Molina Healthcare Inc (MOH) 2004 Q2 法說會逐字稿

Welcome to the Molina Healthcare second-quarter results conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded Wednesday, August 4, 2004. I would now like to turn the conference over to Mr. Juan Jose Orellana, Director of Investor Relations for Molina Healthcare. Please go ahead, sir.

Good afternoon, everyone, and thank you for joining the Molina Healthcare financial results conference call. As a reminder, this call is being recorded and a 30-day replay of the conference call will be available over the Internet through the Company's website at www.MolinaHealthcare.com. If anyone has not seen the earnings press release, it is also available in the investors (indiscernible) at our Company website.

By way of introduction, some of the issues discussed on the call today may contain forward-looking statements. Except for the historical information referred to in this conference call, all forward-looking statements are predictions by the Company's management and are subject to various risks and uncertainties that may cause the actual results to differ materially from management's current expectations. Such factors include -- the Company's third-party contracts; the Company's ability to accurately predict and effectively manage health benefits and other operating expenses; competition; changes in healthcare practices; changes in federal or state laws or regulations, or the interpretation thereof; reduction in provider payments by governmental payors; obtaining the necessary regulatory approvals for the Company's acquisitions; issues related to the integration of the Company's acquisitions; and other risks as detailed from time to time in the Company's reports and filings with the Securities and Exchange Commission. All forward-looking statements in this call represent the Company's judgment as of today's date. The Company disclaims, however, any intent or obligation to update its forward-looking statements.

On the call to answer any questions today are Dr. Mario Molina, our Company's Chief Executive Officer, and John Molina, our Chief Financial Officer. I would now like to turn to Dr. Mario Molina.

Thank you, Juan Jose. Good afternoon, everyone. We appreciate your interest in Molina Healthcare, and thank you for joining our discussion today. For today's call, I would like to begin by summarizing our quarterly results, and then spend some time discussing our progress in the second half of 2004.

The Company's net earnings for the quarter were $12 million, or 43 cents per share on a fully diluted basis, compared with net income of $10.9 million, or 57 cents per fully diluted share for the same quarter last year. Premium revenues were $247.5 million, representing an increase of $54 million, or approximately 28 percent greater than 2003 premium revenue.

Medical care costs as a percentage of premium and other revenue increased to 84.2 percent in the second quarter of 2004, from 82.5 percent in the second quarter of 2003. Salaries, general and administrative expenses showed continued improvement in the second quarter, decreasing to $18.8 million, or 7.6 percent of operating revenue, compared to $15.4 million, or 7.9 percent of second quarter -- in the second quarter of 2003.

Earnings were affected by shifts in our geographic and (indiscernible) category mix in Michigan and increased demand from our new members and our recent acquisition in Washington. John will be providing additional insight into these results during his remarks.

In addition, we are updating our 2004 full-year outlook from the previous guidance of $1.83 to $1.93 per share to the range of about $1.89 to $2.03 per diluted share, to reflect anticipated net income from our Washington and New Mexico transactions.

As of June 30, 2004, the enrollment in our health plans increased to 652,000 members, reflecting a year-over-year increase of 137,000 members, or an increase of 27 percent. All of our health plans had increases in enrollment with the exception of California, which continues to be affected by administrative efforts to redetermine the eligibility of current Medicaid beneficiaries in Los Angeles County. Our goal has been to increase our membership to 1 million members by the year 2007, and we are ahead of our timetable to meet that goal.

We continue to execute our strategic plan. During our first-quarter conference call we reported on the progress and the expected closing of our acquisitions. Since that time we've announced the completion of two acquisitions and disclosed our intent to acquire the rights to serve the Wellness Plan membership in the state of Michigan.

In June, we reported the completion of the acquisition from Premera Blue Cross in Washington. As part of that transaction, Molina Healthcare added approximately 56,000 new members, raising our Washington enrollment to approximately 269,000 members.

In July, we announced the completion of our acquisition in the state of New Mexico. Our acquisition of Health Care Horizons, the parent company of Cimarron Health Plan, added approximately 66,000 Medicaid members and a block of commercial members. The approval of this acquisition marked our entrance into a fifth space. When combined with the membership announced today, the 66,000 Medicaid members in New Mexico raises Molina's July 2004 enrollment to approximately 718,000 members. In order to continue our focus on government programs for the poor and uninsured, the Company announced its intent to transfer the commercial membership in New Mexico to Ardent Health Systems. Today, we announced the completion of this transaction.

Moving on to our pending transaction. In July, the Michigan Circuit Court approved a rehabilitator's petition to sell the rights to serve the Wellness Plan membership in four counties to Molina Healthcare of Michigan. As part of this transaction, Molina Healthcare of Michigan has agreed to pay approximately $19 million for the rights to serve about 85,000 members, subject to purchase price adjustments and the negotiation of a definitive agreement. We are pleased with the progress we have made on the acquisition front, and have continued to evaluate other opportunities in new and existing on markets.

From a management resource perspective, we believe we are well-positioned to engage in new opportunities as they arise. On the one hand, our corporate-level team begins the initial activity by evaluating opportunities and supporting this with due diligence and negotiations. On the other hand, our local leadership, management and integration team address implementation and integration. This approach has worked well for us, as evidenced by our ability to quickly execute these transactions and to integrate the new membership.

I want to take a moment to discuss the nature of our integrations and how an acquisition in a state where we currently do business differs from a new state.

Acquisitions in existing states are generally less difficult to integrate. In an existing state transaction, our infrastructure, required licenses, human resources, IF (ph) systems, and overlapping provider networks are already in place. This results in both speed and ease of integration.

For example, our acquisition of the Premera members in Washington was fully integrated within four months of the announcement of that transaction; however, postponed utilization of medical services observed during the transition period can affect medical care costs in the short run. Conversely, in a new state where we enter through acquisition, we are acquiring the infrastructure required to operate in that state. A new state transaction such as New Mexico is therefore more complex, as there are more issues to address. We may have to address the disposition of noncore assets, conversion of legacy information and claim systems and a conversion to the Molina business model. Nevertheless, we have demonstrated that we can carry out both types of transactions.

Although we have been very active on the acquisition front, we continue to evaluate opportunities to enter new states through start-up or de novo operations. In addition, we have dedicated resources to evaluate other growth opportunities within our Medicaid core business. Among them are initiatives focused on serving the aged, blind and disabled category of Medicaid beneficiaries.

According to the Kaiser Commission on Medicaid and the Uninsured, it's estimated that in 2003 the aged, blind and disabled constituted roughly a quarter of all Medicaid beneficiaries; however, they accounted for nearly 70 percent of Medicaid spending. In order to create savings, many states are looking at the possibility of enrolling their aged, blind and disabled members into managed care.

For example, our Washington health plan was awarded a contract by the State to provide integrated care to the aged, blind and disabled members. This contract, which is slated for implementation in January of 2005, would benefit up to 6000 members in (indiscernible) County.

Our Utah health plan is involved in two demonstration projects for patients requiring nursing home level of care. The first project is part of a long-term care initiative program sponsored by the Utah Department of Health. The program, known as Molina Independence Care, assists Medicaid members that are currently residing in nursing facilities to transition to a setting that does not require institutionalization. We also participate in another long-term care initiative called Weaver Max (ph), serving Weaver and Morgan counties.

Our Michigan health plan continues to solidify its market position and received a renewal of its contract in that state. This year, we observed an upward pressure on the medical care ratio in Michigan as a result of capitation rate issues. As John will discuss in greater detail, we expect these trends to be positively affected by announced rate increases that will come into effect in the fourth quarter 2004.

Our California health plan has experienced decreases in enrollment in Los Angeles County, where the County has undertaken a reconciliation of eligibility files, seeking to identify members that are no longer eligible for Medicaid benefits. Individuals identified as no longer eligible for benefits are removed from the program, resulting in lower enrollment.

Despite these challenges, the outlook for California remains encouraging. First, the eligibility redetermination is nearing its completion and eligibility numbers should stabilize. Second, California has a new budget. The new budget maintains the current reimbursement levels for providers and does not cap enrollment in the SCHIP program. These are both very positive developments for low income families and children in California.

I'm pleased with the progress our company is making in executing our strategy, and our management team remains focused on tackling many of the challenges we face. Although we have experienced noteworthy growth, we are proud to report that quality has not suffered. Quite the contrary, we remain committed to a strategic plan that calls for NCQA accreditation of all of our health plans. Currently, three of our five health plans have NCQA accreditation. Furthermore, we received the Pinnacle Award from the Michigan Association of Health Plans to recognize our efforts to provide early intervention for children with developmental delay.

Before John speaks about the results in greater detail, I want to comment that the second quarter of 2004 concluded Molina Healthcare's first year as a publicly traded company. When we began as a public company, we stated our intent to grow profitably and to diversify our revenues. We achieved books.

Our membership has increased 40 percent to approximately 718,000 members, and we have successfully completed four acquisitions -- two in Michigan, one in Washington and one in New Mexico -- further reducing our reliance on California.

In addition, net income is one year ahead of where we thought it would be at this time. We are proud of these milestones and achievements in our corporate history, but more importantly, we look forward to continued progress and results consistent with our long-term goals and objectives.

Thank you for your time, and now I would like to turn to John.

Thank you, Mario, and good afternoon, everyone. As we've done in previous calls, I would like to walk you through some of the clarifying comments related to our earnings release.

Let's begin with revenue. I apologize for my voice. Premium revenues for the second quarter ended June 30, 2004 were 247.5 million, up 28 percent from 193.5 million in the same quarter a year ago. Increased premium revenue from membership growth contributed approximately 70 percent of the increase, while increases in premium rates contributed the balance.

Our enrollment as of June 30, 2004 reached 652,000 members, up 27 percent from 515,000 members a year ago. This figure excludes the 66,000 members added in New Mexico. Our largest sequential gain in the quarter was experienced in our Washington health plan, principally as a result of the integration of 56,000 members from the Premera transaction which closed on June 1, 2004.

The Company recognized 1.1 million of out-of-period premium revenue as the result of a positive premium rate adjustment by the State of California. The increase in premium revenue represents the extent to which the new rates exceed those that were accrued by the Company between October 1, 2003 and June 30, 2004.

For the second quarter of 2004, the Company's medical care ratio increased to 84.2 percent from 82.5 in the second quarter of 2003. In absolute terms, medical care costs increased $209 million in the second quarter of 2004 from 161 million in the second quarter of 2003. We believe this increase in our medical care ratio is the result of the expansion in our health plans in Michigan and Washington.

The increase in medical care ratios is most pronounced in Michigan, where costs have been influenced by increased overall enrollment and utilization from our aged, blind and disabled patients in counties where capitation revenue is relatively lower than in other counties.

During the first six months of the year, the majority of our growth in Michigan occurred in regions outside of Metropolitan Detroit. Rates in these counties were less than rates in the metropolitan areas. This higher medical care ratio becomes evident when our Michigan medical costs are calculated on a per-member per-month basis.

Our costs were flat on a per-member per-month basis, but our per-member per-month revenue rates actually decreased. This has the effect of increasing the medical care ratio. However, these trends are expected to improve as the State implements actuarially sound rates in October.

The Michigan HMO Association has calculated a blended average managed care rate increase of 9 percent for the State that will take effect October 1, 2004. Based on our membership and geographic mix, the Company anticipates a blended rate increase of approximately 10 percent. This rate increase should reduce the medical care ratio to its expected level.

Our Washington health plan experienced increased utilization as a result of the Premera integration. In previous transactions, we have gathered data that suggests that during a membership transition there is a postponement of non-urgent care until the provider networks and contractual agreements have been solidified.

Furthermore, we honor pre-transaction medical authorizations to ensure continuity of care for our transition members. These two factors resulted in a temporary increase in medical costs, which we estimate reduced earnings by two to three cents per share. This delay usually causes a temporary increase in medical costs, which we would expect to return to normal levels.

For example, for the month of June, utilization reports revealed that pre-authorizations per 1000 members for our new Medicaid members exceeded those of our existing membership by 50 percent, and pharmacy costs for the new population were 4 percent higher. Preliminary data for July shows that utilization is returning to historic levels. We believe it is important to highlight that in existing market acquisitions, we can expect integration costs to impact our medical costs more than our administrative costs.

For the second quarter, we believe the increases to our medical care ratio to be temporary and offset by rate increases in Michigan and the post-integration stabilization in Washington, medical care costs should return to their expected levels.

Salaries, general and administrative expenses, excluding premium taxes, decreased to 5.9 percent of revenue for the second quarter of 2004, compared to 6.7 percent in the second quarter of 2003. Including premium taxes, which are directly related to membership and capitation rates, SG&A stood at 7.6 percent of revenue for the second quarter of 2004, as compared to 7.9 percent of revenue for the quarter ended June 30, 2003. We continue to leverage our competitive SG&A to bring synergies to our acquisitions, and believe we have sufficient administrative capacity to continue to execute our strategy.

Net income for the quarter ended June 30, 2004 totaled 12 million, or 43 cents per fully diluted share, versus net income of 10.9 million, or 57 cents per fully diluted share for the quarter ended June 30, 2003. As a reminder, net income per diluted share for the second quarter of 2004 was calculated using 27.7 million shares. The increase in diluted shares is a result of the Company's issuance of approximately 7.6 million shares during the IPO in July 2003 and 1.8 million shares issued in the secondary offering in March of 2004.

Cash flow. Operating activities provided 12 million in cash for the quarter ended June 30, 2004. Sequentially, the Company days and claims payable also decreased from 53 days at the end of the first quarter 2004, to 51 days at the end of the second quarter of 2004.

The Company continues to have the benefit of cash resources in excess of risk-based capital at the parent and subsidiary doubles. As of June 30, 2004, our free cash at the parent company stood at approximately $127 million, of which approximately 75 million was used for the New Mexico acquisition.

At the subsidiary level, excess cash stood at approximately $69 million as of June 30, 2004. Our Washington acquisition was financed through excess cash at our Washington subsidiary, and the reduction is reflected in the 69 million. Our cash on hand, combined with our access to our undrawn $75 million credit facility, places Molina in a competitive position to execute on additional expansion opportunities.

Now I would like to update the guidance that was given during the first quarter of 2004 to reflect the two acquisitions -- Washington and New Mexico -- the new share count that has resulted from our secondary offering in March, and the divestiture of the commercial business that we had in New Mexico

We expect the following for the year ended December 31, 2004. Earnings per diluted share from continuing operations will be in the range of $1.89 to $2.03. Net income will be within the range of 52 million to 55.8 million. Premium revenue will be in the range of 1.1 billion to 1.15 billion. Medical care ratio will be in the range of 83.5 to 84.0 percent. This includes the effects of the New Mexico acquisition, which has a greater medical care ratio. SG&A, including premium taxes, will be in the range of 7.9 to 8.3 percent of total revenue. All estimates assume weighted average diluted shares outstanding of 27.5 million.

These estimates also assume an effective tax rate of 37.5 percent, which is not taking into account any favorable state tax credits the Company might receive from prior periods during 2004. We anticipate that we will recognize out-of-year tax benefits during the third quarter of 2 to 3 cents per diluted share, inclusive of SG&A costs associated to collect these benefits.

Finally, as Mario commented, we are a year ahead of where we thought we would be at this time. At the time of the IPO, the current 2004 expectations are what we thought we would accomplish in 2005. We are pleased with our progress but know there is still work to be done.

Thank you for your time. This concludes our prepared remarks.

(OPERATOR INSTRUCTIONS). Joe France, Banc of America Securities.

John, I just wanted to follow-up on your comments about a couple of things. First of all, what was prior period development in the quarter?

Hold on, Joe. $1 million.

So it's pretty (inaudible). The issues that you raised with respect to some of the markets and plans that you just acquired and bought into, are these things that are just very difficult to anticipate?

I'm sorry, Joe. Could you repeat the question?

For example, what happened in Michigan -- I'm sorry, I'm using a speakerphone (technical difficulty) I can talk real close to it. The issues that you highlighted, for example in Michigan and some of the other plans that you've just acquired -- when you first get into these markets, they're impossible to anticipate -- member mix and things like affecting MMR (ph)?

Two cases here, Joe. In Michigan, it's more a function that the state has acknowledged that rates were not actuarially sound, and they have undertaken a program to get the rates up to actuarial soundness. Our problem was we grew in the areas that probably had the least actuarially sound rates or were the lowest in the state. And so as we grew there, the costs -- which are for the most part statewide, because there's a statewide fee schedule -- tended to outstrip the rates. That's why we believe that the rate increase for us will be slightly higher than, as we said, the 9 percent average. In Washington, the increase in medical costs is not unexpected; however, it usually washes it through fairly quickly. We just happened to have -- the first month where you see the biggest increase happened to come at the end of the quarter, as opposed to having the benefit of a full quarter to work those costs through.

Just one final question. Can you talk about your expectation for cash flow for the year?

I can. I think we expect that the cash flow will continue to be strong.

Fair enough.

I will quantify that for you in just a minute, Joe. We can move on to another question.

John Szabo, CIBC World Markets.

Just to follow up on Joe's question. Would it be fair to say that there was no unexpected change in the overall medical cost trend, that what may have been unexpected was just the mix in Michigan, or is that not an accurate statement?

If you look, John, what you see in Michigan is that our actual per-member per-month cost went down slightly in Michigan. The problem, as John points out, is that the areas of most rapid growth were the areas were on a per-member basis we also received the lowest premium rates for the aged, blind and disabled category. If we're going to see substantial rate increases beginning in October, we should bring that medical care ratio back down. I don't think it was so much that the costs were out of line as it was a revenue issue with the way the rates were determined.

Okay. I'll take that as a yes that medical cost trends generally were in line with your expectations for the quarter?

I didn't catch your question, John.

I'm just trying to ask directly, were medical cost trends essentially -- the trend -- essentially in line with your expectations for the quarter?

I would say for the most part, yes. The issues we addressed in Michigan and the fact that we only had one month of the Washington members -- where you see the higher medical cost but you don't get the benefit of the increased revenues as you would if you had them for a full quarter -- had an impact on this quarter's numbers.

My second question was on the guidance. If you look at what the Company has earned through the first six months, it -- at the midpoint of the range -- implies that you're going to make about $1.13 in the back half of the year. Should we assume that that's going to be -- I know you haven't given specific quarterly guidance -- but you know, would I expect that to be more evenly divided between the two quarters, or is there going to be a ramp between Q3 and Q4?

What we're looking at, John, is probably even.

Closer to even?

Yes.

Would that include some seasonality? Usually you get a little more utilization in the fourth quarter, so should I just sort of seasonally adjust that, or would some of the accretion be skewed a little bit more toward the quarter, the fourth quarter, to offset that seasonality?

I think the seasonality is going to cause it to be flat between the two quarters.

Okay. One last thing on the guidance and I'll get back in queue. The New Mexico sale, will that have an effect on the reported numbers for Q3 in terms of the operating income? Are we going to just -- is there going to be a gain or a sale on the loss, and is there going to be a reported income or loss from discontinued in the quarter?

No. We were going to treat that as discontinued operations. From the get go it was running at breakeven, and it sold.

So you're not going to run anything through the income statement below the line because it's breakeven?

You may see something, John, because we did have the commercial business for the month of August -- I'm sorry -- July; we sold it in August.

You're not including that in any of the guidance numbers?

That's correct. Let me clarify a couple of things that I stated and/or misstated. Prior period development was $1 million negative, number one. Number two, we are expecting that cash flow will approximate net income plus depreciation and amortization.

Greg Nersessian, Lehman Brothers.

Just two questions. The first question I had was on the days claims payables declined in the quarter. My sense would be that with the shift from costs in Washington that were capitated are now reimbursed on a fee per service basis, you would actually have to -- I would have expected your DCP to go up as you reserve more for those costs. So I was a little surprised to see the days claims payables continue to tick down. Could you sort of talk to what the offsets are there?

Sure. Washington actually did go up. We had decreases in Michigan; that is primarily a function of during the second quarter really emphasizing electronic submission of claims. So there was a decrease in the inventory there. That's primarily (indiscernible) in California also, especially on the inpatient side, we made a concerted effort to bring our claims speed up. I think for instance we were at one point processing inpatient claims at 20 days and that was brought down to about six days.

We staffed up a little bit in the California claims shop, and that resulted in the significant decrease in the inventory.

The 20 days that's now (indiscernible) -- that's just California or that's all Molina?

That was just California inpatient claims.

Do you have any statistics on your EDI rates and maybe what they were for the quarter versus what they were last year?

I don't have those in front of me.

My last question is on the Wellness Plan that you mentioned. Any preliminary thoughts on impact for the quarter in '04, the fourth quarter of '04, and then potentially into '05?

Typically it's been our policy, Greg, not to make any kind of projections until the deal is closed. And right now we're in the process of negotiating a definitive agreement with the state. So we're not going to make any projections on the Wellness Plan yet.

Eric Veiel, Wachovia Securities.

My first question -- are you guys currently profitable in Michigan right now with your existing business?

Yes.

Yes, we are.

So when you add in the Wellness Plan, given sort of that plans financial troubles, will you still be in the black in Michigan right out of the gate with that?

We're not commenting on -- as Mario said, we're not really commenting on the Wellness transaction because we're still negotiating the deal.

Fair enough. A question on California. As we think about the enrollment there with L.A. County now sort of finishing up its eligibility scrubbing, can we expect membership to start to tip back up in the state, or is there any -- going to be any continued drain on membership there?

There is one more redetermination coming up, but we think that overall the enrollment will be stable, probably flat. We might see some increase towards the end of the year; there is a new county that may come up. And if it does come up this year there is the potential for some slight increase. But for the most part I would look at California as being flat for the rest of the year.

And then, is there any way to quantify what the blended rate is going to look like in California. It's obviously going to be better than what some of the thoughts were early on in the budget process there; but can you quantify what the rate is going to look like?

Let me put it this way. We got our draft rate back in August or October of 2003, and at the end of June we got a letter from the state saying here are your final rates. They paid us at the previous rate and what we did is we accrued an amount that we thought we were going to have to pay back to the state when the final rates came out. When those rates were finally given to us they were a little higher than we expected, and so we picked up a little revenue. We didn't have as much of a decrease as we had initially anticipated. The preliminary rates that we have been given by the state right now show the rates to be flat. Again, I would caution you -- these are preliminary. The good sign is that they are flat, whereas last year they went down about 2.5 percent. So I think it's an encouraging sign, but I wouldn't put too much on that. Right now we are anticipating the rates for California will be flat for next year, and that the physician fee schedule will not change.

Right. And then there is the follow-up question on that, the 1.1 million of revenue that you sort of accrued and then dropped in this quarter. Is it fair to think of that as a -- first of all is it a pre-tax? And secondly, is it fair to think of that as really sort of a onetime benefit that's nonrecurring in nature?

The first answer is yes, it was 1.1 million pre-tax. I wouldn't anticipate -- excuse me -- it to be reoccurring in the future. As Mario, I think, said, they paid us at an old rate and so we accrued an amount that we figured the state would come back to us and recoup. And then in June they sent us new rates, and basically were told that they were going to recoup less than we had booked.

It's an unusual situation. We would anticipate that in the future the state will get us the rates in a timely fashion, and we cannot be in this situation in the future.

So it's an operating item in that it applies to (indiscernible) California for the full fiscal year, but it sort of blends in this quarter? In other words, the previous three quarters are somewhat understated by that from now, and then this quarter is somewhat overstated?

The previous two quarters.

(OPERATOR INSTRUCTIONS). Ed Kroll, SG Cowen.

I think you said that the impact of the higher -- or lower, I guess I should say, PM PM revenue which impacted the MLR there was 2 to 3 cents in the quarter?

No, Ed. The effect of the increased utilization from our Premera acquisition hit us by about 2 to 3 cents for the quarter.

What was the effect on EPS from Michigan, then?

That I don't have quantified, Ed.

Okay. And that California catch-up that you just described, the 1.1 million pre-tax. That's about 2.5 cents positive -- right?

I think so. Yes.

On an EPS basis. In the other states, from an earnings standpoint, other than Michigan and Washington, would you say you did as expected, a little better than expected, or worse? I'm just trying to figure out what is happening in the other markets relative to your expectations.

Your question, then, is how did we do relative to what we expected in California and Utah?

Yes.

California was a little bit -- California from a cost standpoint was better than anything we projected; where California fell a little bit short was on the enrollment side, as Mario said, that the efforts in L.A. County -- excuse me -- for the bigger buy-out of the enrollment than we had forecast last year. And Utah -- I think we're right on the mark.

Part of the problem, Ed, is that this redetermination was supposed to have been done over a much shorter period of time. And what they have done is stretched it out over the course of the year. We expect this to really -- to have been all finished by now. And we're looking at maybe extending it in September.

Just to make sure I understand the Michigan reimbursement issue -- and it sounds like you are getting relief on that starting in October -- you get different reimbursement rates based on the County? Is that the way works?

It's actually based on the region. They group counties into regions. So the counties in the West and the counties in Northern Michigan historically had lower rates than Metropolitan Detroit. Moving under the theory that on a fee-per-service basis, rural areas had less utilization, so they figured the costs were less. The problem is when you then put a managed care program in place and you open up access and guarantee folks access, the utilization state-wide tends to equalize. So now the state has got to go back and adjust the rates to reflect the scope and utilization of services.

Rate setting really is an interim process. And I think that as the state learns more about it, as we supply them with our encounter data, (inaudible) they see what the utilization is like and they put in risk adjusters, you're getting rates that are, I would say, truer. And the state has a plan in Michigan over the next two years to increase the rates, to get them up to a level that's actuarially sound. I think in the Detroit area it's been less of an issue because they had a lot more data. But in some of the rural counties, the state frankly is underpaying us, and that should correct itself beginning in the fourth quarter.

One last thing -- on the cash flow. I think in response to the prior -- previous question, you said for '04 operating cash flow should be approximately equal to net income plus D&A? And it was not -- it was approximately equal to just net income this quarter. I was wondering was there anything of a onetime issue that maybe dampened the cash flow this quarter?

One of the things that we saw in Washington where we added a lot of membership, Washington has a receivable based on the number of births that they get each month. And that went up about 2.5, almost $3 million, I think, for the quarter. And getting back to your question about the rate issue in Michigan. If the rate that we're expecting in October had actually taken place during the second quarter, it would have added about 8 cents to the quarter.

Wow. Okay. So same membership with the higher actuarial sound PM PM, you would have had a nice positive swing then?

That's correct.

One of the problems we encountered here, Ed, is that two of our health plans are on an October rate cycle; California and Michigan get their new rates in October -- not in January or not in July. So we're a little bit sort of off schedule with most of the other states, and that does have an impact on our --

The other thing, Ed -- again (indiscernible) why we want to talk about cost on a per-member per-month basis as opposed to a percent of revenue. Because if you look at Michigan, our costs on a per-member per-month basis were flat. Where we got impacted was the revenue mix, which we're now -- which the state's now going to help us fix.

Chuck Myers (ph), Fidelity Investment.

A quick clarification here in Michigan. By what you're saying about the 8 cent impact, that would imply that just the managed care organizations such as yourself are getting the 10 percent increase and there's no provider rate increase; is that correct?

That's correct. Right now there is no change in the provider fee schedule in Michigan.

So going back to a question asked earlier in the call -- I believe the caller asked what would be the dispersion in Q3 and Q4 earnings, and you said it would be pretty even between the two, yet if there is a Q4 October 1 rate increase in Michigan of 10 percent, and Michigan (indiscernible) 10 to 12 percent of overall Company revenues -- that would imply some medical loss ratio, all else being equal, would have to down 1 percent Q3 to Q4, which would, again, give you that 8 cent quarter-on-quarter increase. So is there -- I just want to make sure that I'm understanding correctly that all else being equal, we should actually see earnings up 8 cents from Q3 to Q4 just because of the rate increase? Would that be a correct assumption?

There is some seasonality in Q4 that's going to hit us that's going to offset some of that.

And that would be (multiple speakers) you think that would be 8 cents, the seasonality part, to make it even from Q3 to Q4?

More or less.

John Szabo, CIBC World Markets.

Just a follow-up on that. Should we also assume that you guys have maybe backed off the membership growth in Michigan for the third quarter, or -- to get a little more growth in some of these regions? Does that sort of imply that the medical loss ratio may come in a little higher in the third quarter?

We're not anticipating big shifts in membership right now. I think that the new contracts come into play in October; we may see some changes in membership after that. And the open enrollment is going to take place in January. So I think that that's going to be tempered by those factors.

Let me go back on the fourth quarter. The other thing that we need to remember, folks, is we've added New Mexico, which is although a small state in terms of enrollment, the revenue is significant. So the seasonality is going to hit also with the New Mexico. And they already have a higher MLR than the average that's going to pick up some of that.

But let me ask you this, John. In the 83.5 to 84 percent guidance that you have given, does that assume a stable membership mix in Michigan, or does that assume some continuation of the trend that you saw in the second quarter?

Stable enrollment in Michigan.

Just one other question. I guess the Governor out there in California has set aside his restructuring program for the Medi-Cal program into next year. Do you have any sort of commentary on what that may have looked like, or why he pushed it back a little bit? Any thoughts on that?

I think the reason that the Medi-Cal redevelopment program was pushed back had to do with the budget. I think the Governor expected his budget to sail right through, and he got some opposition in the legislature. And they just announced their government restructuring; that came out, I think, yesterday, although that government restructuring report does not address the Medi-Cal program. So, I think that it looks like it's going to be more difficult than they thought. It turned out the budget was more difficult to get through than he thought, and I think that with all the complexities of the Medicaid program in California, it's going to take them a little longer to come up with a plan. But I think they're still on track to do something and we probably should hear something in the first quarter of '05.

I'm sorry -- did I miss it? Did you actually give a number as to what the membership impact was on the eligibility scrubbing?

No we didn't, but what's happened in California is that the memberships have pretty much flattened out, and what we're seeing is that one month they do a redetermination and the numbers go down; the next month the membership bounces back up a little bit. So it's been oscillating, but it is holding right around 247? 245 -- right in that range.

So you don't know an exact number as to what it may have done? You can't track the redetermination disenrollments, or --?

You can't track what the disenrollment is; what you can track is what the overall numbers are. Now, the state is projecting that the Medicaid -- overall Medicaid enrollment for the state is going to grow by 100,000 out of several million. So essentially, even with this redetermination in Los Angeles County, the overall state will be flat, in terms of the number of Medicaid beneficiaries. And we think the whole thing is going to stabilize in the fourth quarter. The other thing that we believe is going to happen is that some of these people who are being taken off the rolls because they're not eligible or not using services will come back when they get sick or need services. So this is sort of a temporary measure, and it's occurring because the County of Los Angeles, frankly, got behind on doing these reconciliations which are supposed to be done on a regular basis. In California, the counties do the eligibility determination, not the state.

Eric Veiel, Wachovia Securities.

I just wanted to follow-up on the whole enrollment thing, too. I guess there was no additional confirmation of the 6 to 9 percent enrollment growth number that had been in the first quarter press release? Is that still the guidance for the full year?

Yes and no. The problem we have now is because of all the acquisitions we have done, it's becoming more difficult to follow exactly what is coming as a result of the acquisitions and what is coming as the result of sort of internal growth. And in some of these counties when we pick up a big block of membership like in Washington and take out a competitor, it becomes more difficult to know what that organic growth number is. Right now, we are expecting -- we're at about 715, 718,000 members. And with the Wellness Plan membership we could end up with around 800,000 at the end of the year. But in a period of time when you're doing a lot of acquisitions in-state, it becomes very difficult to measure what is truly your organic growth rate.

Sort of along the lines of county members, I think when the Premera membership was first announced it was like 66,000; then it was next reported at 64. And I think when the deal actually closed it was down to 56. What happened on the membership side there, and was there some adjustment to the price that you paid?

Here's what we do. When we do an acquisition like this in-state, even of a new health plan, we give a number. And that's the number at the time that we do the transaction. We know that there's going to be some attrition of membership, and when a plan is being transitioned -- membership is being transitioned say from Premera to Molina -- there's not a big impetus for people to join that Premera health plan. So we typically see some diminution in the membership. And when we build in our offers, we typically put in -- if there is a membership decline of, say, 15 percent, we will go back and readjust price. So you will almost always see that the number we announce initially will be a little higher than the number that actually transfers.

I want to follow up on that. Our enrollment in Washington between May and June went up 63,000 members; 56 came over in a block from Premera. Some of those folks, some of the doctors moved the members ahead of time because they know they're going to be with Molina. Others -- I think, the state also stopped enrolling members in Premera, so it does deteriorate some. It's really hard at that point to pick apart exactly which membership came from "organic" versus the acquisition. That's why we put the 15 percent membership threshold in.

Okay. That makes sense.

If you look at our forecast, what we're giving you in our guidance are revenue numbers, not necessarily enrollment numbers.

So the 85,000 members in the Wellness Plan, that's sort of the membership there now. By the time that closes we should expect that that is a lower number?

Correct. But what we won't know is how many of those came over to us ahead of time.

Ed Kroll, SG Cowen.

I just wanted to get back to this second half EPS and how those quarters are going to shake out. In trying to get to the ramp from Q2, the quarter you just reported, to Q3, where there will be -- at least there should be a pretty big uptick in operating earnings -- you still feel you can achieve that uptick despite having the drag in Michigan for Q3, right? Because that won't correct itself until Q4.

We're going to three full months of the Premera membership and much of the pent-up demand and increased pharmacy cost will have washed through. As John pointed out, we honor the prior authorizations that they had before we got the membership. And we typically see the pharmacy cost run a little bit higher when we take over a plan until we put our pharmacy management programs in place. I think we do a little bit tighter job of managing the pharmacy benefit than most plans. That's where we're going to see a lot of the benefit.

So you should have a nice swing in the state of Washington, right? Premera was a drag in Q2, and at least the July data suggests that it should contribute the way you previously thought it would in Q3? Is that a fair statement?

Correct. And we're also going to benefit from the New Mexico transaction which came over -- July 1 we got those members. So you're going to see that benefit as well. And remember, New Mexico right now has higher medical costs than the other plans, and it's going to take us a while to work back down. That is our anticipation.

John Szabo, CIBC World Markets.

Sorry to harp on this on the ramp. Should we also assume that there will be in New Mexico a negative impact from honoring the prior off (ph)? Has that been worked into the membership or into the guidance as well?

Actually, John, it's different when we go into a new state. This is one of the differences between an in-state acquisition and a new state. The patients in New Mexico won't see anything different. They're not transferring plans; the ownership of the plan is transferring. So everything's sort of status quo in New Mexico.

If you look at the staff that is running the New Mexico plan for example, before the transition and after the transition it's the same people. So there's no reason why anybody is going to put off an authorization until the following month. All those things will remain status quo, and we anticipate that at least through the transition period, their medical care ratio and medical care costs will remain stable.

Okay. That's fair enough.

(multiple speakers) like we did in Washington.

So if I just think about an equal dispersion between Q3 and Q4, that's like 56, 57 cents a quarter, up from 43; so you've got to ramp 13 cents. You already said 2 to 3 cents from Washington the Washington prior (indiscernible) -- maybe you get 3 cents from just the progression on the base business. Would the rest kind of be SG&A type savings from Washington and New Mexico? Or is there something else in there?

The big ramp-up is going to come in three or four months in Washington, where we have already taken care of the worst part of the -- what we call the pent-up demand; that is behind us. We've also got three or four months in New Mexico, which we didn't have before. And more of a stabilization than a growth in Michigan. And if anything, the seasonality in Michigan should help in the third quarter, and then costs will uptick in the fourth quarter, is how Michigan tends to go.

So you get a little favorable seasonality in Q3, a little negative seasonality in Q4, offset by the rate increases in Q4?

That's right.

Gentlemen, at this time there are no further questions.

Thank you for joining our call.

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