Molina Healthcare Inc (MOH) 2005 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Molina Healthcare third quarter conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded Thursday, November 3rd, 2005. I would now like to turn the conference over to Mr. Juan Jose Orellana, Director of Investor Relations.

Hello everyone, and thank you for joining us. The purpose of this call is to discuss Molina Healthcare's results for the third quarter of 2005. The Company's results were issued today after the market closed and it can be viewed at our Company Web site.

I'm joined today by our President and Chief Executive Officer, Dr. Mario Molina; our Chief Financial Officer, John Molina; Bill Bracciodieta, our Chief Medical Officer, and Terry Bayer, our Executive Vice President of Health Plan Operations. After completion of the prepared remarks we will open up the call to take your questions.

I would like to remind everyone that our comments today contain forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Except for the historical information referred to in this call, all forward-looking statements are predictions by the Company's management and are subject to numerous risks factors that may cause actual results to differ materially from management's current expectations.

Such factors include, without limitation, risks related to the Company's ability to identify and address medical care cost issues; the Company's ability to accurately estimate incurred but not reported medical costs; the Company's ability to accurate accurately estimate, for the fourth quarter of fiscal year 2005, its earnings per diluted share; the Company's ability to accurately predict and effectively manage medical care costs, health benefits and other operating expenses; high (ph) (indiscernible) claims related to catastrophic illness; potential reductions in funding for Medicaid and other government-sponsored health care programs; the award upon remand to Molina Healthcare of California of the medical contracts for Riverside and/or San Bernardino counties, or the outcome of any subsequent litigation or action by the California Department of Health Services related to the contract awards.

The successful renewal of the Company's government contracts. The favorable resolution or settlement of pending litigation or arbitration. The implementation of rate increases. The Company's ability to obtain regulatory approvals for acquisitions, or to successfully integrate its completed acquisitions. The ability to enter into more favorable hospital or provider contracts. Competition. Changes in health care practices, technologies or utilization. Changes in federal or state laws or regulations or the interpretation thereof. Risks associated with the Company's startup operations in these states or its Medicare advantage plans. Inflation, a flu pandemic and other risks and uncertainties as detailed in the Company's reports and filings with the Securities and Exchange Commission and available on its website at www.SEC.gov.

All forward-looking statements made during this call or in replays of this call represent the Company's judgment as of the date of November 3rd, 2005. The Company disclaims any obligation to update any forward-looking statements, to conform the statement to actual results or changes in the Company's expectations. 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.

I would now like to turn to Dr. Mario Molina.

Thanks, welcome everyone. As you know, back in the second quarter our Company experienced a sharp and unexpected increase in medical costs that contributed to our disappointing results for that quarter. Although we believe our third quarter results issued this afternoon continue to reflect many of the medical cost issues identified last quarter, we also believe that our return to profitability indicates that progress is being made.

In our second quarter earnings press release and earnings call, we outlined the various initiatives we intended to implement to address our increasing medical costs. These initiatives shape our strategy, which can be summarized into three major components.

The first component involves migrating Molina Healthcare to a more tightly-managed health plan. In the past, a flexible model was required to gain scale and build market share. Today, Molina faces a business environment that requires tighter controls and stricter medical management. We believe this can be achieved by partnering with cost-effective providers, strengthening medical management, improving the payment process, and finding the right programs for our members.

The second component seeks to enhance our decision-making through medical informatics. This requires converting data into actionable information by use of more sophisticated methods, such as our Millman USA MedInsight tool.

The third component involves investing in our infrastructure to set the foundation for future growth and to improve our administrative services. Terry Bayer, who oversees health plan operations on a day-to-day basis, will discuss these initiatives in greater detail later on in the call.

While this strategy is a roadmap guiding our efforts, I don't want to confuse activity with progress. We've had some success already, but much of our report today will be about the steps we are taking. And we will continue to update our progress in subsequent conference calls.

First, higher hospital costs continue to pose a challenge. The Company continues to pursue its redirection and recontracting efforts towards more cost-effective providers. We've had some success in redirecting our patients to lower cost facilities. However, this will require ongoing efforts by our medical directors at each of our health plans. Terry Bayer will update you on our progress in our contracting efforts.

Second, data from paid claims suggests that the incidence and acuity of catastrophic cases has declined as compared to last quarter. However, we continue to monitor catastrophic cases very closely. As we review this quarterly information today, we would like to caution everyone that one data point does not constitute a trend. And you should therefore avoid extrapolating run rates from these results.

Third, Washington and Michigan continue to experience increased costs in utilization of maternity services. As we identified last quarter, state agencies have set higher hospital DRG payments without adjusting the revenue we receive to provide these services. Deliveries in Michigan are up by over 40% when compared to a similar period in 2004. This increase appears to correlate with efforts by the state to encourage pregnant women to join a Medicaid health plan.

In Washington, delivery case rates have remained unchanged for two years. While we continue to experience upward pressure on maternity hospital costs.

The fourth issue we identified had to do with higher outpatient costs. Caused in part by a high incidence of flu-like illness. Washington and Michigan were most impacted by this phenomenon. Once again, data from claims suggests that outpatient costs are declining.

Up to this point, I tried to provide you with a very high-level perspective of our progress this quarter. I would now like to turn the call over to Dr. Bill Bracciodieta and Terry Bayer, who will provide you with more of the details.

As I stated in the past, my goal as a Chief Medical Officer here at Molina Healthcare is to ensure we deliver the right care to our members at the right time, in the right place, by the right providers, with the right outcome at the right cost.

In our second quarter call back in August, shortly after I joined the Company, I spoke about the four major levers that we can pull to manage medical costs without compromising the delivery of high-quality health care to our members. The first lever is network and contract management.

Where our unit costs are rising, we have the opportunity to evaluate and choose which providers we want to keep in our network and to influence the unit costs of services through selective contracting. On this issue, I am going to defer to Terry Bayer, our Executive Vice President of Health Plan Operations, who is going to give you an update on some of our contracting and network development issues in a moment.

The second lever I discussed is utilization management. Utilization management has been one of the key areas of concentration for me in the past three months. After I began working here at Molina Healthcare in late June, one of my first actions was to conduct a complete analysis of the utilization management processes, procedures and workflows at the state health plan level.

We recently concluded this analysis and identified gaps between what I consider to be optimal medical management functions and current practices. We have taken a number of steps designed to improve the medical management functions at the various state health plans. In addition, I have instituted a search for a new Medical Director for our Washington health plan.

In conjunction with the State Plan Medical Directors, we have developed individualized medical management process improvement plans. These process improvement plans are designed to move the Company towards the processes, procedures and workflows which are characteristic of a more tightly managed health plan.

In addition, I have supervised a development of individualized State Master Medical Action Plans aimed at controlling total medical costs. These action plans are a result of a collaborative effort between myself, the Health Plan CEO, Medical Director and Chief Financial Officer. These action plans address unit costs as well as opportunities for utilization improvement.

Also, as it relates to utilization management, on November 1st, TeleSalud, our 24-hour bilingual nurse advice line, which was developed in conjunction with the Robert Wood Johnson Foundation's efforts to reduce health disparities, was rolled out to serve all of our operating health plans. We believe we need to continue to work hard at getting people back into the offices of their primary care doctors rather than relying on episodic care in an emergency room.

Turning back to the levers, the third lever I discussed is case management and disease management. I believe that we're having some success in this area, but it is still very early in the process. As an example, Dr. Molina mentioned we are experiencing higher utilization of obstetrical services in Michigan. Despite the fact that the number of deliveries has increased more than 40% recently, we actually seen a decrease in utilization of neonatal intensive care unit services.

The fourth level -- lever of available to us is claims payout management. We are making increased use of an automatic claims auditing systems that monitors providers' claims for accuracy, including unbundling and up-coding.

In terms of hospital claims, we've also embarked on a diagnosis-related group, or DRG, validation pilot program. I want to caution you that the results are very preliminary, but they indicate that the hospital DRG validation pilot could become a very successful program.

We screened approximately 300 hospital DRG claims from one state. The pilot criteria led us to a further review of medical records on 90 of those claims. Of these 90 claims, 22 claims were identified as having been coded inaccurately. Thus we were able to reduce our claims costs by 43% for those 22 claims that had been coded inaccurately.

Let me reiterate that these are very preliminary results of a pilot program, which are applicable in only one state. I believe that this pilot does give us a good idea of the potential importance of routinely reviewing hospital DRG claims for accuracy.

Also in the last quarter's call we talked about the importance of partnering with cost-effective providers, and the importance of having actionable data on which to base our medical management programs. I told you that the Company was taking steps to strengthen the management infrastructure and improve our medical informatics. I would like to update you on our progress.

I define medical informatics as the production of actionable information reporting from disparate health care data sources. The guiding principle is that we will treat claims data and authorization data as an economic asset.

At the last call, we told you that we were implementing the MedInsight tool from Millman USA, and building a medical informatics department that would work in conjunction with the state health plans as well as with corporate functions. I am pleased to report that the MedInsight tool continues to be rolled out, and that all state health plans have received training in the use of this tool.

We have assembled an experienced medical informatics department supported by a Director of Medical Informatics, a utilization management nurse, and a Ph.D. level biostatistician. A medical informatics department will give us quantitative and actionable information that can be shared by our health plans. It will allow the medical directors and the provider services personnel to identify the outliers in our network and work with them to improve their performance.

No doctor wants to be an outlier. This information will allow provider services to make more effective decisions about provider contract. Now, let me turn the call over to Terry Bayer.

We have been actively pursuing better contracts with our providers to lower our unit costs of services. During the third quarter, we have successfully negotiated amendments to several hospital contracts that should result in some decrease in our inpatient costs.

In the metropolitan Detroit, Michigan area, we added the Henry Ford Health System to serve OB and pediatric patients, an addition of five hospitals and their associated physicians. In Washington, we have added new contracts with outpatient surgery centers that will allow us to redirect outpatient surgeries from hospitals to more cost-effective freestanding surgery centers.

In Michigan, we have entered into it a new capitated laboratory agreement and added a case rate dialysis contract. This is important because dialysis services represent a significant cost driver for our disabled patients in Michigan. Other contracting efforts to reduce our costs are also underway.

Finally, I want to comment on some of the investments in infrastructure that Dr. Molina discussed earlier. We have fully implemented a voice over IP telephone system which gives us greater flexibility and is part of our disaster recovery plan.

During a recent switch failure at a telecommunication vendor site in Southern California, our voice over IP capabilities enabled us to quickly reroute our inbound and outbound call traffic. By rerouting our calls to New Mexico, Indiana, Utah and Texas, we minimized disruption to our California health plan and corporate offices until regular service was restored. This type of initiative allows us to better serve our customers.

Also in the area of technology, our new Chief Information Officer, Rick Click, who joined us from eBay/Pay Pal, is also instituting measures that will allow us to more effectively interact with our customers over the Internet through our own e-portal. Our e-portal efforts will enable us to achieve greater automation and authorization submission, and online viewing of claims and eligibility status.

The use of technology is expected to decrease the physician hassle factor. Use of the e-portal will also improve our visibility into authorization trends used in our IB&R calculations. These efforts will eventually translate into lower administrative costs.

I would now like to turn back to Dr. Molina.

Managing medical costs is a critical component of our current efforts. However, equally important is maintaining our focus on growth. On the growth front, we're pleased to report that our Indiana startup is exhibiting strong enrollment growth with approximately 16,000 new members this quarter.

We are also very pleased that our health plans in California, Michigan, Utah and Washington have been selected to provide Medicaid and Medicare services to dual eligible members. We've been designated by CMS as a Special Needs Plan, or SNP, to serve dually eligible members in Washington, California, Utah and Michigan, including part D pharmacy benefits.

We anticipate slow measured growth of these members as we gained expertise and comfort serving this population. This is a wonderful opportunity for us, and is a natural extension of our mission to serve low-income persons who receive their care through government-sponsored programs.

We are also very gratified that our RFP appeal relating to our Inland Empire contracts in California was upheld. You may recall that in May of this year, the California Department of Health Services disqualified our proposals, reportedly on technical grounds, and indicated its intent to award the contracts to Blue Cross.

Approximately three weeks ago, the appeal hearing officer set aside the notice of intent to award to Blue Cross, and remanded the matter to the Department with direction to rescore those portions of the proposals pertaining to our provider network and accessibility. For more information on this matter, please refer to our press release issued October 17, 2005.

We look forward to working with the California Department of Health Services and the provider community to continue to meet the needs of our members in the Inland Empire. Now I would like to turn the call over to John, who will discuss our financial results for the quarter.

Net income for the third quarter ended September 30th, 2005 was $6.8 million, or $0.24 per diluted share. Compared with net income of $16.4 million, or $0.59 per diluted share for the quarter ended September 30th, 2004, and a loss of $0.17 per diluted share in the second quarter of 2005.

Our effective income tax rate for the third quarter was 33.9%. We normally anticipate an effective tax rate of 38%. The decrease in our effective rate was the result of two factors. One, a larger percentage of our income this year has come in states that do not have the state income tax. And two, economic development credits in California have been larger than we anticipated. The lower than effective (ph) tax rate increased our net income by $425,000, $0.02 per diluted share.

Premium revenue for the third quarter of 2005 was $426 million, representing an increase of $97 million or 30% over 2004 premium revenue of $329 million. Membership growth, attributable to our acquisitions in Michigan in October of 2004, and California in June of 2005, was a primary source of year-over-year increase in membership which now stands at 907,000 members.

The medical care ratio increased to 86.1% in the third quarter of 2005 from 83.9% in the third quarter of 2004. Medical care costs increased sharply during the second quarter of 2005 as a result of the four issues identified by the Company. However, on a sequential basis, the medical care ratio for the third quarter of 2005 actually declined by 580 basis points when compared to the second quarter of 2005.

General and administrative expenses were $47 million for the third quarter of 2005, representing 11% of total revenue. As compared with $27 million, or 8.1% of total revenue, for the third quarter 2004. As a reminder, the California quality improvement fee, or premium tax, of approximately 6%, became effective July 1st 2005, and is reflected in our administrative expenses for this quarter.

G&A less premium taxes, or core G&A, increased to 7.4% of total revenue in the third quarter of 2005, as compared with 5.9% in the third quarter 2004. Administrative expenses associated with the Company's development of its Medicare Advantage Special Needs Plans, combined with the administrative costs associated with our Indiana, Ohio and Texas startups, contributed to increase in the Company's core G&A ratio.

Investments in the Company's infrastructure, such as the medical informatics department discussed by Dr. Bracciodieta, and initiatives covered by Terry Bayer, were responsible for the remainder of the increase in core G&A.

Depreciation and amortization increased by nearly 1.6 million, when compared to the third quarter of 2004. Increased amortization expense due to our acquisitions in Michigan in the fourth quarter of last year and California in June of this year contributed 700,000 to the increase in depreciation and amortization. Depreciation increased as a result of investment in our infrastructure, principally on our corporate offices.

Operating activities provided cash of 53 million for the quarter and 63 million for the nine months ended September 30, 2005. While net cash provided by operating activities fluctuates, principally due to the timing of premium receipts and claims payments, we continue to believe that over time net cash flows from operating activities will approximate the sum of net income and depreciation and amortization.

Increases in claims payable contributed $20 million in the third quarter and $39 million for the nine months ended September 30, 2005. The increase claims payable is reflected in our calculation of days in claims payable, which stood at 52 days at September 30, 2005. This represents an increase of 2 days on both a sequential and year-over-year basis.

You may recall that during the second quarter of 2005, we increased claims reserve by $12 million over what our models initially predicted, to mitigate the impact of any further out of current (ph) claims development. The increase to claims reserves was necessary given the inherent difficulty in estimating medical claims liabilities when medical costs are rising sharply and unexpectedly. At the close of the third quarter, we believe our claims reserves remained adequate.

For the third quarter 2005, we finished the quarter with cash and investments at the parent Company of approximately $37 million. At June 30, 2005, cash and investments at the parent amounted to 49 million.

The reasons for the decrease in cash and investments at the parent Company during the third quarter included, one, the voluntary repayment of the amount owed on our credit facility. Two, the transfer of equity capital to our startup operations in Texas and Ohio. And three, the repayment to our subsidiaries under our consolidating tax sharing agreement. All our health plans remained well-capitalized, with $52 million in statutory equity in excess of regular direct capital.

With respect to our $180 million revolving credit facility, Molina has entered into an amendment and waiver with its administrative agent and is fully compliant with all credit covenants. As I just mentioned, we elected to pay off in full the outstanding borrowings of $3.1 million under the credit facility. Therefore, as of September 30, 2005, we have access to a fully undrawn facility.

Based upon the results for the third quarter, the Company is making a slight upward adjustment in its most recently issued guidance as it provided in its second quarter earnings report on August 8, 2005. The Company now expects earnings per diluted share for fiscal year 2005 in the range of $0.75 to $0.82. This guidance does not include any potential benefits from the medical cost control efforts we've just discussed.

We would also like everyone to keep in mind that the Company does expect to experience seasonality in the fourth quarter consistent with historical patterns, reflecting higher medical costs in the fourth quarter when compared to the third quarter.

Looking forward to 2006, we believe it is too early to fully assess the impact of the medical cost control initiatives we've discussed today. We're also unable at this time to fully assess the financial impact of the recent events regarding the status of California's -- the California plan's Medi-Cal contracts for San Bernardino and Riverside counties. Accordingly, we believe it is prudent to delay issuing 2006 guidance until January 2006.

Now I am going to turn the call back to Mario.

Despite our current challenges on the medical cost front, quality of care has never been compromised. We're very proud of this achievement. Our Michigan health plan was recently awarded an excellent accreditation status by the National Committee on Quality Assurance, and all of Molina Healthcare's eligible health plans ranked among the top 50 Medicaid health plans in the country by US News and World Report's survey of America's best health plans.

Molina has more NCQA-accredited Medicaid health plans than any other organization in the country, and we look forward to continuing our mission to deliver quality care to those who need it most.

Wrapping up, I'd like to remind everyone that reversing the cost issues I previously discussed will take time as well as additional resources. But we will continue to take a serious look at all aspects of our business, to identify opportunities to better manage our medical costs, and to leverage our administrative costs as a Company.

Molina is accomplishing the goals we set out to achieve and is building a solid future for our Company. Clearly, we hit some temporary setbacks this year. And while the exact timing of a recovery is difficult to predict, we believe a recovery is achievable.

This concludes our prepared remarks. We would now like to open the call to your questions.

(OPERATOR INSTRUCTIONS). Greg Nersessian, Lehman Brothers.

Thanks, good evening. My first question was just on the higher maternity case rates in Michigan. The 40% increase in deliveries there, just sort of wondering -- you mentioned the outreach efforts I guess on the part of the state to get more pregnant women enrolled in HMOs. Was that a matter of policy, or is that just increased investment and outreach?

I guess what I'm trying to figure out is to what extent that took you by surprise, versus being something that was a matter of policy and you had anticipated.

I think the state has been encouraging all the patients to go into managed care that are pregnant. And it did come as somewhat of a surprise to us. We were surprised that the utilization of services and the number of deliveries had gone up compared to historic levels.

Okay. So then my next question is just on the -- Terry gave some detail on the number of hospitals that you're recontracting with, and some of the efforts there. Could you maybe quantify the percentage of the hospitals, of your hospitals that you need to re-contract with, how many of them you notified that you're going to be recontracting and maybe a little bit of the sense of the tone of those negotiations?

If you look at our states, in each state probably 20 to 25 hospitals comprise about 95% of all the utilization. It doesn't necessarily work that way for costs. Hospital recontracting efforts are ongoing, and we're going to address over the next -- whatever the period is -- as many of those hospitals as we possibly can.

Are you finding those negotiations are more challenging or less challenging? Maybe if you could give us a little bit of a sense of the success you had so far.

I think it runs the gamut. You've got some providers in areas where there's a lot of competition or more willing to enter into renegotiations than others. It's like any other hospital negotiating process.

Okay. And moving onto -- maybe this one's for John. The administrative expense, the increase in the quarter, you highlighted a number of factors. I guess on the investment spending, both for the new markets, the new snips in the infrastructure, what percent of those, or if you could quantify somehow the amount of additional spending which you view as ongoing as opposed to sort of one time investment in the development of those products that won't be sustainable going forward?

For the investment in the new products, in the new states? It's about one-third of a percent. And I would say in the addition of the infrastructure, that's probably 0.5 to 0.75%.

The one-third of a percent in the new states, that's investment in -- for ramping up startup implementation costs as opposed to something that you would anticipate continuing? Or is that staffing up for those new states and new products that you would expect to continue -- that spending to continue going forward?

It some of both. It also includes the investment in the Medicare product as well. So some of that is writing RFPs, responding to the regulatory application process, and some of it is also stepping up, getting ready for new enrollment.

Remember too, we're talking about administrative costs that are expenditures when there's no matching source of revenue.

That's what I'm trying to get at. How much of that is going to be offset by revenue when your start enrolling those members, and how much of it is just expenditures that are going into developing those products, but will disappear when those members are enrolled?

I think the admin percentage is going to be a reflection of how successful we are in the enrollment efforts. The higher the revenue, the lower the admin cost is going to be as a percentage. At this point we just don't know.

Fair enough. Last question on the cash flow, for the fourth quarter -- how should we -- and I know you give the guidance of net income plus D&A, you guys are well above that now. Should we think of some claims paydown in the fourth quarter negatively impacting cash flow?

That's quite possible as we are, as Terry explained, putting some additional infrastructures. For instance we just are implementing mass adjudication in our California plan, which should speed claims up there some. And also, we generally (ph) have delayed payments from California at end of the year. So I wouldn't be surprised if cash flow was a bit lower next quarter.

Patrick Hojlo, Credit Suisse First Boston.

Good evening. Looking at days claims payable again here, it's up a little bit. Does that reflect the fact that you are indeed slowing down some of your claims payments because of some of the issues you seem to have detected with the accuracy of some claims?

No, I don't think we have slowed down claims. I think it's just continuing to be conservative on our reserving policies.

Maybe more conservative now than you were even last quarter, given the days claims has popped up a little bit? X of course the onetime reserve addition.

(indiscernible) I don't know if I might say more conservative, I think we are consistent -- same level of consistency.

Can you talk about the magnitude, the hypothetical magnitude of some of these up-coding, unbundling and DRG validity issues that you touched on?

This is Bill. For instance, just to use California as an example, in my opinion California is the up-coding capital of the universe. And in previous experience that I've had, we were looking at 10, 15 or 20% of the claims that have been up-coded that they're -- at least some very significant research into those types of claims.

So in general, if you look at the Medicare data, you can probably extrapolate that data into the type of percentage of that, talking about in terms of 10 or 15% of claims being submitted.

Do you think that's unique to you guys because of maybe a little bit more lax (multiple speakers)

Absolutely not. From the Medicare data perspective, it's a universal problem.

I was about ready to ask is, do you think you're seeing more problems because you've been a little bit lax in your oversight than some of your peers? Or do you think it's just a problem (multiple speakers) to you guys?

I wouldn't say that that's the case. I do think, though, we have to be as diligent as any other managed care organization in looking for that sort of thing.

Moving on to membership trends, shrinkage in Michigan. Is that due to you folks putting the brakes on because of the problems you're having there?

No, I think it's largely attributable to some changes in our provider network. We had a couple of providers that exited the network. And another large provider who had some turnover, it was a large staff model group that had some turnover in providers.

Fair enough. Should that be more stable next quarter for this (indiscernible) -- the current quarter, excuse me?

We think so. And also, the state is going to be implementing a new patient assignment algorithm. And part of the problem we had in Michigan is -- as the largest plan, state algorithm essentially penalized us to certain extent. So we think those issues have been corrected.

What about Indiana? Not surprising to see good growth there, but even a little more than I would've expected. More of the same going forward? You like what you're seeing there in terms of pricing and uptake?

I think in Indiana we've been pretty successful in growing enrollment, particularly in the southern part of the state. Our Executive Director has a lot of experience in the Indiana market, and used some of his old contacts. I think that's what's got us ramped up in terms of the enrollment growth. And I know that he is pretty disciplined about the market rate and pricing structure he's put in place there.

What do you typically reimburse as a percentage of the state's fee schedule, your providers in the southern part Indiana?

Off the top of my head, I don't know.

Thanks for the detail.

Tom Carroll, Legg Mason.

Good evening. My question also is on Indiana. In earlier discussions you targeted 10,000 members by the end of the year in Indiana, and you're at 24,000 now. I think you just answered part of my question, but maybe you could go over your strategy there in terms of provider contracting, because I know we're going to hear tomorrow that you're being very aggressive in Indiana. And that's why we're seeing the enrollment numbers that you have. Maybe if you could quickly go over that again and really how you approach signing up the primary care physicians?

I think we have been fairly disciplined in our approach to the market in Indiana. We are using what we believe are market rates. We are not the most aggressive health plan out there in terms of what we're paying, and as a result we don't have the biggest provider network. But we are happy with the growth that we had. It exceeds our projections.

And what we're really looking for is the opportunity for profitable growth. It's always been our philosophy to avoid trying to buy market share, especially in the Medicaid business. Because we don't have the ability to raise our premium rates, and if we go in and try to buy market share, it can come back and bite you. So it is what it is. We are not going to be the biggest plan in Indiana, but we hope to be one of the more profitable.

Have you seen other competitors of yours paying higher rates on average?

I don't want to get into this game. I know there's been a lot of discussion about who is paying what, and if somebody is overpaying in the market. In the end, I think the best thing is just we have to go to the orange blank filings and see how the plan is performed. I don't want to get into commenting about rates that other plans are paying.

That sounds good. What was the state again, you said, where the DRG payments to hospitals were not reflected in your rates?

This is Bill. We didn't specify the state.

I thought you said it was either Washington or Michigan.

On the OB cases, the state of Michigan increased the DRG rates that are being paid to the hospitals. We are using the state DRG fee schedule. And as a result, our medical costs went up, but our case rate payment from the state has not.

That's what I heard, I misheard it. Something similar happened in the state of Maryland this year, but Maryland came back on July 1, made the MCOs whole. Is there anything like that on the radar screen out there?

What I can tell you is that all the health plan in Michigan are experiencing the same thing, and the Health Plan Association there has approached the state about this issue.

Lastly, you significantly strengthened your reserves in second quarter. Did any of that come down through the P&L during third quarter?

Not to any material amount.

Carl McDonald, CIBC.

Just a follow-up on that last question. You're saying the 12 million perspective reserve that you took is still intact at the end of the third quarter?

I would say yes.

How would you encourage us to think about run rate earnings in the quarter? It's $0.24 a good place to start, or are there some adjustments that you would highlight for us?

I think the first adjustment I highlighted, the $0.02 tax issue. So 22 is probably the starting point. We do expect -- we would not be surprised by higher medical costs in the fourth quarter, because typically you get into November and December, you get more colds and flu just like I've got right now. We expect a little higher costs in the fourth quarter.

Are there any milestones or a timeline that you can give us in terms of the two counties in California, in terms of what the process will be from this point forward?

Unfortunately, the hearing officer's letter did not set forth a timeline. So we don't know yet, but we're working with the state to try and resolve the issue.

Could you comment on the potential for mid-cycle rate increases, if that's something you're looking into, and the likelihood of success there?

We would love to see some mid-cycle rate increases, but we can't count on any of that. I think we have to go with the usual contract periods, and as you know, they vary. California has an October to October cycle, other states are on a calendar year, other states are on June fiscal year. So we are not really counting any mid-cycle rate adjustments.

Joe France, Banc of America.

Just to clarify your answer to Tom and to Carl, are you saying there's no prior period development in the latest quarter?

There is some prior period development, I think that relates primarily back to '04. (multiple speakers) About 2.5 million (multiple speakers) roll forward (ph) table.

I see it nine months. But I didn't know what the six months was. Thank you.

(OPERATOR INSTRUCTIONS). Ed Kroll, SG Cowen.

Just to go back to the rate issues, Mario, you reminded us that the California rates typically are adjusted on October 1st. What kind of adjustments are you getting, or have you gotten this for this new cycle?

This is John. The rate for California was adjusted in July for the provider of the premium tax. We have not seen anything else or a new rate or actuarial study come through yet. I don't know if they're planning to do one, or if that was it.

Okay. Back on the reserves, did you make a similar discretionary reserve boost in Q3 to that -- maybe it's not of the same size, but did you increase reserves on a discretionary basis in Q3? Is that essentially why the days are up?

The reserves are up, but I wouldn't say we put any discretionary amount on top of what our actuaries and the models were showing should be the appropriate reserve.

Okay. Using that terminology then, the 12 million you would describe as discretionary that you made in Q2?

Can you repeat your question?

I just trying to get at if the increase in days is indicative of you adding some additional conservatism to your reserving methodology as you did in Q2.

No. I think our actuary has given the trends that they saw, continue to be conservative, because again, as Mario pointed out, we're looking at just some data points. Probably not enough to string together to cause our declining at a rapid pace or increasing at a rapid pace. We just held over our conservatism from the second quarter. We didn't do anything unusual, either up or down, on the reserves.

Remember, the reason we added the $12 million was because we had a sudden increase in medical costs, a lot of that was unforeseen. And we wanted to mitigate any more out of period negative development. We didn't see that in the third quarter, so there was no reason to bring additional reserves in or to take a lot of reserves down.

Got it. But you did see some early signs of optimistic trend on those various things that Bill, Mario and Terry mentioned before.

I think there are a number of things that we are optimistic about, but it's all very preliminary. We only announced our earnings warning just about three months ago. And we put a lot of things in place, but we need a little more time to see those things play out.

The contracting, for example. Some of the contracts that Terry's group negotiated don't take effect until September 1st. Some of them don't take effect until January 1. So those kind of things we think will help, but it's going to be over a period of several quarters, not something you're going to see over a period of a couple of months.

Fair enough. What kind of tax rate should we use for Q4?

I'm going to use -- I would say a 38% tax rate. What you've got to understand is, that's going to bounce around a little bit really based on those two factors that I pointed out. And that's really hard for us to predict. Where the bulk of the income is going to come from. If it comes from states without an income tax, that's going to have an impact. Also, we continue to mind these easy zone credits, and this quarter they came in better than we had expected. But we're going to use 38%.

The Company headquarters is in an area where we get these tax credits, and a lot of the employees that we hire are coming from communities where these tax credits are in effect. So it's kind of a variable thing, and it's difficult for us to predict. But as John says, we're sticking with a run rate of 38%.

Okay, and finally on the systems front, you mentioned you've completed education in all your states for MedInsight. Do you have a timeline when MedInsight will be fully rolled out in all those states? Or (multiple speakers)

This is Bill. MedInsight is pretty much fully rolled out in all the states. The training that I referred to is kind of the basic training on the tool. The tool is extremely sophisticated, and we will be using more sophisticated paradigms embedded in the tool at the corporate level over the next couple of quarters. And we will be educating the state plans over those two quarters as well. So I think the answer to your question is, it's going to take about two quarters before the states are up to snuff on all of the potential uses of the tool. Because it is a very sophisticated tool.

Tom Carroll, Legg Mason.

A quick follow-up on a comment you made earlier about the dialysis case rate in Michigan. Is that a contract that you have with a high-volume provider, or is it something the state is paying you? Could you go over that again?

That's a contract that we negotiated with a dialysis vendor. So that is specific to Molina.

What does the case rate -- what services does the case rate entail? Is it just a certain continuum on during the month of going to get service, or what is it?

If you think about a case rate, basically what we're doing is we're moving from a discount, from a fee-for-service structure, to a bundling. I'm not in a position to detail all the pieces of that. But the important takeaway is that that's a fixed rate and we are not at the mercy of rate movement or fluctuating discounts. It's a better predictability.

All right. Do you have ESRD members in Michigan? You don't have any, do you?

No. Well -- if we are able to transfer them over to Medicare after a period of time. But yes, we do carry renal dialysis patients if they are with us, and in the period before they are able to be moved to an additional funding source.

Not all of them are going to qualify for Medicare, either.

If you recall, we have a significant aged, blind and disabled population in Michigan, different from the load we carry in some of the other states. That's what makes it important there.

Thanks for the additional clarity.

There are no further questions at this time, I will turn the call back to you. Please continue with your presentation or closing remarks.

I have nothing further, thank you for joining us today.

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