Molina Healthcare Inc (MOH) 2017 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Molina Healthcare Second Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded on today's date, Wednesday, August 2, 2017. It is now my pleasure to turn the conference over to Juan José Orellana, Senior Vice President of Investor Relations. Please go ahead, sir.

Thank you, Donnie. 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, 2017. The company issued its earnings release reporting these results today after the market closed, and this release is now posted for viewing on our company website.

On the call with me today are Joseph White, our Chief Financial Officer and Interim Chief Executive Officer; and Terry Bayer, our Chief Operating Officer. After the completion of our prepared remarks, we will open the call to take your questions. (Operator Instructions)

Our comments today will contain forward-looking statements under the safe harbor provisions of the Private Securities Litigation Reform Act. All of our forward-looking statements are based on our current expectations and assumptions, which are subject to numerous risk factors that could cause our actual results to differ materially. A description of such risk factors can be found in our earnings release and in our reports filed with the Securities and Exchange Commission, including our Form 10-K annual report, our Form 10-Q quarterly reports and our Form 8-K current reports. These reports can be accessed under the Investor Relations tab of our company website or on the SEC's website.

All forward-looking statements made during today's call represent our judgment as of August 2, 2017, 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 the Chief Financial Officer and Interim CEO, Joseph White.

Thank you, Juan José, and thanks to all of you for joining us this afternoon. The last few months have been an exceptionally busy time at Molina Healthcare, and I will do my best to bring you up to speed on everything that has happened since we last spoke. But first, let me be clear. The results reported today are disappointing and unacceptable. We must and we will do much better, and we are taking aggressive, urgent and determined actions to improve our financial performance. Those actions, which include a comprehensive restructuring plan and 2018 Marketplace exits in Utah and Wisconsin, will put Molina on secure financial footing and allow us to continue the Molina mission.

My remarks today are going to touch upon 4 general areas. First, I will review our quarterly financial performance and our immediate financial outlook. After that, I'm going to speak to how we reached the place where we are at today. Then I will discuss our path forward and our plans for restoring and reinvigorating our great company. Finally, I will conclude with some personal remarks about how I regard our current challenges at Molina Healthcare.

So taking these topics in order, I will turn first to our financial performance. Today, we reported a net loss per diluted share of $4.10 for the second quarter of 2017. This compares to net income per diluted share of $0.58 for the same period last year.

High medical costs were a key contributor to our poor performance in the second quarter, and our medical care ratio was nearly 95%. This high medical care ratio was a result of several issues. First, we adjusted our medical cost estimates for 2016 dates of service. As a result, we recognized, in the second quarter, about $85 million worth of medical costs that were actually related to 2016. Some of these adjustments to our prior period estimates resulted from claims payments, others resulted from legal settlements with providers.

As part of the broader restructuring program that I will discuss later in the call, we are undertaking a thorough and comprehensive redesign of our provider payment process. This will address issues that extend from the design of our provider contracts to the actual payment of providers. We expect this process redesign to result in greater transparency and improved administrative cost efficiency.

Continued challenges in the Marketplace were another cause of our poor performance in the quarter. Settlement of risk transfer and cost-sharing rebate liabilities related to 2016 dates of service reduced pretax income from the quarter by $44 million. We also recorded a $78 million increase to our 2017 Marketplace premium deficiency reserve. The increase in the Marketplace PDR was driven by our assessment that, based upon trends observed in the second quarter, Marketplace performance in the second half of 2017 will fall substantially short of our previous expectations. The increase in the Marketplace premium deficiency reserve, along with our decision to curtail our Marketplace presence in 2018, were both outcomes of the hard look we have taken at our business over the last few months.

Finally, profitability at 4 of our health plans this quarter, Florida, Illinois, New Mexico and Puerto Rico, was disappointing, even after allowing for out-of-period items. Inpatient and pharmacy costs were major contributors to performance at these health plans.

Our restructuring plan includes a concerted effort to remediate high-cost contracts and to build around high-quality, cost-effective networks, even if those actions result in lower enrollment and revenue. In addition, we have recently made management changes at 3 of these health plans.

Our administrative cost ratio was flat quarter-over-quarter and for the first half of 2017, it was running at a much lower rate than anticipated in our original 2017 outlook. With the major step we took in our restructuring plan last week, we can expect further reductions to our administrative cost ratio in the future.

There are also 2 other items of note that contributed to our second quarter loss. We recorded an impairment charge of $72 million, primarily related to the goodwill and intangible assets of our Pathways subsidiary. As part of the comprehensive review of our entire business, we have determined that the anticipated benefits from Pathways, including its integration with our health plans, will be less than originally anticipated when we closed on the acquisition 2 years ago.

We also took a charge of $43 million in the second quarter for restructuring and separation costs. This charge is primarily for the termination benefits for our former Chief Executive and Chief Financial Officers and represents the contractual obligations under their employment agreements. You may recall that I told you to expect this charge on our previous earnings call. This line item also includes consulting costs incurred through June 30 for the implementation of our restructuring plan.

We are withdrawing our previously issued 2017 outlook as a result of our second quarter performance, uncertainty around the funding for Marketplace cost-sharing subsidies in 2017 and the uncertainty around the timing of benefits achieved and costs to be incurred as a result of our restructuring plan.

Now that we have discussed our second quarter results, let's talk about how we got here. I believe that our current situation is a result of 3 key factors. First, we did not properly adjust our business to absorb the growth that resulted from the Affordable Care Act. Second, we did not fully appreciate that growth in the ACA Marketplace required robust development of new capabilities that we did not have. And finally, our direct delivery network is simply not competitive with other care delivery channels available to the company.

Fortunately, we are well on our way to remediating these issues. Let me talk about them one at a time. The implementation of the Affordable Care Act brought a sudden growth. We prepared for that growth by spending more on existing processes, procedures, capabilities and technologies. In hindsight, this was a mistake. As a result of trying to manage our rapid growth within an infrastructure designed for a much smaller, simpler business, we experienced breakdowns in areas like provider payment, utilization management, risk adjustment and information management. The utilization management issues we saw last year, in the first quarter of 2016, and the out-of-period claims expenses occurred in this quarter were emblematic of these difficulties, as are the challenges we have faced in adequately measuring our exposure to Marketplace risk adjustment liabilities.

In retrospect, a better approach would have been to undertake a full review of the organization in anticipation of the potential growth resulting from the Affordable Care Act. Instead of increasing investment in existing processes, we should have conducted the full redesign of our business that we are doing now.

Our challenges in the Marketplace point to the second source of our current difficulties: the failure to fully appreciate the unique demands of the Marketplace product. While our Marketplace members share many characteristics with our Medicaid members, the Marketplace is fundamentally an individual insurance market and, in some respects, very different from the Medicaid market. To be clear, our Medicaid-based provider network is an important competitive strength in the Marketplace. However, there were other aspects of the Marketplace business for which we were not as well prepared: member billing, risk adjustment and pricing, to name a few. We have learned much about these activities, but we have paid a price for that learning. We continue to monitor our Marketplace business and remain committed to making tough decisions should they be necessary.

Finally, our direct delivery network is simply not competitive with other care delivery channels available to the company. But as with Marketplace, we have learned a great deal, and we are now ready to put those insights to use.

So that is how we arrived where we are today. Now what are we doing about it? How will we become the high-value health plan serving people receiving government assistance? We have taken a hard look at our financial performance and have developed action plans to address the issues we have identified. Fortunately, we have better visibility now into the causes of our financial performance than we have had at any time in the recent past. With improved visibility comes greater confidence that we can fix what is broken and return the company to profitability.

We are streamlining our organizational structure to improve efficiency and the speed and quality of decision-making. We expect those changes to be largely complete by the end of 2017 and anticipate that this effort will ultimately yield an estimated $200 million in annual run rate savings. We are redesigning core operating processes such as provider payment, utilization management, Marketplace risk adjustment and quality monitoring and improvement to achieve more effective and cost-efficient outcomes. While this effort will extend well into 2018, we hope to see our first meaningful results by the end of 2017.

We are remediating high-cost provider contracts and building around high-quality, cost-effective networks. This initiative will take time and will likely not show meaningful benefits until 2018. We are restructuring our direct delivery operations. We expect these changes to be complete by the end of 2017.

Finally, we are reviewing our vendor base to ensure that we are partnering with the lowest-cost, most effective vendors. As with remediating high-cost provider contracts, we do not expect meaningful results from this part of our plan until 2018. Of course, we are also taking precautions to ensure that our actions do not impede our ability to continue to deliver quality health care to our members, secure new managed care contracts and retain existing contracts.

We estimate that our restructuring plan will reduce annualized run rate expenses by approximately $300 million to $400 million by the end of 2018, including the $200 million of these run rate reductions that will be completed in time to be fully effective for all of 2018.

I have given a lot of thought as to how I might convey to you the sheer size of this opportunity. We have pulled guidance for 2017, and it is too soon to speak of 2018 in detail. So I think the best way to scale these potential savings is to measure them against our 2016 performance. The low end of our estimated cost improvement range of $300 million is almost 1.5x the size of our entire income before taxes of $205 million in 2016. Obviously, our financial statements will look much different in 2019, when the full benefit of our restructuring plan is realized, than they did in 2016. But I think this example captures the general magnitude of the results we are seeking.

As part of our organizational restructuring plan, we are reducing our workforce by approximately 10% or 1,500 employees. The reduction is designed to increase operating efficiencies while reducing costs as part of the reorganization of our corporate and health plan operations. This was a very difficult decision and one that we do not take lightly. We never want to lose any of our talented and dedicated colleagues. We are committed to treating our departing colleagues with dignity and respect, and we'll be providing severance and outplacement assistance to those affected.

We initiated the first wave of the workforce reduction last Thursday, July 27. This single action will reduce annualized run rate expenses by $55 million and constitutes a substantial down-payment on our commitment to build a profitable business that delivers better shareholder value. We estimate that total pretax costs associated with our restructuring plan will be approximately $130 million to $150 million incurred in the second half of 2017, with an additional $40 million to be incurred in 2018. To be clear, these are onetime costs as opposed to the recurring nature of the benefits that we expect to see.

In addition to our restructuring plan, we are taking the following steps to manage our Marketplace exposure in 2018. We are exiting the ACA Marketplace in Utah and Washington (sic) [Wisconsin] effective December 31, 2017. For the 6 months ended June 30, 2017, these 2 health plans contributed only 60% of our total Marketplace revenue, but they constituted slightly more than half of our consolidated Marketplace operating loss. We are also reducing the scope of our 2018 participation in the Washington Marketplace.

In our remaining Marketplace plans, we are increasing our premiums for 2018 by 55%. Our premium increase assumed the absence of cost-sharing reduction subsidies. Had we assumed that the CSRs would be funded for 2018, the premium increase would still have been 30%. It is also important to note that the performance of our Marketplace products in California, Michigan, New Mexico and Texas remain acceptable. We will continue to monitor political and programmatic developments in the Marketplace, and we may withdraw from additional markets for 2018 if necessary.

I want to emphasize that neither our focus on profitability nor the reduction to our Marketplace footprint suggest any diminished enthusiasm on our part for growth in the Medicaid managed care space. As demonstrated by our recent wins in Washington and Mississippi, we remain committed to Medicaid managed care and expect to claim more than our share of the growth expected across the country over the next few years. We are taking extra care to be certain that our restructuring activities improve our contract retention and capture capabilities. Our recent RFP wins demonstrate that the improvements we have made in our revenue procurement capabilities are bearing fruit.

Finally, some personal remarks. The path we are on is by no means an easy one. But as we work to place our company on a solid foundation, we are reminded that many high-growth companies have walked a similar path. We will move forward and continue our mission of providing high-quality health care services to people receiving government assistance. Despite the results we reported today, I want to stress how excited I am about our future. There has never been a more challenging time to work at Molina Healthcare, but there has never been a more satisfying, a more stimulating or a more meaningful time to work here either. Today, more than 20,000 Molina employees carry a rich tradition forward into a better future. I am grateful to be one of them.

On a final scheduling note, we have not settled upon a date for our next Investor Day. We are, of course, eager to meet with all of you and look forward to phone calls or face-to-face meetings as you may see fit. We will let you know as soon as our next Investor Day is scheduled.

This concludes our prepared remarks. Donnie, we're now ready to take questions.

(Operator Instructions) It appears our first question comes from the line of A.J. Rice with UBS.

I guess I want to ask about the restructuring a little bit. Is there any need to put more capital into any of the subsidiaries as a result of today's announcement and the things you're doing? And then also, can you give us some flavor on the restructuring and the layoffs you're taking? Is it sort of reducing headcount 10% across the board? Or is it concentrated in certain areas? And do you have to communicate what you're doing in any way to the state's Medicaid programs?

A.J., I think -- Juan José, did you want to make a clarification?

Yes. I just wanted to make a really brief clarification. We are exiting the ACA Marketplaces in Utah and Wisconsin. We had said Utah and Washington. It's Utah and Wisconsin.

I am sorry for that. So A.J., I think your question had been -- was your first question about capital requirements that's tied to the restructuring plan?

Yes, and the earnings release today and where you're at. Does it require you to -- is there any need for incremental capital?

The restructuring plan in itself does not pose capital demands for the health plans. The financial performance of some of the health plans, particularly as they relate to the Marketplace performance, do indeed create capital demands for the health plans, which we are funding. But the restructuring plan itself does not touch on the capital needs of the health plans. It's funded through the parent. To the second point, I think your second point is, is we believe we're in compliance with all notice requirements in regards to any actions we are taking under the restructuring plan, and we are very closely engaged in discussions with our state partners in letting them know what happens. Your third question, I think, was about the nature of staffing reductions we've implemented. I don't think you can say they reach into any specific areas more than others, with the general caveat that most of these reductions are affecting -- are reflecting managers and affect people leaders, individuals higher up in the organization. As part of this effort, we are trying to expand spans of control for managers, which is the -- unfortunately is resulting in the exit of a large number of our management personnel.

Okay, okay. I guess is all of this -- just maybe clarifying one last thing. I assume this is all the result of the strategic review you talked about in the last quarter. Are you pretty much done with the strategic review? Or is that ongoing?

The strategic review initiated very early this year, back in February. I think we're done with the outlines of the plan and the path forward and the setting of savings targets. Of course, there's going to be modifications as we go along, and many of these activities, such as provider recontracting, vendor recontracting, will continue well into 2018. But I am confident in saying the plan is fleshed out and is built and is complete in terms of planning and design. Now again, the operation and the rollout of the plan will continue through 2018.

Our next question comes from the line of Scott Fidel with Crédit Suisse.

First question, just -- Joe, can you talk about how you're thinking about some of these RFPs that are ongoing or upcoming just in the context of the financial pressures that you've seen in some of the markets? And just in particular, I was hoping just to drill in a little bit into Illinois and then into Florida. Saw that the MLRs did spike there pretty materially, and those are markets where there are pretty active RFP processes in place right now.

Right. Sure. I think the most important thing to grasp, Scott, is that the savings we are deriving from the restructuring plan are not going to interfere with our ability to capture or retain any of our Medicaid managed care business. We are not retrenching from Medicaid managed care. We think these savings actually better position us to compete for contracts and better position us to compete, particularly as a low-cost provider. I think everything we've seen out of Washington lately, while the developments in Washington are very murky, I think what is becoming crystal clear to everyone is that the open-ended nature of the Medicaid entitlement is coming to a close. And we're going to see more and more efforts by the federal government and the states to reign in Medicaid growth. That can be growth in spending. That can be very good for Molina. There is no doubt that managed care is a documented cost-effective way for states and, by extension, the federal government to manage growth in Medicaid spending. We are taking efforts to make sure that we are, indeed, a low-cost provider and we are there to serve states as a low-cost Medicaid provider. So in a nutshell, this restructuring effort is a huge benefit to that effort. In regards to -- I'll take your states in order. In regards to Illinois, there's no doubt that the path for the company and Illinois has been a rocky path. We are gratified that the state budget crisis is resolved. We actually received a payment on premium, I think, the -- probably 2 weeks ago now, so it's good to see the premium money starting to flow. There is no doubt that we've had our challenges from a cost management area there, but we've installed a very capable new management team in that state, and I think they're already making progress in that regard. We're watching it very closely. This quarter, they continued to be troubled by provider settlements and claims payments from 2016, but nevertheless, I've been gratified by my engagement with the new management team there. Florida is a situation that's colored by our experience in the Marketplace. When you take that Marketplace experience away, while Florida has not had a great year by any stretch of the imagination -- again, we have a very good management team in place there. We have some very good people working there, and I remain very optimistic about that health plan, too. We'll have to watch Marketplace in Florida, in particular. The increase we're putting forward there is north of 50% when you include the assumption that CSRs won't be funded, around 30% if they're not. I think we're pricing appropriately, but we'll have to watch Florida Marketplace, too. In general, that health plan, though, I think, is on a sound footing.

And I just had one follow-up question. Just if you can talk about how you feel about the adequacy of the medical claims reserves at this point. And just given the extent of the negative reserve development that you highlighted in a number of the markets, thought maybe we would have seen a bit more of a bump in the claims payable for the second quarter. So maybe just sort of talk about your comfort with reserves adequacy at this time.

Sure, sure. We beat the bushes pretty hard on claims reserves this quarter. We looked very closely at certain states, Illinois being one of them, that were having provider settlement issues. And we've really pushed the staff, the local staff and the corporate staff, to come forward with their best estimates. We emphasized that this constant drip-drip, as you -- probably more than a drip-drip of old claims coming through and settlements coming through is simply not acceptable. And I think the staff has stepped up, and I'm very confident we've got reserves appropriately set.

Our next question comes from the line of Chris Rigg with Deutsche Bank.

Just want to try to connect the dots a little bit on your sort of historical commentary about the exchange performance versus sort of what you call spiking out now. I guess my understanding in the past was that the core medical cost trends were sort of running reasonably well, and most, if not all, of the problems were related to the risk adjustment monies. Now it seems like you're actually seeing some real issues in the business. I guess is it fair to -- was 2016 -- was the 2016 performance maybe -- was your view of it maybe a little off-base? Or has there been sort of a fairly remarkable shift in the utilization on the exchange population for you guys?

Well, there's no doubt, Chris, that our experience has been -- certainly, we saw this in the second quarter. Our experience has been some pretty dramatic increases in pharmacy utilization among the Marketplace membership. If you look at the population as a whole compared to other membership groups, they are lower utilizers, particularly on the inpatient side. But certainly, pharmacy trends have been much higher than we expected this year.

Okay. And then just when I think about how you're evaluating the participation next year. I guess are there certain indicators that you're looking for in the other states that would make you more likely to exit at this point? Like I'm just trying to figure out like where your mind-set really is in terms of the level of participation in 2018 outside the 2 states you're calling out already.

Well, the first thing we're looking at is strategic fit. There was -- looking back on our involvement in Wisconsin and Utah, the populations in those states were probably not significant enough to move the needle for the company in a positive way. The cost experience certainly moved it in a negative way. But frankly, I think the markets there were just so small as to just not offer a lot of upside. So as we look at other states, we're looking very closely at the degree to which Marketplace can support or is, in some way, advantageous to the Medicaid line of business. I think that would be most critical. But again, we've got a little more time to decide on this, and as I said in my remarks, my prepared remarks, we're prepared to make hard decisions. There's no doubt, performance in Texas has been very nice. Performance in some of the smaller states, Michigan and New Mexico, has been nice. California has been okay. Florida, though, has not been a good market for us. We're going to have to look closely at it.

Our next question comes from Sarah James with Piper Jaffray.

Maybe I could go at medical costs a little bit of a different way. If I look at it by product, it looks like there's more headwinds than just on the exchange book. It was kind of up across all products but Medicare. So I'm wondering if this is the [PYD] because if I run the math, I feel like there's more than exchanges and PYD . Maybe you can talk through some of the other things that are driving up medical costs across like the CHIP TANF ABD book?

Sure. And I think you're correct. I think you're correct, Sarah. We called out, specifically, inpatient issues in the 4 states that are most problematic, higher inpatient costs than we anticipated. We're seeing it in places like neonatal ICU. Pharmacy, while it is most pronounced in trend on the Marketplace product, is also an issue in certain states. So I think in general, yes, you're correct. We are seeing cost pressure. I would say it is more outside of Marketplace and it's more in-patient than anything else. And there are specific pockets, neonatology, radiology, things like that.

Got it. And on the restructuring plan, I understand the staff reduction portion, but I'm wondering if there's also any additions being made to key areas like medical management or the actuarial team. And just big picture-wise, post restructuring, should we still think about fixed cost leverage as about 10 to 20 basis points SG&A reduction per $1 billion in revenue added? Or is the fixed cost leverage changed now?

To your first question, there are pockets of the company where we will see additional resources directed. So for example contract procurement, business development, RFP team, we'll see more resources directed in that area. There may be some aspects of medical management that we will, indeed, direct more resources to, but I think that will be a reshuffling of resources more than the assignment of new resources. We'll probably beef up our contracting capabilities, both in terms of provider contracting and just basic vendor -- administrative cost vendor contracting. We think there's some opportunities there. So there are places in the company where we will see increased resources directed. To your other question, I have not gone back and looked at that scaling lately of revenue, $1 billion of revenue to what it compares to G&A lift. I think that got a little bit skewed when we went so deeply into Marketplace, which obviously has a very different administrative cost structure. I will say this, though. The savings we anticipate, which, at the high end, are split about -- from the restructuring plan, which, at the high end, are split about 50-50 between medical and admin. At the low end, they're probably 65% admin. The restructuring plan has the potential to lower our administrative cost ratio by as much as 100 bps.

Our next question comes from the line of Ana Gupte with Leerink Partners.

I wanted to check in. So it's kind of a follow-up again on some of Sarah's questions. Just a rough math, and pardon me if this is all very quick. Obviously, you just reported. Like $1.50 or so of your EPS loss seems to be coming from continuing ops. And we've had a string of hospital reports [we're following,] they're really seeing pressure. And insurers are talking about how -- I mean, the MLRs, these they attribute it in part to value-based care and all of that. So operationally, it seems like there were a lot of challenges, and you're going through all these layoffs. And I understand the 50% rate increase and even 30% without -- with CSRs and all that. But aren't you taking on a lot with everything you've got going right now? And how do you see yourself coming out of this?

Well, I don't -- I'm not sure where your $1.50 from continuing operations, how you derived that, Ana. It's probably not that -- we can probably go into that in a separate call. Pretax, our loss was about -- was $314 million for the second quarter. The items we called out, which included the Marketplace premium deficiency reserve, were about $330 million. To me, that suggests more or less running at breakeven for the quarter, at least. But I think what we're essentially finding, and I come back to what I said in my prepared remarks. A lot of the build we've done in this company in 2012, in 2013, into 2014, when we were talking to you all about the way we were spending more money on admin. Honestly, I think we directed it -- we placed it in the wrong direction. And I think we were doubling down on existing processes, existing methods of doing things when we actually needed to just essentially strip down to the fundamentals and rebuild the chassis of the business. That's something we've been spending a lot of time with our -- among ourselves as a leadership team and with our consultants over the last 6 months or so. And I really think there's enough spend in this company to -- more than enough spend in this company to manage it very well. I think we simply have to redirect people's energies and redirect people's focus to more productive activities. To be, for example, to be revisiting...go ahead.

No. So I'm happy to know that I might be wrong. And at least on Medicaid, you're saying the dollar amount that I came up with was -- and now I'll have to refine my math, but it's (inaudible).

Yes, but we'll talk about it. Yes, I mean, there's a lot of out-of-period activity, which I think we've closed the door on this quarter. You look at the impairment, look at the PDR, which is forward-looking. I think we're running at about breakeven for the quarter, pure period, but others may have a different opinion.

Okay. Now with these losses and with this report in terms of your capital adequacy, how do you think your company would go with the ratings agencies? Because one cannot say that, for sure, especially with the Marketplaces performing the way they are, that even this year, leave alone next year, despite the ratings, that things won't be bad.

Yes. And we've been engaging, obviously, with the rating agencies over the last couple of days. They are appropriately, asking hard questions. I think they are -- I think they welcome the restructuring plan. I think as we've walked representatives of the rating agencies, both of them through that restructuring plan, they understand that the restructuring plan has real teeth. There was $55 million of cost take-out last Thursday that is obviously not reflected in these numbers because it was a July event. So we're already $55 million down the path to that $200 million we've committed to for the full year. But again, the rating agencies see the numbers you see, and they're asking hard questions. And we're engaged with them, and we'll have to see how that plays out.

(Operator Instructions) Our next question comes from the line of Peter Costa with Wells Fargo Securities.

I'd like to dig a little bit more into the -- your cash position and capital position at this point. Capital -- cash at the parent was $270 million at the end of the first quarter. Where is that today? You did the bond offering. So can you kind of go through with what you have today at the end of the second quarter; what you know you've already funded down to the sub level; what you're planning to fund down to the sub level. And then whatever you think is going to happen with the convert.

Sure. Okay. So to take that in order, just to be clear, the notes we issued back in early May are, in effect, set aside for payment of the 2044 converts that become potentially puttable to us next year. So that is down in a segregated cash account. So that is outside of any discussions, the rest of anything else I want to talk about. So that's set aside, again, to protect us in the event the notes that could be put to us in 2018 are indeed put to us. So at the parent company at the end of June, we had about $165 million of cash. We're going to do some further funding of our subsidiaries in the next day or so. That's probably going to take perhaps another -- probably bring that down to $100 million. We are also going to take a draw upon our revolver. We've spoken to our bank syndicate. They're very supportive. We're going to take about $300 million draw on our revolver either tomorrow or the next day. With that, we should be fine. What's going to happen, obviously, is we'll incur some pretty hefty costs on the -- as you can see, on the restructuring plan for the latter half of the year, but only about 2/3 of those are cash. Some of the items we have in the -- as cost for the restructuring plan that we talk about in the 10-Q are going to be lease terminations and all of that. And then by the time we roll around into January of next year, in 5 months, we're going to have the benefit of about $200 million of run rate reduction off of where we're at right now. So I think we're in a decent position in terms of liquidity.

So where do you think your cash will be at the end of the year, cash at the parent?

My bet would be $200 million or $300 million.

Okay. And then I just have to ask, in Ohio, you signed this agreement with the Cleveland Clinic. Don't you think that's going to bring less healthy people to you in your Medicaid book? And at this point in time, signing up with a premier facility like that makes you concerned that you're going to get an adverse selection. Why would you do something like that at this point in time given all the other things going on?

I'll let Terry Bayer answer that question.

Yes. This is Terry. We were successful in negotiating a very competitive rate with the clinic and we're confident that our commitment to that market will assist us in managing those patients.

Do you think you're going to get an adverse selection from having that in your network?

We'll know after we're in business. We draw -- the Cleveland Clinic also is attractive in terms of drawing the broader population. They've been in the Medicaid network in Ohio and that will come into our rating as we go forward with the state agency.

Okay. And my last question, just on the Medicaid rate increase in Puerto Rico. You didn't mention that. What did you get for a rate increase in Puerto Rico?

I think it's in the neighborhood of 5%, 5.5% effective July 1.

And what do you think that will do to your operating performance there?

It will certainly help. Yes, we'll have to see how trends rollout in terms of medical cost, but it's a nice increase.

Our next question comes from the line of Kevin Fischbeck with Merrill Lynch.

I guess first, the $400 million number of savings that you're talking about, how much of that is in G&A versus in medical cost? So it sounds like you are doing some things around networking and contracting and things like that. So I just wondered if you could break out the plan.

Absolutely. At the lower end, Kevin, at the lower end of the $300 million end, it's probably 60% to 65% admin. Bear in mind that probably 3% of our MLR is administrative-related medical cost. So as we reduce staff, we reduce not just the admin, but we reduce medical cost. But again, at the lower end of $300 million is probably 60% to 65% admin. By the time you get to that higher end, it's probably 50-50.

Okay. And so when you talk about that 3% of MLR that's kind of admin cost, are you including that in the 65% admin? Or you're just going to say G&A is admin for this purpose, tentatively everything else is MLR?

No, no, no, we're assigning them to the right cost category, either medical or admin.

Okay. So in the $300 million number, 65% comes out of G&A and 35% comes out of MLR?

Yes, I would assume so, yes.

Okay. And you kind of gave the numbers. I'm sure we can back into it from what you gave, but it'd be just easier if we get the explicit number. What does the guidance assume for Wisconsin and Utah exchange losses this year in absolute dollars?

I don't -- we certainly haven't shared that and I don't have that handy right now, sorry.

Okay. And I guess, these numbers, it sounds to me like you're not really looking to invest a lot of money. So when we think about $300 million to $400 million, these are both the gross and basically a net number. There's not going to be $50 million of investment somewhere else that comes up later on. This is both a gross and a net number. Is that right?

Yes, well, I think you're looking at it correctly. Just remember though that as is disclosed in our 10-Q that we filed and also in the ER, there's about $150 million -- I think it's maybe -- around $150 million cost to the plan in the second half of this year and maybe another $50 million in -- $40 million or $50 million in 2018. But beyond that, no.

These are just kind of the onetime severance costs?

Yes, exactly, exactly. And again, as I said, they are net. They are generally gross and net numbers. There is increased spending to support RFP and business development efforts. There's some increased spending in terms of contracting, but most of it is in -- to the extent we are putting more money into places, we're redeploying existing spend.

Yes, because I think -- I guess, I think certainly, the impression of Molina from the outside is not necessarily that the company was fat from a G&A perspective. I mean, obviously, there's always room to cut in any organization. But I guess, the perception had always been that you guys needed to do more work around the medical management side of things. And when I look at the quarter, this quarter, it seems like medical costs are the problem, not that G&A somehow exploded in the quarter and that created a problem. It's really that medical costs were out of control. So I guess I just want to understand why the solution here is about cutting G&A when I think most people would expect you to be saying, no, we should be putting more money into systems and medical management initiatives and things like that. That's usually the game plan we always hear from other companies, is we're going to spend $100 million more on XYZ to deliver twice as much or 3x as much savings in years 2 and 3. This is just unusual to me to hear it this way.

Yes, and I'll be honest with you, as the last 4 or 5 months have unfolded, I've been surprised, too. We -- I was not alone, as you, thinking that at Molina, we were essentially lean. We were essentially lean from an admin perspective. What I don't think that assumption recognized was that over the last 4 or 5 years, we have become probably the pure-play Medicaid outside of Marketplace HMO. And the reality of it is, is that as a -- with such a focus on Medicaid, we can, and should, run much lower than the competition. So that's been something, frankly, of a learning process for me because I think I would have been in -- had your point of view 6 months ago. But as we've dived into the numbers, and we've done a deep dive, there's clearly spend we can take out of Medicaid -- or out of admin without harming the business. And again, there is again, there is going to be, as I said, by the time we get to $400 million in savings, there is considerable medical cost savings tied to better provider contracting, essentially the restructure of our direct delivery organization is going to bring some money to the bottom line. So there are medical savings there.

Okay. And I guess my last question. When you talk about the provider contracting process that you're fixing, what exactly is it that was wrong with the process as it was historically? How are you fixing it? Is it just a matter of going back and taking out high-cost providers in the network? Or is there something else in that process?

There is no doubt in terms of how we -- bluntly, in terms of how we've engaged certain -- particularly, certain inpatient facilities, certain hospitals over the years. There is no doubt, frankly, that we've left some money on the table. We've come across that, for example, at our New Mexico health plan. We've come across it at a few other health plans. We've had to make some tough decisions. I mentioned the fact that we've replaced leadership teams at 3 health plans in the last 8 months. We've -- honestly, we've just left some money on the table when it comes to engagement with providers.

And then, I guess, what is leading you to think that you left money on the table? Is it that you've kind of benchmarked against what Centene or [competitors] are getting?

Exactly. The benchmarks tell the story. The degree to which -- the speed with which claims become outliers, things like that tell a story that we could have been more efficient in how we contracted.

Okay. On that I lied because I got one more question. So I guess, to the extent that 1/3 to half of these savings are going to be medical management in nature, I guess it's always easier for us to model in G&A savings. I think there's some pretty good visibility you're achieving what you're talking about when you talk about G&A savings. Medical management is always a little more difficult to kind of rely on. To what extent do you believe that these medical management savings are kind of high-visibility things? I guess, just getting a better price and the ability to get a better price versus what you've gotten historically versus something else that may be a little bit more nebulous as far as like provider engagement to change outcomes and shift cost to lower -- shift volumes to lower-cost settings, et cetera?

Yes, well, there's no doubt that it's going to be -- there's no doubt that it's a little harder and -- because we're modeling this out for the exact purpose you've spoken to. There's no doubt that it's going to be harder to track and firmly identify savings on the medical side. But we can certainly see changes in unit cost per contract. It gets a little bit murkier when you talk about trying to encourage members to see more effective, what we would call preferred networks. That becomes a little bit harder. But I think we're going to be able to measure that, too. And frankly, I also think we're going to be able to measure some of our utilization improvements as we have more time and more resources to direct to patients we can influence, to the complex patients. And I think we'll be able to see that in our utilization side, too. But you're correct, it will be harder to measure.

The next question comes from Gary Taylor with JPMorgan.

A couple of questions. So going back to that $300 million to $400 million savings figure, and you've provided some context like comparing it to 2016 pretax income. I guess the question is, do you have confidence that, that level of savings makes its way down to the pretax line by 2019? Is there any reason why that level of savings, if you achieve it, doesn't find its way to the pretax line ultimately?

I have very high confidence we can do that. Again, we've already got visibility into a lot of the stuff we're going to do, we've already done this summer and we're going to do this fall. Now certainly, as part of this process, we're going to have to be disciplined to make sure that cost doesn't creep back in. I think everybody who's been through one of these restructuring exercises understands, you've got to make sure the rubber band doesn't snap back. But we have a -- it's a very detailed process we're going into. We're basically developing staffing ratios. We're developing spans of control. And we're going to be looking very closely at this going forward. So I certainly feel very good about the low end of that range, the $300 million. Obviously, as you move more up toward $400 million, I think it becomes more speculative. But -- and to answer your question succinctly, yes, I'm confident we can do that.

Okay. And in terms of -- you had asked a -- you had responded to an earlier question about, obviously, remaining committed to the Medicaid market, et cetera. What about the RFPs for new populations? It seems like it'd be reasonable to think in the rest of this year and probably even in '18 you may not be participating in RFPs for new chronic populations, et cetera. So is that fair or unfair?

You're talking about Medicaid populations?

Correct.

We're all-in. And that's not a correct statement. We are all-in.

On assuming and entering into new populations over the -- even in the near term?

Yes, yes, we're all-in.

Okay. And then my last question is, when you talked about direct delivery network not being competitive, I presume you're talking about owned physician practices and clinics. Is that correct?

Correct. And I would say owned -- managed in the way we've managed direct delivery heretofore, correct.

And so the question was just why? Is there a little more color, I just -- I'm not sure I understand why upon review those weren't being managed health. You think they should be or can be?

I think there are a few points. First of all, there's a matter of where our expertise is at. As part of our direct delivery strategy with our captive professional corporation, for example, we felt the need to retain our own in-house management service organization, our own in-house MSO. The MSO is the entity that does all the administrative processes for the medical group. Well, as a practical matter, we simply do not have the expertise to provide at a -- efficiently, administrative services for a medical group. Secondly, it is probably -- just by reason, definition of scale, it is impossible to build an MSO out to provide administrative services to a single medical group that's only seeing Molina members. So right off the bat, we've really struggled with the maintaining of a full direct delivery administrative infrastructure. This is everything from setting up appointments, to providing office space, to providing equipment, to providing office help. We just haven't been able to do that efficiently. Part of it is a question of expertise, but part of it, frankly, is a question of scale. So from a direct delivery perspective, I think entities that look outside to leverage third-party MSOs are going to be more effective. The second issue we've struggled with is to -- with an in-house medical group or a friendly, what's called a friendly professional corporation. We've struggled to incentivize physicians to manage care appropriately. A third-party IPA simply has every incentive to manage care in the most effective manner. When one doesn't have a -- when the individual physician doesn't have a profit incentive, you're going to get a different outcome. So I would point to those 2 things as being the key catalysts for that decision.

Last quick one for me. I apologize, we are all digesting a lot so I can't remember if you said this or if I read this. But I know there was a comment somewhere along the way that the permanent CEO search was underway and you were encouraged by the responses or something to that effect. Do you have kind of a -- or when should we expect to see that announcement made? Is this by the end of the year thing for sure or by the end of the year hopeful or any tighter framework for us?

I mean, I can't commit to a time frame. I will say that the search is narrowing. There've been a number of very qualified candidates, a number of whom remain in the pool, and it's proceeding very well. I hesitate to give a time frame, but boy, I would be surprised if it took to the end of the year. I'd be very surprised if it took that long.

Our next question comes from the line of Justin Lake with Wolfe Research.

This is Steve Baxter on for Justin. Just want to ask a couple of questions about the business as it kind of is today and underlying trends there. So I was hoping that you could maybe provide an update on the outlook for rates in the Medicaid expansion business and what the profitability of that business is currently running at today? I mean, our understanding is that plans are looking at a pretty meaningful rate reduction in California. So we were hoping you could share what you're expecting to see there in terms of rates that you guys have.

Yes, there was a pretty hefty rate reduction in -- on Medicaid expansion in California, July 1. I don't have that handy. With that said, though, there was also activity in the other direction in terms of the other Medicaid products. We had guided back in January to an overall fully bended 4% rate decrease in California. It came in -- which would include all lines of business. It looks like what we've seen of a July rates effect, it has come in closer to 2% decrease. So that's actually been a bright spot for us right now. In general, we continue to see expansion rates move more towards the other Medicaid, the TANF and ABD rates as we see margins move in that direction, too. But I think in general, I think in general, the outlook for Medicaid expansion is still pretty good. So I guess I would say, Steve, let me just be a little more concise, even with the drop in California, July 1, we've got pretty good relief on other product lines.

Okay. And then thinking just about the exchanges and sort of the volatility that's ongoing with CSRs at the moment. Can you give us, I guess, an estimate that assuming that CSRs are paid for the balance of the year, how much will you have been reimbursed by the federal government in total for the 2017 plan year?

CSRs, for the full -- all of 2017, we expect that to run around $400 million. We expect to give back, right now, we expect probably give back half of that.

In terms of giving it back, sorry, how do you -- what do you mean by giving it back?

Excuse me, my voice is breaking. We're always in a position, at least have always been in the past on CSRs in most of our states where the amount funded by the Feds is in excess of what our members utilize. So at that point, we have to do -- we have to repay the Feds the amount that the member, in effect, doesn't utilize. It's a process of repricing claims and seeing what the members' co-pays and deductibles would have been. So basically, it's about -- we think it's going to be about $400 million for all of '17, and we think we'll probably give about $200 million of that back.

Okay. So then about $200 million net.

Our next question comes from Patrick Barrett with TCW.

I just want to ask about the way that you all report EBITDA. So when you came to market with the note it was $544 million on an LTM basis. Would be curious to know if you have the number as of this quarter, and if you'd be willing to share with us which of the items you've identified that are sort of nonrecurring in nature that are permissible to be added to that EBITDA number?

Actually, Patrick, I don't have that indenture information handy. We can certainly have a call on that. The EBITDA we share is a non-GAAP measure, is a traditional EBITDA. I would imagine the notes probably adjust for stock compensation and items like that. So I don't really have that -- I really don't have that number. I think it might be running around $470 million LTM, but we should probably have a talk with you about that, Patrick. Let's have a call afterwards and we can track that down.

Our next question comes from Michael Baker with Raymond James.

Joe, I was wondering if you could give some color on the shortfall on Pathways relative to what you were expecting. And is that another kind of delivery area where you may look to do some outsourcing as well?

Certainly. Pathways is a very interesting business. I want to be clear. It is a functioning business. And it is -- the fact that we took an impairment on Pathways, bear in mind, we only -- we did not impair the full amount of the Pathways goodwill for this exercise. So I want to be clear. We wrote off about 40% of their goodwill. So it's still a functioning business. What we've -- from an operational point of view, we've had several challenges with that business. One challenge has been simply the retention of staff. Without the frontline client-facing psychologists and counselors, you simply can't build the rev. You can't build the revenue. So it's very much a business that's tied to your ability to retain individuals who can do the work to get you build. The second issue we've run into in terms of Pathways related to that is, we've had to increase various employee incentives to compensation-related benefits to retain staff for that very reason. And I think the third issue we're running in, in Pathways, frankly, is some of the payers are becoming more demanding in terms of their reimbursement. The business has moved a little bit more towards -- a little bit away from fee-for-service Medicaid, a little bit more to third-party payers, other insurance companies. And we've had a little bit of an issue adjusting to what they require in order for us to get reimbursed. So again, it's a good business, but those 3 issues, I think, retaining staff, finding a way to -- the admin cost of retaining the staff, and again, a shift a little bit in terms of payer behavior have been a little bit challenging.

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

Joe, I think before the Aetna Humana deal break, the company had added some Medicare resources in anticipation of the divestiture. And I wondered if Medicare was an area, one, of continued commitment relative to earlier questions about Medicaid? And second, is that an area where maybe because of those added costs prior, that might be a disproportionate area of cost reduction in your restructuring?

Yes, we're still very enthusiastic about the -- about what I call the Medicaid adjacent Medicare space. The SNPs, the MMPs, those are just parts of the business where we continue to want to play. I don't have a full list in front of me, but we are moving into a few new geographies coming in 2018. The Medicare spend, while we're talking about ramping it up, it hasn't been astronomical by any stretch of the imagination. We'll weigh decisions like how much advertising we do and stuff like that. We'll see where we are in November and December, but I would say, in general, we remain enthusiastic about anything related to Medicare that in any way abuts the Medicaid space. And there's a lot of that. So I think overall we remain positive.

Okay. And then just one more on -- you talk in the restructuring about consolidation of regional support services. I'm not sure how significant that is, but I guess I would think that you would have to be running kind of the regional services in parallel with what new, say, new centralized group you might build out. Could you talk about how you manage that in a nondisruptive fashion and what the cost implications are of that?

That's a great question. When you talk about these kind of transitions, whether physically from one location to another or just in terms of individuals assuming new duties, it has to be managed very carefully. What we're trying to do as we look at that is, we're trying to look at health plans with similar characteristics. Initially, looking at this very simplistically, what I had in my head was you'd group everything geographically. That's the way I looked at it. And the operations team spent some time with me and I think clearly demonstrated that it isn't about the geography, it's about the characteristics of the health plan. So for example, a smaller health plan with, essentially, a TANF type of membership base, you want to group those together. The health plans with the more complex members, you probably want to group those together. You need to consider things like just management stability in a health plan, management capabilities. You need to consider where they are in their reprocurement cycle. So there's a lot of stuff to be considered as you create these regional capabilities. You also just want to make sure that your staff, again, have the right knowledge mix and capabilities mix. And that's a big part of what we're trying to do with our restructuring is make sure we attract and retain capable, highly motivated, highly talented people. So it needs to be done very carefully, but I think the key to it is, is look for the similarities that are not just obvious like geography. And we've been very thoughtful about that.

And our last question is a follow-up from the line of Ana Gupte with Leerink Partners.

So on the CEO search, it sounds like it will be pretty quick. Do you think there's any chance that you might still consider exiting exchanges and might that not mitigate your risk of having to raise equity or whatever with the ratings agencies? It will certainly kind of improve sentiment on The Street.

Well, I certainly think we are -- we said in the call or in the prepared remarks, all of that participation, all of the exchange participation is up in the air right now. As I like to say with the company right now and where we're at, we have to do what the numbers suggest to us. The numbers kind of tell us what to do. There is no doubt we do have a strategic advantage in the Marketplace with our Medicaid network, but I understand investor concern about the volatility of that network -- I mean, about the volatility of the Marketplace. We understand the frustration there. And essentially, we've exited 2 of our markets. It's up in the air on the rest. We're going to take -- look very closely at developments, particularly in the political area over the next month or so. We've got until September 27. And we're taking a very hard look at that. So it would not surprise me if we have further exits. We'll just have to wait and see.

Okay. One final one and just a follow-up on that. When the state insurance commissioners are talking to you about all this, and they're equally concerned, it sounds like on CSRs and everything. Are they more focused on just your synergies and adjacencies as you say, the Medicaid HMO. Does it put your Florida RFP or Illinois or anything else at risk? Or are they saying, hey, it's okay, 55% is so big that even under a stressed capital situation, everything is going to be fine.

Well, I don't think anybody's going to explicitly link the retention of a Medicaid contract to staying in the Marketplace. Certainly, we know that the departments of insurance we deal with, who do not control the Medicaid contracts, by the way, nevertheless have an interest in a stable insurance market. They have a very difficult situation. That stable market, number one, is a balancing act of having insurers in the market, but also making sure those insurers have financial stability. In general, we have found the regulators very supportive of our situation. They, like us though, are sometimes caught between a rock and a hard place. And it's a case-by-case basis. We made the decision to exit Utah and Wisconsin. There may be more states. And again, we'll have to be guided right now by what is best for the company.

Well, thanks, everyone, for joining. That concludes our call for today. And we'll talk to you next quarter.

Thanks, everyone.

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