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Executives

Julie Loftus Trudell - SVP, IR

Jim Carlson - Chairman and CEO

Jim Truess - EVP and CFO

John Littel - EVP, Government Relations

Dick Zoretic - EVP and COO

Analysts

Scott Fidel - Deutsche Bank

Tom Carroll - Stifel Nicolaus

Carl McDonald - Citigroup

Joshua Raskin - Barclays Capital

Ken Levine - UBS

Peter Costa - Wells Fargo Securities

Chris Rigg - Susquehanna Financial

Sarah James - Wedbush

John Rex - JPMorgan

Scott Green - Bank of America

Sam Wass - Goldman Sachs

Brian Wright - Citadel

Amerigroup Corporation (AGP) Q2 2011 Earnings Call July 29, 2011 8:00 AM ET

Operator

Welcome to Amerigroup Corporation’s second quarter earnings conference call. (Operator Instructions)

I will now turn the conference call over to Julie Loftus Trudell, Senior Vice President, of Investor Relations at Amerigroup.

Julie Loftus Trudell

Good morning and thank you for joining Amerigroup second quarter 2011 conference call and webcast.

With me this morning are Amerigroup’s Chairman and CEO, Jim Carlson, and Chief Financial Officer Jim Truess. In addition, Dick Zoretic, our Chief Operating Officer, and John Littel, our Executive Vice President of External relations, will be available for questions.

The press release announcing our second quarter earnings was distributed this morning. A replay of this call will be available shortly after the conclusion of the call through Friday, August 5th, 2011. The numbers to access this replay are in the earnings press release. The conference call will also be available through the Investors page of the company's website, approximately two hours following the conclusion of this live broadcast for 30 days. For those who listen to the re-broadcast of this presentation we remind you that the remarks made herein are as of today July 29th, 2011 and has not been updated subsequent to the initial earnings call.

During this call we will make forward-looking statements including statements relating to our growth prospects, rate, medical cost trends and our 2011 outlook. Listeners are cautioned that these statements are subject to certain risks and uncertainties many of which are difficult to predict and generally beyond our control. These risks and uncertainties can cause actual results to differ materially from our current expectations and we advise listeners to review the risk factors discussed in our press release this morning and our filings with the SEC.

I’d now like to turn the call over to our Chairman and Chief Executive Officer, Jim Carlson. Jim?

Jim Carlson

Thank you, Julie and good morning. Let me start this morning with some highlights and perspective on the quarter. We reported second quarter earnings per share of $0.83, results in the quarter were negatively impacted by a retroactive premium adjustment in Georgia. Jim will walk you through the details of this in a few minutes.

We are pleased with the underlying results of the quarter, excluding prior period items, the second quarter performance was in line with our expectations, were revenues not adversely impacted by the Georgia adjustment, the second quarter margin would have been at the high end of our targeted range. We went into this year believing that 2011 will be pivotal in setting the stage for future growth and we are seeing that emerge with an existing markets as well as new markets, like Louisiana.

We are devoting considerable attention to making sure that we are disciplined in pursuing new business opportunities even as we fortify our capabilities. We want to make sure the growth we take on is likely to become profitable growth. On Monday, the Louisiana Department of Health and Hospitals announced that Amerigroup was one of five managed care organizations selected through a competitive procurement to offer healthcare coverage to almost 900,000 low income Louisiana citizens. Of the five selected, we will be one of the three providers that will offer services on a full risk basis beginning in the first quarter of next year.

Currently Louisiana has approximately 1.2 million Medicaid beneficiaries in a largely unmanaged program with potentially 400,000 more with the implementation of the Affordable Care Act. Louisiana has consistently ranked in the top states in Medicaid spending but far lower in terms of quality of care. Consequently we view this as a tremendous opportunity to provide solutions to Louisiana’s formidable Medicaid challenges. The Governor and the Department of Health and Hospitals conducted an exhaustive process over the past four years to improve Louisiana’s Medicaid program. They took a thoughtful measured approach fully examining the program and assessing their capabilities to make improvements, studying other state approaches and best practices, engaging a broad array of stakeholder including providers, advocates and other health policy makers and designing the program in the open, allowing input at each stage and communicating clearly throughout the process.

As for long-term prospects of the state there remain many opportunities to grow, behavioral health, dental and pharmacy are currently carved out. There are also additional populations such as dual eligibles and those requiring long term services and support that are currently excluded.

We see those areas as opportunities for future growth as the program matures and demonstrates its effectiveness. We are excited about the opportunities to serve the citizens on Louisiana and look forward to a positive partnership with the state. While we are on the subject of our fees, I would like to discuss the recent Kentucky procurement. We wanted to enter the state and we believe we had a solid hit. Kentucky invited us to further negotiate price, ultimately we could not get comfortable with the price we were asked to accept. We remain disciplined in our approach to new opportunities and quite frankly believe our investors except us to apply such discipline especially when there are numerous opportunities available to expand our business.

Beyond these new states, we are quite pleased with the results of the state legislative process this year and the resulting expansion into our existing markets. Let me provide some highlights. As part of the Medicaid redesign efforts, New York has moved both pharmacy and personal care services into managed care. New Jersey is carving an additional benefits in population in 2011, benefit changes include carving communicating based services and therapies for all populations effective July 1st. In addition, pharmacy and home health services will be carved into the ABD non-dual population. Duals and non-duals currently in fee for service will be mandated into managed care throughout 2011. In Virginia we expect to go live in the Winchester area in September and then to eventually expand into the Southwest region.

Finally and most significantly, we anticipate that the awards for the Texas re-procurement and expansion will be made in early August. As we plan for 2011, we’re mindful that medical cost trends were stable and we had enjoyed results of our targeted level of profitability for several quarters. We knew that medical cost trends and margins would inevitably migrate to more typical levels. As many of you will recall, in the fourth quarter of 2009, we saw medical cost trend moderate significantly following the abatement of the H1N1 influenza outbreak. Since then we and many others in the industry have been pleasantly surprised that trends have remained quite low.

In the second quarter, we believe we are seeing modest elevation in our medical cost trends. The aggregate trend remains low by historical standards and after an extended period of abnormally low trend, a modest increase should not be surprising. Another perspective we held is we approached 2011 was an actuarial soundness we continue to drive the rate process. From everything we see that has certainly been the case. Actuarial soundness grow better rates than many expected over the past few years and now it's producing rate for the reflective of last year's lower medical cost trends I just mentioned. The process cuts both ways and while rate actions are down in the number of states, the changes are actuarially sound.

This morning we are adjusting our aggregate (inaudible) rates for the year downward a bit although we still have a few states that have not finalized their processes. Here are some updates [on this].

The New Jersey rates increases approximately 1% inclusive of risk adjustment. Tennessee rates which reflect the significant cost moderation we have seen in the market are decreasing approximately 5%. Rates for Virginia which were decreased approximately 3% again reflecting favorable experience in the market. In New Mexico, the rates reflect a 3% trend increase. Texas rates are effective in September, but the process is largely finalized now. The rate decrease will be approximately 5.4% which includes certain direct pass-through provider fee reductions by the state. There are also certain state initiated fee reductions that will not pass directly through. Therefore, we are initiating targeted contract renegotiations in medical cost savings initiatives to mitigate the difference. Further, it is important to remember that we have historically rebated substantial amounts of premiums and taxes under the gain sharing model, well in excess of $40 million last year. Depending upon the magnitude of cost savings that we are able to ultimately achieve, we may rebate a smaller amount of premium under the gain sharing model in the coming contract year. On balance, the impact of the rate cut is muted by this gain sharing model. All of our observations indicate that the states continue to follow an actuarially sound process and we recognize that the rate actions we see this year reflect the moderation of medical cost trend in the base period.

So, it is important to keep in mind two things, trends still remain modest by historical standards and second the rate of cost spread we expect to experience for the balance of the year should yield acceptable margins and profitability for full-year 2011 at the upper end of our historical target range of 2.5 to 3.5%.

The final point I’d make about our expectations going into 2011 is that we knew this would be an important year for maintaining our momentum relative to (inaudible) critical operational imperatives. We continue to strengthen our clinical quality performance and we are very excited by the progress we are making in building more collaborative and substantive relationships with providers particularly physicians in private practice who serve low income patients. More on this at our upcoming Investor Day.

Our balance sheet continues to be strong another topic Jim will review, but my perspective is that the growth opportunities we are seeing make the balance sheet particularly important at this time due to the need to capitalize subsidiaries in proportion to the growing revenues. We are expanding in New Jersey, New York and Louisiana and we hope to expand our presence in Texas. We believe our balance sheet and operations are well positioned to take on these new opportunities.

Well all of the attention on Medicaid spending in state legislative session allow us to promote our value proposition even further. Saving tax pay dollars while improving access to care and better health outcomes and at a time when it is most needed. This have turned into the robust growth opportunities I highlighted in our existing markets. Similarly the national debate over the debt ceiling and longer term cuts may offer even greater opportunities for growth. Some changes (inaudible) programs are inevitable in virtually every deficit reduction scenario but there are several options that we believe would have grew services and save significant dollars. For example, an expansion of long-term care recipients in managed care on a national basis or mandatorily enrolling to dual eligibles as envisioned in the (inaudible) recommendations will produce tens of billions of dollars in savings over a 10 year period. Combined state and federal spending for dual eligible individuals exceeds $300 billion annually.

A full integration of Medicare and Medicaid services for the duals will produce even more savings as well as far better health outcomes for the individuals enrolled. To that end CMS recently issued a letter to the states encouraging them to develop integrated partnerships among the states, federal government and health plans. This is potentially very important from both the policy and opportunity perspective. CMS has exclusively recognized the importance of state long-term care programs and the fact that Medicaid health plans enjoyed the advantage of existing state relationships as well as experience managing the needs of low income seniors in people with disabilities.

As a leader of long-term services and supports, Amerigroup is extraordinarily well positioned for this potential new opportunity. These are all viable and sensible recommendations that we believe can produce significant savings and better care. We look forward to working with policy makers on this and other suggestion in discussing it further with you at our Investor Day in September.

So with that I’ll turn the call over to Jim.

Jim Truess

Good morning everyone. Today I want to cover highlights in the quarter including a discussion of the Georgia retroactive premium adjustment, a review of our health benefits ratio results in the quarter, as well as some thoughts on our balance sheet and cash flow. I will wrap up with an overview of our updated outlook parameters for 2011.

For the second quarter, net income was approximately $44 million resulting in diluted earnings per share of $0.83. This compared to $70 million or $1.37 in the first quarter of 2011. Premium revenue for the second quarter of 2011 increased 6.6% to 1.52 billion versus 1.43 billion in the second quarter of 2010. Sequentially, premium revenue decreased 12.4 million or 0.8%.

Second quarter 2011 results were negatively impacted by a $13.8 million retroactive premium adjustment in Georgia. This premium adjustment reduced diluted earnings per share by $0.16. It's the magnitude on the current price this is a fairly unique situation for a state. I want to spend a moment on some of the details.

We recently identified anomalies in the monthly membership files we received from the State of Georgia indicating that the state was not current in its process of merging duplicate enrollment records. For various reasons it is common for Georgia to assign members more than one Medicaid number which results in (inaudible) enrollment records and duplicate premium payments for the same member. In normal course the state attempts to correct these duplicate member records in a timely manner.

Based on our enquiry to Georgia regarding these membership files, the state initiated a comprehensive review that uncovers systemic membership record problems impacting the health plans since the start of the program in 2006. Following this review the state notified all health plans of the premium payments, the state believes should be returned as a result of duplicate member identified during the review.

We have established an estimated liability for premium payments we believe will be returned to the state. But the correction process doesn’t end there. The membership record changes go back many year to periods of time that have been or are being used as the basis for per member premium rates paid by the state to the health plan.

Since the membership accounts were overstated, the per member rate have been understated, and we believe that needs to be addressed. While we have been advised that the state intends to address these premium rate issue through settlement agreements with the health plan, we have no established a receivable for any such amount because in our opinion any settlement value cannot e estimated with an adequate level of accuracy for establishment of an asset on the balance sheet at this time.

There are two other factors that compressed revenue in the quarter. Accruals for premium rebates associated with state gain sharing arrangements were elevated in the quarter, also other routine prior period revenue adjustments were on balance slightly negative. These factors together explain why premium revenue declined sequentially when our membership increased.

Second quarter investment income and other revenues were $4 million essentially in line with the first quarter of 2011. On a year-over-year basis recall that the second quarter of 2010 investment income and other included $4 million due to the sale of the trademark.

Health benefits expense as a percent of premium revenue was 84.1% for the second quarter of 2011 versus 82.3% in the second quarter of 2010, and compared to 81.8% in the first quarter of 2011. The sequential increase in the health benefits ratio was due in part to the retroactive premium adjustment in Georgia that unfavorably impacted the health benefits ratio by 80 basis points.

Favorable reserve development net of associated premium rebate accruals for experienced rebate in Texas, applicable medical loss ratio, (inaudible) and other gain sharing arrangements with state customers positively impacted the health benefits ratio on the second quarter by 50 basis points compared to a 140 basis points in the first quarter of 2011.

(inaudible) were made modest during the second quarter relative to long-term norm as Jim mentioned, there are emerging signs of trend to begin to move up from the unusually low levels experienced in prior quarters. As we have discussed in the past our expectation has been that medical costs trends were unlikely to remain at low or even flat levels for an extended period of time as I had in 2010.

While I’d hesitate to establish any definitive conclusions based on one quarters worth of experience, I do believe we are beginning to see trends emerge again. This is not a surprise. And based on the visibility we have today trends remain modest by normal standards.

Selling, general and administrative expenses were 8% of total revenues for the second quarter of 2011 versus 7.5% in the second quarter of 2010 and compared to 7.6% for the first quarter of 2011. Selling, general and administrative expenses increased sequentially primarily due to scheduled increases in compensation. We implement annual merit increases in the second quarter each year. Total SG&A expenses were in line with our expectations for the quarter.

Second quarter tax rate was 36.2% versus 37.5% in the first quarter of 2011. The rate decrease is primarily attributable to a decrease in the blended state income tax rate resulting from increased income in states in which we are not subject to income tax. Our year-to-date tax rate of 37% is a good indicator of the trajectory for the full-year.

Cash and investment at June 30th, 2011 totaled 1.84 billion of which 255 million was unregulated compared to 269 million of unregulated cash and investments at March 31st, 2011. During the quarter we collected $40 million in dividends from our health plan subsidiaries, this inflow of funds to the parent company was offset by a repurchases of approximately 815,000 shares of our common stock for $55 million pursuant to our ongoing share purchase program driving a slight decline in unregulated cash.

Our subsidiaries remain well capitalized, our weighted average risk based capital ratio across our health plans is approximately 490%. I believe this represents a highest level of capitalization for the health plans we have ever achieved. We currently expect to collect close to $100 million in net dividends from our subsidiaries in the second half of the year. Our strong performance allows our health plans to build robust capital positions and generate dividend income to the parent company.

Our debts total capital ratio decreased to 16.6% as of June 30, 2011 from 16.8% as of March 31, 2011. At 16.6% we are comfortably at the lower end of industry norms and below our targeted debt to capital range of 20 to 30%. As s reminder our convertible notes are due in May of 2012. So they moved up to the current liability section of our balance sheet this quarter. Prior to this maturity date we intend to secure new debt as a replacement for these notes. Because our leverage ratios remain low we may choose to borrow more than the principal value of the notes and thereby generate increased liquidity.

Medical claims payable as of June 30, 2011 totaled $520 million compared to 540 million as of March 31, 2011. Days and claims payable represented 37 days of health benefits expense compared with 39 days in the previous quarter. The primary factor that drove the decline in days and claims payable was an increase in claims processing speed aided in part by an increase in (inaudible).

Cash flow from operations totaled $115 million for the six months ended June 30, 2011 and 31.1 million for the three months ended June 30, 2011. Cash flow in the quarter was impacted by decline in the medical claims payable liability as well as the normal occurrence of making two estimated income tax payments in the second quarter.

We thought operating cash flow might be slightly higher in the quarter under the presumption that more states would fund premium payments before the end of June to optimize federal matching but some did not avail themselves of that opportunity. We continue to view our cash flow and liquidity position in a positive way. We anticipate the cash flow from operations was fee net income for the full-year ad we are particularly pleased of our ability to generate substantial cash flow at the unregulated parent company level.

As we look forward to the unprecedented Medicaid managed care growth opportunities we believe our substantial liquidity places a company in an enviable position. Our health plans are well capitalized. Our unregulated cash position is strong. We are generating solid income from ongoing operations that builds statutory network and drive subsidiary dividend. And debt leverage remains low relative to our long-term targets.

These are important factors but the allowance to comfortably increase business volumes in our existing health plans and enter new market as these opportunities arise. We are positioned well for the planned Medicaid expansion in 2014 and have flexibility to pursue M&A opportunities should favorable transactions become available.

Finally, I want to touch on our ongoing share repurchase program. We continue to repurchase shares each quarter, with regard to our objectives for the program at the base level we want to offset the dilution from equity based compensation. Second, the warrants we sold in 2007 related to our convertible notes issued that year have diluted potential. As we move toward the settlement of that instrument next year, we like to offset as much of the dilution is possible.

Finally, overtime we like to continue to return some level of cash through the buyback program and thereby support the maintenance of a desirable capital structure. Importantly our repurchase program affords a lot of flexibility, which we believe is advantageous during this period of potentially high growth. As shifts occur in our capital needs for operations we can easily adjust our repurchase program to accommodate.

Now let me walk through our updated parameters associated with the company’s full-year 2011 outlook. We are maintaining our total revenue expectations for the year, total revenue growth at an upper single-digit percentage rate. Our expected range for the full-year 2011 HBR ratio is now 83.1 to 84.1% compared to the previous range of 82.8 to 83.8%. We are raising our range by 30 basis points for two reasons, on balance the recent premium rate actions we received were a bit below our expectation, (inaudible) appropriate in light of the medical cost experience.

We now expect the composite rate increases for the year to be neutral to slightly negative. On the medical cost trend side, we think it's prudent to slightly raise our trend assumption for the back half of the year in light of our most recent information.

Turning to our SG&A ratio, we are now targeting the ratio of 7.8% plus or minus 20 basis points for the year. This is an increase from our previous SG&A ratio expectation of 7.6% plus or minus 20 basis points. This change reflects incremental spending in support of the large number of potential expansion opportunities in both new and existing markets including startup cost for Louisiana.

We continue to believe that a net income margin range of 2.5 to 3.5% represents an achievable long-term operating performance target for our company and we expect to operate in this range for the full-year of 2011, although more likely toward the upper end of the range. We continue to expect a share account to be within the range of 53 to 54 million of a full-year.

To wrap up, I wanted to note the recent addition of Amerigroup to the large cap Russell 1000 index during the latest reconstitution. Also S&P added the company to their Mid-Cap 400 index at the end of June. A couple of nice milestones in recognition of the company’s rising stature.

Let me conclude here so we can preserve our time for questions. Thank you for your time and attention this morning. Operator we would like to begin the question-and-answer session.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from Scott Fidel with Deutsche Bank.

Scott Fidel - Deutsche Bank

Thank you. First question I just wanted to follow-up on the Georgia rate issue. Just interested first in terms of the timing of when you initially found out this issue and discuss this with the states. And then is there something over to all the health plans in Georgia tax I'm just a little bit surprised as I actually didn't hear syncing talk about this issue on their second quarter call.

Jim Truess

Yes a couple of points on that. We started to see some indication in the first quarter as Georgia wasn’t as caught up as we normally would expect them to be wasn’t particularly significant at that point. By the time we got into the second quarter we fell like it was getting more significant and we wanted to really confirm what we were seeing with the state. So we had a dialogue with the state about that and I think it really triggered them to go back into a much more comprehensive review. I think they are feeling at that point in time the process was okay. And the fact that we were seeing some differences trigger them to go back and conduct a more comprehensive review. They were working on that hard over the last month or so and I think particularly in the last month or so we've got some pretty good visibility as they completed a fairly exhaustive review. To my knowledge this has affected all the health plans. Certainly we operate in different regions and have different market shares and that sort of thing. But to my knowledge it’s a broad-based issue and unfortunately recognizes that there was some defects in hindsight in the work that Georgia did.

Scott Fidel - Deutsche Bank

So, basically that Georgia overly estimated the entire Medicaid managed care population that was enrolled in the program?

Jim Truess

Yes, with regard to the way it has impacted the rates over the years. You know when you think about this is of course, oversimplifying it, but in essence the rate for instance the rate we get paid in any period, the function of the medical cost divided by the membership and if the membership was overstated, that drives a lower rate. So as you can imagine, there's a level of consistency between the membership files that they use to pay us and a premium rates the calculated. So those on the line records for duplicates in a, it has affected the rates as well.

Scott Fidel - Deutsche Bank

Okay. And then just wanted to ask a follow-up just relative to the change in tone a medical cost trends. And maybe Jim, if you could frame what you are previously during the medical cost trend? A topic you're kind of thinking flat to up slightly? And how much of a change of the major in terms of your expectation for the full-year? And then maybe just discuss specifically some of those early signs that you talked about of trends sort of normalizing? What’s specifically out there are you seeing on that front?

Jim Truess

Sure. Not a dramatic change in our outlook. I think if you go back to what we were talking about a quarter ago or maybe even two quarters ago, it's continued to be our expectation that we would see some reversion to the mean on medical cost trends. And we continue to and always factor that into our forecast. We made a slight adjustment this quarter. I think that's prudent in light of what we are seeing, but it's not that significant. So as I say, we have always expected this to come, I think we have had a couple of quarters see where trends ended much lower than we expected, and that certainly was nice, but I think this is more consistent now what we are seeing then and what we have seen over the last couple of quarters. With regard to what we are seeing, obviously there is only so far you can take your most current experience on given claims lags and all of that, but I think as you are probably seeing fairly broadly across the industry, in patient utilization and new patient costs continue to be very stable and at favorable levels. I think what we are seeing may be in contrast to the way things were six months or year ago, we are seeing a little bit more outpatient cost increases and whether that be in hospital outpatient setting or the professional side, that seems to where the increase is.

Scott Fidel - Deutsche Bank

Okay. And then just last quick question, do you have initial estimate yet for Louisiana in terms of how much enrollment and annualized revenue run rate you expect to generate there?

Jim Truess

Yes, I think it's still little early, as you know there is five plan selected. I think it’s still speculative as to what the distribution might look like. Probably a lot of it will ultimately have to do with the strength of networks, the various people established and I think that’s still early to make any comments about that. But as you can imagine, we are certainly very pleased to participate. We are looking forward to being a robust player in the market and I think as has been the case in most markets that we operate in, we are usually able to garner our fair share and we certainly expect that to be the case in Louisiana. But probably a little early to put any finer point on it at this stage.

Operator

Your next question comes from Tom Carroll with Stifel Nicolaus.

Tom Carroll - Stifel Nicolaus

Hi, just back on Georgia again. Just to confirm. Is this an issue that you guys proactively brought to the state?

Jim Carlson

Yes we did. Just to levels set this for people. Retroactive adjustments are part of virtually every insured contract I can think of. What we are dealing with here is something that was of a magnitude and scope that grew over time and the other thing is the duration over which it occurred. That's what makes it a little bit different. So, it’s very normal for our reconciliation people to be looking at data flow from any of our states and making these adjustments. We saw enough of it in the first quarter to draw our attention. And we saw as Jim said the increase in Q2 and as the state looked into it they came to the conclusion that they did relative to its size and triggered their communications with the health plans. Typically what a state does when they have a communication on something like this is not uncommon for everybody get sort of e-mail or communication to all health plans and so forth and that's why we have a belief that it affected everybody. And you have to also keep in mind that the rates that we get paid, for lack of a better descriptive term, our community rate, so it's pretty hard to isolate the impact exclusive to your firm beyond what the state is telling you individually.

Tom Carroll - Stifel Nicolaus

So just couple other things. Could you maybe provide a bit more detail on your commentary about emerging medical cost trends? And then just to nitpick a little bit, Jim, you mentioned we're going to hear about Texas in early August. Do you think it sounds like you have some visibility there? Is it going to be a next week event?

Jim Carlson

Well let me take the second part first and then turn it back to Jim on medical costs trends. I do think that the state is publicly acknowledged and announced by the end of the month, I think people should not be surprised if it happens earlier than that. That's where I’d like to stop. Jim?

Jim Truess

Sure. If you go back to our commentary last quarter, when we were talking about medical cost trends, I think we were seeing it very consistent with what we saw in 2010, very low to flat experience. I think as we get into the second quarter, I think if we look at adjusted for the fact that there is seasonality associated with medical cost, I wouldn’t characterize the movement from first to second as flat. I think it's a little more than that and moving back towards – we think long-term range is for our business over, if you look at many years of our experience, 3 to 5% kind of a normal long-term trend rate and whereas last year we might have said flat to zero. I think we're moving back towards that more normal range. We're probably not even all the way back to that normal range yet, but I think that’s the distinction between what we see today versus what we may have seen a quarter ago.

Tom Carroll - Stifel Nicolaus

How about inpatient days specifically year-over-year?

Jim Truess

Yes it's interesting. You know, on a gross basis, our inpatient days have been very flat and certainly in some markets probably down. Some of it has to do with I think as everyone is aware the birthrate continues to decline and that’s certainly a factor for our business and maybe a significant factor for our business given the number of young mothers that we enroll. So that’s a factor in driving that decline. But as I mentioned earlier, I think our view of inpatient cost continues to be stable and I think our management of that continues to be very effective. And so I think that’s sometimes why, it's always easier for everybody, us included to track and monitor inpatient days and I certainly think many years ago, that was a much bigger piece of the equation than certainly it is today. But that continues to probably I’d say be stable and something that we don't see particularly significant.

Operator

Your next question comes from Carl McDonald with Citigroup.

Carl McDonald - Citigroup

I wanted to talk on the net income margin. It looks like you had roughly 3.75% first half of the year, the guidance is around 3.5% for the full-year implies something like between 3 and 3.5 for the second half of the year. I know you're not giving any sort of guidance going forward, but is that sort of what you think about as a reasonable margin range ex any new opportunities for say the 12 months or so?

Jim Truess

I think we certainly had a very high net income margin percentage in the first quarter and so that’s having an impact on the full-year value. I think as we are going to be coming back more into a normalized range, I think that’s our expectation, and that's why when you look in our thoughts on outlook with regard to the margin percentage, we think we will be in our range, but more towards the upper end of that range for the reasons that we mentioned. So, we continue to feel very good about that as we talked about in the past when you’re operating at a margin percentage that we are talking about here, the return on capital is very favorable. So, we continue to feel real good about where we are at and again, it's really nice when you're making for 4.5 or whatever, but we never felt like that was a long-term sustainable numbers great to have. But down at the level that we think we are going to see in the future and out into the long run, we continue to feel that’s a very nice way for us to deploy our capital and integrate return for our investors.

Carl McDonald - Citigroup

And then on the states where you don't have final rates yet, can you give a sense of maybe particularly with Florida, how much visibility you do have there, so what’s the potential for a meaningfully different outcome relative to the expectation at this point?

Jim Truess

Yes, the two big ones that are still pending are Georgia and Florida. And you know we don't have tremendous amount of visibility on that, the states are usually working and doing their analysis and honestly we probably would have had more visibility on Georgia today than we actually do because in light of this membership issue Georgia has had to go back and recalculate their numbers. So, that has been postponed a little bit. So we are still waiting on both of those.

Carl McDonald - Citigroup

And do you think the potential PMPM rate adjustment that you see in Georgia will be reflected in this upcoming rate or is that going to be a longer process?

Jim Truess

Well, I think there’s two things that are going to happen. One is the rate renewal that will be effective July 1st of this year in Georgia will take into accounting rebates membership number different than otherwise would have been had this correction not been initiated. Secondly, I think we will ultimately establish, in each of the plans we will establish a settlement agreement which will be associated with the fact that the premium rates that we are being paid today are calculated based using too many members in the denominator. If you will allow. So I think they are probably be two discrete processes, they don’t necessarily have to line up and happen in exactly the same time, but I think the state is going to move as quickly as they can to get that resolved and obviously that’s in everybody's best interest.

Operator

Your next question comes from Joshua Raskin with Barclays Capital.

Joshua Raskin - Barclays Capital

Just back on the [MRR] guidance it looks like you are raising your guidance for the full-year by about 30 basis points. I calculated Georgia is probably two-thirds of that. So it looks like [MRR] guidance is only really up 10 basis points. It doesn’t seem like a change at all and yet you are talking about higher costs and lower rates. So, I’m trying to figure out what exactly the magnitude. I mean are we really talking about a couple of basis points here and there for rates for cost trends? Or would you say this is more of a definitive change in trend?

Jim Carlson

I think as we mentioned in the commentary, I think our profile on rates is slightly lower than we thought before and our trend assumption is slightly higher. I think as far as when you're trying to kind of put the pieces together and think about the Georgia issue, we do think we will make some level of settlement recovery against the impact that we took in the second quarter in the back half of the year. So, portion of the Georgia impact that’s hitting us in the second quarter we think we will get back in the back half. So, I think it's fair to characterize our change on the HBR range, is more than a couple of basis points.

Joshua Raskin - Barclays Capital

Okay, and I guess if Georgia had not occurred, would you have even bothered updating the [MLR] guidance?

Jim Carlson

We probably still have made a slight move.

Joshua Raskin - Barclays Capital

Okay. And then just the second question, I know you guys don't give EPS guidance, you tend to have a decent spread. May be you can talk a little bit about the seasonality 3Q versus 4Q in terms of the remaining earnings for the year? Any sense of where you think 3Q versus 4Q comes out?

Jim Carlson

I think generally our expectation is due to normal seasonality, that the third quarter will have higher earnings in the fourth quarter and that primarily has to do with a normal years, we generally get a lot of rate increases in July. That’s not a significant this year given the rate environment we are in and then medical cost start to come up in the fourth quarter. So the seasonal pattern usually is Q3 highest than Q4 down a bit.

Joshua Raskin - Barclays Capital

I guess if I look at last year, it was a $0.09 sequential change, 3Q down to 4Q. It just seems like some of the rates are coming in as we progress lower and lower. I’d have thought it be a little bit more seasonally adjusted? 3Q might be a little bit higher than normal, but is that not necessarily the case?

Jim Carlson

No. I think that’s an astute observation actually. I think that in an environment where you are seeing some rate compression you think about we are getting a downward adjustment in our rates in Texas and that’s most powerful in the fourth quarter. So we may see more or little bit more pronounced seasonality. I think the other thing that was always is another factor that plays into it though, many markets that we operate in we have been sharing a lot of money back to the states through premium rebates and that's the performance has been so favorable. You start to get a little bit of compassion, that's starts and wind a bit and that ask as a damper again some of those changes.

Operator

Your next question comes from Ken Levine with UBS.

Ken Levine - UBS

I just wanted to kind of ballpark what the actual Q2 earnings were relative to your expectations. I know in the prior remarks you said that Q2 was kind of in-line with your expectations ex the prior period claims talk. So, I guess if you take the $0.83 reported and add back $0.16 Georgia and then there's also about it looks like a $0.07, $0.08, for my favorable prior period adjustment, so that we can a ballpark what you're expecting at the $0.90 level? Is that roughly where you are?

Jim Carlson

We saw our budget last fall and we break it down in the quarters and the number that you are solving to (inaudible) close to what we setup for our internal budget. And so we retested at the end of the first quarter relative to forecast, and that’s pretty much what we thought for Q2. That's why we made the comment we did about consistent with our expectations. It is. And we based variable compensation offerings like that and so forth and that's where we feel we are.

Ken Levine - UBS

Okay. And of the 20 basis points has any effect for the full-year, have you disclosed kind of what Louisiana comprise of that? And as all that extra 20 basis points that come into second half of 2011 is any of it recognized in Q2?

Jim Truess

Hi Ken, I think that adjustments partly associated with the second half. I think the only other dynamic when you think about it from a ratio perspective is that we are getting a little bit of revenue compression because of these prior period revenues impacts. That is a slight factor. Little bit of it for Louisiana. So, certainly pleased, it is nice to have to spend the money, because that means we are entering a new market and think that will actually do a lot for us on the ratio in the future when we are up and running. We are also as you can imagine, we're continuing to spend a fair amount on other opportunities as well. And you know, we do think in a lot of these opportunities you need to and want to do a fair amount of work on the ground. And so we look at the large size of this pipeline, we obviously want to be careful with our dollars, but we don't want to understand when there are good opportunities. So we are doing a little more on that side. So it's kind of a combination of both, but really that dollar spend from an adjustment perspective is really in the second half of the year through the first half of the year we are really spot on our plan.

Jim Carlson

I might underscore that a little bit Jim in terms of the expansions within our existing markets. And we didn’t provide any sort of revenue direction on what’s going on in New Jersey and New York and Virginia right now and so forth. Perhaps we have a little bit more insight on that by Investor Day certainly when we start to talk about 2012, we will provide more information. But there's a lot of work going on here relative to dealing with this expansion that meet some of our SG&A calculation as well.

Ken Levine - UBS

Okay, thanks. And then just lastly on the Georgia issue. How much membership does that kind of coming from? And going forward, should we expect that perhaps Georgia membership goes down in future quarters just on this, kind of on a re-class if you will?

Jim Carlson

You know, by and large it’s a relatively small number of members in any given month. It's just when you have as many months since you have been in the state, and we are talking about readjustments in years back are relatively small. But it's more of a relatively small number of members in a given month but over a lot of months. You can generate a lot of member months when you multiply those two together.

Operator

Your next question comes from Peter Costa with Wells Fargo Securities.

Peter Costa - Wells Fargo Securities

Hi. On Georgia, can you tell us how much of the $0.16 charge the last year. You said it goes back 2006, but you also said that the problem was growing through the years. How much s in the most recent year? And then can you talk about your cost trends in terms of what states saw the higher cost trends?

Jim Truess

Sure. Pete, certainly the majority of the adjustment is through more recent periods for us. When you look at the adjustments all the way back to 2006, they are definitely much smaller in the first year. And part of that is because the state has done some clean up at different times and so certainly the more significant impact is back to let's say calendar 2010. But I'm not sure that that’s entirely consistent across the plan. I think we have some indication and is a fair amount of deviation between the plans. And I think that’s just a function of the way membership worked and more just kind of random variation. That's one of the reasons why it makes it very difficult today to establish what an estimate maybe for the settlement because each of the plant has visibility on their own membership adjustments, but you don't really have visibility of the others. And at the end of the day, what’s going to happen is the adjustment is going to be a function of a composite impact, not each individual plans impact. So that's one of the things. And that's why we haven’t made an estimate for that receivable. We just don't feel like you can really put up a credible estimate today and that visibility will come in the future.

With regards to the cost trend question, by state, I'm not sure I would spike that. I think we are talking about pretty subtle variations here and there's always some deviation, some of our states always doing a little better and worse than others. But I’m not sure at this time I’d (inaudible) point to any state where we are seeing something that’s significantly different from another state.

Peter Costa - Wells Fargo Securities

And then just one last question. In Texas, it looks like your net rate impact is sort of a negative 2%. Where do you think you'll be able to take that out in terms of getting the cost savings to recover that? Is that going to be tougher provider rates or lower SG&A in Texas? What is your plan there?

Jim Truess

Just to start off, I'm not sure about the 2%. But our nominal number is down 5.4. But that is neither here nor there. We have a variety of strategies. Some of it's going to be contract renegotiations, some of it other adjustments, other medical management initiatives. But certainly it's going to be a heavy dose of working on the way we work with our providers in the reimbursement that we pay them.

Peter Costa - Wells Fargo Securities

And then have you negotiated already those rate changes with providers at this point? Or have you not?

Jim Truess

Yes I don't think we are going to (inaudible), we are involved in negotiations with lot of different people and I don’t think I want to get more specific about that. It's hard to engage in those negotiations on a conference call, I guess put too much of that out there. But we look back at our experience in Texas and the management team that we have in place, that is really a team that has and continues to perform at a very high level. And so we look at things we need to do and our ability to perform in Texas, we always have a lot of confidence about that, because we really do have a great team and a lot of experience there. So, it’s certainly a nice market for us.

Peter Costa - Wells Fargo Securities

And if my net 2% is wrong, what would be better number?

Jim Truess

I think like we said, our net number is 5.4. Is the net reduction and so that's after the automatic pass-throughs. Yes, 5.4.

Peter Costa - Wells Fargo Securities

5.4 is after the automatic pass-throughs?

Jim Truess

Correct.

Operator

Your next question comes from Chris Rigg with Susquehanna Financial.

Chris Rigg - Susquehanna Financial

My last question was actually my first question. But I guess surely you have to have some assumption for rates in Florida and Georgia even though you say visibility is low. Can you give us a sense at least directionally how we should think about those numbers?

Jim Carlson

You are right we do have an assumption for those and that’s certainly something that’s factored into our outlook parameters. As has always been our practice, because there is a certain amount of give-and-take that goes on after we receive initial visibility from the state and what their expectations are. We just don't think it's prudent for the company to put those numbers out. You know it has somewhat analogous to the last question, we just can’t negotiate these things in public. So we certainly have assumptions. In our expectations about the markets is that rates will be modest by historical standards and that's a function of the favorable experience in those markets. But that's really as far as we can go. And I’d love to give you (inaudible), but hopefully understand that that’s just not a good thing for a business to do that.

Chris Rigg - Susquehanna Financial

Okay. And then on the SG&A expense if I just to sort of simple analogies, just role through the second quarter and the third in the fourth quarter, that gets it out closer to your previous guidance of 7.6%. So, to get to the new guidance range, is that all expansion costs or is there some other cost that we could see in the latter half of the year that we don't know about right now?

Jim Carlson

I think I would characterize it as expansion costs and business development. So, I wouldn’t fail the increases associated with Louisiana, some of it is, but also we're continuing to make incremental investments to position ourselves for new opportunities as well as Jim was mentioning earlier, we are seeing some significant benefit changes and expansions in New Jersey. And that comes particularly with clinical management resources and those sorts of things. So, some of it is that as well.

Operator

Your next question comes from Sarah James with Wedbush.

Sarah James - Wedbush

Thank you. Not to believe at the point too much, but I'm still a little bit unclear on what’s going on with the inpatient cost. You mentioned that costs are going up, but days are flat to down in some markets. So is it severity or unit price that has been driving increase?

Jim Carlson

Hi Sara. Let me just go back and clarify. It's not that we are necessarily saying inpatient cost up. So inpatient costs continue I think we probably characterize them as stable. When you look at where they are going on a year-over-year basis. So, I wouldn’t characterize them as up. But the fact I was trying to mentioned earlier was when you think about aggregator gross inpatient costs as we are seeing the birth rate decline, you know in some cases that put the downward pressure or downward movement on your aggregate inpatient expenditures. You know, because we receive different payment depending upon what rates people are in, we may be seeing lower premium than associated with the lower birth rates as well. So, it doesn’t necessarily represent any sort of gross margin impact let's say. But that how I characterize the inpatient side.

Sarah James - Wedbush

So, what would you say is the offset costs are going down for lower birth rates, what specifically could be some of the offset that you are seeing?

Jim Carlson

I think where we are seeing the emergence and trend is more on the outpatient side. And that can be both on the hospital outpatient side and our physician reimbursement. So that tends to be more where we see it. I think the other thing is going on in, and I think this is probably an industry wide phenomenon. And in some cases there is a little bit of upward pressure on the pharmacy side as well as and that’s partly due to a lot of pharmaceutical companies on branded drugs are pushing their prices up particularly in those cases where drugs are about ready to come off patent. They are trying to get the last few dollars out of those products before they come out of patent. So, we see a little bit of push on that as well.

Sarah James - Wedbush

Outpatient is a utilization or unit cost that you are seeing a pressure on?

Jim Carlson

Generally, it’s utilization and our mix of services. There's really no significant upward push on unit reimbursement for unit cost and some cases states are even reducing reimbursement. But sometimes you can see a mix of service change which can push costs up a bit.

Sarah James - Wedbush

And then I guess the last question is just how long has that been going on? Has it just been since the last quarter ended or has it been something that you have seen over the past few months?

Jim Carlson

I think I largely characterize it as in the second quarter. I think I also wouldn’t want to put an overly fine point on that. I think until we get full run out on the period and can be more exhaustive analysis, I think you have to be careful about trying to put too fine a point on that. But I’d characterize it is in the second quarter. We need to keep moving along here.

Operator

Your next question comes from Charles Boorady with Credit Suisse.

Unidentified Analyst

Hi, this is Jason (inaudible) for Charles. Just a quick question around the cost trend outlook. Are you seeing some differences between the different types of populations you have, like [China] for ABD's?

Jim Carlson

Jason, I wouldn’t necessarily call out any particularly strong distinction. I think there can always be differences between markets, and that's how the two let’s call in general categories of members are. But I don't think I’d particularly call that up.

Unidentified Analyst

And with the components differ, have you seen anything like a spike in inpatient or outpatient our physician for one of the other over now?

Jim Carlson

Like I said, certainly no spike on inpatient. I think we continue to characterize inpatient utilization as a stable. So no I don't think I would call that. And I want to answer your question, I’d be happy to tell you everything that we know, but also I don't want to project a level of precision on some of these things particularly when you talk about what’s happened in the last month or two. We only have paid a limited number of claims on those periods, I guess to be careful about being overly precise about this.

Unidentified Analyst

Okay, that's fair. And just as a follow-up question around DCP. Can you just talk a little bit more about kind of what’s driving the increase in your (inaudible) rate? Is it just like the mix of claims that you're getting in or is it just more providers or just providing cleaner claims or just a little bit more around that for me?

Jim Carlson

Sure, good question. It's interesting we continue to work pretty hard on our own internal processes, because we know from an administrative perspective, more claims that we can process automatically or (inaudible) the more efficient that is for us. So we continue to work pretty hard to try to have our system be able to process a greater percentage. I think that fortunately we have been real successful at that. Some of it also does have to do with the mix of claims as we continue to pay more long-term care claims, those tend to come in more quickly and process more quickly. So, when you think about the composite, that has an impact. And then one other thing that also is having an impact on the pace is we receive more claims electronically now from providers than we ever have. And that percentage continues to go up. So if you think about the claims processing cycle really involves two pieces, to the pace at which from the data service the pace at which the claim gets to our door and then the pace at which it processes through our system. And I think both of those sides are speeding up a bit. Providers are getting claims to us more quickly, and then we're processing them more quickly.

Jim Truess

(inaudible) additional question, is to limit their question to one please.

Operator

Your next question comes from John Rex with JPMorgan.

John Rex - JPMorgan

Yes thanks. So, I absolutely agree Jim with your commentary that actuarial [found cuts] both ways and clearly the margins were very high across the industry in 2010. But they are high in 2011 also, I guess as we look at that, wouldn't you expect kind of almost regardless of the state budgets situation, wouldn't you expect this pressure on rate as a states performed their actuarial soundness reviews to continue kind of into the next rate setting your also? Is there a reason we shouldn't expect that I guess?

Jim Carlson

I think we would say rates are more correlated to the medical costs than margins. Margins are a byproduct of the rate of costs and SG&A and tax rate and everything else. But if medical costs start picking up a little bit, that will be feeding the look back period that are used for rates in the future, (inaudible) of our rates in 2012 and we're sitting here in the middle of 2011. But I guess we just underscore the notion of actuarial (inaudible) probably as we did because sometimes in the commentary other firms, they're not as active in this businesses we just think that sounds though the rates are being set on an arbitrary basis, and they are not. I mean they weren't if not enhanced funds reporting the states and they are not now either with low medical costs in a base period so we will see what 2012 bodes. I think one of the things would be healthy if this economy picked up a little bit in the Medicaid role started coming down a little bit, because Medicaid budgets tend to be Medicaid budgets. And if the states found themselves with fewer people inside those budgets, they might be able to build rates that look a little bit better down the road. That's what the optimist might think. So let's move on to next question please.

Operator

Your next question comes from Scott Green with Bank of America.

Scott Green - Bank of America

Thanks. Can you elaborate on if you know the actual revenue opportunities in New York, New Jersey, for those market expansions?

Jim Carlson

Yes we have some models that we are working with but we are not prepared to be explicit about them this morning. We are going to (inaudible) 2012 and revenue implications at the same time we would like to start get a little line of set on what’s going to happen in Texas for instance. And we will update that for you when we feel so wise to do so. There is some impact of the balance of 2011 but there is largely 2012 events.

Operator

Next question comes from Matt Borsch with Goldman Sachs.

Sam Wass - Goldman Sachs

Hey guys, this is Sam Wass on for Matt. To your comment about potentially increasing your debt load when your convertibles come due next year, would that just be sort of to bring your debt-to-capital ratio into your long-term range? Or do you have an updated strategy on what your capital allocations plans might be?

Jim Carlson

That's right, we would be thinking about do we want to, and I don't to characterize as we made a decision yet, but I do want to this is something we are thinking about is it’s certainly would be a time in which we could come back more into our range as I mentioned we are below our 20 to 30% range and have been below that for a while. So, long-term we would like to get back into that range. So with that, if we were to do that, and then the incremental liquidity that would produce, that does give us a fair amount of flexibility. But it is kind of back to the if you think about our traditional ways that we think about that, and depending upon the needs that we have, to fund growth and new opportunities in our states or new states, depending upon if M&A opportunity was to present itself. And then also, it gives us the ability (inaudible) to buy shares. So, I can’t think about it in totality, but certainly I think it represent a key point of flexibility that the company has and also the fact that we continue to have the luxury to be able to deploy a fair amount of capital and our objective always is, what’s the best and highest return place to deploy that capital? And so it's just nice to have the capital and then you make that next decision which hopefully is to deployed it in the place we can get the highest return.

Operator

Your next question comes from Brian Wright with Citadel.

Brian Wright - Citadel

Just one from me. Are there any other states that are undergoing a similar kind of review process of their claims submissions or claims of their enrollment page?

Jim Carlson

I would just say, again, Brian, to underscore the fact that reconciliation of membership is a constant phenomenon in these contexts. And frankly, large employers are doing the same thing with their insured contracts. That being the case, we have no other issues like this in any of our states of the country.

Jim Truess

(inaudible) that is not uncommon to have small adjustments pluses or minus in any quarter, getting in Georgia is much larger than anything we have ever seen. So that's the distinction.

Brian Wright - Citadel

Just one follow-up if I can, does this indicate like a structural with interest? The healthcare system issue that is under appreciated as far as going to an exchange environment as far as being up to track people? Given the current systems and whatnot?

Jim Carlson

Well I think that’s fairly speculative at this stage, given we don't have enough clarity as to how the states are going to manage the enrollment and eligibility process. That is something to keep on your radar screen, yes I think it's a good question. You know, when you see states go to vendor changes in IT and so forth, those are maybe times when you might be a little apprehensive whether they got the conversion rate. And frankly, those sorts of models are going to have to be built all over the country and they're going to have to operate at 133 to 134% (inaudible) level. Pretty accurately for the exchanges to have integrity relative to the people in them and what benefits they are getting in prices and costs and so forth. But a little premature to know exactly how that’s going to play out in exchanges beginning in 2014.

Operator

I will now turn the call back over to Mr. Carlson for closing remarks.

Jim Carlson

Well, great. Thank you all for joining us this morning. Sorry we ran just a little bit over, we know it's a busy morning with a couple other companies that report out today. We appreciate your interest in our company. And it's just a special reminder that Investor Day is Friday, September 16, and we look forward to seeing all of you there. Thanks a lot.

Operator

This concludes today's conference call. You may now disconnect.

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