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Molina Healthcare, Inc. (NYSE:MOH)

Q2 2014 Earnings Conference Call

July 30, 2014 5:00 PM ET

Executives

Juan José Orellana – Vice President-Investor Relations & Marketing

Joseph Mario Molina – Chairman, President and Chief Executive Officer

John C. Molina – Chief Financial Officer

Terry P. Bayer – Chief Operating Officer

Joseph W. White – Chief Accounting Officer

Analysts

Michael A. Newshel – JPMorgan

Sarah James – Wedbush Securities Inc.

Peter Heinz Costa – Wells Fargo Securities

Joshua Raskin – Barclays

Kevin Fischbeck – Bank of America/Merrill Lynch

Chris Carter – Credit Suisse

David H. Windley – Jefferies

Thomas A. Carroll – Stifel, Nicolaus & Company

Andy Schenker – Morgan Stanley

Ana Gupte – Leerink Partners

Christian Rigg – Susquehanna International

Brian Wright – Sterne Agee

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Molina Healthcare Second Quarter 2014 Earnings 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, Wednesday, July 30, 2014.

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

Juan José Orellana

Thank you, Melody. 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, 2014. The company’s earnings release reporting its results was issued today after the market close, 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. If you have multiple questions, we ask that you get back in the queue so that others can have an opportunity to ask their questions.

Our comments today will contain forward-looking statements under the Safe Harbor provisions of the Private Securities Litigation Reform Act, including but not limited to forward-looking statements about the reimbursement of the ACA Insurer Fee, and the recognition of quality-based revenue by our Texas Health plan.

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 the SEC’s website.

All forward-looking statements made during today’s call represent our judgment as of July 30, 2014, 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 thank you for joining us today as we report our second quarter results. We are pleased that the results for 2014 are unfolding as we anticipated when we provided guidance in February.

The three key elements that we shared with you in February remain critical for our success in 2014, and they have not changed. These elements are the growth of membership and revenue, the provision of high quality cost effective care to our members and improving administrative efficiency.

The membership continues to increase and we finished the second quarter with approximately 2.3 million members up from 1.85 million members at the end of the second quarter of 2013, an increase of 22%.

In fact, we added over 100,000 members since last quarter alone. Much of this growth is due to the expansion of Medicaid that is added over 230,000 members since last year, and has exceeded the 160,000 new expansion members that we had projected in guidance at our February Investor Day.

Several sates including California, Michigan and Illinois where we have health plan operations have reported backlogs affecting the processing of applications for Medicaid. For example, California reported a backlog of 600,000 applications, but they expect to cut the backlog to 350,000 by September.

In Illinois, the backlog has decreased from 500,000 in April to 150,000 in June. As the states processed the backlog of applications, we expect to see our Medicaid enrollment continue to grow.

The new members that are enrolling as a result of the Medicaid expansion tend to be slightly older compared to our channel members. The Urban Institute estimated that nearly 50% of the uninsured are over 35 years of age, consistent with this estimate, about 60% of our Medicaid expansion members are over 35 years old. It is too soon for us to know exactly what the final cost and characteristics of these members will ultimately be.

Total revenue is tracking in line with our expectations, and is up 44% as compared to the second quarter of 2013, this is consistent with the growth in membership, and the shift to members that are older and have more complex medical needs.

These members come with higher premiums. At 89.3% of premium, medical costs are higher than the same quarter a year ago when they were 86.2%. However, it is difficult to make meaningful comparisons to last year, because of the change in our member demographics. What is more important is that, Medical costs are in line with the 89% that we projected in guidance for 2014.

Let me speak for a moment on Florida. First, it’s important to note that we have limited exposure in Florida due to our relatively small enrollment in that state, and that our participation in the Managed Medical Assistance or MMA program did not begin until July 1.

Once the program is fully implemented, Molina Healthcare will be operating in only three regions 7, 9 and 11, which geographically speaking represents Central Florida, the Florida Treasure Coast and South Florida. As part of the implementation of the new Medicaid contract awards in that state, we’ve had to exit some markets and start operations in others.

This has resulted in temporary declines in enrollment in June and July as we exited Tampa and Boulevard Counties. However, the membership decline will be offset with new membership in Miami-Dade, which started on July 1, as well as Orlando and Palm Beach Starting August 1. We will closely monitor the implementation to determine how it is tracking with our expectations.

The life and pharmacy costs reflects the higher cost of drugs in general. The increased prescription drug needs of some of our new members, and the cost of new drug such as Sovaldi. While the utilization of Sovaldi appears to have plateaued in the second quarter, we remain concerned about the high cost of Gilead Sovaldi and the impact it could have on state Medicaid budgets.

We are even more concerned about the future impact of specialty drugs, of which Sovaldi is just a single example. Competition generally brings with it lower costs. However, the specialty drug market may be an exception.

Senator Wyden from Oregon and Senator Grassley from Iowa recently wrote and “In order for a marketplace to function properly, it must be competitive, fair and transparent, it is unclear how Gilead set the price for Sovaldi that price appears to be higher than expected given the cost of development and production and the steep discounts offered in other countries, an efficient market needs to inform consumers to keep costs down”. We at Molina hope that in the future the pricing of specialty drugs by pharmaceutical companies will be competitive, fair and transparent.

Another important strategic objective for this year and next year is the implementation of six demonstration contracts for the coordination of care for patients eligible for both Medicare and Medicaid. These so called duals represent much higher medical costs than typical for Medicare or Medicaid beneficiaries. They tend to have multiple chronic medical conditions and they face obstacles associated with poverty that further complicate their care.

We are very proud to have been selected to participate in the Medicare/Medicaid plans demonstration programs. In addition to the 44,000 duals, we currently serve through our dual-eligible special needs plans, we began enrolling members in the MMP demonstration contracts in Illinois, California, and Ohio.

Recall, that these dual eligible beneficiaries are first given the opportunity to enroll with a health plan that will coordinate both their Medicaid and Medicare benefits. Those that fail to do so will be assigned to a health plan through the process of passive enrollment.

However, the beneficiaries have the right to elect, to continue to receive their Medicare benefits on a fee-for-service basis by opting out of the demonstration plan. We projected that 50% of the duals would opt out. Our experience so far leads us to believe that this is still a realistic estimate. There has been no change to the timeline for the implementation of our duals contracts for other states. We expect that these contracts will be implemented in Michigan, South Carolina and Texas in 2015.

In keeping with our commitment to have all of our health plans accredited by NCQA for Medicaid, we are proud to announce that our health plan in Wisconsin received accreditation from NCQA in April of this year.

Finally, we continue to see progress in administrative efficiency. Our general and administrative expense ratio declined sequentially to 8.4% in the second quarter of 2014. We expect this trend to continue as we guided to approximately 8% for the whole year.

The quarter was negatively affected by three issues. The first is reimbursement of the health insurance fee or excise tax that is part of the Affordable Care Act. The second is the non-deductibility of this fee that increases our effective tax rate. And the third is the decision by the company to delay the recognition of some of the quality incentive revenue under our contract with the state of Texas. These are the same issues that affected our earnings last quarter as well. John will discuss these three issues in greater detail in a moment.

The second quarter of 2014 much like the first quarter was consistent with our expectations and the guidance that we provided in February. We continue to make progress towards our goals for the year.

Now, I will turn the call over to John.

John C. Molina

Thank you, Mario, and hello everyone. As we previously discussed, we are focusing on adjusted net income as our reporting metric, as we feel it better reflects how we manage our business.

For the second quarter, adjusted EPS from continuing operations was $0.71 per diluted share. Overall, membership grew by 22% compared with the second quarter of 2013 and sequentially by 5%.

Premium revenue has grown again this quarter to $2.2 billion, up 12% compared with the first quarter 2014. General and administrative expense ratio declined sequentially by 70 basis points to 8.4% in the second quarter of 2014 from 9.1% in the first quarter of 2014.

The positive development I just outlined occurred despite some adverse factors which carried over from the first quarter of 2014. These include the delays in some of our states and securing agreements for the reimbursement of the Affordable Care Act’s Health Insurer Fee, as well as a gross up to cover the non-deductibility of that fee, and delays in the recognition of quality-related revenue at our Texas Health plan.

These delays reduced earnings by a combined total of approximately $23 million or $0.20 per diluted share for the second quarter and $45 million or $0.41 per diluted share for the six months ended June 30, 2014.

In other words, have we caught up in the second quarter with all of these timing differences, our year-to-date results would have been higher by $0.41. Total revenue this quarter increased by about $240 million, a 12% increase over the first quarter of 2014.

The increase was due mainly by higher Medicaid expansion enrollment. Since the first quarter of 2014, our Medicaid expansion membership experienced a significant jump of almost 100,000 members, a 75% increase.

As Martha mentioned, our current Medicaid expansion enrollment now exceeds the guidance of 160,000 that we laid out in February. As we previously discussed, we decided to delay recognition of a portion of the Texas Quality Revenue. To refresh your memory, the state implemented several new quality measures in 2014. Health plans earned this revenue by demonstrating improved performance for certain metrics in 2014 over 2013.

The calculation of these new measures is extraordinarily complex and is performed on the state’s behalf by a third party using proprietary software. It is the state’s intent to distribute 2013 base line data to health plans some time in the second half of this year.

We are calculating our performance against the measures today using our best estimates. But without seeing the state’s methodology, we believe it is prudent to see that our performance in 2014 is better than what the state has measured for 2013 performance, before we recognize any revenue for these measures.

In the first half of the year, we had about $13 million in quality revenue in Texas that we decided not to recognize. Medical costs this quarter experienced a modest increase partially offsetting the benefit from the increased revenue.

We don’t consider the change in medical care ratio between the first quarter and the second quarter to be significant. We believe that the rapid growth in our membership in the first half of the year coupled with the introduction of new benefits like long-term care services and new programs like Medicaid expansion make the fluctuations in medical care ratio between the first and second quarter less meaningful.

Our anticipation is that our medical care ratios will remain influx during 2014 driven by factors such as pent-up demand, retroactive eligibility changes, member confusion regarding when and how to access care, and delays in our receded claims for services provided.

However, we expect that the overall trend will remain in line with our guidance for the year. We are pleased to improve our administrative cost leverage this quarter. General and administrative expenses were 8.4% for the second quarter 2014, a decrease from 9.1% in the first quarter of 2014.

Our expectation remains that as new programs are implemented, and their associated revenues finally start hitting our books. We will gain further administrative leverage resulting in a lower administrative expense ratio. So far, the decline in G&A ratio is trekking closely to the quarterly estimates we provided at Investor Day, positioning us well towards achieving our 7.5% target for the fourth quarter of 2014, and an overall 8% for the entire year.

Finally, an update on our effective tax rate. The non-deductibility of the ACI Health Insurer Fee continues to affect our financial results through higher effective tax rates. We have recorded an effective tax rate of around 58% this quarter.

Days and claims payable was flat at 46. And as of June 30, 2014 the company had cash and investments of around $1.9 billion including approximately $300 million at our parent company.

The company’s guidance for fiscal year 2014 remains unchanged, and is as follows. Adjusted net income per diluted share in the range of $4 to $4.50; and net income per diluted share in the range of $1.65 to $2.15.

Our operations are tracking as anticipated as Mario suggested, but the timing of the ACA Health Insurer Fee in the Texas Quality Revenue may not be resolved until the fourth quarter. We believe these are timing differences not operating issues.

This concludes our prepared remarks. Operator, we’ll now take questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Justin Lake with JPMorgan. Please proceed with your question.

Michael A. Newshel – JPMorgan

Hi, this is Mike Newshel in for Justin actually. So with the variation of guidance, last quarter you said your bias was towards the upper end of the range, is there any change there in terms of how the quarter came in?

Joseph Mario Molina

I think that we’re tracking just as we’ve said in the script, and in the press release.

Michael A. Newshel – JPMorgan

So you won’t – you’re not earning the upper end of the guidance range, just sort of the whole – just laying out, it’s going to fall within the whole range?

John C. Molina

That’s right. And specifically on the MLR, I mean it sounded like, you go with an up tick that was – that may have fluctuated above what you’re expecting for the quarter, but still was in line for the full year. I mean is it in line with what you’re expecting for the quarter or just if not so high, that it’s still within the same guidance range?

Joseph Mario Molina

This is Mario, if you look at our Medical Care ratio for the first six months of the year, it comes in right at 89%, and that’s right in line with guidance.

Michael A. Newshel – JPMorgan

Got you. And specifically, on the Medicaid expansion, are they still tracking around 88%? That you mentioned.

Joseph Mario Molina

Again no, everything right now is tracking in line with guidance.

Michael A. Newshel – JPMorgan

Okay, great. Thank you.

Operator

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

Sarah James – Wedbush Securities Inc.

Thank you. It looks like California MLR just keeps improving. Things are going very well there. Are you guys paying back under the EBIT agreement by now, and what should we think about as a run rate MLR under that agreement?

John C. Molina

Sarah, this is John. No we have not started paying back we still have a reserve or receivable from the stake. I think the run rate for California again there is a lot of changes in California especially now with the doors coming on, but as Mario said I think overall the picture is we are right tracking with guidance.

Sarah James – Wedbush Securities Inc.

Got it. And I hit a several back on this, but when I think about specific to this quarter, and the expansion number should if I am kind of doing the math on where run rate have been for a couple of markets and where MLR ended up it's just looked like a little bit higher than the number and some of the expansion in states like Illinois, Michigan, Utah, Washington.

So I got the rest on tracks for the year, but just specific to this quarter are they at 88% or maybe that was never meant to be a quarterly specific number maybe that was the year end. Could you just talk about that a little bit.

John C. Molina

Sarah, here is the challenge while Illinois, Ohio and Michigan are expansion, they didn’t have much expansion enrollment in the quarter. It’s really hard to get that granular and give you folks a picture of the overall half of the company.

So, rather than try to figure out what the MLR is for the expansion population in X-state or Y state. The message is everything combined is tracking per guidance just like we have been talking about.

John C. Molina

Sarah, this is Mario. Let me just add if you look at the six biggest states that we have California, Michigan, New Mexico, Ohio, Texas and Washington, four of those states are tracking with MLR’s below 89%, and two of them are above. So again I think overall it’s tracking within expectation and I don’t place a lot of emphasis on a small state like Illinois, it doesn’t really impact the numbers that much. So, we tend to focus more on the bigger states.

Sarah James – Wedbush Securities Inc.

Okay. Thank you.

Operator

Our next question comes from the line of Peter Costa with Wells Fargo Securities. Please proceed.

Peter Heinz Costa – Wells Fargo Securities

If you look at most of your states that they grew in membership a little bit sequentially and yet the loss ratios mostly relative as well. So, just the new membership is coming on at higher loss ratios. But I guess it wouldn’t be a typical, but if that continues and you’re talking about the members coming on from the back of the state.

Do you think that your loss ratio should actually raise generally speaking through the rest of the year? And how confident are you that they’re not going to raise it at a more accelerated rate than you’re already looking at right now.

John C. Molina

So Peter we always have higher cost from the new programs come on as Mario said, for the first half of the year the MLR, we haven’t see or rather is about 89% we’re expecting to end the year by 89%, so I think that sort of addresses your question.

Peter Heinz Costa – Wells Fargo Securities

Yes, but if you look at the trend that you’ve seen, it seems like it would be driving it slightly different direction, so what gives you the confidence that it’s not going to continue to go with higher loss ratio as we go forward.

John C. Molina

Take California as an example. California is the state that’s had the most growth, and their medical loss ratio is actually coming down. So I don’t think you can just make a blanket statement that the medical loss ratio is trending up and they were not going to hit that 89%. We still believe that the guidance number 89% is the right number.

Peter Heinz Costa – Wells Fargo Securities

I am just looking at generally your state, the state patterns other than California. California is a little bit of an exception with an improving loss ratio sequentially. Most dealers once, it didn’t improve particularly where you had membership growth.

John C. Molina

Well. We still maintained at 89% that we’ve put in guidance is the correct number for the year. And Peter remember we will always discussed that has the population sort of ages in as we have more time to get people under care management et cetera, we can bring them the medical care ratio down. So while may gone up sequentially, it will start to track down.

Peter Heinz Costa – Wells Fargo Securities

Okay.

Joseph W. White

Peter, its Joe White speaking. Hi, as you can imagine, I’m speaking because we’re going to get into a technical discussion right now which we try to avoid. You also though have to look at when you measure the quarter-over-quarter developments, you have to look at the way our estimate of our 12/31/13 claims liability played out.

If you recall back to the first quarter, we anticipated picking up about $51 million of favorable prior period development from 12/31/13 that dropped to $37 million in the second quarter, about a $14 million swing. And within individual states, I don’t want to go into that much detail state-by-state, but prior period development of that size can move individual states pretty significantly.

Peter Heinz Costa – Wells Fargo Securities

That’s helpful. Thank you very much.

Joseph W. White

Sure.

Operator

Our next question comes from the line of Josh Raskin with Barclays. Please proceed.

Joshua Raskin – Barclays

Thanks. I just want to follow-up on Joe’s response here real quick, so relative to historical norms or normal course of business prior period reserved development was there any abnormal or was there any negative development in the second quarter.

Joseph Mario Molina

Certainly we did again Josh, I'm talking about the development to be clear of the reserve we established the 12/31/13. It didn’t come in as robustly, as we using anticipates. I think a couple of states may have actually met them below the margin, but the many states were essentially beneath the target margins I think we can’t attribute that any specific thing other than I just sink with the new membership we got sharing in January 1. I think our claims payment was delayed a little bit which extended our lag factors a bit.

Joshua Raskin – Barclays

Okay. And then massive pick on Illinois, but Illinois was like it’s mostly new membership right it’s tools and expansion. And the MLR is 106%, so is that – in my understand I would be surprised if you had enough claims data to make a call one way the other.

So I would assume that sort of an underwritten margin. So is that what you’re expecting, we are expecting based on the rates that you were seeing that you be in the 106% range. Or do you actually have some claims data already that putting you towards a level that is higher than expected.

Joseph W. White

Again it’s Joe speaking, and we’re venturing into a accounting technicalities here, but one of the real challenge is with according to the MCR in Illinois is that with anticipation the expanded enrollment and with anticipation of the dual eligibles coming on, we had a front load a lot of our medical management staff.

So, if you think a typical health plan, if you think consolidated basis, normally what we called quality assurance costs, medical management runs about 2.5% of revenue. And Illinois it’s running about 10% of revenue. So, certainly it’s one of our higher costs medical markets, but if you normalized for the administrative costs burden, the medical management burden, you knock about 10% off for that MLR for Illinois.

Joshua Raskin – Barclays

Got it. And you put all of those quality expenses in the medical cost line?

Joseph W. White

Correct.

Joshua Raskin – Barclays

Okay consistent with any IT guidelines et cetera. So and then, one more question for you the opt-out rates, I’m just looking at the second quarter, it looks like you're about 62%. I think you guys have been talking about 50% opt-out rate.

Can you sort of maybe just walk us through the timings of the dual roll out? So this is an issue where you’ve got a timing issue and that – this will migrate more towards 50% or is that 62% in line with your expectation?

Joseph W. White

Josh, it’s Joe and Terry is going to get into the more substantive business explanation of this in a minute. But as far as how we’ve reported this not the numbers, that the major factor here is Ohio. Unlike our other MMP states, in Ohio the state is enrolling in every one for their Medicaid benefits and the individual until January 1 to receive the Medicare piece of the MMP has to opt in.

So the result of that is, we are getting a lot of – we are starting to get members in Ohio who are default to just in the Medicaid piece of the MMP benefit, and have chosen not to opt into the Medicare piece. So the result of that is what you see right there on the – in terms of the way we disclose enrollment in the earnings release.

Joshua Raskin – Barclays

And so…

Joseph W. White

Terry is…

Terry P. Bayer

Josh I will just add two more factors and at this point we are telling you that we are tracking toward that 50% opt-out number which is one we put in guidance we don’t have any indication will not be there.

Some people opt-out before they ever come into the program some opt-out in the first month there are in the program, but what Joe just explained Ohio was a different situation where the path of enrollment will not begin until next January. So you got Medicaid coming in and then a voluntary opt-in on the others.

So there are so many factors I think we’ve discussed it late and look at Illinois, California and Ohio from our different points in the voluntary and passed that process and our conclusion is that we are not seeing that we will exceed that 50% of opt-in. The bottom line is too early to tell we are waiting for that information to finally come in.

Joshua Raskin – Barclays

So just to clarify in Ohio then, all of these individuals have been assigned Medicaid.

Terry P. Bayer

Yeah.

Joshua Raskin – Barclays

Possibly. And then they will get their Medicare assignment on January 1 possibly as well. And then there is probably an opt-out period after that as well.

Terry P. Bayer

Correct. They can opt out of Medicare at any time, I just want to also clarify for you the entire Ohio enrollment has not been assigned yet will that’s coming in segments and you are seeing in the June 30 numbers, only the first half in selected regions that will continue to occur over the next month or two.

Joshua Raskin – Barclays

Right. You will get a big bump in the auto assignment for Jan I and then it will sort of come down a little bit as people opt-out after that.

Terry P. Bayer

Yes. But even the Medicaid is coming in over the course of couple of months not all at once.

Joshua Raskin – Barclays

Got it. Okay. Thanks.

Operator

Our next question comes from a line of Kevin Fischbeck with Bank of America/Merrill Lynch. Please proceed.

Kevin Fischbeck – Bank of America/Merrill Lynch

Okay. Great, thanks. I am struggling to fully understand some of the commentary that you guys made so far. And I will get the 10-Q it looks like in the quarter California got a bunch of payments that were out of period revenue payments related to Q1 of 2013 which I believe may be MLR look lower by back that was not coming up with MLR up 150 basis points sequentially, is that the right way to think about it? And if so want to go back to the question earlier about revenue growth and rising trend in MLR?

Joseph Mario Molina

Sure. It’s Joe speaking yes. I think the way you laid it out is a way I would lay it out on, the California benefited from other period revenue adjustment in the quarter that more or less offset consolidated prior period development. So we didn’t see I need to call that one on a consolidated basis, Kevin.

But when everyone started to talk about individual health plan performance, I was just making the point that unfavorable prior period development on a comparative basis from the previous quarter easily squeeze other health plan MLRS. So I think the way to look at it is without going into too much detail, California’s MCR helped by the $15 million of out of period revenue, the other health plans hurt by prior period development.

Kevin Fischbeck – Bank of America/Merrill Lynch

Yeah. I think the number was 2015 the sideline Q1 that’s obviously a 2014 numbers, do you include in the 2014 to offset 2015, 2013 that you would back out?

Joseph Mario Molina

Exactly, 2015 versus 2015 for last year.

Kevin Fischbeck – Bank of America/Merrill Lynch

Okay. So I mean it does seem then like on a normalized basis that generally speaking I understand the concept of relating that’s hard to get a clean numbers if you don’t have prior, but it’s still directionally feel that the comment before that new enrollment coming and higher costs.

Generally speaking is the right way to think about it and I think you guys have also talked about that historically that when you don’t have visibility on claims you take a little bit more conservative thoughts on MLR, So it is interesting that we have that enrollment coming on normally we would think it should be a higher MLR, the bridge in the ramping guidance is pretty dramatic obviously you are expecting to get the healthcare insurance fee in terms of payments.

So, I just trying to think about the bridge there is it all about the G&A reduction and exceeding that is that kind of other big reason for the dramatic increase in earnings when MLR might not be the answer.

Joseph Mario Molina

That’s a big. It’s Joe speaking again. That’s a big chunk of it. I don’t want to model for everybody, but if you look at if you do the, if you look at where guidance is at on the revenue side versus where we’re today for the first half and then take the impact of the admin ratio, we talked about for the year which we still believe we’re going to get, it’s a pretty substantial number drop into the bottom line.

Kevin Fischbeck – Bank of America/Merrill Lynch

Okay. And then just last question on the Texas incentive payments, just want to get an update, any color you can provide about your conversation you had with the state about where you’re versus those numbers and obviously that’s maybe restriction way it actually book at the just any color you have about the confidence of actually hitting those numbers.

John C. Molina

This is John. We’ve got our own internal calculations that we feel pretty comfortable with our performance is improving, but until we see what the base line is and we have to get that from the state and they have to get that from the third party vendor it’s impossible for us to know.

Kevin Fischbeck – Bank of America/Merrill Lynch

Is that timing on the Q3 event or is that Q4?

John C. Molina

They have told us Q3, but space it we recognized that often times when states are rolling out new data that there are delays.

Kevin Fischbeck – Bank of America/Merrill Lynch

Okay. All right. Thanks.

Operator

Our next question comes from the line of Chris Carter with Credit Suisse. Please proceed.

Chris Carter – Credit Suisse

Thanks, good afternoon. Just quick when I go back to your Investor Day book, I think I come up with a target of around 60,000 duals I think you’re targeting for the year. I mean you guys on pace for that, given where you are today?

John C. Molina

That’s a good question.

Joseph Mario Molina

I think it’s Joe speaking again, I mean, I think that point since and we’ve talked about the delays is the rollouts in…

John C. Molina

South Carolina.

Joseph Mario Molina

Michigan and South Carolina. So, we don’t want to go in that level of detail, but I think it’s fair to say we’ll come up a little bit less than that.

Chris Carter – Credit Suisse

Got it. Okay. And then just on the Texas MLR, I mean that looked elevated in the quarter. Is that just simply related to the revenue recognition or anything else going on there?

Joseph W. White

It's Joe speaking. Again, yes, it’s the revenue recognition it’s also if you look at it compared to last year it’s also add to do with some timing of recognition of profit sharing to back of the stay.

Chris Carter – Credit Suisse

Okay. All right. Thank you.

Operator

Our next question comes from the line of Dave Windley with Jefferies. Please proceed.

David H. Windley – Jefferies

Hi, thanks for taking the question. So a follow-up on the dual Medicare opt-out, I’m wondering beyond the obvious that you don’t get the medicare premium portion, are there other implications to that opt-out in terms of your ability to manage the members care and perhaps the saving assumptions that are baked into the premium that you are getting.

John C. Molina

I think that we are still going to be responsible for managing the long term care benefits. The savings that are baked in are baked in only for the MMP program. So if they are not fully enrolled there is no savings expectation.

They are essentially like our Texas STAR PLUS members, where we are responsible for the long term care benefits, but there is no associated savings, the savings idea was that if you could co-ordinate the care for both Medicare and Medicaid there would be some synergy and some cost savings, to the extent that the members don’t participate in both programs that are outside of that contract.

Joseph W. White

And that how we have modeled it in our guidance.

David H. Windley – Jefferies

Okay and so you feel like the premium that you will get in opt-out situation is appropriate for the benefits and the savings that you’re responsible for?

Joseph W. White

That’s right.

David H. Windley – Jefferies

Okay.

Joseph W. White

Yeah. And I also think that there is an opportunity later on for those patients to voluntarily enroll, if they choose to. And I think that if we do a good job of managing their other Medicaid benefits, they may gain confidence in health plan and decided that they want to fully participate. So it’s not as if these members are permanently gone on the Medicare side, they could come back to us later.

David H. Windley – Jefferies

Sure. Are there – on that point, are there other steps that you can take that would change the proportion of opt-outs, change the network and things like that?

Joseph Mario Molina

Well certainly one of the reasons that people opt-out in the Medicare side is if we don’t have their provider in the network. And it becomes more difficult on the Medicare side because these beneficiaries have multiple positions, whereas typically on the Medicaid side, the real contact with healthcare is through their primary care doctor.

On the Medicare side, it’s often the specialist. And if you’ve got four or five specialists and one of them is not in our network, you may opt-out. So as time goes on, I think we will shore up the network. We do get information about who the providers are.

David H. Windley – Jefferies

Gotcha. So last question, coming back to the MLR, there is lot of focus on the new members that are coming in or will come in over the balance of the year and impact on MLR. What about your expectations for MLR underwriting margin for the members that we’re looking at today.

The decline as they mature into your plants and the medical management resources that you have in place, maybe you could talk us through proactive steps that you are taking to make sure these folks get into plans and their cost experience declines as they seize them.

Terry P. Bayer

This is Terry. We’re executing on our model of care that we have been working on and focused on the last few years. We use a model of care whether each trying to stable patients in our Medicare D snip and we’ve extended it now to the new enrollment. The patients are all risk assessment is completed upon their entry to the program and they are dependent upon that are modeling tools and our tearing of the severity and the need for immediate intervention. Folks are getting assigned to case managers.

I think we have shared with you in the past we’re focused on community connectors and care transition workers, so that we’re working with members in their homes and when they leave the hospital just as much as we’re managing them during their in-patient stage.

So our full care management model which is very focused on coordinating medical, behavioral and social needs is in play on these members, not 100% on day one and that’s where our triage mechanism come in place, so that we can focused on those of most greatest need in the beginning.

There is also medication therapy management programs that come, so all of the members who have a high number of medical diagnosis and prescription drugs are each in dialogue with the registered pharmacist to coordinate their drug program and that’s another way that we focused on those most greatest need in the beginning.

David H. Windley – Jefferies

All right. Thank you.

Operator

Our next question comes from the line of Tom Carroll with Stifel. Please proceed.

Thomas A. Carroll – Stifel, Nicolaus & Company

Yes, good afternoon. I wonder if you could talk about the process that you are taking with your states to get the ACA fee totally covered and wrapped up above. I thought by this time of the year, you might have a bit more visibility on it. So is there, are you more conservative in your process make? Additional color will be helpful there?

John C. Molina

Sure, Tom. This is John. I think one of the important things is, we’re waiting for a contract language. So while there are a couple of states Utah and Michigan, where the legislature has passed budget appropriations to cover the fee and the gross app, we’re not going to recognize that revenue until they get a contract amendment.

Thomas A. Carroll – Stifel, Nicolaus & Company

Okay. And then just to clarify one other thing, did your prior guidance also excludes of all these spending?

John C. Molina

Yes.

Thomas A. Carroll – Stifel, Nicolaus & Company

So it did, your prior. I guess one when was that I’m just trying to figure out when that – when you excluded that was in your Investor Day?

John C. Molina

That wasn’t Investor Day.

Thomas A. Carroll – Stifel, Nicolaus & Company

Okay very good. And then is there any comment you could – you were hesitant to comment on first quarter bouts of all the spending, but may be and I appreciate the comments about telling, is there any kind of order of magnitude description you could give to us kind of first quarter into second quarter?

Joseph Mario Molina

Yeah, this is Mario. I don’t want to quantify that. Certainly the spending in the second quarter was greater than the first quarter. We request for the drugs seem to plateus, so we think that that’s going to flat now. And, I think that part of that is an expectation if there are new drugs in the pipeline and so some positions maybe waiting for those new treatments.

Thomas A. Carroll – Stifel, Nicolaus & Company

Okay, thanks for that.

Operator

Our next question comes from the line of Andy Schenker with Morgan Stanley. Please proceed.

Andy Schenker – Morgan Stanley

Hi, it’s Andy Schenker, thanks for the question. I’m just following up on the some falsy comments there. I mean you previously highlighted obviously we got the team in Florida. You guys had acknowledged it and these Texas acknowledged that the drug wasn’t in rates.

I mean how are those conversations going with Texas that reimbursement as they are specifically going forward and how your conversation and the other states potentially is going to pay retro actively and then as your expectation, it will be in rates when they renew?

Joseph Mario Molina

As a whole lot of questions here, Andy.

John C. Molina

Yeah, I’m not aware that any worth playing pays retro actively I think that states are talking about what they can do on a prospective basis and I think that what I would say is it’s all over the math, every state is taking a slightly different approach to this and I think they are building that into the rates for next year.

As I stated in my remarks earlier a big part of our concern is not just above all of, but all the other specialty drugs and I think that the governments needs to step in here and make sure that the market is rationale.

If we as a health plan with rate increase, we have to go to our regulators and get it approved. There is no such thing going on in the pharmaceutical market. Right now, pharmaceutical companies can charge whatever they want and I think there need to be rational basis for all this.

If we’re going to cover all of these people, all these uninsured people, the only way to do that is by bringing down healthcare costs and we can’t do that if we see a large number of specialty drugs that sell at the medical trend.

So it’s a problem not only for Medicaid companies, but it’s going to be a problem for Medicare, for the VA and for commercial plans. This is truly a national problem that’s going to affect everyone.

Andy Schenker – Morgan Stanley

And just following-up, on your states that are off talented to fiscal year rate increases, any updates on how those rate discussions are progressing?

John C. Molina

We generally don’t talk about how rates are progressing until we actually get rate manuals, rate sheets et cetera. But as Mario said, it does run the (indiscernible) from folks like Florida doing payment to others are going to increase the rates as certain percentage specifically for Sovaldi or our specialty drugs like Sovaldi.

Andy Schenker – Morgan Stanley

I think and also just beyond on Sovaldi just in general how discussions are trending?

John C. Molina

I think that with the discussions on the ACA fee and Sovaldi, those have sort of taken the forefront. So there hasn’t been a lot of discussion yet about base volume trends other than for Sovaldi et cetera. I think that now that we’re getting that populations in the MMPs getting in the Medicaid expansion, getting some data, will some of those discussions and trends to the forefront.

Andy Schenker – Morgan Stanley

Okay, thanks.

Operator

(Operator Instructions) Our next question comes from the line of Ana Gupte with Leerink Partners. Please proceed.

Ana Gupte – Leerink Partners

Thanks, good evening. Appreciate for taking my question. I wanted to do get some qualitative color if you can offer it at this point on the Medicaid expansion lives as far as the venue or the site that they are presenting themselves. What types of services are they seeking? And you think about the premiums of about 50% to 200% higher depending upon with state you are in.

And do you think there is adequate rates in there to cover maybe the upfront our patient pharmacy emerging you know those types of costs for potentially untreated, unmanaged patients.

Joseph Mario Molina

Ana, this is Mario. As I said before, the patients are older than our typical tenant members, but I still think it’s early for us to be making statements about the rates or the place of service or the kinds of services that they are getting.

I mean for example we picked up a 100,000 members from the first quarter to the second quarter, and so I don’t feel that we have enough claims data yet to be making those kinds of statements beginning into lot of the member characteristics or healthcare patents yet, I think its developing and, we’re just going to have to watch it and maybe we can update you on that in future quarters, but right now it’s probably to assume.

Ana Gupte – Leerink Partners

And then the hospitals I think some of them are talking about, expecting the outpatient care might trend down and it eventually transition to the inpatient setting or you has a health plan taking any step to get primary care interventions or anything of that nature, is this just going to kind of happen relatively unmanaged and they end up in the ER and so the plans don’t really have that much control over what happen?

John C. Molina

Well, we certainly hope that this is not going to be on Managed Care, that’s sort of what we’re here for. And we are trying to manage the patients as best we can. As Terry mentioned for a lot of the patients we’re doing initial health assessments, we’ve got all kinds of care managers, John talked about the investments we made in Illinois. Across the board and this is reflected in our admin costs, we staffed up and you saw a lot of that infrastructure growth last year.

So I wouldn’t say that this is just going to develop in an unmanaged fashion. We’re learning as we go. We will try to continue to improve on the method of care for these numbers, but I’m hoping that the tools we have will help us to manage them.

Ana Gupte – Leerink Partners

And then with the States, at the point when you and the states together can make decision as to whether the rates were adequate or in excess or too little. Let’s assume they were excessive. Do you think the states will manage the margins to where they think they should be through a risk corridor, MLR floor type mechanism or on top of that there may be some rate adjustments?

And if there were rate adjustments, do you think the states will use the expansion population in the federal subsidies to manage against their budgetary constraints in other areas that (indiscernible) that type of thing?

John C. Molina

Ana, this is John. I am not sure how a state could do what you’re discussing in terms of the last point. These are federal dollars, so I don’t know how the state could use it for their budget issues.

There are number of states that have caps and floors with respect to the expansion populations, but the rates for the expansion populations have to actuarially sound. And so as we get data in on demographics and utilization, we’ll have discussions with the states on what the appropriate rates are.

Joseph Mario Molina

Yes, Ana, I think that’s an important point that John just made. In addition because of these sort of rate quarters that we have in lot of the contracts, there is some additional mitigation that you don’t see. We set aside money for claims that have been incurred but not received yet but there is also risk quarter or mitigation factors that will help us as well.

Ana Gupte – Leerink Partners

And then we last talked I think there was something about a rate change in July, did that actually materialize and then California I might have just missed that all together but.

Joseph Mario Molina

California is looking at rates per certain counties in July but I don’t know haven’t seen them all yet and don’t know what the impact on the expansion if any is.

Ana Gupte – Leerink Partners

And then finally just on duals with the opt-outs that you’re seeing any sort of selection in that opt-out equation where the more acute care utilizes for the Medicare portion of this some more likely to opt-out because they get more unmanaged usage of that sort of (indiscernible).

Joseph Mario Molina

Well, we really don’t know. What I’d say as this. The members opt-out is a voluntary choice on their part. And we don’t have a lot of insight into things like what their prior care or what your health status today at a time they are opting out. We really don’t any get an information as to why they opt-out. It’s really anecdotal information that we get.

We suspect based on our experience with the dual eligible special needs plans, that a big driver of this are the providers and the provider network that we have. But I can't give you that kind of detail as to who’s opting out and why and what their patterns of utilizations are, that’s just something we don’t have any insight into.

Ana Gupte – Leerink Partners

And if I could seek on last follow-up on that point you made, do you do any outreach to these other same people so that you know who you’re reaching out to and trying to keep and retain within the system either through the provider base or any other channel.

Joseph Mario Molina

The moment that we are allowed to reach out to these members, we do so.

Ana Gupte – Leerink Partners

Okay, all right. I appreciate the color.

Operator

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

Christian Rigg – Susquehanna International

Hey, guys, thanks for taking my question. I just want to sort of kind of dumb down the guidance for the year and make sure I understand what exactly the message is. The year-to-date EPS is $0.26, the normalized for the health annualized was about $0.60 and then the taxes issue annualized about $0.24, but it gives you to roughly a $1.20 which leaves you $0.45 to $0.95 from your guidance.

I guess is the message on the low end, do you think you can get there just on G&A improvement and then to get to the upper end we need to see the MLRs come down a bit?

Joseph Mario Molina

This is John. I hate to make it that (indiscernible). As we’ve discussed, there is a lot of moving parts. But I think if you want to characterize it that way, I would think that just bringing the G&A down, that would get us beyond the low end.

Christian Rigg – Susquehanna International

Okay. And then, the DCP remained at an elevated level here from the first quarter and I guess I’m just trying to get a sense for what’s the right level to think about as we move into the back half of the year or maybe just a little bit longer term.

Joseph W. White

Joe speaking. Are you asking about what’s the right level for DCP is?

Christian Rigg – Susquehanna International

Yes, I mean it looks like there is some conservatism baked into that and you’re not alone in the industry at this point, but I’m just trying to figure out where you think that shakes out overtime.

Joseph Mario Molina

We don’t put a lot of stock in DCP, but I think you can expect it come down a day or two as the population mature, we work through our client backlogs and we get more confidentially where we are in terms about cost estimation.

Christian Rigg – Susquehanna International

Okay. And then my last question or questions, I guess the health insurance fee and the remuneration for that, is that still a split like an (indiscernible) split between the states and the fed’s picking up most of that on behalf of the states?

Joseph Mario Molina

It is a split. Part of it is contributed by the state, part of it is contributed by the feds.

Christian Rigg – Susquehanna International

Right and then I mean this is kind of crazy, but then when you think about Texas and sort of where they are cortically, big rate of governor who seems to low everything about the ACA, is there any political element in your mind with regard to them not agreeing, you have to remunerate that because they may just say, hey we don’t care, it’s a federal tax and we don’t want any part of it.

Joseph Mario Molina

Well, what I would say about that is, that we have a very good relationship with the Health and Human Services Commission. And we have dialogue with them as do the other health plans. I would not describe a lot of political mode of do anything at this point.

Christian Rigg – Susquehanna International

Okay, great. Thanks a lot.

Operator

And our final question comes from the line of Brian Wright with Sterne Agee. Please proceed.

Brian Wright – Sterne Agee

Thanks, and I apologize I may have missed this. But could you talk a little bit about the sequential move in Michigan on the MLR to just give us some understanding to what happen there?

Joseph W. White

Hey, Brian, it’s Joe speaking. That’s one of those mechanical developments in terms of how 12/31 changed, if that combined and again the numbers are small and consolidated but they are relative to some revenue adjustments on Medicare there.

Brian Wright – Sterne Agee

Okay.

Joseph W. White

Not significant enough to move the needle consolidated but they can impact on the health plan.

Brian Wright – Sterne Agee

Okay, thank you.

Operator

Dr. Molina, there are no further questions at this time. I’ll turn the call back over to you.

J. Mario Molina

Well, thank you all for joining us today, and we look forward to talking to you with our next quarter results.

Operator

Ladies and gentlemen, that does conclude today’s conference call. We thank you for your participation and ask that you please disconnect your lines. Thank you and have a great day.

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