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Executives

Juan José Orellana - Vice President of Investor Relations

J. Mario Molina M.D. - Chairman of the Board, President, Chief Executive Officer

John C. Molina J.D. - Chief Financial Officer, Executive Vice President

Terry P. Bayer - Chief Operating Officer

Michael M. Siegel, MD. - Vice President and Medical Director

Joseph W. White, CPA - Chief Accounting Officer

Analysts

Joshua Raskin - Barclays Capital

Daryn Miller - Goldman Sachs

Gregory Nersessian - Credit Suisse

Thomas Carroll - Stifel Nicolaus & Company, Inc.

Carl Mcdonald - Oppenheimer & Co.

Scott Fidel - Deutsche Bank Securities

Molina Healthcare Inc. (MOH) Q2 2009 Earnings Call August 4, 2009 5:00 PM ET

Operator

Good afternoon ladies and gentlemen my name is Mohamed and I will be your conference operator today. At this time I would like to welcome everyone to Molina Healthcare’s Second Quarter 2009 Earnings Conference Call. (Operator Instructions). As a reminder this conference is being recorded Tuesday August 4, 2009. I would now like to turn the conference over to Mr. Juan José Orellana, Vice President of Investor Relations with Molina Healthcare. Please go ahead sir.

Juan José Orellana

Thank you, Mohamed. Hello, everyone, and thank you for joining us. The purpose of this call is to discuss Molina Healthcare's financial results for the second quarter ended June 30, 2009. 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. Michael Siegel, Vice President and Medical Director who is filling in today for Dr. Jim Howatt, who is not available today; 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 our 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 August 4, 2009, 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.

Dr. Mario Molina

Thank you Juan José and hello everyone. In my remarks today I will provide a brief overview of our second quarter performance and update you on the progress we have made in positioning Molina for improved long-term performance and growth. Dr. Mike Siegel will provide some commentary on the H1N1 outbreak and then John will provide greater details related to our second quarter financial results. After John’s remarks we will open the call to answer your questions.

By now I assume you have all had a chance to review our press release. Our earnings per share were $0.56. Our results for the second quarter can be summarized as mixed with several notable, positive developments offset by higher medical costs and continued pressure on premium rates. Higher medical costs and revenue pressure resulted in lower profit margins across some of our larger markets.

In reviewing our results it is important to focus on what has changed since the first quarter as well as what continue to be key factors affecting our short-term financial performance. We have experienced greater utilization of outpatient services, some of which we believe resulted from the H11 flu epidemic, a substantial increase in new membership in the first half of this year, and higher professional fees and outpatient facility cost trends. Some of the items we discuss during the first quarter continue to remain at issue; state budgets are still a problem; healthcare unit costs are on the rise, and interest rates remain low.

Let me share with you some of the progress that we have made. On the membership front today we reported membership of 1.37 million members, a 9% increase from December 2008. Excluding Florida membership has grown almost 7%. We are therefore well on our way to meeting our full year enrollment goal as shared with you in January. As we have stated in the past our historical organic growth rate has been in the range of 3% to 4%; however as we reminded everyone at our most recent Investor Day new members generally come with higher costs, at least initially. Our experience has been that new members typically incur higher medical costs during their first nine months of enrollment, but we have also observed that the utilization tends to stabilize over time.

We have some good news in the second quarter. I am pleased to announce our successful contract renewal in the state of Missouri. Molina Healthcare of Missouri was successful in retaining its existing business in the three regions we currently serve. I am also very pleased to announce our success in retaining our Medicaid contract in the state of Michigan. This new contract in Michigan will become effective October 1, 2009 and we will expand our service area in the state from 42 to 46 counties.

n addition, the Texas Health and Human Services Commission issued a tentative contract award to Molina Healthcare of Texas for the Children’s Health Insurance Program, or CHIP, in rural counties. The award, which covers up to 170 counties in Texas, is contingent upon the successful negotiation and execution of a contract with the state. The new contract has a tentative operational start date in September 2010. We are pleased to expand our contracting relationship with the state of Texas and look forward to providing greater access to quality healthcare services to the rural populations in that state.

The New Mexico Retiree Healthcare Authority notified our New Mexico health plan that its Medicare product will be offered as an option to the state employee retiree group business. This new opportunity and our new contract in Texas further our strategic goal of diversifying along product and geographic lines while remaining true to our mission.

I am also pleased to report that our Texas health plan earned accreditation from the National Committee on Quality Assurance. Molina Healthcare of Texas is the only Medicaid health plan in the state that has earned an accreditation from NCQA. Molina Healthcare continues to be among the leaders in healthcare quality with health plans in seven states accredited by NCQA in California, Michigan, New Mexico, Ohio, Utah, Washington, and now Texas. Currently only 22% of the nations Medicaid plans are accredited by NCQA. I want to offer my congratulations to the staff of our Texas health plan for his achievement.

In these challenging times we continue to manage our business for the long-term and are pleased with the progress we are making towards our strategic goals. We continue to expand in new and existing markets, we continue to leverage a lean administrative structure, and as always we remain intensely focused on quality.

I would now like to turn the call over to Dr. Michael Siegel who will provide an update on the H1N1 virus. Dr. Siegel?

Michael Siegel, MD

Thank you Dr. Molina. Hello everyone. In early April a child in California was diagnosed with the novel H1N1 influenza viral infection. The new influenza strain has now reached pandemic levels. Currently in the United States there are over 43,000 documented cases. Sadly the infection has resulted in 302 deaths. It is thought that the H1N1 flu infection is far more prevalent than these statistics would suggest.

This summer we are continuing to see higher than normal numbers of influenza like cases caused by the novel H1N1 flu virus. Over the past several weeks there have been reports of children being sent home from overnight camps with flu like illnesses. Several of the children have tested positive for the novel H1N1 infection. These cases associated with increased physical proximity may foreshadow an increase in the number of novel H1N1 cases when children return to school next month; however at this time we do not know how much of a role this new virus will play in the approaching flu season.

The disease attack rate is highest in persons under 25 years of age. This group constitutes a significant portion of our membership. We are closely following the progress and the development and distribution of a novel H1N1 vaccine. As of last week the CDC projects that there will be a vaccine available by mid-October. We are augmenting our seasonal flu prevention program with the following actions:

We are increasing the level of member notifications both by mail and by interactive voice response outreach. We are also increasing our efforts in working with providers to reach high-risk patients. We are urging members to get their annual flu shot earlier than usual. We will be providing member and provider updates as more information becomes available. We are starting our own employee flu prevention education program now and plan for early worksite flu vaccinations. Finally, as Dr. Howatt said during the last earnings call all of us should keep in mind important behaviors that will help minimize the spread of the virus: wash your hands frequently; avoid touching your eyes, mouth, and nose; stay home when you or your family members are ill; avoid contact with ill people; cover coughs and sneezes; and practice good health habits including adequate rest and nutrition.

Now I would like to turn the call over to John Molina.

John Molina J.D.

Thank you for that important update Dr. Siegel, and now to our financial results.

Results for the second quarter of 2009 were $0.56 per fully diluted share. Net income was $15 million for the quarter ended June 30, 2009 as compared to $16 million recorded for the quarter ended June 30, 2008. Our 2009 second quarter revenue increased 22% or $164 million when compared to the second quarter of 2008. As outlined in our press release today membership growth has been strong and we continue to generate administrative cost efficiencies. Unfortunately we have experienced significant cost pressures and medical margin pressure. In the long run we are confident that the benefits of increased membership will out weigh the challenges of higher medical costs.

Since the beginning of the year the Company has grown by over 112,000 members. To put this in perspective, we have added more members in the first half of this year than the total enrollment at our Missouri and Texas health plans combined. Our medical care ratio increased from 84.2% in the second quarter of 2008 to 86.8% in the second quarter of 2009. This is an increase of 260 basis points year-over-year and a 70 basis point change for the prior quarter ended March 31, 2009.

As we have discussed in the past, the Company usually experiences a decline in medical costs in the second quarter; this was not the case during 2009. Higher utilization was responsible for higher medical costs. Contributing to the situation was the outbreak of the novel H1N1 virus and a higher utilization associated with newer members.

Although the first quarter of 2009 may have benefited from a lighter flu season the Company believes that the H1N1 flu outbreak was partially responsible for the absence of the usual seasonal drop in medical costs from the first to second quarters. The Company also suspects that the media attention on H1N1 may have driven more patients to seek care than would otherwise have been the case.

Physician and outpatient costs exhibited the most unfavorable cost trend in the first half of 2009. Together these costs increased approximately 18% on a per member per month basis compared with the second quarter of 2008. Emergency room utilization was up approximately 8% and cost per visit was up approximately 13% were the primary drivers of increased costs during the first half of 2009.

During the first half of 2009 we observed some providers billing at higher levels of care than in the first half of 2008. For example, the billing codes for emergency room level of care, which reflects the intensity of services provided in the emergency room, with level 1 being the least intensive and level 5 being the most intensive, changed significantly in the first half of 2009 compared to the first half of 2008. Level 1 visits decreased by 16% while level 2 visits decreased by 10%; however both level 3 and level 4 visits increased by 13% and level 5 visits increased by 18%.

We have also seen an increase in physician office visits and preventive care services. Both inpatient and pharmacy costs increased approximately 4% per member per month year-over-year. Capitated costs increased approximately 11% PM PM year-over-year due to retroactive capitation payments in New Mexico and the transition of members in a capitated arrangement in California.

Now I want to take some time to talk specifically about California and Washington.

California health plan results have adversely affected the Company’s current quarter and year-to-date results. Year-to-date California plans Medicaid medical margin has decreased by approximately $12 million when compared to the first half of 2008. Based upon claims paid through June of this year the Company estimates the claims reserves from the California health plan were under stated by approximately $5.2 million at December 31. 2008. This adverse claims development was partially offset by $3.2 million in revenue recognized by the California health plan in connection with a settlement of a rate dispute with the state for 2002.

A reduction of about $9.00 per member per month in the Washington health plans premium rates have also affected the Company’s current quarter. This decrease in premiums was not fully offset by cuts to the Washington Medicaid provider fee schedule. We now know that only about 1/3 of the $9.00 PM PM revenue decrease is being offset by the change in the fee schedule. This resulted in a decline in medical margin of about $5.4 million for the quarter or $10.6 million for the first half of the year.

The Company has taken a number of steps to improve profitability. We are reexamining our network strategy in California; furthermore we expect to receive rate increases in California of about 4.5% in the fourth quarter of 2009. The premium rate increases for the health plans in California were included in the State of California budget that was signed on July 28th. The cuts in the MediCal program in California do not affect the managed care contracts. We may experience a decrease in enrollment in the CHIP program due to changes in the state budget, but at this time we do not believe this will have a material impact on our financial results.

On July 1, 2009 the State of Washington lowered Medicaid premium rates by 7.5% to reflect reductions in the Medicaid fee schedule. Our analysis shows that the reduction in our medical costs will largely mirror the reduction in the premium rate. In addition, in Washington, we will exit the basic health plan contract in King County affective January 1, 2010.

Based on claims paid through June 2009 we believe that our year-end claims reserve in 2008 was more than adequate; in fact, the benefit we report on our roll forward table is nearly the same as we reported at this time last year. The run out of the reserve we established on March 31, 2009 for the first quarter of this year has not been as favorable as in previous years. This had a negative impact on second quarter results as we replenished reserves to a more typical level.

We are pleased with our success in managing administrative costs. General and administrative expenses in the second quarter were 10.1% of total revenue, or $94 million, as compared to 11.4% of total revenue for the second quarter 2008, or $87 million.

Core G&A expenses decreased nearly 120 basis points to 7% of total revenue for second quarter 2009 as compared to 8.2% for second quarter 2008. The decrease in core G&A compared with the second quarter of 2008 was primarily due to lower administrative payroll as a percentage of revenue. Core G&A expenses have also declined on a per member per month basis by approximately 6%, highlighting the administrative leverage resulting from higher enrollment levels. We continue to hold the line on our administrative costs as we grow the top line revenue.

We view our administrative leverage as an additional cushion during times of pressure on premium rates. The effective income tax rate decreased to 16.8% in the quarter ended June 30, 2009 from 41% in June 30, 2008. The lower rate is primarily due to discrete tax benefits of $4.4 million recorded in the second quarter of 2009 as a result of settling tax examinations in the voluntary filing of certain accounting method changes. The Company’s tax rate would have been 43.5% for the quarter 2009 absent these discrete tax benefits.

Cash flow provided by operating activities for six months ended June 30, 2009 increased substantially to $95 million compared with cash flow from operations totaling $39 million for the same period in 2008, an increase of $56 million. The increase was due mainly to two factors: first increase deferred revenue of approximately $45 million and second increased medical claims in benefits payable of approximately $22 million. These increases were partially offset by increased receivables of $21 million. We do not expect to [audio gap].

Excluding restricted investments the Company had cash and investments of approximately $660 million. The parent company had free cash and investments of approximately $30 million plus access to our untapped credit facility. The Company is revising its EPS guidance for fiscal year 2009 to $2.15 per diluted share. We have provided a number of metrics that go into the development of that guidance in our press release and we encourage you to review that document for additional detail.

As I am sure you have noticed, we have moved away from providing ranges for key metrics and have instead settled on single point measurements. I want to take a few moments to discuss this change.

In the past we have provided a great deal of information with respect to premium revenue, investment income, EBITDA, medical costs, and administrative costs in order to help our investors and the analysts understand how we view the immediate future of our business. In the past we have given these inputs in terms of ranges. Many investors and some analysts have struggled with translating these ranges into a single point expectation of net income. Too often people will compile each input at the bottom of the range and assume that this will lead them to the bottom end of our EPS guidance range. Conversely they will assume that by compiling the top end of each input range they can build a figure that matches the top end of our EPS range. However, it is rarely the case that all the bad things will happen together and it is equally unlikely that all of the good things will happen together. We therefore decided to provide single points of reference in an attempt to provide greater clarity, which will allow our investors to make their own determinations as to the likelihood of the ultimate outcomes.

I would again urge you to review our press release for a very thorough disclosure of the important financial metrics that comprise our expectations for the balance of the year. While you can review the numeric inputs, let me describe some of the key issues facing our business in the second half of 2009.

We do not expect enrollment to grow in the second half of the year as it did in the first half of this year. If enrollment gains are as large as they were in the first half we may continue to see elevated medical costs. Our revised guidance includes changes to individual health plan premium rates that were not anticipated when we first provided guidance in January. As you may recall, we did not expect to see substantial rate increases this year; however, as detailed in our earnings release we now believe we will get rate increases in some states, rate decreases in other states and oddly enough both increases and decreases, just timed differently, in a couple of states. For example, we would not have expected any rate increases in California but have found that the current budget did fund some of these increases effective October 1, 2009.

Where we believe there is a greater chance than not that the rate changes will happen we have incorporated those changes into our guidance; however many states have fragile budgets. If the actual state tax receipts and stimulus dollars come in less than expected there is a chance that the state will delay the implementation of rate changes or actually decrease rates. We will not speculate where, when, and if rate changes will happen, but want you to understand that it is a possibility.

We have often discussed seasonality with respect to our medical costs. Typically medical costs are highest in the first quarter, decrease in the second quarter, reach an aid year in the third quarter and rise in the fourth quarter. It is important to note that while costs rise in the fourth quarter, they are generally still below the costs incurred in the second quarter.

As we have discussed today we did not see the typical decline in medical costs in the second quarter. We have developed guidance to assume that medical costs will not follow typical patterns this year. We have projected a slight decrease in our medical care ratio for the second half of the year. Should we see a return to more normal seasonal patterns we would expect medical costs to decrease further thus earnings increase. On the other hand, we have not projected a virulent outbreak of H1N1 or other seasonal flu. If H1N1 returns with wide spread applicability our medical costs could rise beyond what we are anticipating and our earnings would go down.

This concludes our prepared remarks. Mohamed, we are ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Joshua Raskin with Barclays Capital.

Joshua Raskin - Barclays Capital

My question sort of relates to second half earnings run rate and the guidance here. The first quarter you guys reported $0.46, but there was really a $0.04 gain in there; this quarter is $0.56 but $0.18 from tax benefits, so excluding the tax benefit you get about $0.84, you are talking about $1.13 in the second half which seems like a pretty big ramp. You just talked about the muted seasonality expectation and I am actually calculating an MLR that’s about 40 basis or 45 basis points better on a year-over-year basis on the second half and the first half. So, I am just curious how you bridge from 1H09 to the second half of ’09.

John Molina J.D.

I think although it may simple to just exclude what might be 1x items, we don’t detail out every up and down potential change that may or may not reoccur. Certain things happen through out the quarter; we just draw your attention to a couple of them that sort of stick out. So, what I would say is in terms of the back half of the year we have given our best estimate of guidance of being $2.15 and so we expect to bridge the gap between where we are at the end of Q2 to get to $2.15.

Joshua Raskin - Barclays Capital

Maybe then I could ask it another way. It looks like the guidance implies a much better earnings run rate in the second half than the first half. I am just curious what some of those positive factors are that would lead to that?

John Molina J.D.

I think the rate increases are a big factor in that Josh. We didn’t have those in January.

Mario Molina M.D

We are also expecting some decrease in medical costs in the second half of the year and we are making some progress on the contracting front. So, there are a number of things that we think will lead the second half to be better than the first half.

Joshua Raskin - Barclays Capital

Okay and then just a follow up, could you walk us through the timing; it didn’t sound as bad, obviously, in the first quarter and it looks like you guys were still buying back stock in the second quarter so how did this sort of develop and what were some of the indicators and how comfortable are you that you sort of figured out what the new run rate is?

John Molina J.D.

Are you talking about the run rate on guidance, or the run rate on the repurchases?

Joshua Raskin - Barclays Capital

Medical costs, I’m sorry, how do you know you’ve got the right level of medical costs [inaudible].

John Molina J.D.

We pour through reams and reams of reports from our actuarial and our medical cost departments to make sure that we, as best as possible, understand what the underlying drivers for the cost and utilization data and that is something that just doesn’t stop. We are continuing to look at that continually.

Mario Molina M.D

There are a number of factors that went into this. The first, I think, is increased outpatient utilization. We have seen this, and I think that some of the other health plans that have reported have also commented on this. We think that there was some contribution from the H1N1 flu virus, but that doesn’t explain all of it. We have also seen in the past that new members come with higher costs in the first six to nine months and with the large influx of new members we think that contributed to the elevation in the costs. It was mostly outpatient; it was really not so much pharmacy or inpatient. So those are some of the main cost drivers that we have seen in the first half of the year.

We think that there are some indications that costs will come down in the second half of the year and we have got some preliminary data from pharmacy that would suggest that the costs are coming down in July, and I think this is consistent with what some of the PBMs are reporting.

Joshua Raskin - Barclays Capital

Okay, we can follow up. Thank you.

Operator

Your next question comes from Daryn Miller with Goldman Sachs.

Daryn Miller - Goldman Sachs

I have a question on the California budget. It looked like the amount that they were looking to cut out of MediCal was fairly significant. I am just wondering since a portion of that doesn’t seem like it’s coming from managed care. Where is that money going to come from?

Mario Molina M.D

The decreases in the MediCal budget are coming from a variety of sources, but what we can say that affects us is that there was budgeted a rate increase for the managed care plans. That remained in the budget and we have gotten rates that will be effective October 1st, which give us about a 4% to a 4.5% rate increase for the fourth quarter. So, we are very hopeful that that will remain, but as John pointed out the budgets are fragile, so for the time being we aren’t counting on that money. If anything changes we will let you know.

Daryn Miller - Goldman Sachs

Do you have any speculation in terms of what aspects of the program not related to managed care that would be trimmed to generate the savings?

Mario Molina M.D

I don’t want to get into that, since it really doesn’t affect our business.

Daryn Miller - Goldman Sachs

You said if they change the CHIP program the impact would be modest. Can you potentially size that aspect?

Mario Molina M.D

We think that we could lose 2,000 or 3,000 members this year, so we don’t think it’s going to have a significant impact on our financials for the remainder of 2009.

Joe White

Just to put that into perspective that’s about a $75.00 per member per month premium.

Daryn Miller - Goldman Sachs

Okay. Do you guys have any expectations, you are picking up a lot of new enrollment, what is the duration of that new enrollment do you think? Or, how long is it going to be around?

John Molina J.D.

We are seeing that one of the things that are driving increase in overall membership is that we are not losing as many members through out the back end as we are gaining coming in the door for the first time. I don’t know that we have done a complete duration study to see what the average length of enrollment has been. I would say to Mario’s point the medical costs seem to be elevated for the first six to nine months and then begin to lower, but I don’t know that we have sufficient data right now on total average monthly enrollment.

Mario Molina M.D

I think it is really too soon to tell. I mean some of these members have only come on this year, so it is hard for us to know. We will just have to see, but as John points out disenrollments are down and you would expect that in a difficult economy.

Daryn Miller - Goldman Sachs

Yes, I guess maybe going back to previous downturns, because if we think about this maybe higher than expected costs up front, but if disenrollments stick around for two and a half or three and a half years there is potentially quite a bit of benefit on the back end. Are there any indications from previous downturns how long disenrollment might be around for?

Mario Molina M.D

I think that you are right about the fact that there is some upside, the longer the members remain on the plan. But, to be honest, I don’t think we’ve had a downturn like this since the 1930’s, so it is a little bit difficult for us to go back and look for a comparable historical period.

Daryn Miller - Goldman Sachs

That’s fair. The trend that we are seeing on provider behavior seems to be pretty wide spread. Is there any common themes as in types of providers that are up coding or billing for more activities? Is there any theme or trend on those types of providers?

John Molina J.D.

We did see, as an example that I cited, some of the ER providers, but right now I don’t think we know enough to ascribe broad patterns or trends.

Mario Molina M.D

I will tell you anecdotally that I periodically get emails inviting me to seminars on coding. So, I don’t know if this is an industry trend or if this is just a blip that reflects the current state of the economy.

Daryn Miller - Goldman Sachs

Okay, thank you very much guys.

Operator

Your next question comes from Gregory Nersessian from Credit Suisse.

Gregory Nersessian - Credit Suisse

I have a couple of questions on some of the specific items you outlined in the press release. The New Mexico capitation expense increase, were both the retroactive premium revenue and the costs all booked this quarter; so it was a net benefit from that item this quarter?

Joe White

Yes, it is.

Gregory Nersessian - Credit Suisse

Okay, so that was about a $3 $3.5 million net benefit this quarter?

Joe White

I think out of period was about $2.5, yes.

Gregory Nersessian - Credit Suisse

Okay and the California, I understand that you had negative reserve development within that health plan, but it looked like your aggregate prior period reserve development was basically in line. Is that a fair characterization at the consolidated level?

Mario Molina M.D

At the consolidated level as of the end of last year, yes.

Gregory Nersessian - Credit Suisse

Okay, so is it fair then to sort of look at that $3.2 million in revenue as sort of a 1-x item, the deferred revenue going back to 2002?

Mario Molina M.D

Yes.

Gregory Nersessian - Credit Suisse

Then I guess the swine flu data that I have looked at from the CDC suggests that it is mostly kind of been a Northeast phenomenon. I was wondering if you could spike out which markets you are seeing that in a more pronounced way. Are there any specific states where it has become more prevalent?

Michael Siegel, MD

Reviewing the surveillance report from the CDC from last Friday there is wide spread activity in California, regional activity in Washington and Florida and then lesser degrees of activity in the rest of the Molina states.

Gregory Nersessian - Credit Suisse

So California is getting materially worse is that how you would characterize it in terms of the [interposing].

Michael Siegel, MD

Yes for the reports submitted to the CDC.

Gregory Nersessian - Credit Suisse

Okay and on the California rate increase, the 4.5%, does that all accrue to you, or are there some provider payment changes underneath that that would mitigate some of that rate increase?

Michael Siegel, MD

The only provider payment that might negate is we have a contract with Health Net for the Inland Empire that mirrors the one we have in L.A. so we have to pass some of that through to them, but it is a very small amount.

Mario Molina M.D

So basically the answer to that is no Greg.

Gregory Nersessian - Credit Suisse

So you are getting almost the full effect of that 4.5%.

Mario Molina M.D

Yes, as long as it stays.

Gregory Nersessian - Credit Suisse

Okay and then any changes to your approach to reserves? The days dropped a couple of days in the quarter. Was there any reserve strengthening you could speak to in the quarter, or maybe you could just give us some color commentary on how you approach the reserves given the unexpected spike?

Joe White

I think it is fair to say you mentioned 12/31/08 reserve development a minute ago. We talk in the release and we even have a table in the back end. The 03/31/09 reserve was comparatively light, when we set that at the end of the last quarter, so we have had to make up some ground on that this year. If you look at the roll forward tables specific to the 03/31/09 reserve you will see that the benefit hitting us in the second quarter was only $26 million, when we probably normally expected something in the $40 million range. So, certainly we have had to strengthen for that.

On the other side we resumed our large downward in terms of the inventory numbers. They are down about 17% from the second quarter; so we feel like we caught up with what happened in the first and second quarters and obviously a little bit of the negative impact, a little bit of the negative cost trends we’re seeing in Q2 obviously should spill over into Q1 if we’d se the reserves a little bit more consistently back in March.

John Molina J.D.

The bottom line is we have not changed our methodology for reserving and in fact we are not allowed to pad the reserves in the expectation of something bad might happen in the future. Our reserves are set on all of the information we know at the time we set the reserves at the end of a period.

Gregory Nersessian - Credit Suisse

All right, okay, thank you.

Operator

(Operator instructions). Your next question comes from Thomas Carroll with Stifel Nicolaus & Company, Inc.

Thomas Carroll - Stifel Nicolaus & Company, Inc.

I want to drill down a little more, pick up on Greg’s question a bit, related to the 1-x items and then how that translates into the back half of your year. So you are putting up a $0.56 quarter here, I am taking out $0.08 a share for the California settlement, about $0.27 for the tax benefit and another $0.08 for the difference in the New Mexico retro payments and then adding back the negative development in California which is about $0.06; so, you put that all together and you’re getting to like a $0.29 or $0.30 quarter. Is that going to then turn into a $0.56 quarter on third quarter because of lower medical expenses? Could you help me out with the math there and please point out where I am wrong?

John Molina J.D.

Again, what I would say is there are other 1-x items that just for the sake of brevity we did not include. Let me give you an example. We had an additional $2 million expense in the quarter related to New Mexico insurance pool premium pools. We didn’t detail that out. There is probably another $0.5 million somewhere else, and then another $1 million somewhere else. We just don’t detail them all. They go back and forth all of the time because we have got a complex business, I mean we are talking about nine health plans and several hundreds of millions of dollars worth of revenue and expenses going through.

What I would say is the end of the year number is our best estimate taking everything into consideration, medical costs, adding in expenses, investment income, plus those changes that occur that are seen and frankly sometimes that are unseen because they are just too small or numerous to put in place, or to detail out.

Thomas Carroll - Stifel Nicolaus & Company, Inc.

But you would suggest these three things that you highlighted are probably non-recurring in nature, is that correct?

John Molina J.D.

Yes.

Thomas Carroll - Stifel Nicolaus & Company, Inc.

I mean you are not going to get another California, I guess you could get another California tax settlement next quarter, but you are not expecting one?

Mario Molina M.D

We do have other disputes on rates with the state of California, but no Tom we are not expecting any settlement in the near future.

Thomas Carroll - Stifel Nicolaus & Company, Inc.

All right, the one other question I had for you back to some of the text in your press release about, I believe it was the Washington state market where you were getting the $9.00 PM PM lower amount that you thought was going to be mostly passed through in lower fee schedule numbers that is not being all the way accounted for. Is that a trend that perhaps we might see in other states and not just with you guys, but in any particular market where a rate, a fee schedule comes down, it is translated to a Medicaid HMO cap payment then ultimately doesn’t work out the way we think?

John Molina J.D.

We can’t speculate on what’s going to happen with other states. It happened in Washington. When they did the subsequent rate decrease in July and we looked at the data provided by the state to see how they determined the decrease and we feel that the fee schedule adequately covers the decrease in our premiums so that our costs should go down a commensurate level.

Mario Molina M.D

I want to add a little bit to that. A lot of times when the states are calculating their rates they come up with certain assumptions and it is an aggregate across all health plans. Sometimes you will see differences between health plans within a state depending on things like utilization patterns and case mix; so, it can vary. You can see this kind of thing when rates are readjusted. If the actuaries for the state have done their job properly these things should be neutral and as John points out we think the next cut that they have made to the fee schedule should be neutral to us. We always examine these things, but it is difficult to be 100% sure.

Thomas Carroll - Stifel Nicolaus & Company, Inc.

So you don’t think that phenomenon, if you will, is going to continue July 1, ’09 through the remainder of the Washington contract period?

Mario Molina M.D

I think generally the states are getting better in terms of the actuarial requirement and setting the rates properly.

Thomas Carroll - Stifel Nicolaus & Company, Inc.

Okay thank you.

Operator

Your next question comes from Carl Mcdonald from Oppenheimer & Co.

Carl Mcdonald - Oppenheimer & Co.

I would be interested to know if you think there is any specific initiatives you can do, particularly thinking around the physician and outpatient costs. So if you take the emergency room data that you cited, is there anything that you can do from your end to try to bring the levels back down to what you have seen historically, or is that something that just sort of plays out on its own?

Mario Molina M.D

Yes, I think there are things that we can do and we are really trying to get after the outpatient costs. One of the things that we are trying to do is get more people to use the nurse advice line and triage patients that don’t need to go to the emergency room to urgent care centers. A lot of this is educational. Remember, we had 112,000 new members on the plan this year and it takes time to change people’s habits and behavior. We are also looking at opening up perhaps some other clinics in other areas to catch some of this over flow from the emergency rooms and redirect people away from the higher cost facilities.

The other thing that I think we need to do is examine the records to see if this is simply a matter of up coding or if people are sicker and going to the ER, and then finally as I think Mike pointed our, or maybe it was John, there is some concern that the media promoted some of this because people were panicking over the flu and they heard about patients dying; so, people that had colds that might otherwise have stayed home and said it is a bad cold either went to their doctor or went to the emergency room and that increased utilization.

On a positive side I think we saw an increase in preventive care services and that is something we have been trying to encourage which should benefit us on our HEDA scores. In the re-procurement of the Michigan contract there was 125 point total per county and if you look at the scores that we got you will see that we received the full 60 points for the quality points and we were the only health plan to get all five of the value added points; so right there our efforts in terms of improving our quality and HEDA scores is helping us with our contract renewal, and I think that is the kind of thing that we’ll see more of in the future with RFPs from the states on Medicaid contracts.

Carl Mcdonald - Oppenheimer & Co.

Just beyond that Michigan contract when you look at the counties where you were added and the other counties where you were taken away, and the same thing with the competitors, will there be any significant shifts in the membership?

Mario Molina M.D

It is hard to say if there are going to be big shifts in the membership, but we think there is definitely some upside potential for us. We have some competitors that lost some counties and so we will have fewer competitors in some of the counties. At the same time I think we have added some counties, so there may be some upside there. We will just have to see how it plays out. But, I also think that our HEDA scores which helped drive the enrollment algorhythm in Michigan are definitely going to move us up in the enrollment algorhythm. In some of the counties we have been at tier 3 and we are now moving up to tier 1.

Carl Mcdonald - Oppenheimer & Co.

Great, thank you.

Operator

Your final question comes from Scott Fidel with Deutsche Bank Securities.

Scott Fidel - Deutsche Bank Securities

My first question is back to medical costs. I am interested in how utilization looked for your existing membership, maybe the longer tenured membership as compared to the newer membership where clearly there were higher costs there. I guess thinking about utilization on the longer membership did you see an increase there too, and maybe if you parsed out swine flu just sort of a secular increase on the longer tenure membership?

Mario Molina M.D

It is a little bit difficult to tease that out, especially at this point, but we have done a couple of studies and it does vary a little bit from state to state, but there are some clear trends. One of the most pronounced trends is in California where we see that the members definitely have higher utilization and the break point comes at about nine months. To the extent that we can retain members beyond nine months their costs do come down and we should get some benefit from that. But, at this point it would be a little bit premature to break out the new members we received in 2009 versus the longer existing members. Do you follow me?

Scott Fidel - Deutsche Bank Securities

Yes, yes I do. I have a second question on the exit from King County in Washington and to match for January, how many members will be impacted by that or how many members do you have enrolled in that county currently?

Terry Bayer

It is 10,000 members in the basic health contract that we are exiting.

Scott Fidel - Deutsche Bank Securities

Then on the commentary that you had on the tax benefits in the quarter, you had referenced a couple of changes to voluntary accounting methods. Joe, could you give us some details on exactly what changes you made in the accounting methods there?

Joe White

Sure. The biggest item was a settle up of a purchase accounting issue which per FAS 141R results from an income, from a tax perspective, results in a P&L impact. Of the $4.4 million that was about $3.5 million in the benefit. The remaining $900,000 of the benefit related to changes in terms of accounting practices and the biggest one was we now file as an insurance company. So between that and a few other small items we picked up about $900 K of benefit from accrued interest relates to those tax positions.

Scott Fidel - Deutsche Bank Securities

Okay, thank you.

Operator

Sir, I will now turn the call back over to you. Please continue with your presentation or your closing remarks.

Mario Molina M.D

I will close by saying thank you for joining us and we look forward to talking to you again next quarter.

Operator

Ladies and gentlemen that does conclude the conference call for today. We thank you for your participation. (Operator Instructions)

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Source: Molina Healthcare Inc. Q2 2009 Earnings Call Transcript
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