Centene Corporation (CNC) Earnings Call Transcript & Summary

Good morning, and welcome to the Centene Corporation 2020 Guidance Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Ed Kroll, Head of Investor Relations. Please go ahead.

Thank you, Tara, and good morning, everyone. Thank you for joining us on our 2020 consolidated guidance conference call. Michael Neidorff, Chairman, President and Chief Executive Officer; and Jeff Schwaneke, Executive Vice President and Chief Financial Officer of Centene, will host this morning's call, which can also be accessed through our website at centene.com. A replay will be available shortly after the call's completion also at centene.com or by dialing (877) 344-7529 in the U.S. and Canada or in other countries by dialing (412) 317-0088. The playback code for both dial-ins is 10139468. Any remarks that Centene may make about future expectations, plans and prospects constitute forward-looking statements for purposes of the safe harbor provision under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in Centene's most recent earnings release and Form 10-K dated February 18, 2020, and other public SEC filings. Centene anticipates that subsequent events and developments will cause its estimates to change. While the company may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so. This call will also refer to certain non-GAAP measures. That's generally accepted accounting principles. A reconciliation of these measures with the most directly comparable GAAP measures can be found in our 2020 consolidated guidance press release, which is available on Centene's website at centene.com under the Investors section. Finally, a reminder that we will host our first quarter 2020 earnings call on Tuesday, April 28, 2020. And with that, I'd like to turn the call over to our Chairman and CEO, Michael Neidorff. Michael?

Thank you, Ed. Good morning, everyone, and thank you for joining Centene's 2020 Guidance Call. My remarks this morning will be brief before I turn the call over to Jeff to walk you through the details of our guidance. I will discuss our 2020 growth, the progress on the integration of WellCare as well as the steps we're taking with regard to the novel coronavirus. Our business is performing well on all fronts. For 2020, we are forecasting revenues of $104.8 billion to $105.6 billion, an increase of 41% at the midpoint of guidance compared to 2019 revenues. A large part of the growth is obviously driven by the consolidation of the WellCare business. Before I go further, we want to remind you that our policy has been that once a transaction is closed, we don't discuss the legacy business. We focus on the business as a consolidated. Our guidance also assumes strong organic growth across our business, enabled by our All Products, All Markets strategy and the new products we added through the acquisition. Let me quickly highlight some of our growth priorities. Medicaid. We have firmly solidified our national leadership position in Medicaid. We have a leadership position in 10 states, including the 4 largest Medicaid states. We continue to have a long runway driven by a very robust RFP pipeline. Medicare. We are projecting approximately 1 million Medicare Advantage members by the end of the year. We are committed to driving significant growth here. The business will be managed by Mike Polen out of the Tampa office, and our Medicare brand will now operate under the West -- the WellCare brand name. Our teams are coordinating our 2020 bids, and we are in the process of aligning strategies to improve the plans' overall CMS Star ratings for all the businesses. Marketplace. We continue to be pleased with the strong performance of our Marketplace business. Our Marketplace membership stands at 2.2 million members, and we now have additional geographic opportunities. This enhances Centene's market-leading national position in this product. Cost and productivity. We remain as focused as ever on cost management and productivity initiatives. Centene Forward, a very successful program, will continue its success as an important execution engine. And we will continue to drive significant value as we expand the scope across the entire enterprise. And of course, we're also focused on delivering the cost synergies from the transaction. From an earnings perspective, we expect to deliver adjusted EPS in the range of $4.56 to $4.76 for the full year 2020. As we noted in our press release, this assumes a $0.17 impact due to the potential Medicaid rate decrease by New York State. The state recently informed us of this proposal due to the budget pressures they are facing. This is not final, and we will be discussing with the state in the coming weeks the impact of this. Importantly, over half of the adjustment to the rate is coming from the quality initiative program, and we will have discussions with the states about their impact. However, having an abundance of conservatism, we have decided to be prudent and include these new rates in our guidance. Jeff will discuss how we intend to offset some of this impact. The planned integration of WellCare is going extremely well. We anticipate it to be no less than breakeven accretion in the first full year. The integration of medical management, personnel, systems will be completed by the end of the year. And finance and insurance systems will be fully implemented by July 1. As another example, the New York health plan will be fully integrated this June 1. The organizational structure is falling into place, and those structures are being implemented as we speak. As a reminder, we are expecting to take several years to complete the full integration of operational systems. In addition, the PBM business is an important aspect of the transaction synergies and overall value creation. We have appointed Drew Asher to lead our pharmacy strategy and innovation team. The teams are actively evaluating the additional opportunities in pharmacy costs and implementing the integration strategy. In short, we are well on track to drive the previously communicated synergy targets and value across the entire enterprise. Before I turn it to Jeff, I want to say a few words about the novel coronavirus, given that it is a focus of many health officials today in the U.S. as well as globally. Needless to say, we are monitoring the situation closely. The situation is fluid. However, we have not seen any impact on our business thus far. It is too early to make a determination given how quickly this could evolve. We do fully expect it to be manageable. Our focus has been on business continuity program to ensure we're able to deliver the high-quality care our recipients have come to expect. We have a plan and internal team led by Ken Yamaguchi, Chief Medical Officer; and Mary Mason, Chief Medical Officer of Health Initiatives, both of whom have extensive experience with the flu and other high-risk situations. Among others, this committee includes risk managers, human resources and senior operations personnel to evaluate and advise on appropriate actions, if necessary, as the situation evolves. Specific internal guidelines have been issued, namely: No international travel, business travel that is; only absolutely necessary domestic travel; and the avoidance of large gatherings. Importantly, all statistics show that over 80% of those who are affected have relatively mild symptoms. Furthermore, our senior personnel are in close communication with authorities and other members of the business community, and we are prepared to work closely with the medicine community should we see an escalation here in the U.S. Our goal, should there be an outbreak in the U.S., would be to ensure that those affected will able to receive the treatment that they need quickly and effectively. In closing, we fully expect our environment will continue to be influenced by headline volatility from the coronavirus as well as the political landscape. We maintain our approach of making decisions based on the facts as they are today. This has served us very well. Turning to the other issues. Importantly, we continue to believe that the Supreme Court will uphold the Affordable Care Act. I remain confident in the strength and outlook of our diversified health care enterprise as we look ahead to 2020 and beyond. Thank you for your continued support. And now I'll turn it over to Jeff, who'll go through the financial details.

Thank you, Michael, and good morning. Yesterday, we released our consolidated guidance for 2020, accompanied by a presentation that is posted on our website at centene.com under the Investors section. On a combined basis, including the acquisition of WellCare, we expect 2020 total revenues in the range of $104.8 billion to $105.6 billion or $105.2 billion at the midpoint, an increase of 41% over 2019; and adjusted diluted earnings per share in the range of $4.56 to $4.76. Three key areas are driving revenue growth for 2020: First, the acquisition of WellCare; second, organic growth driven by a full year of contribution from expansions and new programs that occurred in 2019 as well as growth in our marketplace business that we highlighted on our February call; and third, the return of the health insurer fee. As a reminder, from December, this growth is partially offset by lower-than-expected pass-through payments, primarily in New York and California. The growth is also partially offset by lower revenues in New York because of potential rate reductions received from the state in early 2020 and by the divestiture of our Illinois business. The HBR for 2020 will be in the range of 85.9% to 86.3%. The slight decrease in HBR in comparison to our previous guidance is driven by the effect of the WellCare acquisition. We expect our SG&A ratio to be between 9.3% and 9.7% in 2020 due to onetime transaction and integration costs associated with the WellCare acquisition, and the adjusted SG&A ratio to be between 8.9% and 9.3%. We expect onetime transaction and integration cost to be approximately $400 million in 2020, with approximately $385 million impacting the G&A ratio. Next, earnings per share. First, I will discuss the effects of the WellCare acquisition and the proration of January on full year 2020 guidance. The transaction closed on January 23, 2020, which means we had 22 days of the divested Illinois business that is included in our 2020 guidance and 9 days of January for the acquired WellCare business. We estimate the effect of the proration to be a net reduction of approximately $1.8 billion in total revenue for the year and a net benefit to GAAP and adjusted diluted earnings per share of $0.09 for the year. There are a lot of moving parts associated with the proration effect, however, they can be broken down into 3 primary drivers. First, the lack of owning WellCare for the 22 days was a slight benefit due to the normal seasonality of the business in January. This benefit was substantially offset by a delayed synergy capture, which is back-end loaded for the year. And lastly, the remaining difference is the lower overall average share count for the year as a result of the transaction closure timing. Just to be clear, if the transaction had closed on the 1st of January, these adjustments would not be necessary. So I want to verify that for those looking for a jumping-off point for 2021. Now we expect the net benefit to GAAP and adjusted diluted earnings per share to be offset by the potential New York rate change that we highlighted in the press release. As has been discussed in the media and widely publicized, the Medicaid program in the State of New York faces a large funding deficit over the next several years. On February 6, we received potential rates from the state that would result in an overall net rate reduction of approximately $200 million pretax for 2020. Over half the potential rate adjustment is due to the elimination of the quality incentive program, which incentivizes managed care providers to deliver high-quality health care to members. We continue to work with the state on actuarial soundness and other program design changes to mitigate the effect of the rate adjustment. Therefore, the adjustment is not final, and the state has established a Medicaid redesign team to investigate how to address the underlying cost of the Medicaid program. We have begun to develop initiatives to mitigate a portion of the potential adjustment for 2020. Based on the facts we have at this point in time, we expect $150 million of the adjustment to potentially lower our pretax earnings for the year, translating to a $0.17 per share impact on our GAAP and adjusted diluted earnings per share guidance. While the rate change is not final, we believe it is prudent to reflect the $0.17 reduction at this time. Bringing it all together, for 2020, we expect a net $0.09 benefit related to the timing of the acquisition close and a $0.17 headwind from the New York State rate change, resulting in a net reduction of $0.08 per diluted share to our previous guidance of $4.74 at the midpoint. Therefore, 2020 adjusted diluted earnings per share are now expected to be in the range of $4.56 to $4.76 or $4.66 at the midpoint. For modeling purposes, I want to make clear that post acquisition, the seasonality of our 2020 earnings is now weighted 52% to the second half of the year due to the timing and nature of synergy capture, divestitures and shares outstanding. As is our historical practice, we do not provide quarterly earnings guidance. However, given the size of the acquisition, the lack of comparability to prior year and the synergy capture impact, we will provide more color on the first quarter adjusted earnings per share. We expect our first quarter 2020 to be in the high $0.80 to low $0.90 range for adjusted diluted earnings per share. Again, we do not expect to provide this in the future. Overall, our accretion expectations for the WellCare acquisition remain unchanged. We continue to expect no less than breakeven accretion in the first full year post acquisition, and mid- to upper single-digit accretion in the second full year. We also remain comfortable with our net synergy targets of $500 million in the second full year and $700 million run rate. The integration process continues to progress well, and we have executed on the majority of the expected synergies for year 1. Additionally, we intend to utilize the after-tax proceeds from divestitures to complete a combination of debt reductions and share repurchases that will be neutral to our debt-to-capital ratio. We have been thoughtful on the economics of the share repurchases and have already repurchased a small amount. We have not included any benefit of future share repurchases or debt reduction in the guidance today. We estimate the after-tax proceeds from divestitures to be $900 million. Switching to the tax rate. We expect our GAAP tax rate to be between 38% and 40%. This rate is higher than the Centene stand-alone rate, driven by nondeductibility of certain transaction costs and the effect of the nondeductibility of certain compensation under the provisions of 162(m)(6) on the WellCare business. Historically, WellCare was not subject to the compensation deduction limitation provisions. For an adjusted tax rate, we expect the rate to be between 32.5% and 34.5%. We expect full year diluted shares outstanding to be between 584.5 million and 587.5 million shares. As highlighted earlier, this does not include any effect of future repurchases but does include the effect of the transaction closure on January 23. The timing of the transaction closure decreased our full year diluted shares outstanding guidance range by approximately 10 million shares. Cash flow from operations are expected to be between 1.5 and 2x net earnings and adjusted EBITDA between $4.9 billion and $5.1 billion. As always, the cash flow metric is subject to fluctuations due to the timing of payments from states. Excluding the divestiture proceeds which I discussed earlier, we expect to deploy capital in 2020 primarily to fund growth, including statutory capital into our subsidiaries, investments in innovations, systems and infrastructure as well as disciplined M&A. In conclusion, the WellCare acquisition and integration is on track and delivering on our expectations. We will continue to expand upon our leading Medicaid and exchange platforms with continued product and market expansion. We are actively developing and implementing plans to advance our Medicare business under the WellCare brand and believe our enhanced capabilities will drive improved growth going forward. The combination enhances our scale in pharmacy, which provides us with another key driver of future value creation. And our dedication to cost discipline, Centene Forward, has become ingrained throughout our organization. That concludes my remarks. And operator, you may now open the line for questions.

[Operator Instructions] The first question will come from Ricky Goldwasser of Morgan Stanley.

I understood that the corona -- on the coronavirus, it's still very early. But as we think about the potential implication, I know that Cuomo said -- announced plans to waive co-payments for all medical expenses related to testing in emergency department care. So if you can just help us kind of like think through potential implication going forward, should we see -- is this something that states would reimburse you or adjust rates for after the fact? Or how should we be thinking about potential financial impact? And if there's anything historically like H1N1 outbreak that we can use to draw some parallels.

I'll start, and I have some of our medical people on the line, so they can add to it as necessary from a technical standpoint. We're viewing this virus at this point in time, we have a flu season every year and some are milder than others. This one right now has been pretty normal, and it has the potential for being a little more severe. And there's a lot of anecdotal evidence, not a lot of specific evidence. You have anecdotal evidence where doctors, when they get a call from their patients are saying, "Well, probably -- look, it's like a bad cold. So come in, we'll give you a prescription as needed." Because they don't want to expose a lot more people to it. So we've not seen a big uptick as a result of this. Now there are some requirements by states and others to pay for testing, and that's normal course of business for us. However in this case, my concern is there aren't a lot of tests available, it's undersupplied. So I mean -- so I guess as we look at it, it’s business as usual at this point. We have, in our planning, a flu season sometimes, as I said, it's greater or lessened. If there were some pandemic or some very severe thing, we do have the opportunity to always go back to states and say, "We think it's appropriate to consider a rate adjustment because of the severity of something." So right now, it's business as usual. Does that answer your question, or do you need more technical information?

So just in terms -- we read somewhere, to your point, that if someone has a bad cold, they might not go to the doctors. So based on just kind of like past precedents that you've seen, going back -- some experts compared this to kind of like H1N1. Have you -- do you have any kind of like supporting data that says that people might actually go less to the doctor because they don't want to be infected while there? Or any data points that could just help us frame the potential impact from the doctor there?

I think the data we have is very anecdotal at this point, and the H1N1 was some time ago. And as best we can be -- [ medical is ] going back to look at our files and get some information. It was -- it did not have a significant impact on our cost structure. It may have had a basis point type increase in medical expense for a quarter or so. But we treat that kind of as a onetime effect. And so far, we're not seeing where this is anything more. I might add, and this is just my own supposition, whatever that might be worth. But I think there's -- it's been elevated to a level it concern because of how it broke out in China. [ With that said ], the difference of medical care there and here that it's been elevated to a level where people are so sensitized to it, that to be more cautious in many ways. And you heard some of the policies we put in place just to be safe. So that's not something we do during a normal flu season. So I'm hoping that some of those things that most industries are doing will just mitigate it. Ken, is there anything you want to add? Or Mary?

This is Ken Yamaguchi. I'm the Chief Medical Officer. And I would just reiterate Michael's thoughts there. While there is a lot of concern, I think there's also a lot of reassuring things we can say based on the facts today. As Michael stated, at least 80% of people who get the infection just have mild cases. So this is not anywhere close to a uniformly dangerous condition. And as far as China, a promising situation there is that the number of cases as well as the number of severe disease and -- there has slowed down considerably, and it appears to have peaked already. And considering that the first case was on December 31, this actually may represent a relatively rapid time line to peak transmission. And China isn't a very good comparison to the United States, but what might be a reasonable comparison is South Korea, which has the second-largest burden of COVID-19 in the world and has health system very similar to the United States. And in South Korea, the risk of significant disease is substantially less than China and really starts to approach a really bad flu season. So those things are somewhat promising. Our -- another issue is that one of the most important risk factors for severe disease is age. And in that context, if you look at our membership, 45% of our members are under the age of 19, and 94% of our members are below 70 years old, at which point, special risks occur. So hopefully, these -- we do have populations with related comorbidities, but the relative youth of our population may help them with the burden in our members.

And this is Mary Mason. The only other thing I would add is that communication is so key is that we have learned when -- from our experience with H1N1 and Zika. And local health departments are the ones who often are executing the guidance is coming from the CDC. So this is a great example how Centene's local approach really puts us at a very advantageous position when such issues like this occur.

Just one other point is that we are fortunate enough to say at this time that we do not have any members or employees that have a known infection with COVID-19.

You ask what time it is, we will just build a watch for you.

The next question will be from Kevin Fischbeck of Bank of America.

This is Adam actually on for Kevin Fischbeck. I appreciate you taking the time. If you could quantify potentially what the impact was from the HIF on 2020 now that MA is a bigger part of your business, how that incorporated into pricing and if it was in the guidance.

Yes. So the -- obviously, the impact of it is in the 2020 guidance. I would say there was some margin compression, if you look at the total Medicare business. But if you listened to our year-end conference call, you would have heard that, for 2020, we returned to 4 stars which primarily offset the health insurer fee impact. So it's in the numbers.

Okay. And then on the New York rate cuts, I believe they don't take effect until April 1. And so you're saying it's a $150 million headwind. Doesn't that imply that it's higher in the outyears? Is there something that could potentially offset it more in 2021 and beyond? Just trying to frame this.

No, there's 2 things. The draft rates were -- there's 2 things. There's a quality -- 50% of the New York rate change is associated with the elimination -- as I said in my prepared remarks, the elimination of the quality improvement program. And so that happens immediately as well as the rate adjustment was on 1/1 effective. The normal rate cycle is 4/1, you're correct. But these would be 1/1 effective.

Okay. Got it. And then maybe a last one. Just in 2019, you saw a lot of issues on Medicaid rates broadly from redeterminations. So just wondering if we can get an update on how that's played out so far in 2020, and if you expect any impact.

I think we've seen it dissipate and slow down considerably. And I think we found the states by and large responsive to the impact on the acuity of the membership that was left. It take -- they didn't pick it up as fast as we wanted to, but we did eventually get a catch-up. So we see any redetermination as more minimal, and we'll continue to work with the states.

Yes, yes. I just want to clarify one thing to add to what Michael said, is that there are still states where there's obviously a delay between the impact of the redeterminations and when we receive rate adjustments for. So there are still states where we are experiencing that timing delay. And we're still working with a handful of our states ultimately for premium adjustments as a result of the change in acuity.

The next question comes from Josh Raskin of Nephron Research.

Wanted to ask about sort of as we roll into 2021, I'm not asking for guidance, but just want to make sure the known differences at this point. The WellCare $0.09 will kind of be a headwind, I guess. The timing will be a headwind. But then I guess there's offsets from increased synergies, North Carolina becomes a tailwind, HIF obviously becomes a tailwind. Any other major ones that we're missing there in terms of 2021 known events at this point?

I think you've kind of summarized it in some ways, Josh. In fact, we didn't spend a lot of time talking about until December, but you've probably identified the most obvious ones.

Okay. And then just -- I appreciate you guys giving more color on first quarter of '20. And I think that's important this year, especially with -- I'm assuming a full impact of the New York cuts, which will annualize probably more $0.06 or $0.07 -- or I'm sorry, in the quarter, more $0.06 or $0.07. But thinking about that sort of $0.90-ish midpoint number that you're talking about, it seems a little bit lower than we were thinking about. So what are the other major factors there? Is there some MLR seasonality? Or is it just no synergies in the first quarter? I guess I'm just trying to figure out the year-over-year impact on 1Q.

Yes. Yes, there's a handful of things, Josh. So first, I'll start out with the transaction. So as you're aware, you pick up the shares the day the transaction closed. And the other thing that happens is the divestitures are immediate as well, so you feel the effect of the divested businesses. And synergy capture really happens later because you're executing on actions that really drive more of the value, I would say, in Q2 and beyond. The other thing is you're correct on if you're comparing to our previous stand-alone guidance, New York would be another item. And then also the PDP business is larger this year with the Aetna acquisition. And generally, the PDP business has its higher MLR in the first quarter.

Okay. So is it possible MLR in 1Q is actually up year-over-year? That's the way to think about it?

On a -- yes, on an aggregated basis, I mean, I would say -- yes, right. But I would say, yes, the biggest pieces are obviously the divestiture and the synergy timing, clearly.

The next question is from Mike Newshel of Evercore ISI.

I just wanted to go into the process and time line for the discussion with New York on rates now. And that -- like how is this related to the budget negotiations for fiscal 2021? I mean you mentioned the Medicaid redesign team, which I think is supposed to come up with $2.5 billion in savings. So I mean, are you just hopeful whatever they come up with will only affect providers rather than health plans, and they will be able to reverse the premium cuts? Or is there no risk of a further rate cut on top of the 1% [ in New York ]?

No, I think there's a couple things. One, they're community rated, and the rates have to be actuarially sound. And so there are -- the plans, they will probably impact even more than us from an actuarial soundness standpoint. And so then, we carried a lot of that water in terms of getting the rates right and where they need to be. Now we will be in discussions with the state. And historically, when we talk to states about this, we remind them that we're kind of the golden goose. We're the ones that saved them a lot of money. And they want to help us be successful. And we're not a charity. We have small margins. We have to deliver to attract the capital we need to keep growing the business and be successful. And sometimes, we need to draw on their margins, but it has to be actuarially sound. Now the other aspect is we'll discuss with them is the quality issue. We have the largest plan and we have the highest quality, so it's something really impact for us. And I suspect, when they stop to think about it, I would hope that they will realize. And I think the last thing we want to do is sort to disincent -- it wouldn't stop us from trying to be the highest quality, but you don't want to disincent or give people the image that you're not as concerned about quality. So we'll have those discussions with them. And I anticipate, from the prior experience when we've done the deals and acquisition, that these are people you can talk to and only consider the facts. And so stay tuned. Those discussions will start over the next few weeks. And we'll keep you informed.

Yes. So in terms of the time line, this should all be kind of like resolved in the talks to finalize the budget for the April fiscal year. So it should be -- we should [ follow ] in the coming weeks?

I think that's part of it. But one thing I've learned. My time line -- our time line and the states' don't often agree. We want it all yesterday, and we want it delivered. And the states can take their time and they can have a budget. And having an overall budget does not mean to have the detail behind it. So we're one of the details. So I want to be cautious to not create an expectation that we're going to resolve this short term.

Got it. And when are you getting -- in terms of the $50 million in mitigation you talked about, what are like the sources of that? And is there any further mitigation from maybe renegotiating rates of providers?

Yes, yes. I mean obviously, we're at the beginning here of the mitigation strategy. And I would say think of the normal medical management network, all those types of things that we normally do as what I'd say is in the $50 million. And we're not done, right? I mean we're continuing to work.

The next question will be from Sarah James of Piper Sandler.

Can you give us an idea where did New York -- where did that book sit in the spectrum of margins in your state portfolio before this change, and where does it sit after?

I'm not sure we get into that level of detail, Sarah, state by state. It varies quarter-to-quarter and month-to-month, and so I think that's a bridge we don't want to cross.

Okay. Can you help us think about the risk of the coronavirus in your Centurion book specifically? So is there a potential for higher spread in that type of environment? And I'm not sure what the age or acuity in that population is. But if there are any issues, do you guys have reinsurance? Or is that the type of contract where you can go back to the states and renegotiate if possible?

I think any of these contracts, we feel very comfortable going back. I mean when the hep C vaccine came out and things which were exceptional, we went back to the states. And hep C's hitting a higher incidence of it in that environment, and a lot of them. So we went back and successfully discussed it. And sometimes, we carve out some of that. It's hard to say at this point in time. [ This flu's ] -- we've not seen various incidents where it's greater in that population -- in the population at large. And so it's the type of thing I would expect it to be normalized, [ that hasn't been confined ]. But a lot of us are confined to our offices and other locations where flu spreads. So it's very similar, I think, as we think about it, Sarah.

And in a typical flu season, is that population -- do they have high uptake levels of flu vaccines? Because that's the one thing that I could think would be different between a normal flu season and this, is your rate of vaccination.

I think it's offered there like it was offered everywhere else. And I can't say specifically whether they take more or less. I can try to find out for you. But what we have found, when it comes to those kinds of situations, it's a fairly normalized population. It's only when you get into the hep C and some of the more acute areas that you see some differences.

The next question will be from Justin Lake with Wolfe Research.

A couple of questions here on the numbers. The first is, Jeff, you've kind of laid out, I think, the fact that the synergies, remind -- correct me if I'm wrong, but are around $500 million in year 2. But year 1, to your point before to Josh's question, has a pretty steep curve. Clearly, you're coming out of the box net negative because you've got the divestitures without any synergy and then the synergy starts ramping from negative to positive. Is there any way to help us understand that in year 1, just given how wide this swing is, in terms of kind of how you start out and where you kind of end up, year 1?

Yes, I'm going to start. And then, Jeff, pick it up for you. But just based on the work I'm doing in totality, Justin, I mean, in fact, the organizational changes. So there are areas where you need continuity, finance and HR and other areas. When you have continuity, so you're retaining the staff. And you may have told them, "Look, we're going to be coming back." But over the course of the year, that's just one example I'm trying to give you, where later in the year, when the finance department are all on the same systems and that's resolved, and we are paying people retention in terms of stay until release. It's those kinds of expenses upfront that starts to dissipate. And that's -- so if you think about it, you have this normal flow of attrition that was not normal, but you really planned for it. And you start to realize the benefits in the back half because you're working to keep people on board until you're ready to release them. Anything else you want to add?

Yes, no, I'd just go back to the comments, 52% of the earnings are in the back half of the year. I mean that would effectively reflect the synergy capture. So it's in our numbers when you look at the first half, second half.

Okay. And then secondly, Jeff, can you give us -- I think you laid out that the cash flow will be about 1.5 to 2x GAAP net income, the cash flow from operations. But I think you also said that there's not going to be a lot of free cash after spending needs. Can you give us a little more color on -- do you have a CapEx number? Can you talk about what you need to fund the business? And what are those other items? I'm just trying to understand kind of how the cash flow is going to -- the free cash flow of the business is going to look kind of coming out of 2020. What are the kind of adjustments we need to think about?

Yes. I mean I guess to your point, I would say, CapEx. And we've historically -- you've seen our historical CapEx number and WellCare's. And I would say it would be something inside the combination of the two as we work through the portfolio rationalization. We obviously have statutory capital that we're required to contribute for the organic growth in the business, which is pretty significant. And then as I mentioned in my comments, we're continuing to grow the business and invest in systems and capabilities and disciplined M&A. So those things are what I would say are on the table to continue to grow the top line.

The next question will be from Steve Valiquette of Barclays.

So just to circle back on some of the questions from the 4Q conference call that were deferred to today. First, just in relation to the timing of converting some of your outsourced PBM services into the AdvanceRx platform. And there does seem to be some changes on the timing and flow of the sort of legacy Centene operations. So I guess, curious, can you confirm whether the full Medicaid book has now been converted? And then which books will be next to convert? And then were there any notable changes on timing? And then I'll have a follow-up on the -- from the WellCare side.

Yes. I think the timing -- the schedule has been adjusted, technically. The focus has had to be the integration of the 2 businesses, and we have Drew working on the pharmacy side of things. So we did recognizing the impact of the totality of it. We said, "It's not how fast, it's how well." So we did slow that down. And work still being done to ensure that they're developing what's necessary to continue the program. But we did slow that down because the focus of everybody's energy had to go against -- more importantly, go against the integration of these 2 businesses, which, as Jeff said and I've said, is going incredibly well. So there's no question that that's where it's that. And the synergies. And getting behind those synergies is so important to us that we don't want anything distractive. So we did slow the RxAdvance down a little bit. But there are some new markets that will be added, and we were still planning to expand it as appropriate.

Okay. That's helpful. And then just with the renewal of WellCare's PBM contract with the third party for another 3 years. I guess, I'm curious how you balance the 3-year duration of that new contract with any flexibility that the new merged company, Centene-WellCare, may have still wanted to be able to roll some of that legacy WellCare business onto the AdvanceRx platform within the next 3 years. Seems like it had to be set up for 3 years, maybe it was longer than what some people would have been thinking about. Just curious on that...

Any contract will always be renegotiated. I don't get hung up on that. But I want to emphasize something that's very important, that we work with [ people ] and independents are important to us, too. We're putting in place some programs to work with independent pharmacies in a very significant way. But we have 3 basic larger groups. We have Walgreens, and there's a lot of strength in the intercity. And then it's what you have -- CVS, that's more in the suburbs. And you have Walmart that's more in the rural market. So all 3 are important. And so we're working incredibly hard -- not working hard at, but we're working to ensure that we maintain the balance across the 3 of them. And in some cases, the terms of the contract, there are caveats in there. They have to deliver certain things to continue. So those contracts, any contract can be adjusted as necessary by mutual agreement. So don't read anything more into that than there is. It's just trying to protect the continuity of certain businesses across all 3 networks and the independents while we get everything lined up. It goes back to not how fast, but how well. And so we're being very methodical as we go at it.

The next question comes from Gary Taylor of JPMorgan.

I just wanted to point out, I think, with respect to Josh's question about the first quarter. The leap year is probably also an obvious factor that impacts the year-over-year. Just worth referencing, probably. My real question is just going to WellCare, who obviously exceeded their original projections by about 11%. And I presume that since that's worth maybe $0.12 or so of outperformance to the combined company, and that falls within a $0.20 range of guidance, the WellCare's outperformance in 2019 sort of falls into that range. But if so, since they weren't holding public calls, maybe could we just talk a little bit about what was driving the WellCare outperformance? Does any of that look to be nonrecurring? And...

Gary, let me help. One, as I said in my prepared remarks, going forward, we talk only the total enterprise. I will tell -- I will repeat some of that comments I made earlier in the year when I was talking about the performance of WellCare. If I was selling a company, I would ensure that my performance met or beat expectations. Because, obviously, how well they do in that period of time will impact the purchase of stock, particularly where the stock and as a component. And so you want to ensure that their stock stays up because presumably, you're getting a fixed ratio of that stock. So we would do certain things. I'm also not surprised, if I were doing it, that in the fourth quarter, we wouldn't see it come down and adjust accordingly. So I don't think there's a good comparison. And so that's why going forward, we take the approach, and have done it, whether it be Health Net or it's Fidelis any of them, even small ones. From the point in time that the transaction closes, we just look at what's the consolidated business and what are we going to do going forward. And that's really the only way I can look at it.

Okay. Fair enough. Any comment on WellCare's PDP enrollment? I guess it's now your consolidated PDP enrollment. But it looks like retention was potentially better there. Just how much of that retention versus really new membership growth? And does that have any material impact on a financial outlook?

I'm going to turn it over to Jeff, but I really compliment you because you said, "your PDP", because you recognize [ as we go through it ] that is now ours, okay?

Yes, very strong enrollment. And I think I mentioned this on the February call, 4.4 million members in the PDP business, which is good.

The next question will be from Dave Windley with Jefferies.

Gary took a stab at one of the questions I was going to try to ask. The other one I wanted to ask was around MLR. With this New York rate cut that would seem to put downward pressure on MLR, it came in -- your guidance is a little lower than consensus. Was expecting SG&A the other way. Wondering if there's any kind of P&L geography as you fold WellCare Group in. Did they classify expenses differently? Or if not, what are some of the bridging factors that brings MLR down year-over-year and versus consensus?

[ Really a trajectory part to it ]. But we're not comparing [ in the indirect ] at this point. Go ahead, Jeff.

Yes. Yes, just real quick. I mean there's -- effectively, it's just the combination of the 2 companies. The other thing I would highlight is that -- we've mentioned this in the past that probably a little more than 50% of the synergies are in the medical cost line. So as you look at that, that would be one thing. But I mean, I'm not really trying to compare to a consensus HBR number, right? We've given a guidance range. This is the combination of the 2 companies. And if I were to say, adding the 2 companies together, what would be reducing the MLR? It would be the synergies.

The next question will be from A.J. Rice with Crédit Suisse.

First, I've got 2 questions. First one, on the New York rate adjustments, I think, you said about half of it were ties to the bonus payments. I'm just trying to understand, as you make your argument for actuarial soundness, I understand that, that applies to the direct rate adjustment. Does it also apply to the bonus payments? Or were the bonus payment something that went beyond just getting an actuarially sound rate?

A.J., that's something separate. But I have no trouble arguing the value and the perception of bonus payments for high quality. And I think when one has -- they put that program in for a reason. And so we're not the only one that will receive it. And we will -- I've always said, highest quality is lowest cost. So I mean, we're really committed to quality. But I think also, what we do to put the energy and what we do to deliver the quality, we are entitled to those bonuses. And so I think we have a very good argument, outside of actuarial soundness, to make with the state on it, from the current perception standpoint.

Okay. And then my other question was when you look at the updated guidance you're offering today, I'm assuming there isn't any adjustment on these items relative to which you offered in the December Investor Day. But I just want to double check that your assumptions about public exchange margins, the North Carolina Medicaid start date and the PBM contract extension or renegotiation. There's been no change in the way you're thinking about 2020 related to any of those items?

Yes, yes, that's correct. So the only thing would be the New York rates, which we've highlighted.

The next question is from George Hill with Deutsche Bank.

Just -- maybe just a follow-up on the PBM. Given that you've kind of locked in the contract on both the core business, and -- Michael, I'll make you happy, the combined business now for the next couple of years. What you are doing -- or what the plans are to kind of achieve synergies and drive synergies? Or do they all come out of the contracting which has just been renegotiated? I guess, I'm trying to figure out what are the savings that come from the current contracting versus what's incremental that you can do going forward.

So I think it's a matter of a combination of factors. So there's some contracting, but there's also now a much bigger business at the geographic dispersion of, with the different approaches used, all come into play. So it's kind of a totality and it's hard to pinpoint one thing or the other. So if we look at it, it's a totality of $105 billion business with a $30 billion drug spend, rural, intercity, urban. I mean so it's just a combination of all those things. And we look at it in the totality of it. And work with all 3. All 3 are very important, and -- but we're going to be very balanced in what they all receive as well as the independents. So I mean, we want a very balanced network working equally with all of them.

And this concludes our question-and-answer session. I would now like to turn the conference back over to Michael Neidorff for any closing remarks.

Well, I want to thank everybody for joining us. I think that we will keep you informed. We're going to work hard with the State of New York. But -- in experience, why we did this, and that has been our standard practice, to be conservative, really not to overpromise, and hopefully underpromise and hopefully overdeliver. But we appreciate your interest, and I think we're looking forward to 2020. There's lot of momentum going into it, and we expect to capitalize on it. So thank you, and we look forward to talking to you in April. Take care.

Thank you. The conference has now concluded. Thank you all for attending today's presentation. You may now disconnect your lines. Have a great day.