Molina Healthcare Inc (MOH) 2006 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Molina Healthcare second quarter 2006 conference call. During the presentation all participants will be in a listen-only mode. Afterwards we will conduct a question-and answer-session. (OPERATOR INSTRUCTIONS).

As a reminder this conference is being recorded Tuesday, August 1st, 2006. I would now like to turn the conference over to Juan Jose Orellana - Vice President 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 second quarter of 2006. The Company's results were issued today after the market closed and they can be viewed on our Company Web site.

With me here today are Dr. Mario Molina, our CEO, and John Molina, our CFO, Dr. Bracciodieta, our Chief Medical Officer and Terry Bayer, our Chief Operating Officer will also be available for questions at the completion of our prepared remarks.

Our comments today contain forward-looking statements including an update to our 2006 earnings guidance. All forward-looking statements are subject to numerous risk factors that may cause our actual results to differ materially. Such risk factors are more fully discussed in our periodic reports filed with the SEC and include risks related to the continuation of the observed improvement in our medical care cost trends; our ability to accurately identify and to successfully address our medical cost issues through our various initiatives; our ability to actively estimate Incurred But Not Reported medical costs; slower growth and enrollment than projected in our Ohio and Indiana subsidiaries; potential reductions in funding for Medicaid and other government sponsored health care programs; successful renewal and continuation of the government contracts to our health plans; the favorable resolution of pending litigation or arbitration; the adequacy of contractual rates, risk adjusters and premiums paid for our health plans and implementation of appropriate rate increases; our ability to successfully integrate our completed acquisitions; the ability to enter into more favorable hospital or provider contracts; high dollar claims related to catastrophic illness; the availability of financing to fund our acquisitions; membership eligibility policies and methodologies including citizenship, certification requirements and the successful maintenance of member enrollment levels; unexpected changes in member utilization patterns; health care practices or health care technologies; changes in federal or state laws or regulations or in their interpretation; risks associated with our start-up operations in new states or new populations; retention of key employees and other risk factors as detailed in our filings with the SEC and available on its Web site at www.FTC.com.

All forward-looking statements and earnings guidance represent our judgment as of August 1, 2006. We disclaim any obligation to update our forward-looking statements. This call is being recorded and a 30-day replay of the conference call will be available over the Internet through the Company's Web site at www.MolinaHealthcare.com.

I would now like turn to the call over to Dr. Molina.

Thank you, Juan Jose, and welcome everyone to today's conference call.

You will recall that it was around this time last summer that an unexpected increase in our medical care costs resulted in an earnings shortfall and a revision to our earnings outlook. As indicated in our earnings release, continued improvements to our medical care costs have contributed to stronger second quarter results in 2006.

Today I plan to provide you with some perspective on our continued operating improvements and key activities affecting our business, while John will discuss our financial results in detail including the upward revision to the Company's guidance for the remainder of 2006.

When I think about how Molina Healthcare has changed over the past year - whether it is our approach to medical management, our improved visibility of medical cost, the expanding capacity of administrative infrastructure or the strengthening of our management team - I am convinced that Molina is now better positioned to succeed in both the short-term and the long-term. The changes across the organization over the last 12 months have been systematic, productive, and inspired by a constructive sense of urgency.

In order to better understand how Molina has changed as an organization it is important to examine where we have been. During our second quarter call in 2005, we outlined the four primary areas that had adversely affected our medical care costs. These areas included increased hospital costs, increased costs from catastrophic cases, increased maternity costs, and increased outpatient costs.

So what is different from a year ago?

We strongly believe we are doing a better job at managing our hospital costs, our catastrophic cases and our outpatient costs. Much of the improvement in our medical costs can be attributed to reductions in unit costs, as a result of our recontracting efforts. The Company experienced lower hospital costs across many of our states in the first half of 2006 compared to the first half of 2005. These lower hospital costs were most noticeable in our New Mexico health plan.

In terms of catastrophic cases the Company experienced a decline in the number and the amount of claims paid in the first half of 2006, compared to the first half of 2005, despite an increase in enrollment. An example of our progress in this area is the successful negotiation of a contract amendment with the state of Washington, under which we have been paid approximately $2 million in reinsurance payments related to certain hemophilia claims. This amendment limits our Washington health plan's exposure on a continuing basis.

In Michigan, we have increased our referrals of qualifying cases to a program for children with special needs. And in New Mexico we've been successful at redirecting pediatric heart cases to a contracted center of excellence.

We have also observed improvements in outpatient costs. A late and prolonged flu season straddling the first and second quarters of 2005 affected our Michigan and Washington health plans. Flu indicators in 2006 which include outpatient, pharmacy, and inpatient costs point to a mild flu system season as flu-related costs were lower in the first half of 2006 compared to the first half of 2005. National flu activity reports for 2006 by the Centers for Disease Control confirmed that flu activity was low in January, increased in February and peaked in early March.

Maternity costs remain a challenge in both Michigan and Washington. As we have stated in previous calls, reimbursement levels in these states have not kept pace with maternity costs. In addition, in both states we are still experiencing higher birthrates than we previously had in the past. We will continue to work to achieve greater state awareness of this issue and adequate reimbursement levels.

As we have discussed in prior calls the Company has implemented a number of initiatives to better address our medical costs, including partnering with more cost-effective providers, strengthening medical management, enhancing utilization and cost analysis, seeking appropriate compensation from our state payers, finding the right programs for our members and improving the claims payment process. We have also made significant investments, both in tools and personnel in our medical and utilization management resources, and have changed management personnel at the health plan level where needed.

Data from tools like [Med Insight] and other medical informatics have also been used to improve our business. Based on the analysis provided by these new reporting tools and metrics, the Company exited Alpena County in the state of Michigan and Island County in the state of Washington. Although the withdrawal from these counties resulted in a membership decline, the resulting impact to our bottom line was favorable.

I would also like to provide a quick update on a progress of our IT initiatives. Our IT department has been working diligently to implement many positive technological changes that impact individual health plans, as well as the entire organization. Some of these changes include hardware and software upgrades to our existing data platforms for scalability and performance enhancements, as well as deployment of electronic claims submission capabilities.

As might be expected, progress has not been even across all of our health plans. In California our health plan is experiencing higher hospital unit costs and increased utilization, primarily in our San Diego operations acquired last year. We feel confident we can improve the California health plan's performance just as we have achieved noticeable improvements in Michigan and New Mexico plans over the past year.

Overall, we are pleased with our initiatives, are on track and that the benefits of 12 months of hard work have decreased our medical costs.

Although our efforts this year have centered on addressing our medical cost issues we have also continued to pursue growth opportunities. In Ohio for example, Molina was awarded four regions during the RFP process. The Southwest, the West Central, the Southeast and the Central regions.

The Ohio Department of Job and Family Services has communicated that the enrollment process for the Southwest and West Central regions will begin on August 1st. Voluntary enrollment in these two regions will take place in August; and Medicaid beneficiaries who select the plan will be enrolled in that plan beginning September 1st. Beneficiaries who do not choose a plan will be automatically enrolled in October.

For the Southeast region the enrollment process is expected to begin on September 1st; and beneficiaries who do not choose a plan will be automatically enrolled in November. As a result of this schedule, the Company expects increases in enrollment and related premiums for these two regions to be spread over the third and fourth quarters.

The state has not yet set a definitive date for the expansion in the Central region. However we expect enrollment to occur in this region some time in the fourth quarter. If the state rolls out all four regions by the end of the year, we expect to enroll a total of about 120,000 members in Ohio.

In Texas, managed care expansion is already underway. Molina is participating in this expansion in the Harris service area which covers the Greater Houston metropolitan area and the [Bayer] service area which covers San Antonio and its vicinity. Voluntary enrollment is currently underway and will continue through August. Any new beneficiary who does not choose a plan will be assigned to a managed care plan, effective as of September 1st.

In addition, any current fee-for-service, primary care case management patients who have not chosen a plan will be assigned to a plan in November. As a reminder, Molina is currently participating in the Star and Chip programs in the Harris service area.

Starting in 2007, we will begin participating in Star Plus program in both the Harris and Bayer service areas. The Star Plus program is the managed care program in Texas for elderly and disabled Medicaid beneficiaries. Based on the Texas expansion schedule, the Company expects its enrollment in Texas to reach approximately 15,000 members by the end of 2006. In Indiana, our enrollment continues to grow steadily and our financial performance is meeting our expectations.

Our acquisition of Cape Healthplan in Michigan closed during the second quarter of 2006. With the completion of the transaction, Molina Healthcare of Michigan added about 90,000 Medicaid members to its Michigan enrollment and has expanded Molina's geographic presence within Michigan by adding Monroe and St. Clair counties in the southeastern part of the state. Southeastern Michigan has traditionally been a profitable market for the Company.

We have worked very hard in lowering our medical costs, and at the same time I am very proud that the quality of the services we provide has continued to the outstanding. Our Michigan Healthplan, for example, completed its reaccreditation process by the National Committee on Quality Assurance [NCQA] and earned an excellent status. Our Michigan health plan now joins our Utah, Washington and New Mexico health plans, which have all earned an excellent accreditation status.

I would like to congratulate our Michigan staff for a job well done in reaching this new accreditation status.

We believe deeply in the value of our services and our commitment to fulfilling the health care needs of our patients and in creating value for shareholders. We will continue to work hard to deliver on those beliefs. I would now like to turn the call over to John.

Thank you Mario.

Net income for the second quarter ending June 30, 2006 was approximately $13.2 million or $0.47 per diluted share compared with a net loss of $4.7 million or $0.17 per diluted share for the quarter ended June 30, 2005. Second quarter results include approximately $5 million or $0.11 per share of favorable prior period claims development from 2005. Comparability between the second quarters of 2006 and 2005 is affected by prior period development. Excluding prior period development, medical care ratio would have been 84.8% in the second quarter of 2006 as compared to 88.6% in the second quarter of 2005. For the six months ended June 30, 2006, our medical care ratio, net of prior period development was 85.0% as compared to 88.5% in 2005.

As Mario has discussed we have been very systematic in resolving many of the issues that arose during the first half of 2005. Additionally, we believe that we have greater visibility into our medical costs and liabilities. As a result we are better positioned today to address these challenges going forward.

A noticeable improvement in our financial results during this quarter was the decrease in our medical care ratio from 91.9% at the end of the second quarter of 2005 to 83.7% at the end of the second quarter of 2006. On a sequential basis our medical care ratio for the second quarter of 2006 also improved by 160 basis points or 50 basis points excluding prior period development when compared to the first quarter of 2006.

Although we believe many of our medical cost initiatives are responsible for the improvement on the year-over-year comparison, we must point out that on a sequential basis at least -- for the sequential basis at least some of the benefits may be related to the inherent seasonality in our business.

In previous conference calls, we suggested that you should compare the first half of 2006 with the first half of 2005. This is because a better assessment of the effectiveness of our initiatives could be made by comparing these two longer corresponding periods. This comparison shows that our medical care ratio for the first half of 2006 was 84.5%, representing an improvement of 400 basis points over our MCR for the first half of 2005.

Mario has previously discussed the basis for these improvements.

At the end of the second quarter 2006 our Company reached an important membership milestone by surpassing the one million-member mark. Coordinated membership represented an increase of approximately 10% on a sequential basis and a 12% increase from a year ago.

Membership growth was the main contributor to an increase in premium revenues for the second quarter of 2006, of approximately $78 million or 19% over premium revenues for the second quarter of 2005.

Salary, general, and administrative expenses were $56 million for the second quarter of 2006 representing 11.6% of total revenue as compared with $37 million or 9.2% of total revenue for the second quarter of 2005. Our core SG&A or SG&A less premium taxes increased to 8.6% in the second quarter of 2006 as compared to 6.7% in the second quarter of 2005.

The increase to core SG&A was due to the investments and infrastructure to support the Company's medical cost control initiatives, the launch of our Medicare advantage special-needs plan, our expansion into Ohio and our expansion in Texas. Also related to SG&A, I would just like to remind everyone that our stock option expenses are running at approximately $0.02 per share for quarter.

I would also like to remind you that unlike our core SG&A, premium taxes are beyond our control and are related to member and premium growth in certain markets. As enrollment in premiums grow in these markets premium taxes will also grow. Premium taxes increased from 2.5% of revenue in the second quarter of 2005 to 3.0% in the second quarter of 2006.

We continue to apply consistent reserving methodologies. Although our days and claims payable decreased sequentially to 54 days at June 30, 2006, down from 57 days at March 31, 2006, days and claims payable are up from 50 a year ago. Furthermore, if we exclude the Cape acquisition our days and claims payable would have been 55 days. The sequential decline was expected, given reduced medical expense.

Cash flow from operating activities provided approximately $38 million for the six months ending June 30th, 2006.

We finished the second quarter of 2006 with cash and investments at the parent company of approximately $37 million. Our subsidiaries had a combined $60 million in statutory equity in excess of regulatory requirements. We do $15 million under our credit facility during the quarter and used those funds as part of the consideration for the Cape Healthplan acquisition.

Next I would like to discuss our guidance for the remainder of fiscal year 2006. As you may remember from our previous call, the Company had postponed revising its earnings outlook until after the second quarter results could be evaluated. As a reminder, the EPS guidance we reaffirmed in February was $1.37 to $1.47 per share.

Based on our revised projections we now expect results for the year ending December 31, 2006, to be as follows. Earnings per diluted share to be in the range of $1.60 to $1.65. Net income to be in the range of 45 million to 47 million. We expect premium revenue of approximately $2 billion. We expect our medical care ratio to be approximately 84.7%. This captures improvements in our medical costs. However, it appears flat for the remainder of the year due to membership increases in Ohio, Indiana and Texas where we expect a higher medical care ratio.

Our core SG&A or SG&A excluding premium taxes are expected to be approximately 8.3%. This core SG&A ratio is higher than our initial estimates from January, reflecting the Company's need to invest in additional capacity that can be leveraged through our future growth.

We expect G&A - including premium taxes - to be approximately 11.3%. These estimates assume weighted average dilutive shares outstanding of 28.4 million. Included in our $1.60 to $1.65 EPS estimates are the following items. Consolidated membership of approximately $1.1 million -- 1.1 million members excuse me. An effective tax rate of 38%. The expensing of stock options as required under FAS 123R. The Company expects the impact to be approximately $0.09 per share in 2006.

Guidance also includes approximately $105 million to $108 million in revenue and $0.04 to $0.06 for the remainder of 2006, related to the closing of the Cape Healthplan in the state of Michigan. Estimated results of operations for Ohio and Texas HMOs are also included in these estimates.

In Ohio, the guidance assumes enrollment of approximately 120,000 by December 2006 and a medical care ratio in our Ohio subsidiary of approximately 89.0% for the entire year. In Indiana the guidance assumes enrollment of 45,000 members by December of 2006 and a medical care ratio for our Indiana subsidiary of approximately 90% for the year. Guidance also assumes approximately 15,000 new members for Texas.

Our guidance also includes anticipated rate increases in the second half of the year as follows. For our New Mexico health plan, a net increase of approximately 7% which became effective on July 1st, 2006. For our Michigan health plan approximately a 5% increase effective October 1st, 2006 - which is slightly better than what we had initially expected. This rate increase, however, is still subject to approval by the governor of Michigan.

Our California health plan did not receive a rate increase to the healthy families or SCHIP population as we had anticipated. Our guidance figures do not take into consideration any major impact for the planned proof of citizenship requirements. The guidance also reflects completed acquisitions and does not include future acquisitions.

Operator, this concludes our prepared remarks. We would now like to open the call, the line to take questions.

(OPERATOR INSTRUCTIONS) [Greg Youssefian] from Credit Suisse.

Convening. My first question is an enrollment question. John, I think you mentioned 1.1 million members by the end of the year. You've got, I think my numbers are right, 120 coming on in Ohio, another 40 another 8,000 in Indiana and 15,000 in Texas. Is that just rounding or are you anticipating some disenrollment in some of the other states?

It's primarily rounding.

Okay. Then you give the market-specific MLRs in Ohio and Indiana. Haven't really seen that from you in the past. Wondering, is that anything different from your past expectations particularly in Indiana? It doesn't sound like you're adding that much new membership but wondering if that 90% is what was already built into your expectation for the year or that is due to some change in the market dynamic?

This is Mario. What we have said in the past is that we expect in these new markets that the medical care ratio will run approximately 90% and so we are just reiterating that.

How long do you maintain them at roughly 90%? At what point did they, I guess -- how many quarters does it take for them to mature to a more corporate-wide MLR?

We typically look at it taking approximately six quarters.

Six quarters? Okay. Great. Then just a last question on the San Diego issues you mentioned. I believe, John, you spoke about a provider group in that San Diego market that you terminated last quarter. Are some of the medical costs you are seeing there related to that termination of that contract or is that a separate issue? Maybe you could give us a little bit more color on that?

It's a separate issue. It's really hospital costs. And let me clarify something.

It is not six quarters that we expect the cost to normalize as Mario said previously. It's really six to nine months before we can get really good visibility to what the medical costs are. So out of just getting our feet wet in new markets, we generally use the 90% until we can get enough claims development to get a really good history and track record understanding of the markets.

Tom Carroll from Stifel Nicolaus.

Couple of questions here. Just want to add on to Greg's question about the Ohio and Indiana specific medical loss ratio targets that you put out there. Actually quickly look at first quarter '06 debt filings and you are already over 200 basis points below those targets that you put out there. So am I to assume that it gets worse in those markets for the remainder of the year or are we just being conservative?

Which filings are you looking at?

Just NIC data.

For both states or just one?

For both of them.

I think that we have seen --

I mean it's good news. It just seems good.

We are getting an awful lot of membership ramp in Ohio from -- I think we are right around 25 to 30,000 members if memory serves. [Want to] expected to go up in the next four months to 120. There's a lot more areas in the state. So I think then until we can get a really firm handle on what the new membership profile looks like, 90% is the prudent number to put out.

Same thing with Indiana. We are getting into some new territory in Indiana. We are primarily in the South and we are moving to the Central and the North. So again, we just want to make sure that we don't get too aggressive on those things.

And in terms of Indiana when do you guys expect to hear the results of the reform that is going on there? I have heard this Friday.

I think it is going to be perhaps another week.

Just wondering if you had any more clarity on that for us. Thanks. I will stop there.

Ed Kroll from Cowen and Company.

Good evening. The raised guidance, the $1.60 to $1.65. Does that include the $0.11 of favorable development that you recognized this quarter?

It does.

It does. Okay. Let's see. For the various market ramps you have going on - Ohio, Texas and so on. Does the new guidance also bake in all necessary ramp cost?

Say that again, Ed?

The new guidance. Does that also presume the ramp costs necessary to hit those enrollment targets and have the infrastructure in place to service those members by year-end?

It does. As we discussed, one of the reasons our core SG&A has been running higher than at this point last year is because we have built up additional administrative capacity in anticipation of the new enrollment.

Got it. Okay. Could you quantify just ballpark that for us on an EPS basis? How much that spend is?

At this point, I don't think I can quantify off the top of my head. Part of what we have done historically is not broken out those, because we view you a lot of the stuff as some spend in anticipation of regular business development versus ongoing operations. But I guess it is easy to say that we didn't have Ohio. Didn't have the increase in enrollment in Indiana. Didn't have Texas or the Medicare plans, our SG&A would be lower than it is now. Probably not as low as it was last year because we have invested in medical informatics, medical managements but certainly not as high as it is running now.

Fair enough. One more before I get back in the queue. Were there any timing issues that affected your GAAP cash flow from operations this quarter? If you could just remind us, was there anything extra maybe that you got in Q1? Or were there any pending items at June 30 that you wound up collecting? Big ones in Q3? Anything like that?

Nothing comes to mind. I think AR -- looking for my ARF sheet. AR was up about $3.5 million and it's up almost $7 million since the beginning of the year. But that's nothing too unusual.

One other follow-up on the cash flow. The full year operating cash flow you know, the six-month number - it's still quite strong at 1.7 or so times reported net income. Is that where you think you come in for the full year? 1.5, 1.7 something like that?

Yes; I think we're going to see account go down a little bit. Remember what we have consistently said is, over time cash flow is going to equal net income plus depreciation and amortization. Right now, we are at 1.7 times net income and, mathematically, it is going to decrease at some point to get to that long-term equilibrium.

I'm not saying we are going to hit it by the end of year but I would expect the cash flow will be going down a little bit by end of the second half.

Thanks.

Joe France from Banc of America Securities.

John, I'm sorry if you mentioned it. I got interrupted briefly during the column but Cape acquisition, relative to the change in your guidance what is the revenue and loss ratio combination that you're assuming?

I think we have said revenue is 105 to 108 million. Net income is $0.04 to $0.06 for the year. We picked that up, actually in mid-May. So it's going over 7.5 months.

Scott Fidel from Deutsche Bank.

First question just has to do with, if you can update us on what you sort of view your run rate medical cost trend - excluding PPD let's say in this year and last year would be across all the markets?

We don't typically break them out by market.

No. More of a composite, not across the market. Just overall for the Company?

I think excluding the 5 million of positive PPD that we discussed today I believe that we are looking at a run rate for the entire year of 84.7%.

Not MLR. Medical cost trends.

We typically, Scott, don't do the medical cost trend for two reasons. No. 1, we are expecting and we've seen for the first six months a declining medical cost trend. But also we've got places like Ohio and Indiana, which we are anticipating the cost trends will go up a little bit from what we've seen in the first half of the year as I said from the enrollment ramp. And we are really looking at eight distinct markets.

So it's hard for us to give what we would be comfortable with, a global medical cost trend. Because we are looking at eight separate markets.

That's fine. Just a follow-up, too, just relative to Indiana. One of your competitors has talked about some cost issues that are specifically relative to pharmacy costs. Just interested if you are seeing any higher pharmacy costs in that market or if everything is sort of stable there?

I think we would like to have Dr. Bill Bracciodieta address that.

We have seen nothing out of the ordinary or nothing that we haven't foreseen in terms of any of our new markets in terms of pharmacy cost. So we are looking at a situation where what we predicted is occurring.

Then just a last question, just on California. Can you update us on -- you know you talked about some of the activities you could do to improve the costs there but just what your underlying loss ratio development has been relative to the San Diego business?

Again we don't break things up by those kinds of market segments. You can pull the statutory filings and take a look at the California numbers but we don't break it out by L.A. market versus San Diego market.

Is it fair to assume that you assume no increase on the loss ratio on the guidance from what you had in the first half in California?

Yes.

Thank you.

Carl McDonald from CIBC.

I was wondering if you could break out the favorable development between hospital and doctor and then also any specific geography that that is coming from?

Carl, I don't have it broken down into the various cost components. I think that we - on a geographic basis - New Mexico and Michigan were probably the leaders in where we got the positive development from.

You mentioned Ohio, Texas; the other expansions were having negative impact on the loss ratio's second half. What would the magnitude of that impact be approximately?

Just give me some time to quantify that. I don't top of my head know.

And it looks like you passed on the Tennessee opportunity. Was that something that you took a look at and saw some something you didn't like or was that just a resources and you had expansions going on in other markets?

We have looked at Tennessee in the past. And I think it really was an issue of resources. We were in the process of trying to deal with our medical costs and, given the track record of the [Tenn-Care] program felt that that, in combination with our resource limitation, just made it a little bit too risky for us to go after at this point. We are more comfortable with the opportunities in Ohio and Indiana and Texas and want to just focus our efforts.

Last question is on San Diego. If you could just give a little bit more color. Was that one hospital where you are having a problem? Is that sort of widespread across the geography? Any other color?

It is primarily two hospitals out of ten. They are not the high utilizers but they did have the contracts that had the stop loss provisions.

(MULTIPLE SPEAKERS)

Yes. Those were the ones that we inherited and we purchased the business.

And when do those contracts come up for renewal?

Let me have Terry Bayer who is our COO discuss that.

We are as you know across all the markets and, specifically in San Diego, we have been engaged in renegotiation of those contracts. So we are one year into that acquisition. We have got relationships and we are in the middle of dialoguing in those situations right now and expect to see by the end of the year, a reduction in the unit cost as we are able to close that.

Thank you.

Josh Raskin from Lehman Brothers.

First question. You mentioned the SG&A picking up a little bit around some of the investments in medical and utilization management resources. Could you just outline a couple of the highlights? Some of the successful investments that you have made since last summer?

I think one of the most important ones we've done is just to build out our medical informatics department and we are still working on that. That has given us a much better ability to look at utilization and cost trends and given our medical director something that they can use in dealing with providers in their individual markets.

Also there's been a fair amount of activity around the elderly and disabled patients, as we are picking up more of the ABD group and we have built up a unit to handle our Medicare advantage special-needs plans. We have not seen a lot of growth in membership in the Medicare.

So there is a fair amount of overhead that we have got; but you have got to have that in order to do the programs and do them right. Eventually, as the membership grows, it will offset the costs.

That's helpful. Is it fair to say the informatics group -- and I know we talked about that previously -- just the identification of specific areas of trend picking up, the earlier identification that -- you have the tools in place when you see that sort of stuff. Has it really been the informatics as the enabler?

I think it's -- well, there are three areas that really have the bulk of this. One is medical informatics. Another is claims. And the third is IT. We have talked about some of the things we are working on in all three of those areas. We have been working to improve our claims payment process and we have been working very hard in IT to develop systems that will allow us to accept claims and to be more electronic commerce with our providers and that is a long-term investment.

That's helpful. Next topic, Michigan and Washington. Still not paying adequately for maternity cost. You've seen very small exits in the past. I guess it's been two counties. What are the thoughts on the negotiation process with the state? I know there was some success in Washington around the hemophilia.

Any sense of, I guess it's a negotiation process. How is that going if there is any light at the end of the tunnel there?

Unfortunately I don't think we are going to get them to carve out pregnancy. But we have, I think, made some progress. We spent quite a bit of time especially in Michigan talking to people at the state, making them aware of these issues. I think we are making some headway. We just don't have anything definitive enough at this point for us to really comment other than to say that we continue to have discussions with the state.

Is it an issue of they don't out have corroborating evidence from other plans that may be - I know it's sort of a fragmented market there in Michigan. But I mean is it no one else has got the same level of data or what is the pushback if you have the claims data that shows that versus the thought versus the premium?

I think they are hanging from all the plans in Michigan. It is really an issue of them finalizing their rates and we don't have the final rates yet. So when we do if we can say that there is some improvement there we will communicate that, but it's not yet final.

A quick last question for John. On the days claims payable, it sounds like it was actually up a couple of days excluding Cape. I apologize if I missed that number and then I heard you say it declined with lower costs. Just wondering if you could walk me through that. I think I missed how that works.

Actually it declined a couple of days. It went from 57 last quarter to 54 this quarter. If you exclude Cape, actually, went from 57 to 55.

Why would lower costs reduce today's claims payable?

Part of it is the $5 million positive prior period development.

I see what you're saying. That's helpful. Thanks.

Also, Josh, as we've grown enrollment in Ohio some of that is -- and San Diego is capitated, so that is going to result in lower days in claims payable.

Makes sense. Thank you.

(OPERATOR INSTRUCTIONS) Matt Perry from Wachovia Securities.

A couple of questions on Ohio. Just want to make sure I understand the guidance. Your enrollment guidance was for 120,000 total members at year-end. Is that right?

That's correct.

Secondly will the Ohio market be additive to second half earnings or will the ramp be dilutive to second half earnings?

I think it's pretty much neutral. You have to remember that we are looking at a lot of that enrollment in Ohio, even though it's got a high -- we are projecting a higher than average medical care ratio. It is coming in the fourth quarter. It's not going to have a big impact on the year.

So should most of those new members to get you up to the 120 be in the fourth quarter?

Yes. There will be some spillover in the third quarter; but I think it's mostly going to be fourth quarter.

Than, as I look at your change in SG&A guidance obviously some spending and medical informatics and TP and then the ramp-up in the new markets, but should we think of that run rate as we look longer-term being somewhat lower than that as a percentage of revenue?

I would say yes.

But probably not as low as it was in early '05? Somewhere in between those two levels?

I think we originally guided for the year of a core SG&A of 7%. I don't believe that we can - in the next four quarters - get back to 7%. But I'm pretty comfortable that we can get back below where we were this quarter.

Can you give an update on maybe a little more color on your special-needs plans. What markets are you in now? What markets might you enter in '07 and what the enrollment is now?

This is Terry Bayer. We are currently operating special-needs plans in Michigan, Utah, Washington and California. As we've told you in the past we expected a slow ramp up of this product as we build the infrastructure to be able to manage these members which - whom are very different from those we have served in the past.

And as of June 30th, we have about 1700 members. We are currently evaluating all of the markets to determine where we might expand in the future. But we have not made any decisions on that at this time.

That's helpful. Actually, I think that was all the questions I had. Thanks.

Bill Georges from J.P. Morgan.

My first question is, I guess you cited the four problem areas - one of which was maternity costs getting out of control. I didn't hear you specifically address that as being one. I think you have gotten your hands around. Is that the Michigan and Washington negotiations that are ongoing? Or is there more to it that you are doing to address that issue?

It's really the negotiations we are having and the discussions we are having with the state - primarily Michigan, to a lesser extent Washington - around the adequacy of the reimbursement that we receive for deliveries in those states. I think we have made some headway. As I said earlier, the other health plans in Michigan are all experiencing the same thing. The Michigan Association of Health Plans has been talking to the state as well. It is not simply a Molina-specific issue.

I think when the rates are finalized we will be able to say more definitively if we have been able to get any relief. But at this point things are preliminary and I can't tell you that we have solved the problem.

Are there any other avenues that you could pursue to cap your exposure there? For example, case management or I don't know what you might do?

It's a little hard to case manage pregnancy. The delivery costs are established by the state. The reimbursement we get is established by the state. And as we have seen in both Washington and Michigan, the birth rates are up and they remain up.

It's really a matter of getting the rates set properly.

Next question is, just going back to your cost trends. More generally, is the spread between your premium rate increases and your overall medical cost trends - is that stable? Is it increasing? Can you give at least a little bit of directionality there?

We believe that the spread between our rate increases, our premiums and our medical costs is growing; but then that's offset by what we are expecting in Ohio and Indiana. A little bit in Texas. Texas is not large market for us but -- and that is what is keeping the MCR flat. For the year.

And on pharmacy in particular last quarter, you cited that as being a trend that actually increased by 3%. Any update on that?

You want to address pharmacy?

Yes. Pharmacy management for us has been one of our strong points and as far as overall pharmacy trend, for us it is hard to point out a specific trend because we have a lot of moving parts and a lot of changes at the state levels in terms of benefits. But I guess it is enough to say that pharmacy utilization trend is a negative trend. I don't want to put a number on that because it might be misleading because of the qualifications that I just said.

But we are very happy about our pharmacy management program and what we have been seeing and the negative trend that we are seeing.

Let me just follow-up and say one of the things you have to remember about our organization, again, we are in eight different states with eight different benefit packages, eight different fee schedules, trying to put a broad trend across can be misleading. In Ohio we have premium revenues of $180 to $200. 8% pharmacy spend in Ohio is much different than an 8% pharmacy spend in California where the premiums are only $100.

As we get more members in some of the states where there are differences in benefits and differences in pricing, it may destroy things. But Bill is right. The utilization for pharmacy year-over-year is down.

I'm going to throw in my $0.02 worth too. We have had a benefit change in New Mexico which also sort of skews the data a little bit. So you have to be careful about that. That is why we are looking to give a lot of data on trends because we don't want people to misinterpret things.

Thanks very much.

We have no further questions at this time.

All right, then. Thank you very much and we look forward to addressing you next quarter.

Ladies and gentlemen, that does conclude the conference call for today and we thank you for your participation.