.8 million from the balance at December 31, 2017, largely due to the pay down of debt and share repurchases. Approximately $63.3 million of the unrestricted cash and investments at December 31, 2018 is related to excess capital and undistributed earnings held at regulated entities. Restricted cash and investments at December 31, 2018, a $527.7 million reflects an increase of $62.3 million from the balance at December 31, 2017. This increase is primarily attributable to the growth in MCC, Virginia.

As a result of the shortfall in earnings during 2018, we recently amended our 2017 credit agreement with our lenders to allow for a maximum net leverage ratio up to 3.25 times trailing 12 month EBITDA until September 30, 2019, 2.75 times at December 31, 2019 and 2.5 times thereafter. As Barry noted earlier, we are confirming our 2019 guidance. I note that the majority of the unfavorable developments in the fourth quarter results related to prior periods are non-recurring in nature. Of the balance, we expect the unfavorable run rate impact in 2019 to be offset with several favorable items, which have developed subsequent to our December guidance call, including 2019 rates for several contracts.

With that, I'll now turn the call back over to Barry to conclude. Barry?

Barry M. Smith -- Chairman and Chief Executive Officer

Thank you, John. While 2018 was challenging, we are only midway through our work to create a stronger, more sustainable foundation for the Company. For decades, Magellan was the leader in the carve-out specialty and behavioral health space. While these capabilities remain valuable and relevant today, the reality is that the market has changed to a much more integrated model. We recognize this and proactively took steps to transform our business in a significant way. We've made solid progress in shifting our revenue stream into growth markets over the past five years, including creating and expanding Magellan Complete Care, which now represents over 50% of our healthcare revenue and transforming our pharmacy business into a full service PBM.

Had we not made this pivot both our top-line and bottom-line would have been a fraction of what it is today with little prospect for growth. Instead, we have two major growth platforms well-positioned for the future. As you heard us say in our third quarter call, following these changes to our business, we have taken the opportunity to pause and consider where we are in our evolution and our priorities for the future. We are gaining more discipline and operational knowledge and we've added key resources with specific expertise to help us better digest what we've taken on.

Looking to the future, this team is focused on addressing our operational issues and driving margin improvement over time, while enhancing value for all shareholders. Despite our challenges, Magellan is needed in today's marketplace. Our decades of work in behavioral health, substance use disorder, and specialty pharmacy management have created a wealth of unique expertise that can possibly affect most of the -- the most costly health programs in the nation. In both healthcare and pharmacy management, the awareness of the impact the behavioral health plays in an individual's health the decision making helps us design valuable healthcare solutions for health plans, government, employers and our members. Integrating this knowledge with cutting-edge technology and committed staff is a recipe for success.

I believe our recent staff additions to the reorganizations that we've completed in the fourth quarter will drive our margin recovery strategy. I look forward to sharing future updates and on all of our execution priorities and as the year progresses. With that, I would like to take the opportunity to acknowledge Magellan's 10,000 plus associates on the front lines every day. They are truly leading humanity to healthy vibrant lives. With their support and the more diversified healthcare platform we've built, I remain confident in our ambition and our team as well, as well as our ability to deliver sustainable growth and value creation over the long term.

I'll now turn the call over to the operator for questions, Operator?

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) And our first question comes from Ana Gupte with SVB Leerink. Your line is open. You may ask your question.

Anagha A. Gupte -- SVB Leerink -- Analyst

Hi. Thanks. Good morning. Appreciated taking the questions. I'll ask a few questions on the segments first, and then I have some more broad questions as well. So starting with the Complete Care business, you've missed now, I believe four quarters in a row, largely I think with some of the pressures in Virginia, but also in New York and this quarter, if you are attributing it to out-of-pocket costs in New York, but out-of-pocket and prior year favorable or unfavorable development is kind of par for the course in these businesses. So does this signal in anyway that there may be an estimation issue on your cost itself. Why you feel confident that in 2019 there wouldn't be anything recurring either in New York or anywhere else because I get it that $43 million may not be huge, but on your P&L, it is?

Jonathan N. Rubin -- Chief Financial Officer

Hi, Ana. It's John. A few things I'd note relative to your question. One specific to MCC and let me start with New York. The unfavorable out-of-period non-recurring items that we referenced this quarter were actually revenue items not related to cost of care or what you were referring to as normal prior period development. So specifically in January and February, we got new guidance from New York and the different components of the rate reconciliation and adjustments that I noted earlier. So it really is very confined to the one contract to specific actions by the state and not related to executions.

On the other hand, when we look at actually the cost of care, we've actually made very good progress in the quarter. As we talked about in both third quarter and in December, we were expecting based on the actions we had implemented specifically in Virginia where as you know we had pressures throughout the year, in action plan that really has started to take hold. So for example, as we've discussed previously, we were running over 100% loss ratio in Virginia over the first-three quarters. And we've got that down into the low '90s in fourth quarter and we are in good shape, we think as we turn the quarter into the year in 2019 to achieve our objective is to get that down closer to mid '90s or better.

So in terms of progress, I just wanted to note that, that again the non-recurring items were rate related. The progress on the loss ratio was actually in line with our expectations and again, creating positive momentum as we go into 2019.

Barry M. Smith -- Chairman and Chief Executive Officer

I'd also add to that, just the leadership changes and kind of a much more tight operating metric and following-up on specific details of execution that have been very productive for us. I don't think I was able to say because we -- the last go around, some of the changes we've made leadership. We've made global healthcare changes in leadership, but importantly for MCC specifically, we have a new President, Christy Cooper, who has joined us several months ago as CFO of MCC, then stepped up to be the new President. Christy is a well-seasoned executive with the health plans and on the provider side as well. She ran WellCare in Florida for the turnaround, California and Hawaii. She is just a very experienced healthcare executive with health plans. And so with Christy's leadership and the team that I think I mentioned in the last go around, Sajidah Husain, who is the Chief Medical Officer; Kristen Goetze, who is responsible now new addition to the team over the last several months in med econ and analytics; Ashok Sudarshan, who is -- Ashok came to us with great operating experience, he was the COO, worked for Herb Fritch. And so we just have a new very experienced team that we think has enabled us to up our game. And as you -- you're seeing now some really great progress in Virginia. So we remain confident -- cautious, certainly, but confident that we'll be able to make some material advances in Virginia and across MCC for that matter.

Anagha A. Gupte -- SVB Leerink -- Analyst

Yeah. I hear you, but I mean I get it on the numerator and the denominator on the loss ratio. But in a risk adjusters quality scores, they do fluctuate, there is always volatility I mean companies deal with it, it's again part for the course and the other period issue, maybe this time around the numerator, John, but it's been in the past oftentimes on the denominator -- on the cost of care issue as well. Sorry, if I missed that. I mean, right now you think it's on the denominator, but it's been on the numerator loss ratios as well.

So I just, I would just point out that therein other companies that have had these issues, when they were not at that scale and it just hits the P&L harder, not to say that you can predict what the state might do. But I guess you could maybe have a wider range of guidance or just be more conservative. It just still seems a little bit challenging to me that you after four misses you're so confident about the guidance in '19? Then moving onto pharmacy again here too, maybe the miss wasn't as dramatic, but again here too there are issues around the loss ratio. And is your pricing seeing any pressure here and what is driving the pressure on the pharmacy margins as well?

Barry M. Smith -- Chairman and Chief Executive Officer

Well, that's a good point there is, it's certainly a very competitive environment in the pharmacy world and we've seen it become even more competitive in certain segments of the market. We've seen a very good success on the employer side and we continue -- we expect to see that success. And the MCO market has been very, very tight, and there's a lot of cost, pricing pressure there. I would say that the recent combinations of both CVS and Aetna and Express' CIGNA have introduced a new dynamic into the market, and we're looking forward to see how that ultimately shakes out.

We do think that the pricing ultimately will rationalize. We take that both CVS and CIGNA are very rational market players. We think that we could be competitive in the marketplace, as evidenced by one of our recent substantial wins of over Fortune 100 employer. And so we think, we do have saying power because of our clinical expertise, but Ana, there is no doubt that is a very competitive market for pricing for the PBM.

Anagha A. Gupte -- SVB Leerink -- Analyst

Got it. Thanks, Barry. Thanks, John. Appreciate the color.

Jonathan N. Rubin -- Chief Financial Officer

Thank you, Ana.

Operator

Thank you. Our next question comes from David Styblo with Jefferies. You may ask your question.

David Styblo -- Jefferies -- Analyst

Good morning. Thanks for the questions. I'm going to -- I guess I'm trying to having a hard time reconciling a couple of different parts appearing Virginia is better, but then it just doesn't seem like we're seeing that in the numbers. So maybe at a higher level, I'll take it this way, so if I take the reported 2018 segment profit of $228 million and add back the $50 million of noteworthy items that gets us back to about $278 million. However, that's below $290 million to $310 million guidance range you guys gave in December. So the first question is, I'm wondering what caused the shortfall to that? And the second question is, why wouldn't that shortfall in the core performance caused you to lower your 2019 outlook or at least by a segment profit and EPS to lower end of the ranges? I know you mentioned rate increases, but it seems like rate increases would need to be pretty significant to offset some of that core shortfall?

Jonathan N. Rubin -- Chief Financial Officer

And just to clarify, the guidance for 2019 in segment profit is to $270 million to $290 million, so that probably explains a little bit.

David Styblo -- Jefferies -- Analyst

Now I was going back to the fourth quarter of '18 to what you guys had thought you were going to get for 2018?

Jonathan N. Rubin -- Chief Financial Officer

Okay. Okay. So in terms of -- so two different questions. And for 2018, in terms of the miss, again, think about $50 million being the non-recurring items. There are some other smaller deltas that impacted us as well on the behavioral and specialty utilization side. We had some higher seasonality in the quarter. I would say, it's not outside the normal fluctuations, but we did see a seasonally higher quarter. And then some impacts on the pharmacy side in volume and customer settlements. Again these weren't individually big items, but they did contribute in the quarter.

I think, the second part of your question was, as we think about 2019, what gives us confidence. And again in terms of what's changed, there is some impact from some of the items we mentioned in the run rate. I wouldn't say it's big again most of what hit us in the quarter was one-time or non-recurring in nature, but again those items are offset by slightly higher rates going into 2019 and also a little bit of positive utilization on select contracts, as we go into the year on the MCC side. So again, there's a number of puts and takes and what the rate delta -- the rate benefits we're seeing relative to our original guidance in 19 is relatively modest, you're probably talking 0.5% or so across the MCC book. It does aggregate to a material number just given the volume of revenues. So that's sort of the quick version.

David Styblo -- Jefferies -- Analyst

Okay. I mean, I know you said it's not, it's little less than that, but it does seem pretty material when you're at $278 million and full year 2018 and that's 20 -- it's over $20 million below the midpoint of what you guys were thinking, you're going to land out for the year. It just seems like it's more than a little of this little, little of that and the higher utilization and behavioral and so forth and some of the other things I guess, I just don't -- it provides less clarity as to why we would have confidence in the '19 guidance. Is there -- is there more there that you can elaborate on, I know you hit on a few things. It just seems like a pretty big bridge for us to walk.

Jonathan N. Rubin -- Chief Financial Officer

Yeah. Well in terms of getting the range again -- in terms of the range for '18 versus the actual, it is the items I mentioned, when I say little -- there weren't items that we're, I mean they were all at sort of single-digit million items, but again behavioral special utilization was higher -- pharmacy PBM settlements, both on the customer and network side based on what our settlements were at year-end and some lower script volume and membership on the pharmacy side in the fourth quarter versus expectations. Those were specifically the three items.

You're right if we were going back to the midpoint in aggregates to close to $20 million in those buckets. And there is some carryover, it's not dollar for dollar since these settlements. Some of that relates to prior quarters and what not, it's not dollar for dollar, but there is some impact in the 2019, again based on our current estimates those items are offset by the things I noted the rates we've received already for 2019, and some favorable utilization and other contracts, as we're heading into 2019. Based on our current estimates, so that's the full picture.

David Styblo -- Jefferies -- Analyst

Okay. And then flipping over to the pharmacy side. It sounds like you guys had some progress there with the new employer win on that, and I think you said you had no additional pharmacy, specialty pharmacy carve-out losses. So I think those important points that investors are keeping their eye on, is there anything else, as we look forward that you can share about retention, material contracts that are coming up, I know in the 10-Q you guys do have a pretty sizable contract? I think that comes due at the end of the first quarter, has that one been renewed. And any other color about wins or losses that you guys see that are impacting or could impact 2019 or beyond?

Barry M. Smith -- Chairman and Chief Executive Officer

Yeah. We have made some very good progress, as you point out, Dave. We've had no losses on the specialty contract side and we have had some nice wins on the employer side particularly. We don't have any large exposure we think in terms of any notifications and we are depending upon retention of our client base in the PBM world and we remain cautiously optimistic that we will do so. So there are really no major developments. I think the key is in these various markets. You've got in the States. We've done very well in terms of our ASO contracts, Medicaid programs. We don't have real exposure there to any rebate Safe Harbor issues there in terms of what the administration is proposing. These are ASO contracts largely where the vast majority of the rebates go back to the States directly today. So that really should not create a cloud or an issue for us going forward. We don't think that the rebate issue will bleed over into the commercial market that would take legislative action. We think that's unlikely to take place.

So I think on the pharmacy side, we see that it's just a very competitive world. On the MCO side, as I mentioned to -- responded to Ana's question, it is a very competitive marketplace right now. And so we are seeing traction, but not the same level of traction, as we're seeing in the employer market. And so we'll just have to see how that plays out. The employer market remains robust, but competitive market for us as well. I think with our clinical programs and an ability to serve our clients. We will likely to continue to do well. We're one of the few remaining independent PBMs out there. I think that's a big positive feature and that we don't have the channel conflict that others have. So we think that the pharmacy business, while there is no doubt pricing competition out there that's tough. We think that we'll be able to go through the cycle of pressure and move forward.

David Styblo -- Jefferies -- Analyst

Okay. And specifically, I should may be more specific about it, in the 10-Q, you guys have listed of customers see that are upwards about $260 million of year-to-date revenue in the third quarter, has that contract been renewed?

Barry M. Smith -- Chairman and Chief Executive Officer

Yeah, that, yes.

David Styblo -- Jefferies -- Analyst

Okay. And then, the last one I had would just be on the incremental cost savings and efficiencies that you guys are targeting after 2019. Can you give us little bit more color on where you are in the planning phases for realizing those savings, have those been earmarked and identified at this point? And it's just a matter of, OK, you're going to start to move on those next year or maybe begin to implement them later this year?

Barry M. Smith -- Chairman and Chief Executive Officer

Yeah. We're already moving on them, Dave. There are a number of opportunities that we have throughout the Company, both on administrative costs, as well as managing cost of care. Fortunately, we've had great success in bringing in some very strong operating leadership, that have been able to bring us new ways of thinking about things. We've already launched significant changes in the -- how we're going about the business itself. And we think that through automation and through different processes that we're putting in place today that will not only yield positive results this year, but will bleed into 2020 as well.

So I wouldn't say that it's just a one-year, this is what we're doing in 2019. The changes we're making will really have a very positive run rate going into 2020 as well. And again their fundamental operating metrics and operating ways of doing things, all the way from the claim systems to automating things, we are using labor significantly and how we run those systems, all the way through the fraud and waste and abuse, systems and capabilities, we've been putting in place that have been very effective for us already. And in some cases have outstripped our expectations in terms of savings.

And so we just think that there are whole host of opportunities in low-hanging fruit here that will take advantage of. A part of the issue, I think we've been facing Dave and I mentioned this in the script, is that we've grown dramatically. And I think it's very challenging, you've got the growth rate that we've had to keep up with the fundamental operating both administrative expenses and general operating expenses of the company to keep up with the efficiencies. But, we've kind of taken a bit of a pause and are taking the opportunity to create these efficiencies and improve margins, and that's what we are largely focused on this year, which will yield benefits this year and next.

David Styblo -- Jefferies -- Analyst

Okay. Thanks.

Barry M. Smith -- Chairman and Chief Executive Officer

Great. Thank you, Dave.

Operator

Thank you. Next question comes from Scott Fidel with Stephens. You may ask your question.

Scott Fidel -- Stephens -- Analyst

Hi. Thanks. Good morning. Wanted to start out just had a question just on the HHS rebate proposal and I know one of the areas, where there's a lot of concern in the industry is just around the timing of the proposal and now they're proposing for 01/01/20 implementation. Barry, just interested sort of what you're hearing and whether there's a dialog here from or any recognition from the administration around how aggressive that timing is and whether there's a potential that at least that they were going to move forward with this proposal that they would accommodate a more I think reasonable timeline for implementing it?

Barry M. Smith -- Chairman and Chief Executive Officer

Yeah. It's a very good question, Scott. We think that that timeline is very aggressive, we never know. But with the recently published proposed rule on the sixth to amend it in an effective January 1st, 2020, this whole discount Safe Harbor regulation, as it relates to public sector Part D and Medicare, given particularly the interest that are lobbying at this point in time, we think it's a very, very aggressive timeline. And our sense about it is that while there are lags to it and I think that there will be some impact in the industry, particularly for the public sector business not necessarily Medicaid as much. We do think it will take longer to implement. And so we would be surprised if it went effective January 1, 2020.

Scott Fidel -- Stephens -- Analyst

And then, in the meantime, has there been any guidance from CMS. Just in terms of given it again how short this timeframe is in terms of with the bid submissions or the guidance that you should be sort of preparing two different sets of bids with and without this regulation or what's the feedback that you're getting from CMS even on sort of bid preparation at this point?

Barry M. Smith -- Chairman and Chief Executive Officer

That's part of the -- that's part of the challenge, Scott. There is some general advice and counsel, but not enough specificity to really inform us on how would you go through with the bids. And so it's very difficult, given the fact that we have to really submit those bids mid-year. We need far more direction and understanding as to what the final rule will be. So we think it's difficult, that's why we think the timeline is difficult.

Scott Fidel -- Stephens -- Analyst

Yeah. Okay. Then just on the business side, just trying to keep track on the different moving parts here. On Senior Whole Health maybe can you give us an update on how that business performed in 2018. And then specifically relative to sort of the revenue and earnings accretion targets that you had laid out for 2018?

Jonathan N. Rubin -- Chief Financial Officer

Yeah, Scott. It's John. Let me start with that. First, the business from a fundamental standpoint has performed well throughout 2018 with the important exception what we just discussed today on the New York rates. So if you put aside some of the one-time impact of these rate adjustments, some of which actually go back to prior even the 2018 in terms of the reconciliations and the business has performed well now. And we think as we go into 2019, we'll be add for ahead of what the original acquisition models or business case would have described. But again 2018, we did see temporary pressure in New York. Massachusetts though has done quite well in fact beyond our original expectations.

Scott Fidel -- Stephens -- Analyst

Right. And John, just to sort of clarify the negative item that you saw in New York in the fourth quarter, did that pretty much all relate to Senior Whole Health or because I know you guys are about to carry, there's few different businesses in New York. Is it all Senior Whole Health or spread across a few different things there?

Jonathan N. Rubin -- Chief Financial Officer

It is spread, and in fact, we were fully integrated now. So it's hard for us even to decouple it completely, Scott, but the majority would obviously be connected to Senior Whole Health given they were larger coming into the acquisition in the merger.

Barry M. Smith -- Chairman and Chief Executive Officer

And the other thing I'd say, Scott, as you recall going from '17 into '18 when we were going through the regulatory process of integrating the two, we were not allowed to do marketing. We weren't allowed to have two owned entities market. So we had to stop the marketing for AlphaCare as Senior Whole Health continue to move on. What they did was initially create a lower run rate in terms of (inaudible) lives upfront, but ultimately, we've been able to catch up and do well.

Scott Fidel -- Stephens -- Analyst

Okay. Then just one last question from me. Just an update on Florida MCC and just sort of as you're transitioning to the reduced membership profile, how that transition is going and sort of how the cost structure is absorbing that the low revenue profile at this point?

Jonathan N. Rubin -- Chief Financial Officer

In terms of Florida and the transition in the 2019, Scott, we're very much on track. So that's part of the administrative and operating model improvements that we're making into 2019. Obviously, we've got first and foremost we reduce the cost -- to proportionately for Florida and we're on track. Now, I think as we talked previously in 2019, we are not going to fully get to where we need to in Florida and administrative costs because there are staffing levels, we need to maintain through first quarter to manage the runoff volumes on the larger contract. But in terms of executing on our plans and getting to our ultimate targets, we're on track.

Scott Fidel -- Stephens -- Analyst

Okay. That's it for me. Thanks.

Barry M. Smith -- Chairman and Chief Executive Officer

Great. Thanks, Scott.

Operator

Thank you. And our final question comes from Kevin Fischbeck with Bank of America . You may ask your question.

Catherine Anderson -- Bank of America Merrill Lynch -- Analyst

Hi. This is Catherine Anderson on for Kevin. You touched on this a bit, but I was wondering if you could give us an update on how margins are trending in each of your MCC markets versus your expectations instead of outside of Virginia, where you see the most room for improvement?

Jonathan N. Rubin -- Chief Financial Officer

Yeah. I'd say, if you look across the plans as we head into '19. I would say, we're on track overall. If you think about the plans individually Florida is I just talked about, we are on track, Massachusetts has continued to run well; Virginia, on cost of care and in revenue we're running as expected as we go into the year. Again, I'd say that the market that was the most challenged fourth quarter was obviously, New York. That's something that we're paying close attention to and working very closely with the state on as we go into 2019 to make sure that particularly on the rate side everything plays out as we anticipate.

And again as I said in Massachusetts were actually seeing some favorability as we go into the year. So net-net, again I'd say, on track versus expectations. From a profitability standpoint, again, Virginia we're feeling good about, Massachusetts we're feeling good about, in terms of where we are versus target margins. On New York, we expect to get back to where we need to this year. Florida again will be a little bit dampened because of the transition to the smaller contract in Arizona. We'll be ramping up margins through the year as the scale and membership grows, but that's the picture I would say, largely on track.

Catherine Anderson -- Bank of America Merrill Lynch -- Analyst

Okay. Thanks. That's helpful. And can you give more detail on the non-recurring pharmacy items in the quarter, at what point did you have visibility into those and how confident are you that they will reoccur in the future?

Jonathan N. Rubin -- Chief Financial Officer

Yeah. So in terms of the items in pharmacy, there were few areas that we noted. First is inventory, where -- for our specialty pharmacies, we kind of updated inventory at year-end. Part of it relates to one particular pharmacy location where we closed down and sort of consolidated, where we had to write-off some inventory. That's obviously one-time in nature and shouldn't be an issue at all as we go forward. The other areas are sort of rebate receivables were again, we had some cleanup related to old periods that shouldn't have an impact as we go forward.

And the third area being settlements. The customer settlements that related to the full year. So in those areas again, we feel good about our ability to manage it going forward. And I don't expect any issues related to these items going forward. In terms of the timing really this came to light fully when we're closing the books during the last 30 to 60 days. So that's kind of the time period when all these settlements were done. And obviously we go through a very thorough process at year-end to ensure we've got all the balance sheet items where they need to be.

Catherine Anderson -- Bank of America Merrill Lynch -- Analyst

Okay. Thanks. And then can you give some commentary on earnings seasonality for 2019? Should we expect the net margins and earnings to ramp throughout the year or how should we think about that?

Jonathan N. Rubin -- Chief Financial Officer

Yeah. And again that's consistent with the normal pattern obviously, fourth quarter this year was an anomaly, but if you look at the normal pattern, we've roughly seen in the past and again these are round number not intended to be a precise estimate, but about a 40/60 split between first half and second half of the year, and that relates to a number of things. One, just the normal seasonality in earnings with certain contracts, for example, Part D has a natural seasonality built into the benefits. Also growth, as we go through the year and then obviously the impact of the margin improvement initiatives that continues to build as we come into the year and go through 2019. So those are the key items, but I wouldn't expect it to be significantly different from that pattern that we've seen historically.

Catherine Anderson -- Bank of America Merrill Lynch -- Analyst

Thanks. That definitely helps. Appreciate it.

Jonathan N. Rubin -- Chief Financial Officer

You bet.

Operator

Thank you. And at this time, I'd turn the call back over to the speakers.

Barry M. Smith -- Chairman and Chief Executive Officer

Thank you today for your participation in the conference call. We look forward to speak with you again in April, when we will discuss our first quarter 2019 results. Take care.

Operator

This does conclude today's conference. We thank you for your participation. At this time, you may disconnect your line.

Duration: 53 minutes

Call participants:

Joe Barton -- Senior Vice President, Investor Relations

Barry M. Smith -- Chairman and Chief Executive Officer

Jonathan N. Rubin -- Chief Financial Officer

Anagha A. Gupte -- SVB Leerink -- Analyst

David Styblo -- Jefferies -- Analyst

Scott Fidel -- Stephens -- Analyst

Catherine Anderson -- Bank of America Merrill Lynch -- Analyst

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