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Molina Healthcare, Inc. (NYSE:MOH)

Q3 2010 Earnings Call Transcript

October 26, 2010 5:00 pm ET

Executives

Juan José Orellana – VP, IR

Mario Molina – Chairman, President and CEO

John Molina – CFO, EVP and Treasurer

Joseph White – Chief Accounting Officer

Analysts

Joshua Raskin – Barclays Capital

Chris Rigg – Susquehanna Financial Group

Sarah James – Wedbush Morgan Securities Inc

Scott Fidel – Deutsche Bank

Charles Verdi [ph] – Credit Suisse

Carl McDonald – Citigroup

Ken LaMont [ph] – UBS

John Rex – JPMorgan Securities Inc.

Scott Green – Bank of America/Merrill Lynch

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Molina Healthcare’s third quarter 2010 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) As a reminder this conference is being recorded, Tuesday, October 26, 2010.

I would like to turn the conference over to Juan José Orellana, Vice President of Investor Relations. Please go ahead.

Juan José Orellana

Thank you, Edison. 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, 2010. The company’s earnings release reporting its results was issued today after the market closed, and was posted for viewing on our company website.

On the call with me today are Dr. Mario Molina, our CEO; John Molina, our CFO; and Joseph White, our Chief Accounting Officer. Terry Bayer and Dr. Jim Howatt are currently traveling and will not be joining us on the call today. After the completion of our prepared remarks, we will open the call to take your questions.

Our comments today will contain forward-looking statements under the Safe Harbor provisions of the Private Securities Litigation Reform Act, including statements regarding our revised guidance for 2010. 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 for fiscal year 2009, 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 the SEC’s website. All forward-looking statements made during today’s call represent our judgment as of October 26, 2010, 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 molinahealthcare.com.

I would now like to turn the call over to Dr. Mario Molina.

Mario Molina

Thank you, Juan José, and hello everyone. Our remarks today will be brief, since we provided a comprehensive overview of our business at our Investor Day on September 14.

Results for the third quarter ended September 30, 2010 were $0.57 per diluted share. Today’s results reflect the continuing momentum of the strategic and operational initiatives that we outlined during our second quarter earnings call and our Investor Day. There are some key developments that contributed to our success this quarter that I would like to highlight.

Premium revenues increased in the third quarter as a result of greater enrolment and premium rate increases in some of our states. But they were flat on a per member per month basis compared to 2009. However, medical cost decreased by $5.49 per member per month from the same period last year leading to higher margins.

The biggest declines in medical costs were in our large states, California, Washington and Ohio, which were partially offset by increasing medical costs in New Mexico, Michigan, and Missouri.

Let me talk about these developments in greater detail starting with enrolment. Our Wisconsin acquisition and our new CHIP contract in Texas provided most of our enrolment growth in the quarter. Our enrolment in Wisconsin was approximately 28,000, nearly 10,000 more members than when we announced the acquisition of the health plan in July.

The health plan has the potential to grow even more from the third open enrolment period, which ended in mid-October. We added 54,000 members under our Rural CHIP contract in Texas effective September 1. The new members represent over 40% of the addressable market in the CHIP program. Our involvement in this program complements our existing operation in Texas Star and Star Plus Medicaid programs.

Premium rate increases in Florida, Utah and Washington were enough to offset rate decreases in Missouri and New Mexico during the quarter. The rate increases in Utah and Washington became effective on July 1. So our results reflect a full quarter of the benefit. Florida rates, on the other hand, became effective on September 1. Increases in some states and decreases in others confirm how volatile premium rates can be, and highlight the variation in premium rates that we experience in the States in which we operate. We expect this pattern to continue into 2011.

Higher medical margin combined with enrolment growth have been the keys to greater profitability. Compared to last year, we have seen very little flu activity, and the various contracting and medical management initiatives we have implemented resulted in lower medical costs this year. However, we want to remind everyone that last year the H1N1 flu peaked in late October, and that typically the flu season peaks between December and April.

If flu activity in the fourth quarter is similar to levels observed last year that would present a significant challenge for us in the fourth quarter. The California health plan is performing better than last year. Where we were unable to agree with providers on appropriate fees, we terminated those contracts. We exited the AIM program because premium rates were inadequate. And we left Old Oak [ph] County, where we lacked the scale to support an efficient operation.

California enacted its budget about three weeks ago, and there were two specific provisions that may benefit our California health plan. First, the budget includes an increase of $174 million to provide an estimated 3.7% rate increase to Medicaid managed care plans in the state. We view this as a good sign. The proposed rate increase would take into consideration a pharmacy pricing adjustment, and should be actuarially sound as required by Federal law. As a reminder, the 3.7% increase is an aggregate number. The actual rate increase, specific to each health plan, will be based on a number of factors.

New rates in California for Los Angeles, Riverside and San Bernardino counties go into effect retroactive to October 1, 2010 and on January 1, 2011 for San Diego and Sacramento counties. The second key budget provision transitions the age, blind and disabled beneficiaries from fee for service to managed care programs starting in June 2011.

Currently, there are close to 380,000 ABD beneficiaries in the state that will be served by managed care. In the counties in which Molina operates, about 260,000 ABD beneficiaries will be served by managed care. Our involvement in this expansion will greatly complement our existing participation with ABD patients in California, and help us to build additional scale and expertise in arranging medical care for this population.

As of September 30, our California plan cared for 13,500 ABD members in the state, but our consolidated ABD enrolment was 120,000 members, representing about 8% of our total membership. We have often discussed the strategic value of the California health plan, even when rates and medical cost trends were not favorable. The ABD managed care expansion is a case in point. By participating in California, the largest Medicaid market in the country, Molina is well positioned to benefit from additional managed care expansions in the state, as well as healthcare reform in the not too distant future.

Switching to Molina Medicaid solutions, our fiscal agent business, we continue to make progress in the implementation of our system in Idaho, which began operations on June 1, only a month after we closed the acquisition from Unisys. When the transaction closed, Idaho was already nearing the end of its design, development and implementation phase and there was little we could do to influence the implementation.

Therefore, it is no surprise that we encountered a few challenges. We are fully engaged with the state of Idaho, have supplemented the operation with additional resources, and are working with both the state and local providers to address the issues that have risen since June 1. In contrast, the main system went live on September 1 and has encountered fewer problems then we experienced in Idaho. Early indications over the past few weeks are that the system is working without major problems, and issues that did arise are being addressed.

We have, however incurred greater cost after the system implementation than we had anticipated. As a result, the financial performance of the MMS segment was less favorable in the third quarter than we had anticipated. The state of Maine has been operating without a CMS certified MMIS system for the past five years. We are eager to assist the state of Maine in achieving its CMS certification.

I would like to point out that the implementation of an MMIS is both an art and a science that consists of planning, implementation, training and ongoing maintenance. No two implementations are the same. Timelines are adjusted and changes are always needed to meet evolving customer requirements. This is something that is not new to the MMIS industry, but may be disconcerting for those who have not followed the MMIS space and are new to the industry.

Our strategy for Molina Medicaid solutions, which we have shared with you in the past, is to pursue fiscal agent contracts in states with smaller Medicaid programs, where managed care is unlikely to reach a meaningful scale. We see a robust pipeline of opportunities to bid on new contracts over the next three years, as states seek to procure new Medicaid information systems to deal with issues related to the new ICD-10 classification system, and other requirements coming out of the healthcare reform legislation.

I’m pleased with the results of the quarter, and convinced that we are well positioned to thrive in a rapidly changing marketplace thanks to progress we have made and continue to make across all of our operations.

I will now turn the call over to John.

John Molina

Thank you, Mario. We are very pleased with our results this quarter. Earnings per diluted share for the quarter was $0.57, up over 70% from a year ago. And we achieved this level of performance despite employee severance and settlement costs that reduced EPS by $0.10.

Net income was up $8 million or 89% over last year. EBITDA was up over 87% from last year. As we have discussed, EBITDA is a very important measurement, as it provides us with a better operational metric, by which we can assess the performance of our business.

Operating revenue for the quarter was $1 billion, up $123 million or approximately 13% from the third quarter in 2009. I would like to point out that our Investor Day in September 2007, we communicated our goal of reaching $4 billion in revenues by the end of 2010. Today’s financial results confirm that we are on track for meeting that goal.

The primary drivers of revenue growth this quarter was enrolment, both in Medicaid and in Medicare. Our Medicaid enrolment grew by 97,000 members. That is 6.5% sequentially, and by 174,000 members, or 12.4% over the third quarter of 2009. In the third quarter, the growth in enrolment can be mainly attributed to the transition of members from Abri Health Plan in Wisconsin and from the Rural CHIP contract in Texas. However, the company has experienced solid organic enrolment growth this year.

At our Investor Day in January, we estimated that enrolment would grow overall by approximately 7% in 2010. But for the first nine months of the year, we have grown by 131,000 members or approximately 9% in Medicaid alone. Growth in Medicare enrolment has been equally dramatic. Our Medicare enrolment grew by 22,000 [ph] members, more than 11% sequentially and by 12,500 members or 124% over the third quarter of 2009.

We now serve a total of approximately 23,000 Medicare members. We have been steadily growing our enrollment of dual eligible beneficiaries in multiple states, and look forward to building additional scale in this business. In the past, we have told investors that we expected Medicaid premium rate increases to be in the low single digits. So far, 2010 is proving us to be correct.

If we remove the effects of the carve out of pharmacy benefits in Ohio and Missouri, and adjust for our increasing Medicare enrolment, Medicaid premium growth, PMPM, was approximately 3% in the third quarter of 2010 compared to the third quarter of 2009, and about 2% when we compare the nine months ended September 30, 2010 to the same period in 2009.

We have made the most of these premium increases by better managing our medical costs. Our medical care ratio declined by nearly 250 basis points year-over-year and 180 basis points on a sequential basis. Mario touched on some of our medical management initiatives that resulted in lower medical costs, including recontracting and exiting product lines in some markets.

In addition, other items that contributed to lower medical costs in the quarter included lower inpatient utilization and a less severe flu season so far in 2010. General and administrative expenses were $89 million, or 8.5% of total revenue, compared with $69 million, or 7.5% of total revenue, for the same quarter last year. The main reason for the increase in G&A was the one time employee severance and settlement costs of approximately $4.7 million for the quarter. Absent those costs, G&A expenses would have been 8.1% of total revenue.

Cash flow from operating activities was $8 million for the first nine months of 2010 compared with $130 million for the first nine months of 2009. There are two factors that explain the change between years. Both of these factors relate entirely to the timing of receipt of premiums. The first factor relates to Ohio. In Ohio, deferred revenue, which was a source of operating cash, totaling $61 million in 2009 became a use of cash in the amount of $64 million in 2010.

Simply put, the state of Ohio used to pay us prior to the start of the month of service, but beginning in 2010 has moved payment to the month of service. The second factor relates to California. As Mario discussed in his remarks, the state budget was delayed. This resulted in a $65 million increase in the California health plan receivable as of September 30, 2010. As of today, we have received most of the amounts owed to us. As we have often said, we believe that over time operating cash flow will equal net income plus depreciation and amortization.

The company has cash and investments and restricted investments of approximately $687 million. The parent company had unrestricted cash and investments of approximately $50 million. Days in claims payable for fee for service costs this quarter was 42 days, down two days from the previous quarter.

I would like to call your attention to the row 4 [ph] table presented in our earnings release, which demonstrates consistent favorable development over the measured time segments. As a reminder, the company completed an offering of its common stock in August. Including the over-allotment, the company sold 4,350,000 shares raising approximately $112 million net of underwriting fees.

The funds raised by the offerings were used to pay off the outstanding balance on the facility. By paying off our debt, we gained greater flexibility for investing in strategic acquisitions like Abri and Molina Medicaid solutions and other initiatives that will make our company stronger. As a reminder, the sale of primary shares raised the number of diluted shares outstanding to 28.4 million for the third quarter.

Now let me address guidance. Given the inherent and acknowledged volatility of our business, it has not been our practice to provide quarterly guidance. We see there is little benefit in trying to pinpoint quarterly earnings, which can be influenced by a myriad of factors. We balance that with our belief that transparency is key to success of shareholder relations. Therefore, when material factors arise from time to time, we may adjust annual earnings guidance. This is just such a time.

The company believes that the following factors have been most influential in changing its earnings outlook since guidance was last issued. Our better than anticipated performance during the third quarter of 2010, lower medical utilization at most of our health plans, rate decreases in New Mexico effective November 1, 2010, higher than anticipated stabilization costs in our MMS segment for the first few months after the system went live. Therefore the company is adjusting its full-year guidance for fiscal year 2010 previously issued on September 13.

The revised guidance for fiscal year 2010 is now $1.90 per diluted share. The most recently issued guidance for fiscal year 2010 was approximately $1.70 per diluted share. Other financial metrics that investors may want to incorporate into their financial models are included in our earnings release.

Edison, that concludes our prepared remarks. We are now ready to take questions.

Question-and-Answer Session

Operator

(Operator instructions) And our first question comes from the line of Joshua Raskin from Barclays Capital. Please proceed.

Joshua Raskin – Barclays Capital

Hi, thanks, good afternoon. I guess the first question just – it seems to have been a very good month since we last spoke, and when you gave guidance mid-September. So I'm just curious. A 50 basis points overall full-year improvement in the MLR seems pretty dramatic for sort of one month of claims data. So I'm just curious if you could help us understand what caused that magnitude of improvement since you last gave guidance.

John Molina

Joshua, it is John. Actually it was too much, because when we did our Investor Day, it was mid-September. So September we actually didn’t have August claims run out yet. So, I think also when we did the guidance at the last Investor Day, we were also assuming that the flu would come in to a greater extent than it has, and last, I think that we are gaining some confidence in the medical management efforts that we put in place last year.

It takes a while for us to develop and see the trends. We just don’t want to run off a couple of data points.

Joshua Raskin – Barclays Capital

Okay. That's fair. I didn't realize you hadn't included September. I guess the second question – flu for fourth quarter. What do you have in terms of expectations? Is it a normal flu season or are you now assuming similar to what we've been seeing in terms of trends?

Mario Molina

Hi Josh, this is Mario. We are assuming that it is going to be a more typical flu season this year.

Joshua Raskin – Barclays Capital

Okay, so it's picking up, but not necessarily what we saw last year?

Mario Molina

No, not what we saw last year. Last year was very unusual.

Joshua Raskin – Barclays Capital

Okay. And then, just a last question on the California ABD opportunity, maybe you could tell us a little bit about how you expect that to work in terms of membership allocated to plan, where you think the PMPMs could range, and how you guys think about your expected share.

Mario Molina

Well, this is Mario again. I think that it will roll out in a similar fashion to what we are seeing with the TANF, so the members will be given a choice of plans, and those that don’t make a selection within a given timeframe will be assigned to a plan. I think the assignment algorithms are going to be similar to what we have seen in the past in California.

Joshua Raskin – Barclays Capital

Could you talk a little bit about maybe the revenue opportunity, and how many plans you'd expect to participate and how they're sort of choosing that?

Mario Molina

Well, it will be the current plans that are involved in the Medicare managed care program. So it will vary from county to county, and I think that the revenue opportunity you can probably assume that we will get our pro rata share of the market. We like to get more than that, but I think for modeling purposes, I think you can assume that the ABD market share will be similar to the TANF market share.

Joshua Raskin – Barclays Capital

Okay. And then PMPMs for ABD – obviously, at California TANF I guess is a little bit lower than national TANF averages. Is the ABD similar? Have you guys seen trend data on that?

John Molina

Josh, there haven’t released the rates yet. This is John. They haven’t released the rates yet under the new program, but currently we are getting somewhere between $300 and $400 for the ABD.

Joshua Raskin – Barclays Capital

Okay. Perfect.

Operator

Our next question comes from the line of Chris Rigg with Susquehanna. Please proceed.

Chris Rigg – Susquehanna Financial Group

Good morning guys. Obviously fairly strong performance across the board, but the one state that did stand out was Washington. I was wondering if you could give us a sense, when you talk about reduced fee-for-service costs, are you talking more just reduced utilization, or absolute sort of payment cuts that you are paying the providers.

John Molina

This is John. It is reduced utilization. We are not cutting provider fees.

Chris Rigg – Susquehanna Financial Group

Okay. And then – but what exactly are in the severance and settlement costs?

John Molina

There are settlement and severance costs. We don’t discuss personal matters beyond that.

Chris Rigg – Susquehanna Financial Group

Okay. But it wasn't – was it a group of layoffs, or just some –?

Mario Molina

It reflects the number of employees that were laid off from the company.

Chris Rigg – Susquehanna Financial Group

Okay. And then you guys also commented with regard to Wisconsin, and I think I missed it, but you had mentioned something regarding enrollment growth in mid-October. Could you give us some color as to what you were talking about there?

Mario Molina

Yes, this is Mario. The last open enrolment period ended in mid-October. So we don’t yet have the final numbers from that, but we should be seeing that shortly and we think that there is an opportunity for continued growth in that last segment of the open enrolment period.

Chris Rigg – Susquehanna Financial Group

Okay. Could you guys share what you're sort of near to intermediate term expectations are for Wisconsin, in terms of where you think you could be?

John Molina

Somewhere between 30,000 and 40,000 probably we will end up.

Chris Rigg – Susquehanna Financial Group

Okay. And then lastly, going back to California, would you expect, given that business coming on midyear next year, would that be a net contributor to the bottom line, neutral, or a bit of a drag on the ABD side?

Mario Molina

I don’t think we are prepared to talk, give any guidance for 2011 yet.

Chris Rigg – Susquehanna Financial Group

Okay. I guess I'm just trying to get a sense for would you normally accrue, given it's a new patient population, sort of above reimbursement, or it's more just philosophical here?

John Molina

When we are – this is John. When we are looking at those patients in the early stages, we will factor in what do the rates look like, what are we seeing in terms of utilization, because it is a population that has some experience with managed care. We have got 13,500 enrolled in our health plan already. But it is debatable whether the folks that have not selected to be in managed care are doing so because they are over or under utilizers. Those are arguments to be made in both cases.

Chris Rigg – Susquehanna Financial Group

Okay, all right. Thanks a lot.

Operator

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

Sarah James – Wedbush Morgan Securities Inc

Thank you. Congratulations on the quarter. I had a follow-up question on California, on the ABD program. I wanted to know, Mario, when you mentioned earlier the population, does that include the Los Angeles subcontract through HealthNet? Is that something that would be an opportunity for you?

Mario Molina

Yes, it does. We currently have about 25% of HealthNet’s overall enrolment in Los Angeles County.

Sarah James – Wedbush Morgan Securities Inc

Got it. Okay. And then John, you commented on the rates that you're currently receiving in the state being around 300 to 400. I know there's another data point out there of where the fee-for-service rates are, which is significantly higher. So is there any reason to believe that the rates on the new population will be that far off from where the fee-for-service rates are?

John Molina

Sarah, I don’t know what the other data point you are referring to is. It may include a component of long-term care, which is certainly carved out of what we would do. It might also include behavioral health, and behavioral health drugs. So I don’t know what that other data point is.

Sarah James – Wedbush Morgan Securities Inc

Okay. Got it. I had some fee-for-service data but maybe we can discuss that off-line. I guess the last question is on utilization, if you're seeing anything in those trends that could be more of a sustainable trend rather than just a decrease off of last year's comps.

Mario Molina

Hi, this is Mario Sarah. I think it is a little bit too early to make any comments about sustainable trends. I think the two things that we have seen that are different, first of all is much lower flu utilization this year as compared to last year. And the second thing is we’re seeing lower hospital utilization. But we don’t know if that was going to be a long-term sustainable trend.

Sarah James – Wedbush Morgan Securities Inc

Okay, thank you.

Operator

Our next question comes from the line of Scott Fidel with Deutsche Bank. Please proceed.

Scott Fidel – Deutsche Bank

Thanks. The first question, just while you've clearly MLR improvement in most markets, in Florida there was a bit of a tick-up to 97%. Just maybe if you can comment on that and maybe just talk about how performance tracked in the reform versus non-reform markets, just given commentary from a competitor this morning that they saw pressure on the MLR in their reform counties.

John Molina

I think that – this is John. We’re also seeing some pressure in the reform counties now. Having said that, we are not completely overlapped with that competitor. So, I don’t know exactly where that stat is coming from. But we are seeing some pressure on the reform counties.

Scott Fidel – Deutsche Bank

Is that primarily where you're seeing the higher MLR? Did you see that track up as well year-over-year in the non-reform counties in Florida?

John Molina

We did see a little bit in some of the non-reform counties, primarily due to some provider contracts that have since been renegotiated that should take effect the early part of next year.

Scott Fidel – Deutsche Bank

Okay. Then I just had a follow-up on just the California ABD, Mario, maybe just philosophically – the company has done quite a bit over the last couple of years to diversify away from California, and has talked about a strategy of reducing your exposure to California. Clearly, you have a big opportunity here with ABD that's in your home market. So certainly it would be tough to ignore that. But how do you think about, particularly given the fact that this could be a very significant revenue amount that could come from this ABD, managing your revenue exposure to California if you grow this ABD versus clearly the significant opportunity that you do have there?

Mario Molina

Well, clearly we want to take advantage of the opportunity of. We are not about to walk away from good opportunities like this. On the other hand, if you look at what we have done in the past year, and especially most recently, we continue to diversify the company. We have entered a new market in Wisconsin. We have expanded – we got a service area that now covers most of the state of Texas, and we’re seeing growth there.

We are growing our service area in Florida, and we have added the MMIS business with Molina Medicaid solutions. So we continue to diversify, and I’m comfortable that we are not going to end up with a situation where things become skewed towards California again, even with the growth in enrolment of the ABD population and the California health plan.

Scott Fidel – Deutsche Bank

Okay, and then just one last question, just on Wisconsin, it looks like the MLR tracked at 97.5% in the report. Obviously, very few member months, but is that where the Abri MLR was tracking in the quarter, or were there timing issues or other factors that we should consider on why the MLR was so high in Wisconsin?

Joseph White

Hi, it is Joe speaking. It is fair to say that it is the latter, just timing issues and integration issues. And we want to be very careful as we bring in a new state in terms of how we set reserves. Traditionally, Abri hasn’t run that level of MCR, and we don’t envision that going forward.

Scott Fidel – Deutsche Bank

Okay. So the run rate MLR for them is still – is considerably lower than that?

Joseph White

Yes. I would say so.

Scott Fidel – Deutsche Bank

Okay. Thank you.

Operator

Our next question comes from the line of Charles Verdi [ph] from Credit Suisse. Please proceed.

Charles Verdi – Credit Suisse

Thanks. Good afternoon. First question – can you elaborate a bit on the pressure you said you are seeing in the reform counties in Florida? Am I right you have about 23,000 lives there, mostly in Broward?

John Molina

Charles, John, I don’t know the exact number, but Broward is the largest of the reform counties. I think that the premiums in the reform counties have probably been less than a lot of health plans we would like to see that with a combination of some tough provider contracting, we saw a number of plans exit Broward earlier this year.

Charles Verdi – Credit Suisse

Yes. So, basically just a premium issue, not a utilization issue or higher use of the ER or other things on the cost side that you could potentially address?

John Molina

Well, I think there are always things on the cost side you can address. I do think that utilization has been higher than what we like it to be, especially on the pharmacy side.

Mario Molina

I would also say that – this is Mario. If you look at, when we get into new markets, and I would still consider Florida to be a fairly new market for us. It takes a while to get up to speed and gain enough market share so that we can get better contracts. And we have seen that time and again as we have entered new states. So I think that over time Florida will improve.

Charles Verdi – Credit Suisse

Yes, okay. So is there any chance of getting the appropriate rate increase or what are next steps to improving profitability for that business?

Mario Molina

I think that the two most important things for us to do to improve the profitability in Florida are to continue to work to lower unit cost and to better manage the population.

Charles Verdi – Credit Suisse

Got it. And then in California, the governor signed legislation to create an exchange. I was just wondering if you had a chance to – I know the regs haven't been written yet, but if you've had a chance to think through what the implications are based on how the legislation was written for your company in California.

Mario Molina

Well, this whole exchange issue is going to be very important as we go forward, not just in California, but in all the states, and it is something that we are giving a lot of study right now. I don’t really want to comment too much beyond that because it is all still very new and very much in flux.

Charles Verdi – Credit Suisse

Got it. Anything specific that was signed that could be a source of potential new growth for your company, or are you contemplating getting into new programs like low income subsidy, that sort of thing? Anything – any other risks we should be aware of?

Mario Molina

I think it is too early to make those decisions. We are still studying this. And you have to also understand that it is going to vary tremendously from state to state. We could see regional exchanges. It is just really too soon to know, and there is not lot of experience. Utah has one, Massachusetts has one, California has passed some legislation, and it is all coming at a time when the government in California is going to change. There will be a new administration. We don’t know who’s going to be the governor yet, but I can almost guarantee you that there will be changes in the administration regardless of who is elected.

Charles Verdi – Credit Suisse

Yes. What is – this sounds pretty far out there. What's the earliest do you think that is reasonable that California actually implement what was signed into law regarding the exchange? Are we talking one year, two years?

Mario Molina

I think it is going to be a while. I mean the first thing that governor Schwarzenegger could do is appoint some people to the boards before he leaves office. But there is still an awful lot of work to be done, and I think it is on the order of years before we see the exchange implemented.

Charles Verdi – Credit Suisse

Got it. Okay, thanks.

Operator

Our next question comes from the line of Carl McDonald with Citigroup. Please proceed.

Carl McDonald – Citigroup

Thank you. I just wanted to get a little bit more color on the change in the cost of services ratio on the Medicaid Solutions business, and just try to understand how that will impact the prior guidance for 2011. I think you talked about something like a 20% gross margin. Is the deterioration in the ratio there just a function of some of like the implantations in Idaho that presumably will go away with time, or is there other variables that we should be thinking about?

John Molina

Carl, this is John. It is primarily due to the fact that in Maine, once we went live, while we are in-between – I think we are now considered a pilot phase instead of pure operations. The costs for correcting and making the fixes that Mario talked about are being expensed, whereas prior to go live, they were capitalized. So we are working very, very diligently to get through the pilot phase, number one, and number two cut some of those costs so that we are not carrying the same burden. I think in both Idaho and Maine, we probably went live sooner than would have been ideal, but the states wanted us to do it, and so we did it.

Mario Molina

This is Mario. I think the lesson learned from all this is that you really want to have thorough testing, and you want to have as much of the issues identified and fixed before you go live. Having said that, one that we’re going to understand is that is impossible. You never really know how these systems are going to work until you start dealing with the providers, and some of the problems that we have experienced in Idaho and Maine have been issues that were the providers didn’t understand the systems, where they had to change the way they were billing from previous contractors to our system. And those are things that can be completely anticipated with testing.

Carl McDonald – Citigroup

Okay. And then separately, on the new Texas contract, I think you started out with something in the low 60,000 in terms of enrollment, it sounds like it's closer to 50,000 now. Is that just member selection issues that have ended, or is there a chance that you could see a little bit more movement there?

Joseph White

Hi, Carl it is Joe speaking. We had a net pick up there of about 55,000. We had 10,000 members who rolled over from a previous contract we had. So in some ways we have lost people, the net increase is about 55,000.

Carl McDonald – Citigroup

Got it. Okay. Great, thank you.

Operator

Our next question comes from the line of Justin Lake with UBS. Please proceed.

Ken LaMont – UBS

It's actually Ken LaMont [ph] for Justin. Good evening. Just in terms of the updated 2010 MLR guidance, it looks like it's implying a fourth-quarter MLR of about 84.3%, which is in line with Q3. Should we think about this as kind of a good jumping off point going forward? And if so, what are some of the puts and takes that we should think about the MLR going up or down going forward from this level?

John Molina

This is John. You know, right now we’re not talking about 2011. As usual, we will have an Investor Day in the early part of 2011 to go through guidance, but I don’t want to get into that today.

Ken LaMont – UBS

Okay. And just in terms of the Texas lives, it looks like the MLR is about 89% there. Is the new CHIP laws – are those roughly in line with that, or are they meaningfully different?

Joseph White

Hi, it is Joe speaking again. You know, obviously when you take on new lives, you have to look at the history of those lives, the way the lives were priced and just take the best estimates that you can. Based on what we saw previously with the CHIP lives, we booked that at around 75% direct MCR.

Ken LaMont – UBS

Okay. That is helpful. Thank you. And lastly, just in terms of the new Texas ABD lives coming on next year in the Dallas area, is there a reason why that MLR would be meaningfully different than the existing Texas ABD lives you have?

John Molina

As the same answer John, the same answer as we gave with California. It is going to depend on how they set the rates, and what the provider contracts look like, and what the utilization is going to be. It’s just too early to tell at this point.

Ken LaMont – UBS

Okay, great. I appreciate the time guys.

Operator

Our next question comes from the line of John Rex with JPMorgan. Please proceed.

John Rex – JPMorgan Securities Inc.

Hi, thanks. So just back on MMS again, I realize it's small, but I guess what's just striking me – I think we just cut the gross profit in half from six weeks ago. You always said this was going to be choppy. But so as you get into 2011, I'm just not sure if you answered this question a couple of questions ago. Are you still in the same place of where you expect this to trend in 2011 as these markets stabilize?

Joseph White

Hi John, it is Joe speaking. Yes, I haven’t seen – I don’t think we have seen anything this quarter that would change our views of what say fourth quarter of 2011 is going to look like. We’re just incurring more cost than we anticipated in the immediately post go-live phase. So I wouldn’t call these incremental costs necessarily, operational costs. They are really more a continuation of system build out costs, but the way the accounting works we can’t capitalize them. So again, I don’t think it changes…

John Rex – JPMorgan Securities Inc.

But you did [ph] the accounting back six weeks ago, right, or did something change in your interpretation of the accounting?

Joseph White

No, what has changed is the actual rate at which we are incurring these post go live, shall I say, system development costs. You know, we expect they will trail off once the systems are stabilized. So I really think by quarter four 2011, we are not going to look a lot different than we thought we would look back in September, but certainly fourth-quarter and first quarter of next year are probably going to be rougher than we thought.

John Rex – JPMorgan Securities Inc.

I'm correct in looking – you cut the gross profit view in half for this year, right?

Mario Molina

Close to it I think.

John Rex – JPMorgan Securities Inc.

Okay. So, just the one thing I didn't understand, maybe I misread this, I thought in earlier comments you were mentioning kind of Maine was going much better than Idaho, but then I think, Mario, you said that and then – but Joe, I thought were kind of saying Maine was where the real cost burden was. Is there something like I didn't understand there?

Joseph White

I think our feeling is operationally Maine is going much better, but one reason why, and we think frankly both states are going much better than they certainly were a short time ago, but one reason of that is we’re spending this money, we’re investing this money for the development costs. So I think it is fair to say, we feel like we’re getting much better products there, but it is costing us more than we anticipated.

John Rex – JPMorgan Securities Inc.

Okay. And then what's your outlook for full-year cash flow for 2010? I mean, it sounds like you've got some good – some big receipts post-quarter close. So where do you think you should be for full-year?

Joseph White

Yes, I think we have always been pretty clear that really the operating cash flow like many businesses is just going to trend into net income, plus depreciation and amortization. We have seen some growth in obviously claims payable as a result of the business growth. So that will add a little bit to it. But I don’t think we’re going to see anything much different from what we have seen in the past, which is going to be net income plus depreciation and amortization.

John Rex – JPMorgan Securities Inc.

So kind of for full year 2010, absent kind of another California issue, you expect that ratio to wrap up. I know…

Joseph White

Yes.

John Rex – JPMorgan Securities Inc.

Okay. Just the last thing, just on the severance costs, so do you guys have some kind of headcount reduction plan going on? This is all in the Health Plan, I take it, so I just wasn't aware you had kind of headcount reduction plans, so was it in a specific market and – and my point is being are we expecting this as a go-forward thing? Is there some kind of reduction, headcount reduction effort going on?

Mario Molina

John, this is Mario. No, we look at this really as a one-time event. We don’t anticipate further reductions.

John Rex – JPMorgan Securities Inc.

And was this kind of more one-off special situations, or were you truly kind of realigning headcount?

Mario Molina

It is a little of both, and it was at corporate, not at the health plan level. I mean, one of the things we are trying to do is to clean up some issues here at corporate.

John Rex – JPMorgan Securities Inc.

Okay, great. Thank you.

Operator

(Operator instructions) Our next question comes from the line of Scott Green with Bank of America/Merrill Lynch. Please proceed.

Scott Green – Bank of America/Merrill Lynch

Hi, thanks for the question. I'm thinking about some new opportunities in core markets, and Texas is potentially a big one you highlighted at Investor Day. You've had some success there recently, bidding for CHIP and Star Plus. I was curious. Are there initiatives you can take to further distinguish yourselves in advance of a procurement? So I know you've often highlighted NCQA accreditation. For example, I think Texas encourages the Medicaid HMOs to enroll Star Plus Medicare duals. So maybe you might be expanding Medicare networks. Any initiatives like that?

Mario Molina

Well, this is Mario. I don’t want to comment on specific initiatives, but I think you have hit the nail on the head. One of the things that we have talked about for years is the importance of quality and being able to document that quality through NCQA Accreditation. If you look at the Healthcare Reform Act, one of the things it talks about for qualified health plans is that they be accredited.

So the investment that we have made in getting our health plans accredited will pay off. Almost all of our health plans are now accredited. We have got a couple of more to go, and it is only a matter of time before they are accredited. Another thing that I think you mentioned which is important, is the coordination of benefits and care for the dual eligible population.

United recently put out a paper on that. And we have believed in that for a long time. We think there are opportunities to do a better job of coordinating these programs through a special needs plan contract, and incorporating the funding streams from the Federal government and the state government, and wrapping that around the care of the duals. So these are all tools that we have that we think can add value in the various states where we operate now, and position us well to take advantage of the Healthcare Reform Act come 2013 and 2014.

Scott Green – Bank of America/Merrill Lynch

Okay. Thank you. A couple of other questions here – in Florida, is your expectation – is the rate increase there still 1.4% as you had talked about previously?

John Molina

Yes.

Scott Green – Bank of America/Merrill Lynch

Okay. In Michigan, I know it passed a budget. Was there any rate increase there?

John Molina

I think it was about 1.5%.

Scott Green – Bank of America/Merrill Lynch

Okay. So that would be in your guidance at this point?

John Molina

Yes.

Scott Green – Bank of America/Merrill Lynch

Okay. The MLR in Michigan in the current quarter, was there any other retroactive reimbursement recoupments or anything like that? Or is the 85-7, is that a pure number at this point?

John Molina

That is pretty pure number.

Scott Green – Bank of America/Merrill Lynch

Okay. And was there any success in trying to recover some of that premium recoupment from providers? I think you had talked about that in an 8-K before.

Joseph White

A modest amount.

Scott Green – Bank of America/Merrill Lynch

Okay. And then one last question, if I may, on the flu. Can you talk about how you're positioned to handle flu costs this year versus last, either from a vaccine supply perspective, or does that even matter at the end of the day? Or is it – are you kind of at the mercy of how much flu strain there is out there?

Mario Molina

This is Mario. I think there are several issues here. One is, we would encourage everyone to become immunized. Not only to protect yourself, but to protect the people around you. This is a phenomenon known as herd immunity. So the more people that are immunized the less transmission of the flu there is going to be. So, we have encouraged all of our employees to be vaccinated. We have active campaigns to encourage all of our members.

Having said that, we have about 1.6 million members in the United States, and while they may be concentrated in a few areas, it is still a very small part of the overall population. So we’re trying to do our part but we alone can’t make a –- we can’t have a big influence on the flu season. So a lot of this is really beyond our control.

The other things that we can do is try to encourage people to use emergency rooms appropriately, and that has been a struggle for years. The Medicaid population typically overuses the emergency department, and we continue to work on that. And it always gets worse in the flu season.

Many patients who go to the emergency room with flu symptoms don’t really need to be there.

Scott Green – Bank of America/Merrill Lynch

Okay. Thank you.

Operator

And Mr. Mario, as there are no further questions at this time, I will now turn the call back to you. Please continue with your presentation or closing remarks.

Mario Molina

Well, thank you everyone for joining us, and let me just close by encouraging everyone to go get a flu shot.

Operator

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

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