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Molina Healthcare, Inc. (NYSE:MOH)

Q2 2013 Earnings Call

July 25, 2013 5:00 pm ET

Executives

Juan Jose Orellana - Vice President of Investor Relations

Joseph Mario Molina - Chairman, Chief Executive Officer and President

John C. Molina - Chief Financial Officer, Executive Vice President of Financial Affairs, Treasurer, Director and Member of Compliance Committee

Joseph W. White - Chief Accounting Officer

Terry P. Bayer - Chief Operating Officer

Analysts

Justin Lake - JP Morgan Chase & Co, Research Division

Sarah James - Wedbush Securities Inc., Research Division

Joshua R. Raskin - Barclays Capital, Research Division

Christian Rigg - Susquehanna Financial Group, LLLP, Research Division

Scott J. Fidel - Deutsche Bank AG, Research Division

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

David A. Styblo - Jefferies LLC, Research Division

Peter Heinz Costa - Wells Fargo Securities, LLC, Research Division

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Molina Healthcare's Second Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Thursday, July 25, 2013. I would now like to turn the conference over to Juan José Orellana, Senior Vice President of Investor Relations. Please go ahead, sir.

Juan Jose Orellana

Thank you, Circe. 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, 2013. The company's earnings release was issued today after the market closed and is now posted for viewing on our company website. On the call with me today are Dr. Mario Molina, our CEO; John Molina, our CFO; Terry Bayer, our COO; and Joseph White, our Chief Accounting Officer. After the completion of our prepared remarks, we will open the call to take your questions. [Operator Instructions] Our comments today will contain 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, which are subject to numerous risk factors that could cause our actual results to differ materially. A description of such risk factors can be found in our earnings release and in our reports filed with the Securities and Exchange Commission, including our Form 10-K annual report, our Form 10-Q quarterly reports and our Form 8-K current reports. These reports can be accessed under the Investor Relations tab of our company website or on SEC's website. All forward-looking statements made during today's call represent our judgment as of July 25, 2013, and we disclaim any obligation to update such statements except as required by securities laws. This call is being recorded and a 30-day replay of the conference call will be available at our company's website, molinahealthcare.com. I would now like to turn the call over to Dr. Mario Molina.

Joseph Mario Molina

Thank you, Juan José. Hello, everyone, and thanks for joining our discussion today. We had a good second quarter. We had revenue growth of 8%, a medical care ratio that declined 830 basis points and net income from continuing operations that increased to $16 million, up from a net loss of $33 million this period last year. While the highlights for this quarter was the year-over-year improvement in Texas, we have also benefited from improved operational performance at most of our health plans. In fact, the medical margin improved at all of our health plans except for California. John will talk in more detail about our financial results during his remarks. For now, let's focus on growth.

We were pleased that the budget signed by California Governor Brown included funding to expand Medicaid coverage to more than $1 million low-income people in California. The expansion is anticipated to begin in January of 2014 and as part of the implementation of the Affordable Care Act. Funding the expansion confirms California's commitment to expanding Medicaid, as well as Molina's opportunity for additional enrollment growth.

We see another opportunity for growth at our New Mexico health plan as we assume Lovelace Community Health Plan's contract for the New Mexico Medicaid Salud! program. The agreement will facilitate the transition of Lovelace's Medicaid members to the Centennial Care Program in New Mexico, a program in which Molina is 1 of 4 participating managed care organizations. The transaction is expected to close August 1, 2013, when Lovelace's Medicaid members will become members of Molina Healthcare. The Centennial Care program is the new name for New Mexico's Medicaid program beginning January 1, 2014, and will provide health care to about 735,000 New Mexico residents. Lovelace currently serves approximately 84,000 Medicaid members, while Molina's enrollment in the state this quarter was 92,000.

Next, I would like to take a moment to talk about the latest information we have regarding the Dual Eligible programs in California, Illinois and Ohio. You're probably aware there are often delays associated with the implementation of new contracts or programs. These delays are common. And as we have seen across various state Medicaid programs, the implementation dates are always subject to change. In California, the Dual Eligible demonstration program will now begin sometime on or after January 1, 2014. In Illinois, the implementation for the Duals contract is January 1, 2014. In Ohio, the Duals contract will start voluntary enrollment on March 1, 2014. We continue to make preparations to be ready to provide care for our future Dual Eligible members. Preparations are also underway for additional expected future growth in California. In May, Covered California selected Molina Healthcare as 1 of 13 health plans that will participate in the state's new health benefit exchange program. Molina Healthcare will participate in 4 counties where we currently operate as a health plan: Los Angeles, San Diego, Riverside and San Bernardino. Our offering of marketplace plans is competitive in pricing and supported by a strong provider network. We look forward to welcoming new members as well as ensuring continuity of care for our existing Medicaid members in the event that their eligibility changes requiring them to access health care through the marketplace.

The second quarter was another positive quarter for Molina Healthcare. Our strategic and operational initiatives at the health plans have been successful, as evidenced by the significant improvement that continued into this second quarter. With half the year now behind us, we are excited about the future and focusing our efforts on the pipeline of upcoming opportunities. Now I'd like to turn the call over to John.

John C. Molina

Thank you, Mario, and hello, everyone. As Mario said, the second quarter was a good quarter for us. We can point to improved financial performance at 8 of our 9 health plans, including a substantial turnaround in both Washington -- excuse me, Wisconsin and Texas. Before I go further, though, I'm going to help you better understand why we are now presenting results from continuing operations as a separate line item on our income statement. Our Medicaid contract in Missouri expired June 30, 2012, and effective June 30, 2013, all transition obligations associated with that contract terminated. We also abandoned our equity interest in the Missouri health plan during the second quarter. We now present Missouri operations, including the tax benefit of about $9.5 million that we recognized on the abandonment, as discontinued operations. Missouri operations have also been reclassified to discontinued operations for all prior periods. The breakout of discontinued operations should make it easier for you to understand our financial performance. Other than the tax benefit I mentioned, there has been no material financial activity related to the Missouri health plan in 2013, nor do we expect there will be any material activity for the Missouri plan for the rest of the year. The 2013 guidance we have shared with you during the year and the guidance we are sharing today has not included any impact from Missouri. Therefore, income from continuing operations is the best metric by which to measure our financial performance and is, I believe, consistent with how analysts have developed their models of our financial performance. Thus, our earnings per diluted share from continuing operations of $0.34 is a good metric to measure against the net loss from continuing operations of $0.71 per diluted share in the second quarter of last year.

Let's look at the second quarter in more detail. Premium revenue in the second quarter grew to $1.5 billion, representing an 8% increase over the same period last year. The increase in premium revenue was due to membership growth in Washington and Wisconsin and rate increases in Texas and Washington in the second half of 2012. Our consolidated medical care ratio decreased to 86.2% in the second quarter of 2013 compared with 94.5% in the same period last year. While margin improvement in Texas was significant, stable inpatient utilization and lower pharmacy costs across the company were also important factors in our improved financial performance.

I want to point out that 7 of our 9 health plans had lower medical care ratios in the second quarter of 2013 than in the second quarter of 2012 and 8 of our 9 health plans had higher medical margins in 2013 than in 2012. As Mario mentioned, our success in the other health plans has not been matched in California. While performance in California has been helped by a retroactive rate increase that we recognized during the first quarter of 2013, we do not believe the rates adequately reflect the cost associated with the benefits that we are required to provide to the aged, blind and disabled population.

Now let me discuss another housekeeping issue. Medical margin is a metric that we have not talked about in the past but I think will be an important measure for the future. By medical margin, I mean the total dollar -- total amount of dollars from premium revenue excluding premium taxes remaining after we pay our medical care costs. The medical care ratio measures performance as a percentage while medical margin measures performance in dollars. As we take on members with more complex health care needs, we are also earning higher premiums for those members. States have realized that some administrative costs do not grow commensurately with the complexity of the patient needs. Therefore, states are increasingly setting premium rates that incorporate economies of scale on the administrative side. The result is higher medical care ratios for our members needing more complex medical care. Remember, though, that these members come with much higher premiums so the total dollars, what we call medical margin, that is left over after we pay for medical care is often higher than it would be for our traditional members. Medical margin then is often a better metric for measuring financial performance related to these members than the medical care ratio. In the future, we will be assuming responsibility for a growing number of individuals requiring complex care. So I'm spending time today to familiarize you with this metric, which will be increasingly important for the proper measurement of our financial performance as we go forward. While we may experience a higher MCR, more importantly, we may be more profitable on a dollar basis.

Now let's talk about general and administrative expenses. These expenses increased during the second quarter of 2013 to 10.1% of total revenue compared with 8.5% of total revenue in the same period last year. Partially driving this increase is a provider settlement of approximately $3.5 million recognized this quarter. This settlement reduced earnings from continuing operations by about $0.04 for the quarter. Most of the increase in G&A, which we have talked about before, is a ramp up in administrative expenses as we make the necessary infrastructure investments to support Duals and marketplace program implementations without any offsetting revenue.

Moving now to non-cash items. We recorded in the second quarter a one-time, non-cash charge of $3.9 million related to warrants issued in conjunction with the company's convertible senior notes offered in February of 2013. The warrants were reclassified to equity during the second quarter resulting in a mark-to-market adjustment that reduced earnings from continuing operations by about $0.08 for the quarter. No further mark-to-market adjustments are required.

At our Investor Day in February of 2013, we talked about alternative financing options, including a potential sale leaseback transaction for our corporate offices. In June, this transaction became a reality as we completed a sale leaseback transaction valued at $158 million. You may recall we have paid approximately $90 million for both buildings. As part of the sale leaseback transaction, we sold our principal corporate offices in Long Beach, California, as well as an office building in Columbus, Ohio and entered into a 25-year lease arrangement for those same properties. We consider the sale leaseback transaction as a financing mechanism through which the company borrows $158 million for 25 years with an implicit interest rate of approximately 8%, which is an interest rate consistent with the market for a 25-year debt. The debt obligation, which is self-amortizing, provides a benefit of not requiring a lump sum payment of principal at maturity. The buildings themselves remain on our books, so depreciation and amortization will continue as it was before the transaction. This sale leaseback transaction, together with the senior convertible notes that we issued in February, increases our cash on hand, providing us with greater flexibility to fund future organic growth as well as strategic acquisitions like we did in New Mexico. As of June 30, 2013, the company had cash and investments of approximately $1.5 billion. Days and claims payable remain flat at 38 days when compared to the first quarter of 2013.

Finally, the company announced that it expects net income per diluted share from continuing operations to be $1.55 for all of 2013 and net income per diluted share, including discontinued operations, to be $1.72 for all of 2013. As I noted a few minutes ago, income from continuing operations is the best metric with which to measure our financial performance.

The back half of the year will be affected by a number of items. In the third quarter, these items will be: rate decreases in Ohio effective July 1; rate increases in Texas effective September 1; potential pent-up demand associated with the transfer of members from the Lovelace Community Health Plan to Molina Healthcare in New Mexico; potential pent-up demand associated with the statewide service area expansion in Ohio, which became effective July 1; increased payments for personal attendant services and adult day care in Texas effective July 1. And items affecting the fourth quarter or the entire back half of the year include: potential rate increases in California and Michigan effective October 1; continued infrastructure spending for marketplace, dual enrollment, Centennial Care and the Florida long-term care program; interest expenses associated with our recently completed sale leaseback transaction; anticipated effective tax rate on continued -- continuing operations for all of 2013 of approximately 45%. You will recall that the guidance of $1.55 per diluted share, which we issued previously for 2013, did not include certain administrative expenses associated with membership growth related to the marketplaces, Medicaid expansion and some Duals initiatives. At the time we issued our original guidance, we said we would update guidance at a later date and take into account these additional expenditures. Due to our improved operating outlook for the rest of 2013, I'm happy to report that we've been able to include these costs in our revised guidance without lowering our target EPS. This concludes our prepared remarks. We are now ready to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Justin Lake with JPMorgan.

Justin Lake - JP Morgan Chase & Co, Research Division

First question is on the California exchanges. So the rates are out there. You look like you're competitively priced in a number of markets. Just wanted to get your impression in terms of how you're positioned there, what you're thinking in terms of what '14 membership might look like there and margins.

John C. Molina

Justin, we're not going to talk about 2014 in terms of membership or revenue or anything like that. We'll do that when we issue 2014 guidance. But we are pleased with where we came out in terms of pricing. We're the second lowest silver plan, which is where we want to be.

Justin Lake - JP Morgan Chase & Co, Research Division

Okay. Maybe I can ask 1 or 2 other questions then. First, on premium taxes. One of your peers indicated that there could be some issues in terms of getting the deductibility or the non-deductibility of premium taxes back from the states in terms of Medicaid rates. So essentially, they would get the tax itself or the fee passed through but the nondeductibility could be problematic. Are you -- how do you feel about that right now in terms of that issue?

John C. Molina

Our position is that in order for the rates to be actuarially sound, we got to have the premium tax covered. And to the extent that there's a difference because it's not tax-deductible, it's got to be grossed out.

Justin Lake - JP Morgan Chase & Co, Research Division

And do you feel like states see it that way as well, you're having those conversations, and do you expect to get that?

John C. Molina

We're having those conversations. We know that there are a number of trade groups that are also writing letters to the Medicaid directors, explaining the issues to them. But as of this time, we have not started rate negotiations relative to the ACA tax.

Justin Lake - JP Morgan Chase & Co, Research Division

Okay. Last question, just on SG&A. How should we -- I mean, SG&A was clearly a little bit higher in the second quarter, you are making investments there. How should we think about that in terms of that run rate into the back half of the year?

John C. Molina

I think that for the back half of the year, that will probably be in a stable point. And then as the revenue starts coming in, in 2014, it starts going down. But right now, I would expect the dollar amount spent for the back half of the year to be about what it is for the first half.

Operator

Our next question comes from the line of Sarah James with Wedbush.

Sarah James - Wedbush Securities Inc., Research Division

Following on the exchange discussions here, there's been some talk this earnings season around exchange risk adjusters lowering PMPM to what one of your competitors described as a challenging level if you end up with a very healthy book of business. And whether or not healthy members, even if they receive a subsidy, might be more attracted to bonds level plans with their 0 premiums, especially if they only plan to use this as a catastrophic coverage or default on paying their out-of-pocket expenses. So Molina has the lowest premiums for bronze in San Bernardino, Riverside and the second lowest in LA, and I was just wondering if you could speak to whether or not you see that scenario as a potential risk and if you guys are considering any additional reinsurance beyond what's in the 3 Rs.

Joseph Mario Molina

Well, Sarah, this is Mario. We're pretty happy with where we came out in the pricing. And I think in terms of speculating as to whether it's good or bad or what the enrollment is going to look like, it's really too soon to tell. I mean, I don't think anyone has any idea how this is going to turn out. We can look at what happened in Massachusetts, but for the most part, we really don't have very much information. We're just going to have to see how things turn out.

Sarah James - Wedbush Securities Inc., Research Division

Okay. And then maybe an update on your discussions with California as far as a potential settlement might go. I thought you guys were pretty far along in that process but no word yet. So just wondering if you could speak to an updated timeline on that or any information on what the cause of it taking so long might be.

John C. Molina

Well, the saga continues, and we're actually thinking of turning this into a miniseries.

Sarah James - Wedbush Securities Inc., Research Division

Got it. So no final meeting in sight or planned on that?

Joseph Mario Molina

Not yet. We continue to have discussions with the state.

Operator

The next question comes from the line of Josh Raskin with Barclays.

Joshua R. Raskin - Barclays Capital, Research Division

I think I want to follow-up on a miniseries that you guys are embarking on here. Has your attitude changed around whether or not you think that arrangement with the state around Medicaid margins would be attractive?

Joseph Mario Molina

No, we're continuing to pursue the settlement.

Joshua R. Raskin - Barclays Capital, Research Division

Okay, so it sounds like it's more on the state side in terms of timeline as opposed to any change in what you guys are trying to do?

Joseph Mario Molina

I think part of the problem right now, Josh, is that we've just come through the budget season. And so we've had people on vacation, so we -- discussions have gotten stretched out.

Joshua R. Raskin - Barclays Capital, Research Division

All right. So season finale is still pending, I guess.

Joseph Mario Molina

Correct.

Joshua R. Raskin - Barclays Capital, Research Division

Maybe we could talk -- one just quick one on cash flow. Were there any timing issues in the quarter that impacted the cash flow?

Joseph W. White

It's Joe speaking. There were a couple of issues with just 2 states, California and Wisconsin, paying a month later, presumably as a result of their fiscal year ends. But we collected a bunch of cash in July in those 2 states that we'd have normally collected in June.

Joshua R. Raskin - Barclays Capital, Research Division

Do you happen to know what the total on those 2 payments was, Joe?

Joseph W. White

North of -- I'll have to dig that out and get back to you. It was pretty much a standard monthly payment.

Joshua R. Raskin - Barclays Capital, Research Division

Got you, okay. And then just last question on the California Duals, as you're thinking about the opportunity, implementation, et cetera, you got a little bit more time, obviously, you got to spend in front of that. But any updates in terms of what you think share could look like next year? I know you're not giving guidance for '14 but maybe some parameters about how we should be thinking about how the Duals end up enrolled.

Joseph Mario Molina

I'm sorry, Josh. I didn't understand your question. Can you say that again?

Joshua R. Raskin - Barclays Capital, Research Division

Dual -- California Dual membership in 2014. Basically, I'm looking for how we should think about the members rolling on and any parameters we should think about in terms of sizing the opportunity for you.

Terry P. Bayer

This is Terry, Josh. We do know that we won't get all the memberships at once, that it will be phased in as we experienced with the SPD, so it will be rolling in each month. But what we don't know, and I don't think anyone knows, is how many of these Medicare members may choose to opt out. They have the right to opt out. The Medicaid portion would stay with us, but otherwise, we don't know.

John C. Molina

Josh, this is John. I'll just refer you back to the last presentation we did when we talked about this. We haven't seen anything other than the delay that would suggest that those numbers are far off.

Joshua R. Raskin - Barclays Capital, Research Division

Okay, so you're sticking with that, just let's think more about Jan 1 first [ph].

Operator

The next question comes from the line of Chris Rigg with Susquehanna.

Christian Rigg - Susquehanna Financial Group, LLLP, Research Division

Just wanted to come back to some of the comments about you maintained $1.55 despite all the incremental investment spending. Can you help us think about how much incremental spending there is relative to the prior $1.55?

John C. Molina

Incremental spend for the buildup is probably going to be about $10 million to $15 million.

Christian Rigg - Susquehanna Financial Group, LLLP, Research Division

Okay, even that -- I mean given where the G&A came out in the quarter, that -- is there anything else that would have increased the run rate relative to the first quarter that would be notable?

John C. Molina

Chris, let me back up. Maybe I misunderstood your first question. Are you asking in the fourth -- excuse me, in the back half of the year?

Christian Rigg - Susquehanna Financial Group, LLLP, Research Division

So in the back half of the year -- when I think about the investment spending that you need to prepare for next year, that wasn't in your prior $1.55, and you said earlier that you're maintaining $1.55 despite this incremental spending. I'm trying to figure out how much incremental spending is now in your current guidance.

John C. Molina

Okay, I'm sticking with that $10 million to $15 million.

Christian Rigg - Susquehanna Financial Group, LLLP, Research Division

Okay. And then I wanted to just understand, when you thought about your prior guidance of $1.55 and some of the charges that ran through this quarter on the litigation expense and the charge related to the warrants, was that in the prior $1.55 as well?

John C. Molina

No, it was not.

Christian Rigg - Susquehanna Financial Group, LLLP, Research Division

Okay. And -- just wanted to clarify. So I think you said the warrant cost or the mark-to-market was $0.08 in the quarter and that would imply something different, I believe, than the $3.9 million or a little bit above that.

John C. Molina

No, it's because it's not tax deductible.

Operator

The next question comes from the line of Scott Fidel with Deutsche Bank.

Scott J. Fidel - Deutsche Bank AG, Research Division

First question, just on reserve development. It looks like you had some pretty substantial gross reserve development of around $50 million in the second quarter. Did you reestablish all of that? Or did any of that accrue into the second quarter earnings?

John C. Molina

No. Right now, Scott, the data in claims table being flat. Also, we're pretty comfortable with where we are in terms of our reserve range. So we would say that we replenished it.

Scott J. Fidel - Deutsche Bank AG, Research Division

Okay. Then just second question. Can you just update us on, again, the Ohio rate cut in the third quarter and then the Texas rate increase, what sort of those final estimated numbers are?

John C. Molina

We have not quantified -- we're not going to go into that level of detail in terms of the Ohio and the Texas rate increase. The Texas rate increase is effective 9/1. In Ohio, the rate decrease is partially based on changing to the risk adjusters. They reset the risk adjusters back to 1 for the third quarter. I think it was in large part because they want statewide contracts. We had a risk adjustor that was higher than 1, so that is effectively a rate decrease for us.

Scott J. Fidel - Deutsche Bank AG, Research Division

Okay. And that puts you on a really nice MLR in Ohio in the second quarter, 79.8%, was that benefiting from some of the -- where the risk adjusters were or were there some other factors that drove the really strong underwriting margins in Ohio in the second quarter?

John C. Molina

I think that the risk adjusters are part and parcel with some of the benefits and some of the medical margin that we talked about. Because the risk adjustor do help keep the premiums higher because we have a population that's perceived to be higher costs. They've done a nice job in provider contracting and utilization management in Ohio, which helps keep the medical care costs down.

Scott J. Fidel - Deutsche Bank AG, Research Division

Okay. Then just one last question. It sounds like invitations to negotiate have been sent out recently to the plans for the Florida Acute Care re-procurement. I'm just wondering whether you can confirm that Molina did get one of those notifications or invitations to negotiate?

Joseph Mario Molina

Yes. This is Mario. We did get invited to negotiate, but we're not going to comment further until those negotiations are completed.

Operator

The next question comes from the line of Kevin Fischbeck with Bank of America.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Can you talk a little bit about the Lovelace transaction and kind of how you think about the benefits of entering into that transaction? I guess, it sounds like you made at least some payment for this. I know you expect some integration costs or potentially pent-up demand in the second half of the year. But how are you thinking about the ability to retain that membership heading into next year when the new contracts come in place?

Joseph Mario Molina

This is Mario. This is a really nice transaction for us. We have a very high degree of overlap with the Lovelace provider network, including the hospitals. So what we see is a pretty seamless transition for the members, and we think that we should be able to retain a large percentage of the membership and maybe even grow that membership in the back half of the year. So -- and at the same time, there will be some administrative cost savings. So we think this is a pretty good thing for us, it's a good thing for the members, and I think it's a good thing for the state because it promotes continuity of care.

John C. Molina

And Kevin, this is John. Just to remind you, as we've seen with a lot of other acquisitions that we've done, there's often pent-up demand in the first couple of months because as 1 contract sort of rolls out, providers are reluctant to provide a lot of services for fear of not getting paid, the patients are concerned of getting into new aspects of care until they get the new health plan, et cetera. So we would not be surprised to see medical care costs for the membership that transitions to Molina be higher than it was historically for a few months, which is why we highlighted that when we talked about our guidance.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay. And because of that dynamic, do you expect that this has any impact, positive or negative, on your guidance when you think about your Q1 guidance versus your Q2 guidance now?

Joseph Mario Molina

We don't think it has a negative relative to the full year guidance, but we do think it will have a slight drag in Q3. But then once we get through the pent-up demand, if any, we hit the latter part of Q3 and Q4 very well.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay. And then when you outlined the growth initiatives that were out there for you, I don't think you mentioned California bridge program. How do you think about that opportunity?

Joseph Mario Molina

Well, we like the California bridge program and we have been enthusiastic about it. But I don't think it's in effect yet, right? This is still something that's being talked about. But we have been promoting this not only in California but in other states as well.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay. So way too early to size that or think about that?

Joseph Mario Molina

Yes, I think the authorization was for the state to consider it but I don't think they've actually gone forth with implementation yet.

Operator

The next question comes from the line of Dave Windley with Jefferies.

David A. Styblo - Jefferies LLC, Research Division

It's David Styblo, filling in for Windley. I had a question, just want to go back to the guidance and what was included. Kind of when I sized it out, it looks like there's about -- the guidance is absorbing $0.27 of new cost. The $0.12 you guys had spiked out from the one-off, and then it seems like about $0.15 more of incremental spending. Just want to confirm that, that's right. And then second of all, where is the out-performance coming from to absorb that? Is it in the second quarter alone, or something that's more forward-looking for the rest of the year?

John C. Molina

So this is John. So I think the number you scoped out are right. Where it's coming from, I think as we discussed, we got -- 8 of our 9 health plans in the second quarter had higher medical margins in Q2 versus -- Q2 of 2013 versus Q2 of 2012. We did also beat expectations for the first quarter. So underlying performance in the health plans is improving. California continues to be a laggard, but we think that additional efforts in California plus what we expect to be maybe a rate increase in California in Q4 will help improve California's performance. So really it's the underlying performance in all the health plans that's carrying us into the back half of the year with better expectations.

David A. Styblo - Jefferies LLC, Research Division

Okay, great. That's actually a great transition. I'm going to ask about California. One of your competitors mentioned that they're getting a rate increase. Curious what sort of color you have on the rate increase that you might be getting, if you have one or if that's still in discussions, or if you can size that in anyway, that will be helpful.

John C. Molina

At this point, what we know is the budget that Mario mentioned past in June did include additional dollars for rate increases for health plans. We've also seen some preliminary numbers from the state, and I believe those preliminary numbers maybe on a county level but not plan specific. So until we actually get through the negotiation and the discussion process with the state of California, we won't know exactly what that rate increase is, but all the signs point to rates going up for California.

David A. Styblo - Jefferies LLC, Research Division

Okay, great. If I could just squeeze one more in, on the parent cash, if you could provide an update there and just kind of what you are expecting that to roll forward through the year end.

Joseph W. White

It's Joe speaking. Parent cash is about $525 million as of June 30. As far as year end, that's a little advance. We're not going to do visibility into that right now.

Operator

[Operator Instructions] And the next question comes from the line of Peter Costa with Wells Fargo Securities.

Peter Heinz Costa - Wells Fargo Securities, LLC, Research Division

Can you go over how prepared you feel you are at this point in terms of systems for the exchange business given that, that involves enrolling individuals and collecting premiums from individuals and sending out EOBs and things like that. Can you talk about where you're in that process and how comfortable you are?

Terry P. Bayer

This is Terry Bayer. We're on track. We developed an elaborate plan both for 10/1 when the marketplace enrollment will begin and then 1/1 when we'll begin to serve those members. So our capacity in our health plans is geared up for the care management and network and then the administrative, our build out is occurring according to our plans for the premium billing and collection, et cetera.

Peter Heinz Costa - Wells Fargo Securities, LLC, Research Division

And you're developing all of that de novo? Or how are you going about developing that?

Terry P. Bayer

To a degree, de novo, and we'd built on our existing systems and added the new functionality that we needed for the product where it is different from Medicaid.

Peter Heinz Costa - Wells Fargo Securities, LLC, Research Division

Okay. And then just kind of a follow up to the last question regarding the potential for rate increase in California. Is there any way for you to size for us what you think is in the budget for rate increases in California overall, perhaps even it's not at the plan level. Can you talk about where you might be in relation to that? And as we get closer to that, the competitor talked about the rate being maybe adequate and perhaps even seeing a reversal of the receivables being set up. So I'm wondering if it even makes sense for you to want to have the target -- the risk sharing target anymore going forward. Are you still pursuing that?

John C. Molina

Those are 2 separate questions. At this point, I know that we won't speculate on what our rate will be because there are many factors that go into the final rate development, number 1. Number 2, on the rate negotiation -- the rate settlement negotiations that we've been talking about, Mario's miniseries as it were, I think that, that's a good safety net to have. It beats the alternative of continuing to take the state of California to court. And so if we can reach the appropriate settlement, I think it's the right thing to do for the company.

Operator

And the last question comes from the line of Ana Gupta [ph] with Dowling & Partners.

Unknown Analyst

So the questions about the Dual Eligibles. I appreciate you having the medical margin as the metric of choice going forward instead of MLR, it makes sense. I'm just trying to understand who do you think has the competitive advantage on winning these Duals contracts across Medicare and Medicaid. It seems to me like an arms race that is going on. And Washington, as we found out, United and Regence won the contracts, and it felt like the Medicaid incumbents were sidelined to some degree in Florida. Now Humana is coming in with this acquisition of American Eldercare. It seems like it's targeted to Duals. So how do you see this all playing out in the states that still need to make their decisions?

Joseph Mario Molina

Well, Ana, this is Mario. We feel very comfortable about this. We think we are very well positioned. We won 3 Duals contracts already, and there are a few more in the pipeline. I also believe that the Medicaid part of this is under -- misunderstood and underestimated. This is really not about managing Medicare patients. The Duals are very different than your typical Medicare beneficiary. And right now, we have a considerable number of Duals, one of the largest populations of Duals under management of any company in the country. So we think we're very well positioned to compete for these patients.

Unknown Analyst

So this is more you think about the reduction in institutional care costs relative to acute care costs? And then how does that play out into how the savings are being split between CMS and the state? And how -- is that part of the reason California continues to be more delayed relative to even states like Illinois which seemed to be behind California at one point?

Joseph Mario Molina

Well, there are a number of important components. Certainly, decreasing hospital cost is an important component of this. Pharmacy is a large component of this, but so is long-term care. And the long-term care is more than just institutional long-term care. There are a lot of aspects to that as we'd learn from our experiences in Texas. So those I think are things that play into all of this. As far as why California is behind or ahead or which state is ahead or behind, it has a lot to do with factors behind the scenes between the state and between CMS and also the readiness of the state's infrastructure to handle the contracts. So I don't think we can read too much into that, and things can change over time. So I just want to urge everyone to be patient with the rollout of these contracts. They will come. It will take a little longer than we all thought but I think in the end, it's more important to do it right. And I just want to congratulate our staff on the terrific work they have done in getting ready for these contracts. We've got a couple of readiness reviews coming up here at the very near future, and we feel pretty comfortable about our ability to handle these contracts.

Unknown Analyst

Just one final follow-up on that, again, Mario. On SG&A, do you feel comfortable that what's being baked is consistent with your expectations for what the Duals SG&A load would be? And is there any -- are there any differences by state that concern you?

Joseph Mario Molina

Well, I think as John pointed out, the SG&A load in terms of percentage may be a little less than what we've seen on the Medicaid side simply because the premiums are higher. And so I'm not really too worried about the administrative cost load at this point.

Okay. Well, thank you, everyone. We appreciate you joining us for this call. It's been a good quarter for us, and I just want to mention in closing that the Dodgers are in first place.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.

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