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Molina Healthcare, Inc. (NYSE:MOH)

Q3 2008 Earnings Call Transcript

October 22, 2008 5:00 pm ET

Executives

Juan José Orellana – VP, IR

Mario Molina – President and CEO

John Molina – CFO

Joseph White – Chief Accounting Officer

Terry Bayer – COO

James Howatt – Chief Medical Officer

Analysts

Joshua Raskin – Barclays Capital

Greg Nersessian – Credit Suisse

Shelley Gnall – Goldman Sachs

Tom Carroll – Stifel Nicolaus

John Rex – J.P. Morgan

Brian Wright – Banc of America Securities

Carl Mcdonald – Oppenheimer

Andrew Morey – Cowen Asset Management

Scott Fidel – Deutsche Bank

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Molina Healthcare third quarter conference call. During the presentation, all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. (Operator instructions) I would now like to turn the conference over to Juan Jose Orellana, Vice President of Investor Relations. Please go ahead, sir.

Juan José Orellana

Thank you, Kim. Hello, everyone, and thank you for joining us. The purpose of this call is to discuss Molina Healthcare's financial results for the third quarter ended September 30, 2008. The company's earnings release reporting its results was issued today after the market closed and is now posted for viewing on our company website.

On the call with me today are several members of our executive team; Dr. Mario Molina, our CEO; John Molina, our CFO; Terry Bayer, our COO; Dr. James Howatt, our Chief Medical Officer; and Joseph White, our Chief Accounting Officer. After the completion of our prepared remarks, we will open the call and take your questions.

I also would like to remind you that our comments today contain numerous forward-looking statements under the Safe Harbor provisions of the Private Securities Litigation Reform Act. All of our forward-looking statements are based on the current expectations and assumptions that are subject to numerous risks, uncertainties and other factors that could cause our actual results to differ materially.

A description of such risk factors can be found in our earnings release, our 10-K annual report and our 10-Q quarterly reports filed with the Securities and Exchange Commission. These reports can be accessed under the Investor Relations tab of our company website or on the SEC's website. All forward-looking statements made during today's call represent our judgment as of October 22, 2008, and we disclaim any obligation to update such statements.

This call is being recorded and a 30-day replay of the conference call will be available over the Internet through the company's website at www.molinahealthcare.com. I would now like to turn the call over to Dr. Mario Molina.

Mario Molina

Thank you, Juan Jose, and hello, everyone. Like all of you, we have been closely monitoring the capital markets and the extraordinary pace of change during the past few weeks. Despite these headwinds, we are pleased to report solid financial results for the quarter as well as continued opportunities in both our business and our industry.

Earnings for the third quarter were $0.62 per diluted share. And as John will cover in greater detail, these results continue to reflect strong revenue growth, continued enrollment gains, and a constant focus on administrative efficiency. I want to point out to everyone that today we are confirming 2008 guidance with a midpoint of $2.30 per share. That means that after a year dominated by bad news in our industry that included declining investment income, state budget shortfalls, a bad flu season, a crisis in the credit markets, and the impairment of investment securities previously thought to be safe, we expect the year to end for our company much as we thought it would before most of these events occurred.

Our success speaks both to the resiliency of our Medicaid managed care business model and to the unique strengths of our company. We have 28 years of experience in this business. And we know that a weakening economy brings opportunities as well as challenges. So long as we stay focused on operations, administrative cost control, and conservative cash management, we will continue to serve the increasing Medicaid population that generally accompanies a weakening economy. We stand ready to assist our state and federal partners in providing high quality, accessible healthcare services to those most deeply affected by the current economic downturn.

Once again, John and I will use the framework of our strategic plan to discuss our financial and operating results. The five years of focus under our strategy plan are growth, financial strength, customer service, compliance, and quality. Our revenues continue to grow with premium revenue up 26% compared to the same quarter last year. Our growth is a combination of the addition of the Missouri health plan, strong growth in the newer markets like Ohio and Medicare, and continued organic growth in our more established markets.

We continue to make progress on our diversification strategy. Revenues from California, Michigan, and Washington make up a smaller percentage of our overall revenue today than they did in the third quarter of 2007. This metric is noteworthy because we still achieve organic membership growth in California and Washington. At the same time, our co-administrative cost as a percentage of revenue have decreased sequentially from the second quarter of 2008 and year-over-year comparing to the third quarter of 2007 to 2008, indicating that we are becoming more efficient in the administration of our health plans.

In the area of customer service, we continue to make gains. For example, we endeavor to pay our providers quickly. Evidence of our success can be found in the medical claims and benefits payable section of our earnings release. Claims in inventory per member fell by 35% from 0.17 for the first nine months of 2007 to 0.11 for the first nine months of 2008. Fewer unpaid claims and inventory gives us a better handle on our true medical costs, decreases our IBNR, and means that we are less reliant on estimate to determine our medical costs.

Compliance and quality often go hand-in-hand. Faster payment of claims reduces the risk of paying fines or interest payments on unpaid claims. The Centers for Medicare and Medicaid Services, CMS, contracted with NCQA to evaluate Medicare Advantage Special Needs Plans. As a reminder, Molina Healthcare operates Special Needs Plans for patients simultaneously eligible for Medicare and Medicaid in California, Washington, Nevada, Utah, Michigan, and Texas.

Survey standards include complex cure management, improving member satisfaction, and clinical quality improvements. All eligible Molina Medicare plans scored 100% for all standards in the survey. Congratulations to our Medicare team, our state health plans, and the Corporate Quality Improvement team on this accomplishment.

Next, I would like to cover a couple of issues from previous quarters that remain topical today. The medical costs in the Ohio market have been a focus for sometime. We initially projected that certain initiatives would bring down the medical care ratio in Ohio to about 88% in 2008. Those initiatives have taken longer to develop than anticipated. However, new provider contracts implemented in September should help bring down new costs. Also we now have better control over behavioral health after transitioning responsibility from an outside vendor to our Ohio health plan staff on September 1.

Finally, a revision in risk adjustment factors for elderly and disabled patients in Ohio went into effect on September 1 and will affect revenue by providing an additional $500,000 per month. These three items should mitigate medical costs in the fourth quarter for our Ohio health plan.

Finally, political and economic events relating to the California budget continue to evolve. Governor Schwarzenegger signed the California state budget on September 24. However, the state fiscal situation remains uncertain. The governor and legislative leaders are monitoring the state’s fiscal situation and may be revisiting this issue in the coming weeks. A special legislative session may be necessary.

With the passage of the budget, the state has resumed payments to government contractors. Our California subsidiary has now received its premium payments. These payments, however, were not received until October and therefore negatively affected our cash flow figures for the third quarter.

I would now like to turn the call over to John so that he can discuss with you our financial performance in the third quarter as well as other elements of our strategic plan.

John Molina

Thank you, Mario. And hello, everyone. Results for the third quarter of 2008 were $0.62 per diluted share, which matched our third quarter 2007 performance despite a $3 million year-over-year decrease in investment income. Year-to-date earnings per share are $1.67, a 17% improvement over 2007 results. With all the concerns in our industry about investment income, state budget shortfalls, last spring’s flu season, credit market issues, and the impairment of investment securities, today’s results demonstrate they are strength and resilience of our company.

I think it’s worth emphasizing what Mario just said. Not only have we achieved solid financial performance, but we’ve also capitalized on some challenges just mentioned. We’ve grown enrollment, renegotiated key provider contracts, controlled our administrative expenses, and prudently managed our cash to achieve positive results in an uncertain environment.

In the past, we have discussed non-GAAP measures that are also very helpful in evaluating our financial performance. For example, while net income grew by 17% year-over-year, EBITDA grew by 25% during the same period. You will find an expanded discussion on EBITDA in today’s earnings release. We believe that EBITDA is a useful supplemental measure to investors because it is consistent with how we evaluate our financial performance as it provides greater clarity on the basic operations of our business. EBITDA is frequently used by securities analysts and others to evaluate companies in our industry.

One of the key areas of focus in our strategic plan is growth, which also leads to diversification in revenue and enrollment. The 26% growth in our premium revenues over third quarter of 2007 is primarily the result of our diversification efforts. Our Michigan acquisition contributed about one-third of our growth in revenue, while Ohio and Medicare health plans contributed another third. The remaining third of our revenue growth came from our more established health plans where enrollment grew 5% from the third quarter of 2007. This balanced growth from acquisitions, from new markets and populations, and from core operations is exactly what we mean by diversification.

Our improved diversification is also helping to steady our premium rates. We’ve talked a lot about rate challenges in Ohio and California this year. This quarter we can talk about the rate relief we received in Missouri and Michigan. Effective July 1, 2008, our Missouri health plan received a premium increase of approximately 8.5%. Effective October 1, 2008, our Michigan health plan received a rate increase of approximately 5.5%. Some of these increases are tied to benefit and program changes, and some we passed on to our providers.

In addition, there is another increase of slightly less than 1% to remedy the double taxation we have experienced under the Michigan Business Tax. While we have received draft rates for Ohio effective January 1, 2009, we have not received official notification of any rate changes. The same applies for California.

We also recorded $3.7 million in supplemental revenue at our Michigan health plan during the third quarter. The supplemental revenue is intended to offset the unintended effects of the Michigan Business Tax that replace Michigan’s Single Business Tax effective January 1, 2008. The unintended effect of the Michigan Business Tax is the taxation of both premiums and net income of health plans, driving the effective federal and state combined tax rate on the company’s Michigan health plan to nearly 49%.

The supplemental revenue is intended to offset Michigan business taxation of gross receipts for the nine months ended September 30, 2008. After allowing for the supplemental revenue and the aforementioned ongoing Michigan Business Tax relief, we anticipate that our 2008 Michigan tax expense will be approximately $500,000 higher before federal tax benefit than the amount computed using the Single Business Tax methodology.

I say all of this to emphasize that we have not sought special treatment under the Michigan tax code. We have only asked to have the double taxation of both revenue and net income mitigated. As I mentioned a minute ago, effective October 1, 2008, the Michigan health plan received an estimated blended rate increase of approximately 1% for ongoing Michigan business tax relief.

Medicare revenues continue to grow. Sequentially revenue grew by over 20% or $5 million from the second quarter of 2008. Due to higher enrollment, higher premium rates, and the recognition of approximately $2.6 million in risk adjustment revenue. Consistent with our strategic plan, we continue to enhance our revenue diversification efforts.

Earlier this month, Molina Healthcare of Florida was awarded a Medicaid contract by the Florida Agency for Health Care Administration. This was a key accomplishment for our organization and it marks a point where our health plan startup efforts and our acquisition strategy intersect. Our new Medicaid contract combined with our acquisition of Florida NetPASS will provide us with a necessary platform for transitioning the membership to a full risk contract.

We anticipate that our Florida health plans enrollment of the NetPASS membership will begin in December 2008 with a full transition to be completed in the first quarter of 2009. Florida NetPASS currently provides services to approximately 55,000 Florida MediPass members in South and Central Florida. It’s also important to note that in the third quarter of 2008 we incurred approximately $800,000 in startup costs related to Florida without any associated revenues in that state.

Our consolidated membership grew by nearly 16% year-over-year including the Missouri health plan. Sequentially our membership grew by approximately 5,000 members. Organic enrollment growth during 2008 is running at approximately 8%, nearly double the historic figure of 3% to 4%. It is important to remember that the current economic environment offers us opportunities as well as challenges. State budget pressures make cost-effective solutions like Medicaid managed care more attractive, while increasing unemployment will result in increased eligibility for Medicaid. This transition, however, is not automatic, as assets must be depleted before families become eligible for means- tested benefits.

Our medical care ratio increased to 84.6% in the third quarter of 2008 from 83.7% in the third quarter of 2007. Sequentially the medical care ratio increased by 40 basis points from 84.2% for the quarter ended June 30, 2008. High medical care ratio in California, New Mexico, and Ohio outweighed the improvement in medical care ratios in Michigan, Missouri, and Washington. California’s medical care ratio increase is partially due to premium rate decreases in the first half of the quarter, which were stated by a court injunction on August 18, as well as higher medical costs.

The main causes of New Mexico’s higher medical care ratio are a decline in premium rates and accruals for some significant provider settlements. We continue to work through the obstacles in Ohio, where the overall medical care ratio has yet to come down. But recent operational improvements give us reason to remain optimistic. For example, we in-sourced our behavioral health services and we also renegotiated key provider contracts. We expect both of these efforts to begin bear fruit in the fourth quarter of this year. Additionally, we received new risk-adjusted ABD rates effective September 1, 2008 that we estimate will increase annual revenue in Ohio by approximately $6 million.

Control over our G&A expense is another reason why we have weathered the challenge in the past year so well. G&A expenses in the third quarter were 11.1% of total revenue or $88 million as compared to 11.7% of total revenue for the third quarter of 2007 or $74 million. Core G&A expenses, defined as G&A expenses less premium taxes, were 8% of total revenue for the third quarter of 2008 as compared to 8.4% for the third quarter of 2007.

We’ve recorded an effective tax rate of 39.6% for the third quarter of 2008, bringing our year-to-date effective tax rate to 40.4%. Again, the effective tax rate is higher than our historical rate due to the change in the Michigan state tax calculation that went into effect back in January of this year.

Cash used in operating activities for the nine months ended September 30, 2008 was $20 million compared with cash provided by operating activities of $113 million for the same period in 2007, a decrease of $133 million. Significant contributors to this decrease included the following. First was a $41 million increase in our California health plan receivable as of September 30, 2008 related to our July and August payments. Prior to the signing of the budget on September 24, 2008, the State of California had ceased paying its vendors for the previous two months. Subsequently, all receivables due to our California health plan at September 30, 2008 were collected in October 2008.

Second, the timing of the receipt of premiums recorded as deferred revenue in the Ohio and Utah health plans netted to a total decline of $45 million year-over-year. Assuming that the timing of these payments next year is consistent with this year, we do not expect deferred revenues to have an adverse impact on cash flow in 2009.

And third, the acceleration of claims payments across all of our subsidiaries, combined with the maturation of claims payment practices in Texas and Ohio, reduced medical claims and benefits payable, thereby lowering cash flow by $32 million when compared to the first nine months of 2007.

As we discussed in the past, Molina is striving for operational excellence in the provider payment process. Our primary objective is to pay our providers promptly. And our claim statistics continue to demonstrate that we're doing so as claims inventories continue to decline. Specifically, the number of claims in inventory has declined by 27% year-over-year, while bill charges in inventory have decreased 37% year-over-year.

This improvement in our claims processing is even more impressive when we consider that claims receipts have increased 18% year-over-year and bill charges in claims received have increased 29% year-over-year. I want to reiterate what Mario said. Fewer unpaid claims in inventory gives us a better handle on our true medical costs, decreases our IBNR. That means that we are less reliant on estimates to determine our medical costs.

Share used for computing diluted earnings per share for the third quarter of 2008 were 27.6 million versus 28.4 million in the third quarter of 2007. The company had cash and investments at the parent level of approximately $83 million at September 30, 2008, including the auction rate securities with a fair value of $19 million. We do not have equity exposure in Fannie Mae, Freddie Mac, Lehman Brothers, or AIG. While we do own Fannie Mae and Freddie Mac debt, those instruments are now backed by the US treasury. We therefore do not anticipate any write-downs related to these investments.

Although we remain focused on operating results, we continue to explore ways to protect and maximize our investments. We have pursued safer investments, which have limited our short-term exposure, but are more sensitive to interest rate changes. We have managed our cash position to buy back shares, which we believe is an excellent use of cash in this environment, as we believe our shares are good long-term investment.

During the third quarter of 2008, we repurchased about 91,000 shares of our common stock for approximately $2.7 million at an average cost of $29.97 per share. Through October 22, 2008, we have repurchased approximately 1.7 million shares at an aggregate purchase price of $45 million. We are confirming our guidance previously issued on July 23, 2008. For the purpose of EPS calculation, we would expect diluted shares outstanding to be approximately 27.1 million for the quarter ended December 31, 2008 and 27.9 million for the year ended December 31, 2008. We expect our effective tax rate for the fourth quarter and year ended 2008 to be approximately 41%.

Finally, as Mario mentioned, difficult times lead to state cost pressure and a greater number of families accessing government programs such as Medicaid and SCHIP. Over our 28-year history, we have developed, refined and established a business model for serving those who are most in need and the agencies we contract with regardless of the economic environment. We offer access and a documented quality product and a lower administrative cost, positioning our company as a logical partner for states looking for cost-effective solutions. We are the right solution at the right time.

Thus we entered the fourth quarter with a renewed sense of optimism, as our business and our operations remain strong, our enrollment continues to grow, and our state partners are providing rate relief. All of this, despite the backdrop of a very difficult economic environment.

Operator, this concludes our prepared remarks. We are now ready to take questions. Operator, are there questions?

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Joshua Raskin of Barclays Capital. Please go ahead.

Joshua Raskin – Barclays Capital

Hi, thanks. Good evening. First question, just on the membership growth in the economy, it sounded like you guys alluding to the 28 years of history in the business. I’m curious if you look back, maybe the most recent, the early 2000 period, or even early ‘90s, and I guess you could look back to the ‘80s as well, what are your certain expectations for membership growth? What would you think sort of in an ’09 period in terms of organic membership?

Mario Molina

Well, we’re not making projections today about 2009, but we do know that there are some metrics you can apply to correlate between unemployment and growth in the Medicaid population. We do anticipate it to grow. And as John mentioned, there is going to be a delay because people have to spend down their assets before they qualify for Medicaid. But I think we can confidently say that the pool of Medicaid beneficiaries should grow in 2009.

Joshua Raskin – Barclays Capital

Okay. But I guess not necessary for ’09 guidance, Mario, but maybe even looking back historically, maybe what are some of the data points that you saw? What was sort of growth rates you would expect, or at least –?

John Molina

Yes. Josh, I think Kaiser Family Foundation put out some numbers recently, and they suggest that for every 1% increase in unemployment, you get about another 1 million people eligible for Medicaid and SCHIP.

Mario Molina

And just to be clear, at the end of John’s comments, when he used the word thus, I want everyone to know that John regularly uses the word thus in conversation.

Joshua Raskin – Barclays Capital

Yes, I’ve got it in my notes several times. Second question, just around the risk-adjusted revenues in Medicare, I know it’s still a very small part of the book. It was about $2.6 million. Were those final settlements related to ’07, or what would be – I don’t know if Joe is around, but what exactly was the accounting for that one?

Joseph White

Hi, Josh. Yes, it’s Joe. Those are related to 2007 and 2008, risk-adjusters and a part fee settlement.

Joshua Raskin – Barclays Capital

Okay. So that’s just you are catching up – so some of that I guess would theoretically be related to (inaudible) as well.

Joseph White

That’s correct. And going forward, as we grow, it’s going to be a bigger part of our business. We see that every year.

Joshua Raskin – Barclays Capital

Okay. And then I guess the confirmation of earnings, we can sort of take that for face value, but it sort of implies a very wide range for the fourth quarter. And I was wondering is that just sort of really just a factor of we are confirming guidance for the full year or is there really a lot of uncertainty that could create – how would you get from the high end to the low end for the fourth quarter guidance?

Mario Molina

Josh, there’s really two components. Number one, we don’t give quarterly guidance. And number two, we are confirming the annual guidance that we gave in July.

Joshua Raskin – Barclays Capital

Well, I guess you could have narrowed your annual guidance in an effort?

Mario Molina

Yes, we could have, but that would in effect when giving quarterly guidance since there is only one quarter left, Josh. So, in keeping with our policy to only issue annual guidance, we’re simply going to confirm our annual guidance. We think we are on track to hit those numbers.

Joshua Raskin – Barclays Capital

Okay, understood.

Operator

Thank you. Our next question comes from Greg Nersessian of Credit Suisse. Please go ahead.

Greg Nersessian – Credit Suisse

Hey, thanks. And I’ll be the first one to wish John a happy birthday. Appreciate your spending it with us this evening. First question, could you just clarify the California rate? I guess you said you got the 3% cut through that injunction date and then you went back to the historical rate. So if the cut goes into effect, then can we assume you’d back to a 3% cut and that would apply retroactively? I wasn't sure exactly about the moving pieces there.

Mario Molina

Well, what we have done is taken a decrease in revenue for that period, I believe it was July 1 to August 18, and then gone back to the pre-injunction rates for the revenue. We were all back to provider decreases. And in fact, some of the provider decreases like the capitation, I don't think ever occurred. The injunction is still in effect. And the state is appealing it. So we’ll just have to wait and see what the outcome is. But for right now, we are operating with the pre-injunction revenue and pre-injunction provider contracts.

Joseph White

Yes. Greg, it’s Joe. If I could just add to that, if you want to look at it in shortcut, remember we talked about roughly a 6% decrease. For this quarter, we implemented that for half the quarter and worked out about a 3% decrease. So that is taking a lot shortcuts, but I think you can see how it works out.

Greg Nersessian – Credit Suisse

Okay. So, that 3% that you are alluding to, that’s sort of the net effect of the revenue and the offsetting change in the provider fee schedule?

Joseph White

No, that’s purely revenue impact to us.

Greg Nersessian – Credit Suisse

Okay. And then on the decline in the DCP in the quarter, I think you alluded to both the – obviously the inventory being down significantly, but also you mentioned the IBNR also down. Could you sort of break out that drop in DCP between the IBNR and the inventory?

Joseph White

I think they are interrelated. So it’s not really – we’re not really able to separate the two into two distinct things, Greg. They sort of – the decrease in claims does feed into the decrease in the IBNR because we are getting claims faster than getting them paid faster. So the component of IBNR, which is really incurred by not paid in-house, received but not paid goes down.

Greg Nersessian – Credit Suisse

Okay. And then – okay. And then just on that Michigan tax payment, is it fair to say that $3.7 million, that applied to the nine-month period, so just break that out evenly if you were to sort of recap each of the quarters to appropriately reflect that change?

Joseph White

That would work.

Greg Nersessian – Credit Suisse

Okay. Okay, thank you.

Operator

Thank you. Our next question comes from Daryn Miller of Goldman Sachs.

Shelley Gnall – Goldman Sachs

Hi, thanks. This is Shelley Gnall in for Daryn Miller. My first question, in California, can you provide us some details on the progress of your recontracting, and also comment on what would happen if the 10% provider cut is permanently blocked? What would happen to those recontracted rate?

Mario Molina

Well, as – go ahead, Terry?

Terry Bayer

Yes. This is Terry Bayer. Based on the injunction, we are not taking a fee-for-service reduction of 10%, and we have rolled back the contracts we negotiated and we stored those to pre-cut rate. So those are off the table at this time.

Shelley Gnall – Goldman Sachs

Okay, great. And then moving on to Ohio, do you have a sense of how the Ohio MCR would have looked if your central region recontracting was affected for this quarter?

Mario Molina

I’m sorry, could you ask the question again? I didn’t quite understand.

Shelley Gnall – Goldman Sachs

Sorry, this is a question that is coming from Daryn. Hopefully I'm asking it correctly. He is wondering, do you have a sense of how the Ohio MCR would have looked if your central region recontracting was affected for this quarter?

Joseph White

I think it’s – this is Joe speaking. I think it’s fair to say it would have looked better, but we don’t have that calculation at hand, no.

Shelley Gnall – Goldman Sachs

Okay. And then maybe moving on to the medical cost side, are there interesting trends emerging on the hospital inpatient or outpatient utilization side?

Joseph White

That’s such a broad question.

Mario Molina

Do you mean in Ohio? Do you mean across the country?

Shelley Gnall – Goldman Sachs

I mean, I guess if there is regional variances, I mean I think what we’ve heard from some of the commercial managed care providers is that there has been sort of weak inpatient utilization whereas outpatient I think has been a little bit higher. I’m just wondering if you are seeing any trends emerging.

James Howatt

This is Dr. Howatt. We’ve not seen any unique identifying trends.

Shelley Gnall – Goldman Sachs

Okay, I appreciate it. That’s it for our questions.

Mario Molina

Thank you.

Operator

Thank you. Our next question comes from Tom Carroll of Stifel Nicolaus.

Tom Carroll – Stifel Nicolaus

Hi, good evening. Just couple of clarifications, Ohio and Michigan. Is there any reason to assume that the draft Ohio rates will differ materially from actual? And then secondly, on Michigan, is the rate increase there that you talked about and alluded to in the press release, is that basically all going to be passed through to providers? And I’ll stop there.

John Molina

Okay. Let me talk about Ohio. We don’t want to make assumptions on the rates, which is why we didn’t say anything other than – we’ve got draft rates but nothing official, Tom. So I don’t want to speculate.

Mario Molina

We don’t generally quote things like that until the ink is dry on the contract. So that’s why we are holding off.

John Molina

And as far as Michigan, the rate increase was not tied to any specific provider rate increase. So it’s not a complete pass-through. But I’m sure that some of it to the extent that the provider rates do go up, we passed on.

Tom Carroll – Stifel Nicolaus

So what do you think the net impact will be at Michigan? Is that up?

John Molina

We would think it will be a positive.

Mario Molina

Yes, there will be some net positive effect.

Tom Carroll – Stifel Nicolaus

Okay, thank you.

Operator

Thank you. Our next question comes from John Rex of J.P. Morgan.

John Rex – J.P. Morgan

Thanks. I want to just focus on Washington for a moment here. I suppose that rate process is ongoing right now. Could you just give us a little color, remind us of the timeline here, I think it’s a Jan. 1 renewal? And then maybe a little bit about the environment right now so we can get some expectations for them?

John Molina

Washington is a Jan.1 rate year. I think we’ve got the draft rates in and are commenting on them, John. At this point, I don’t have a specific number for Washington.

John Rex – J.P. Morgan

I mean, I guess should we have an expectation – margins aren’t fairly decent and not planned. Just given the broader environment, would one have an expectation that could possibly be a down rate?

John Molina

I don’t think we have any expectation until we see all the information from the state. And I just don’t think we want to speculate on what it looks like.

John Rex – J.P. Morgan

Any color just in terms of what you are seeing in the – so moving away from that specific Medicaid, but just what you are seeing more globally in the budgeting process in Washington state right now and the challenges they are having?

Mario Molina

Well, I think the State of Washington like most states is going to face some budget challenges. And they will probably address those after the first of the year.

John Rex – J.P. Morgan

All right. Okay. By that you're implying not potentially part of this rate cycle for you?

Mario Molina

I don’t think so, but you never know.

John Rex – J.P. Morgan

Okay, okay, that’s fine. I just want to be clear on California and the expectation here. So, should we expect then kind of when you think about the post injunction rate that you are recording, should we expect then as long as the injunction holds? Should that PMPM go back up again then in the 4Q?

Joseph White

It’s Joe. That’s a fair statement. It should be consistent – as long as the injunction holds, it should be consistent with what we saw the first half of the year.

John Rex – J.P. Morgan

Okay.

John Molina

Yes. No, let me add something though. I mean, first of all, that injunction is a big if. We don’t know which way it’s going to go. But second, October 1 is our normal rate cycle for California. And so we need to see in addition to what happened with the July 1 rate issues, what’s going to happen for October 1, how is that going to roll out. And our San Diego contract is a negotiated rate and we are still working on that. So that’s retro to July 1. So capital [ph] rates going to a little bit murky for a little while still.

John Rex – J.P. Morgan

Okay. And then back to the question that Josh had in the beginning of the call. So, what would be kind of – give us maybe then kind of the reasoning around the $0.20 band on the 4Q in terms of kind of what are the negative scenarios and the positive scenarios that create that kind of fluctuation in your outlook for the fourth quarter, just so we can kind of be thinking why we would have that kind of band.

Mario Molina

Well, I don’t want you to take away from this that we’re saying that’s a $0.20 band on the fourth quarter. What we’re really saying I think is that we are tracking in line for the first nine months of the year. And so we see no reason to change guidance.

John Rex – J.P. Morgan

Okay. But there is no specific things you’d point to that say, hey, this is why it would be $0.72 and this is why it would be $0.52?

Mario Molina

No, we are not seeing any material changes. I think it’s – things are stable, tracking in line. We are running towards the midpoint of guidance, and we think that’s where we are going to end up at the end of the year.

John Rex – J.P. Morgan

Okay, great. Perfect. Thanks.

Operator

Thank you. Our next question comes from the line of Brian Wright of Banc of America Securities.

Brian Wright – Banc of America Securities

Thanks. Is it possible that you are seeing a positive member mix issue as far as your average kind of claims per member kind of size, with kind of the changing demographics in the Medicaid population, given the increase in the unemployment rate? Do you think that there is something going on with that?

Mario Molina

That’s a really good question. And I don’t know. I think it’s probably too early to tell. We probably have to wait until next year. One of the things that I think you are seeing though is as our claims inventory is dropping, we are also paying the larger claims, the hospital claims faster as well. And that’s part of the reason that not only is the inventory dropping, but the cost per claim in inventory is coming down as well. So you are seeing both those effects.

Brian Wright – Banc of America Securities

Is there any sort of recent medical management initiatives that would prevent getting to out their payments more effectively than you have in past years or anything like that?

Mario Molina

No, I don’t think so. And I think we are continuing to do the same things. We follow every patient in the hospital every day in every state. And I think if you look at the Ohio experience, one of the things we learned when we got an influx of members was that not everyone is managing their hospital days as carefully as we are.

Brian Wright – Banc of America Securities

Okay, all right. Thank you.

Operator

(Operator instructions) Our next question comes from Carl Mcdonald of Oppenheimer.

Carl Mcdonald – Oppenheimer

Thanks. Would you mind walking us through how the conversion process in Florida will work from the ASO model to the risk model? Some specific questions. Can you have both an ASO and a risk model at the same time? I know some states don’t allow that. Will it be something that happens over an elongated period, or is it a specific date that a choice has to be made?

Mario Molina

There is a lot of questions in there, Carl. The short answer is, we cannot have the ASO model and the fully Cap model in the same counties at the same time. So letters were sent out and will continue to be sent out on a county-by-county basis, given the patients the option to either to disenroll back into MediPass or they will be automatically rolled over into Molina’s full risk program.

Carl Mcdonald – Oppenheimer

And will the rollout happen at the same time in all counties or do you expect that will be elongated?

Mario Molina

No, it will go – we are hoping that we can get it done in about four months.

Carl Mcdonald – Oppenheimer

Okay. And any sense of the 55,000? What you think a decent retention number would look like?

Mario Molina

Well, this is the first time, I think, in Florida we’re really seeing this type of situation. We think we’ve got – because of the network overlaps between what we’ve got and what Florida NetPASS had, we think that there is a good chance we will get a very good rollover.

Carl Mcdonald – Oppenheimer

Okay. And then the second question is, I know you guys tend to have M&A discussions over a long period of time, in some cases years. Has there been any change in the tone of the discussion over the last couple of months as the economy has turned?

Mario Molina

No. It’s fairly remarkable. The hospitals have the same attitude. Every seller has the attitude that their baby is the most beautiful one on the block. And we just keep going back to our same principles that we’ve used every time. We’re fairly consistent, Carl, in our M&A practices use every [ph] year.

Carl Mcdonald – Oppenheimer

Great. Thank you.

Operator

Thank you. Our next question comes from Andrew Morey of Cowen Asset Management. Please go ahead.

Andrew Morey – Cowen Asset Management

Yes, thanks for taking my question. On Ohio, I might have missed part of your description earlier in the call. But the changes in your network on the behavioral side, is that enough of a fix? I guess because I’m just looking at a 91.5 MCR and just thinking roughly kind of a 7.5% or 8.0% SG&A. So it wouldn't appear that you're really earning any money there currently. So I guess the question is, are those network changes enough or do you need to do other things in Ohio?

Mario Molina

Well, I don’t think it’s primarily the network. We talked in Ohio about a number of things that are going to help us. We have done some provider recontracting, which is going to lower unit cost. Those contracts went into effect in mid-September. And so you really haven’t had a chance to see that yet. The other change we did was to bring behavioral health in-house. And as I alluded to earlier, we think that we manage things a little more tightly than most, and we can help bring down costs by tighter utilization management and making more appropriate use of the resources that are available in Ohio for behavioral health. And the third thing is the risk-adjusted payments for the ABD patients, which has gone up. And we’ll add about $500,000 a month I believe in additional revenue. So those combination of things we think will begin to show an impact in the fourth quarter in 2008. Some of those things went into effect at the end of the third quarter, but really haven’t been around long enough to have any impact on third quarter results.

Terry Bayer

I just want to add a comment that the recontracting is broader than behavioral health. It sounded like your question might have been asking for the specific to behavioral health. While we have network changes to bring behavioral in-house, Dr. Molina’s first point related to the recontracting was broader recontracting.

Andrew Morey – Cowen Asset Management

Okay, thank you for that clarification.

Operator

Thank you. Our final question comes from Scott Fidel of Deutsche Bank.

Scott Fidel – Deutsche Bank

Thanks. I just want to follow up on California, and did you basically say that you are reinstating the higher provider payments, given the injunction? And just wondering how this works if the cuts end up going back through, you basically just go back to those lower reimbursement rates, and how much timing does it take to adjust based on what California is doing with these rates relative to your provider reimbursements?

Mario Molina

Well, right now we have rolled back the contracts to the ones that we had before. We do have the ability if we need to institute the new contracts if the state does reinstitute the 10% provider cut. I personally think that’s unlikely. But we have the ability to make the change and we’ll take sometime because you’ve got to change computer systems. But we've done it once, we reversed it once, and we can do it again if we need to.

Scott Fidel – Deutsche Bank

Okay. So basically it’s a bit of a – it will be a bit of a roller coaster around those reimbursements right now?

Mario Molina

Yes, but I suspect that it’s more likely than not that the injunction will be upheld.

Scott Fidel – Deutsche Bank

Okay. And I just had a follow-up just around the DC and I’m talking the second stimulus package. Maybe if you can give us an update on what you are hearing around what that can include around Medicaid?

Mario Molina

That’s a really good question. Both the House and the Senate have proposed to increase federal matching funds for Medicaid in the neighborhood of $14 billion to perhaps as much as $20 billion. And that may get put into the package for the stimulus. That I think would be helpful. All the states would like to see more federal dollars put into the Medicaid programs. It helps them and they are having a tough time. But it remains to be seen if that’s going to pass.

Scott Fidel – Deutsche Bank

Do you have any sense of what that would do for the map? I know it’s 57% federal right now, where that would take it to if that went through?

Mario Molina

I’m not sure out of top of my head, and it also varies on a state-by-state basis as well.

Scott Fidel – Deutsche Bank

Right. Okay, thanks.

Mario Molina

Okay. Thank you, everyone. We’ll see next quarter.

Operator

Ladies and gentlemen, that does conclude today’s conference call. We thank you for your participation and we ask that you please disconnect your line.

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Source: Molina Healthcare, Inc. Q3 2008 Earnings Call Transcript
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