Molina Healthcare Inc (MOH) 2009 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Molina Healthcare second-quarter 2009 earnings conference call. (Operator Instructions). As a reminder, this conference is being recorded Tuesday, August 4, 2009.

I would now like to turn the conference over to Mr. Juan Jose Orellana, Vice President of Investor Relations with Molina Healthcare. Please go ahead, sir.

Thank you, Mohammed. Hello everyone, and thank you for joining us. The purpose of this call is to discuss Molina Healthcare's financial results for the second quarter ended June 30, 2009. The company's earnings release reporting its results was issued today after the market close, and is now posted for viewing on our company website.

On the call with me today are several members of our executive team -- Dr. Mario Molina, our CEO; John Molina, our CFO; Terry Bayer, our COO; Dr. Michael Siegel, Vice President and Medical Director who is filling in today for a Dr. Jim Howatt, who is not available today; and Joseph White, our Chief Accounting Officer.

After the completion of our prepared remarks, we will open the call to take your questions.

I also would like to remind you that our comments today contain numerous forward-looking statements under the Safe Harbor provisions of the Private Securities Litigation Reform Act. All of our forward-looking statements are based on our current expectations and assumptions that are subject to numerous risks, uncertainties and other factors that could cause our actual results to differ materially. A description of such risk factors can be found in our earnings release, our 10-K annual report and our 10-Q quarterly reports filed with the Securities and Exchange Commission. These reports can be accessed under the Investor Relations tab of our company website, or on the SEC's website.

All forward-looking statements made during today's call represent our judgment as of August 4, 2009, and we disclaim any obligation to update such 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 website at www.holinahealthcare.com.

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

Thank you, Juan Jose, and hello everyone. In my remarks today I will provide a brief overview of our second-quarter performance and update you on the progress we have made in positioning Molina for improved long-term performance and growth. Dr. Mike Siegel will provide some commentary on the H1N1 outbreak, and then John will provide greater details related to our second-quarter financial results. After John's remarks we will open the call to answer your questions.

By now, I assume you have all had a chance to review our press release. Our earnings per share were $0.56. Our results for the second quarter can be summarized as mixed, with several notable positive developments, offset by higher medical costs and continued pressure on premium rates.

Higher medical costs and revenue pressure resulted in lower profit margins across some of our larger markets. In reviewing our results, it is important to focus on what has changed since the first quarter, as well as what continue to be key factors affecting our short-term financial performance. We have experienced greater utilization of outpatient services, some of which we believe resulted from the H1N1 flu epidemic; a substantial increase in new membership in the first half of this year; and higher professional fees and outpatient facility cost trends.

Some of the items we discussed during the first quarter continue to remain at issue. State budgets are still a problem. Healthcare unit costs are on the rise and interest rates remain low. Let me share with you some of the progress that we've made.

On the membership front today we reported membership of 1.3 7 million members, a 9% increase from December 2008. Excluding Florida, membership has grown almost 7%. We are therefore well on our way to meeting our full year enrollment goal as shared with you in January.

As we have stated in the past our historical organic growth rate has been in the range of 3% to 4%. However, as we reminded everyone at our most recent investor day, new members generally come with higher costs, a least initially. Our experience has been that new members typically incur higher medical costs during their first nine months of enrollment, but we have also observed that the utilization tends to stabilize over time.

We had some good news in the second quarter. I am pleased to announce our successful contract renewal in the state of Missouri. Molina Healthcare of Missouri was successful in retaining its existing business in the three regions we currently serve. I am also very pleased to announce our success in retaining our Medicaid contract in the state of Michigan. This new contract in Michigan will become effective October 1, 2009, and we will expand our service area in the state from 42 to 46 counties.

In addition, the Texas Health and Human Services Commission issued a tentative contract award to Molina Healthcare of Texas for the Children's Health Insurance Program, or CHIP, in rural counties. The award, which covers up to 170 counties in Texas, is contingent upon the successful negotiation and execution of a contract with the state. The new contract has a tentative operational start date in September 2010.

We are pleased to expand our contracting relationship with the state of Texas, and look forward to providing greater access to quality healthcare services to the rural populations in that state.

The New Mexico Retiree Health Care Authority notified our New Mexico health plan that its Medicare product will be offered as an option to the state employee retiree group business. This new opportunity and our new contract in Texas further our strategic goal of diversifying along product and geographic lines, while remaining true to our mission.

I'm also pleased to report that our Texas health plan earned accreditation from the National Committee on Quality Assurance. Melena Healthcare of Texas is the only Medicaid health plan in the state that has earned an accreditation from NCQA. Molina Healthcare continues to be among the leaders in health care quality with health plans in seven states accredited by NCQA, in California, Michigan, New Mexico, Ohio, Utah, Washington and now Texas. Currently only 22% of the nation's Medicaid plans are accredited by NCQA. I want to offer my congratulations to the staff of our Texas health plan for this achievement.

In these challenging times we continue to manage your business for the long term, and are pleased with the progress we are making towards our strategic goals. We continue to expand in new and existing markets. We continue to leverage a lean administrative structure, and as always, we remain intensely focused on quality.

I would now like to turn the call over to Dr. Michael Siegel, who will provide an update on the H1N1 virus.

Hello everyone. In early April a child in California was diagnosed with the novel H1N1 influenza viral infection. The new influenza strain has now reached pandemic levels. Currently in the United States there are over 43,000 documented cases. Sadly the infection has resulted in 302 deaths. It is thought that the H1N1 flu infection is far more prevalent in than these statistics would suggest.

This summer we are continuing to see higher than normal numbers of influenza-like cases, caused by the novel H1N1 flu virus. Over the past several weeks there have been reports of children being sent home from overnight camps with flu-like illnesses. Several of the children have tested positive for the novel H1N1 infection. These cases associated with increased physical proximity may foreshadow an increase in the number of novel H1N1 cases when children return to school next month. However, at this time we do not know how much of a role this new virus will play in the approaching flu season.

The disease attack rate is highest in persons under 25 years of age. This group constitutes a significant portion of our membership. We are closely following the progress and the development and distribution of a novel H1N1 vaccine. As of last week the CDC's projects that there will be a vaccine available by mid-October. We are augmenting our seasonal flu prevention program with the following actions. We are increasing the level of member notifications, both by mail and interactive voice response outreach. We are also increasing our efforts in working with providers to reach high risk patients.

We are urging members to get their annual flu shot earlier than usual. We will be providing member and provider updates as more information becomes available. We are starting around employee flu prevention education program now and plan for early worksite flu vaccinations.

Finally, as Dr. Howatt said during the last earnings call, all of us should keep in mind important behaviors that will help minimize the spread of the virus. Wash your hands frequently. Avoid touching your eyes, mouth and nose. Stay home when you or your family members are ill. Avoid contact with ill people. Cover coughs and sneezes. And practice good health habits, including adequate rest and nutrition.

Now I would like to turn the call over to John Molina.

Now to our financial results. Results for the second quarter of 2009 were $0.56 per fully diluted share. Net income was $15 million for the quarter ended June 30, 2009, as compared to $16 million recorded for the quarter ended June 30, 2008.

Our 2009 second-quarter revenue increased 22% or $164 million when compared to the second quarter of 2008. As outlined in our press release today, membership growth has been strong, and we continue to generate administrative cost efficiencies. Unfortunately, we have experienced significant cost pressures and medical margin pressure. In the long run we are confident that the benefits of increased membership will outweigh the challenges of higher medical costs.

Since the beginning of the year the Company has grown by over 112,000 members. To put this in perspective, we have added more members in the first half of this year than the total enrollment at our Missouri and Texas health plans combined. Our medical care ratio increased from 84.2% in the second quarter of 2008 to 86.8% in the second quarter of 2009. This is an increase of 260 basis points year-over-year and a 70 basis points change for the prior quarter ended March 31, 2009.

As we have discussed in the past, the Company usually experiences a decline in medical cost in the second quarter. This was not the case during 2009. Higher utilization was responsible for higher medical costs. Contributing to the situation were the outbreak of the novel H1N1 virus and higher utilization associated with newer members.

Although the first quarter of 2009 may have benefited from a lighter flu season, the Company believes that the H1N1 flu outbreak was partially responsible for the absence of the usual seasonal drop in medical costs from the first to second quarters. The Company also suspects that the media attention on H1N1 may have driven more patients to seek care than would have otherwise been the case.

Physician and outpatient costs exhibited the most unfavorable cost trend in the first half of 2009. Together these cost increased approximately 18% on a per member per month basis compared with the second quarter of 2008. Emergency-room utilization, up approximately 8%, and cost per visit up approximately 13%, were the primary drivers of increased cost during the first half of 2009.

During the first half of 2009 we observed some providers billing at higher levels of care than in the first half of 2008. For example, the billing codes for emergency-room level of care, which reflects the intensity of services provided in the emergency room, with level I being the least intensive, and level V being the most intensive, changed significantly in the first half of 2009 compared to the first half of 2008. Level I visits decreased by 16%, while level II visits decreased by 10%. However, both level III and level IV visits increased by 13%, and level V visits increased by 18%. We have also seen an increase in physician office visits in preventive care services.

Both impatient and pharmacy costs increased approximately 4% per member per month year-over-year. [Capitative] cost increased approximately 11% PMPM year-over-year due to retroactive capitation of payments in New Mexico and the transition of members in a capitative arrangements in California.

Now I want to take some time and talk specifically about California and Washington. The California health plan results have adversely affected the Company's current quarter and year-to-date results. Year-to-date California plan's Medicaid medical margin has decreased by approximately $12 million when compared to the first half of 2008. Based upon claims paid through June of this year the Company estimates that claims reserves for the California health plan were understated by approximately $5.2 million at December 31, 2008. This adverse claims development was partially offset by $3.2 million in revenue recognized by the California health plan in connection with a settlement of rate dispute with the state for 2002.

A reduction of about $9 per member per month in the Washington health plan's premium rates have also affected the Company's current quarter. This decrease in premiums was not fully offset by cuts to the Washington Medicaid Provider Fee Schedule. We now know that only about one-third of the $9 PMPM revenue decreased is being offset by the change in the fee schedule. This resulted in a decline in medical margin of about $5.4 million for the quarter or $10.6 million for the first half of the year.

The Company has taken a number of steps to improve profitability. We are re-examining our network strategy in California. Furthermore, we expect to receive rate increases in California of about 4.5% in the fourth quarter of 2009. The premium rate increases for the health plans in California were included in the state of California budget that was signed on July 28. The cuts in the Medi-Cal program in California do not affect the managed care contracts.

We may experience a decrease in enrollment in the CHIP program due to changes in the state budget, but at this time we do not believe this will have a material impact on our financial results.

On July 1, 2009 the state of Washington lowered Medicaid premium rates by 7.5% to reflect reductions in the Medicaid fee schedule. Our analysis shows that the reduction in our medical costs will largely mirror the reduction in the premium rates. In addition, in Washington we will exit the basic health plan contract in King County effective January 1, 2010.

Based on claims paid through June 2009 we believe that our year-end claims reserve in 2008 was more than adequate. In fact, the benefit we will report on a roll forward table is nearly the same as we reported at this time last year. The runout of the reserve we established on March 31, 2009 for the first quarter of this year has not been as favorable as in previous years. This had a negative impact on second-quarter results, as we replenish reserves to a more typical level.

We are pleased with our success in managing administrative costs. The general and administrative expenses in the second quarter were 10.1% of total revenue or $94 million as compared to 11.4% of total revenue for the second quarter 2008, or $87 million.

Core G&A expenses decreased nearly 120 basis points to 7% of total revenue for second quarter 2009 as compared to 8.2% for second quarter 2008. The decrease in core G&A compared with the second quarter of 2008 was primarily due to lower administrative payroll as a percentage of revenue. Core G&A expenses have also declined on a per member per month basis by approximately 6%, highlighting the administrative leverage resulting from higher enrollment levels. We continue to hold the line on our administrative costs as we grow the topline revenue.

We view our administrative leverage as an additional cushion during times of pressure on premium rates. The effective income tax rate decreased to 16.8% in the quarter ended June 30, 2009, from 41% in June 30, 2008. The lower rate is primarily due to discreet tax benefits of $4.4 million recorded in the second quarter of 2009 as a result of settling tax examinations in the voluntary filing of certain accounting method changes. The Company's tax rate would have been 43.5% for the quarter of 2009 absent these discrete tax benefits.

Cash flow provided by operating activities for six months ended June 30, 2009 increased substantially to $95 million compared with cash flow from operations totaling $39 million for the same period in 2008, an increased $56 million. The increase was due mainly to two factors. First, increased deferred revenue of approximately $45 million, and second, increased medical claims and benefits payable of approximately $22 million. These increases were partially offset by increased receivables of $21 million, mostly in California and Utah. We have not received any IOUs from the state of California, and we do not expect to receive any now that the budget is signed.

Excluding restricted investments, the Company had cash and investments of approximately $660 million. The parent company had free cash and investments of approximately $30 million, plus access to our untapped credit facility.

The Company is revising its EPS guidance for fiscal year 2009 to $2.15 per diluted share. We have provided a number of metrics that go into the development of that guidance in our press release, and we encourage you to review that document for additional detail. As I'm sure you've noticed, we have moved away from providing ranges for key metrics and have instead settled on single point measurements. I want to take a few moments to discuss this change.

In the past we provided a great deal of information with respect to premium revenue, investment income, EBITDA, medical costs and administrative costs in order to help our investors and the analysts understand how we view the immediate future of our business. In the past we have given these inputs in terms of ranges. Many investors and some analysts have struggled with translating these ranges into a single point expectation of net income. Too often people will compile each input at the bottom of the range and assume that this will lead them to the bottom end of our EPS guidance range. Conversely, they will assume that by compiling the top end of each info range they can build a figure that matches the top end of our EPS range. However, it is rarely the case that all of the bad things will happen together, and it is equally unlikely that all the good things will happen together.

We therefore decided to provide single points of reference in an attempt to provide greater clarity, which will allow our investors to make their own determinations as to the likelihood of the ultimate outcomes. I would again urge you to review our press release for a very thorough disclosure of the important financial metrics that comprise our expectations for the balance of the year. When you review the numeric inputs, let me describe some of the key issues facing our business in the second half of 2009.

We do not expect enrollment to grow in the second half of the year as it did in the first half of this year. If enrollment gains are as large as they were in the first half, we may continue to see elevated medical costs. Our advice guidance includes changes to individual health plan premium rates that were not anticipated when we first provided guidance in January. As you may recall, we do not expect to see substantial rate increases this year. However, as detailed in our earnings release, we now believe we will get rate increases in some states, rate decreases in other states, and oddly enough, both increases and decreases, just timed differently, in a couple of states.

For example, we would not have expected any rate increases in California, but have found that the current budget did fund some of these increases effective October 1, 2009. Where believe there is a greater chance than not that the rate changes will happen, we have incorporated those changes into our guidance. However, many states have fragile budgets. If the actual state tax receipts and stimulus dollars come in less than expected, there is a chance that the state will delay the implementation of rate changes or actually decrease rates.

We will not speculate where, when and if rate changes will happen, but what you to understand that it is a possibility. We have often discussed seasonality with respect to our medical costs. Typically medical costs are highest in the first quarter, decrease in the second quarter, reach an nadir in the third quarter, and rise in the fourth quarter. It is important to know that while costs rise in the fourth quarter, they are generally still below the cost incurred in the second quarter.

As we have discussed today, we did not see the typical decline in medical costs in the second quarter. We have developed guidance to assume that medical costs will not follow typical patterns this year. We have projected a slight decrease in our medical care ratio for the second half of the year. Should we see a return to more normal seasonal patterns we would expect medical costs to decrease further, thus earnings increase.

On the other hand, we have not projected a virulent outbreak of H1N1 or other seasonal flu. If H1N1 returns with widespread applicability, our medical costs could rise beyond what we are anticipating and our earnings would go down.

This concludes our prepared remarks. Mohammed, we are ready to take questions.

(Operator Instructions). Josh Raskin, Barclays Capital.

Good afternoon. A question relates to second-half earnings run rate and the guidance here. I guess the first quarter you guys reported $0.46, but there was really a $0.04 gain in there. This quarter is $0.56, but $0.18 from tax benefit. So excluding the tax benefit, we get to about $0.84. You're talking about $1.13 in the second half, which seems like a pretty big ramp. You just talked about the muted seasonality expectation and I'm actually calculating and MLR is about 40 basis points or 45 basis points better on a year-over-year basis in the second half than the first half. So I am just curious how we -- how you bridge from 1H'09 to the the second half of '09.

This is John. I think -- although it may appear simple and convenient to just exclude what might be one-time items, we don't detail out every up-and-down potential change that may or may not be reoccur. Certain things happen throughout the quarter. We just draw your attention to a couple of them that stick out.

What I would say is in terms of the back half of the year, we have given our best estimate of guidance of being $2.15, and so we expect to bridge the gap between where we are at the end of Q2 to get to $2.15.

Maybe I could ask it another way. It looks like the guidance implies a much better earnings run rate in the second half than the first half. I'm just curious, what are some of those positive factors that would lead to that?

I think the rate increases are a big factor in that. We didn't have those in January.

This is Mario. We are also expecting some decrease in medical costs in the second half of the year. And we are making some progress on the contracting front, so there are a number of things that we think will lead the second half to be better than the first half.

And then just to follow-up, could you walk us through the timing? It didn't sound as bad, obviously, in the first quarter. It looks like you guys were still buying back stock in the second quarter. So how did this develop. and what were some of the indicators? And how comfortable are you that you have figured out what the new run rate is?

I would say -- you're talking about the run rate on guidance or the run rate on the repurchases?

On medical costs. I am sorry. Have do know whether you have got the right level of medical costs?

We pour through reams and reams of reports from our actuarial and our medical cost departments to make sure that we, as best as possible, understand what the underlying drivers for the cost and utilization data is. And that is something that just doesn't stop. We are continuing to look at that continually.

This is Mario. There are a number of factors that went into this. The first, I think, is increased outpatient utilization. We have seen this, and I think that some of the other health plans that have reported have also commented on this. We think that there was some contribution from the H1N1 flu virus, but that doesn't explain all of it. We have also seen that in the past new be members come with higher costs in the first 6 to 9 months. With a large influx of new members we think that contributed to the elevation in the cost. It was mostly outpatient. It was really not so much pharmacy or inpatient. So those are some of the main cost drivers that we have seen in the first half of the year.

We think that there are some indications that costs will come down in the second half of the year. And we've got some preliminary data from pharmacy that would suggest that the costs are coming down in July. I think this is consistent with what some of the PVMs are reporting.

Okay. All right. We can follow-up. Thank you.

Daryn Miller, Goldman Sachs.

Just a question on the California budget. It looked like the amount that they were looking to cut out of Medi-Cal was fairly significant. I am just wondering since a portion of that doesn't seem like it is coming from managed care, where is that money going to come from?

The decreases in the Medi-Cal budget are coming from a variety of sources. But what we can say that affects us is that there was budgeted a rate increase for the managed care plans. That remained in the budget, and we have gotten rates that will be effective October 1, which give us about 4% to 4.5% rate increase for the fourth quarter. So we are very hopeful that that will remain. But as John pointed out, the budgets are fragile, so for the time being we are counting on that money, and if anything changes we will let you know.

Any speculation in terms of what aspects of the program not related to managed care that would be trimmed to generate the savings?

I don't want to get into that, since it really hasn't affect our business.

Then you said if they changed the CHIP program the impact would be modest. Can you potentially size that aspect?

We think that we could lose 2000 or 3000 members this year, so we don't think it's going to have a significant impact on our financials for the remainder of 2009.

It is Joe. Just to put that in perspective, that is about a $75 per member per month premium. (multiple speakers).

Yes, that is very small. Okay. I just wondered, do you guys have any expectations -- you're picking up a lot of new enrollment, what is the duration, do you think, of that new enrollment, or how long is it going to be around for?

We are seeing that -- one of the things that is driving increase in membership -- overall membership -- is that we are not losing as many members throughout the backend as we are gaining coming in the door for the first time. I don't know that we have done a complete duration study to see what the average length of enrollment has been. I will say to Mario's point, the medical costs seem to be elevated for the first 6 to 9 months and then begin lower. But I don't know that we have sufficient data right now on total average monthly enrollment.

This is Mario. I think it is really too soon to tell. Some of these members have only come on this year, so it is hard for us to know. We will just have to see. But as John points out, disenrollment are down and you would expect that in a difficult economy.

I guess -- maybe going back to previous downturns, because if we think about this maybe higher-than-expected costs up front, but if this enrollment sticks around for three years or 2.5 or 3.5 years, there is the potential quite a bit of benefit on the backend. Any other -- any indication from previous downturns how long this enrollment might be around for?

I think that you are right about the fact that there is some upside to longer the members remain on the plan. But to be honest, I don't think we have had a downturn like this since the 1930s. So it is a little bit difficult for us to go back and look for a comparable historical period.

That's fair. One last quick one. The trend that we are seeing on provider behavior seems to be pretty widespread. Is there any common themes, as in types of providers, that are up-coding or billing for more activities? Is there any theme or trend on those types of providers?

We did see -- as an example that I cited -- this is John -- some of the ER providers, but right now I don't think we know enough to ascribe broad patterns or trends.

I will tell you anecdotally that I periodically get e-mails -- this is Mario -- inviting me to seminars on coding. So I don't know if this is an industry trend or if this is just a blip that reflects the current state of the economy.

Greg Nersessian, Credit Suisse.

I just had a couple of questions on some of the specific items you outlined in the press release. The new Mexico capitation expense increase -- were both the retroactive premium revenue and the cost all booked this quarter? So was the net benefit from that item this quarter? Is that right?

Yes, it is. It is Joe speaking. Yes, it is.

So that was about a $3 million, $3.5 million net benefit for the quarter?

I think out of period was about $2.5 million, yes.

Then the California -- I understand that you had negative reserve development within that health plan, but it looked like your aggregate prior period reserve development was basically in line. Is that a fair characterization, including -- at the consolidated level?

At the consolidated level as of the end of last year, yes.

So is it fair then to look at that $3.2 million in revenue as a one-time item -- the deferred revenue going back to 2002?

Yes.

Great. I guess this swine flu, the data that I have looked at anyway from the CDC suggested it is mostly has been a Northeast phenomenon. I was wondering if you could spike out which markets you are seeing that in a more pronounced way? Is it -- is there any specific states where it has become more prevalent?

Reviewing dealing the surveillance reports from the CDC from last Friday there is widespread activity in California, regional activity in Washington and Florida, and then lesser degrees of activity in the rest of the Molina states.

So California is getting materially worse, is that how you would characterize it in terms of the --?

Per the reports submitted to the CDC, yes.

Then just maybe just one more question. On the California rate increase, the 4.5%, does that all accrue to you, or are there some provider payment changes underneath that that would mitigate some of that rate increase?

The only provider payment it might mitigate is we have a contract with HealthNet for the Inland Empire that mirrors (inaudible) in LA. So we have to pass some of that through to them, but it is a very small amount.

I think basically the answer is no.

Okay, so you're getting almost a full effect of that 4.5%?

Yes.

As long as it stays.

Yes.

Than any changes to your approach to reserves? The days dropped a couple of days in the quarter. Was there any reserve strengthening you could speak to in the quarter, or maybe you could just give us some color commentary on how you approach to reserves, given the unexpected spike?

It is Joe. I think it is fair to say -- you mentioned 12/31/08 reserve development a minute ago. We talk in the release, and we even have a table on the backend, the 3/31/09 reserve was comparatively light when we set that at the end of the last quarter. So we have had to make up some ground on that this year.

If you look at the roll forward table specific to the 3/31/09 reserve, you will see that the benefit hitting in the second quarter was only $26 million, when we would have probably normally affected something -- expended something in the $40 million range.

So certainly we have had to strengthen for that. On the other side, we resumed our march downward in terms of the inventory numbers. They are down about 17% from the second quarter. So we feel like we have caught up with what happened in the first quarter and the second quarter. And obviously a little bit of the -- a little bit of a negative impact -- a little bit of a negative cost trend we are seeing in Q2, obviously should spillover into Q1 if we had set the reserves a little bit more consistently back in March.

The bottom line is we have not changed our methodology for reservings. And in fact, we are not allowed to pad the reserves in the expectation that something bad might happen in the future. Our reserves are set on all the information we know at the time we set the reserves at the end of a period.

(Operator Instructions). Tom Carroll, Stifel Nicolaus.

Just -- I want to drill down a little more, pickup on Greg's question a bit related to the one-time items, and then how that translates into the back half of your year. So you're putting up a $0.56 quarter here. I'm taking out $0.08 a share for the California settlement, about $0.17 for the tax benefit, and another $0.08 for the difference in the New Mexico retro payments. I am then adding back the negative development in California, which was about $0.06. So you put that all together and you're getting to a $0.29 or $0.30 quarter. Is that going to then turn into a $0.56 quarter on third quarter because of lower medical expenses? Could you help me out with the math here, and please point out where I am wrong?

Again, what I would -- this is John -- what I would say is there are one-time items that, just for the sake of brevity we did not include. I am going to give you an example. We had an additional $2 million expense in the quarter related to New Mexico insurance premium pools. We didn't detail that out. There is probably another $0.5 million somewhere else. And another $1 million somewhere else. We just don't detail them all. They go back and forth all the time, because we've got a complex business. We are talking about nine health plans and several hundreds of millions of dollars worth of revenue and expenses going through.

What I would say is the end of the year number is our best estimate, taking everything into consideration -- the medical costs, admin expenses, investment income, plus those changes that occurred that are seen and frankly sometimes that are unseen, because they are just too small and numerous to put in place -- to detail out.

But you would suggest these three things that you highlighted are probably nonrecurring in nature, is that correct?

Yes.

You're not going to get another California -- I guess you could get another California tax settlement next quarter, but you're not expecting one.

We do have other disputes on rates with the state of California, but no, we are not expecting any settlement in the near future.

The one other question I had for you, back to some of the text in your press release about, I believe it was the Washington State market, where you were getting the $9 PMPM lower amount, that you thought was going to be mostly passed through in lower fee schedule numbers, that is not being all the way it accounted for, is that a trend that perhaps we might see in other states? And not just with you guys, but in any particular market where a rate -- a fee schedule comes down. It is translated to a Medicaid HMO cat payment and then ultimately doesn't work out the way we think?

We can't speculate on what is going to happen with other states. It happened in Washington, when they did the rate -- when they did the subsequent rate decrease in July, and we looked at the data provided by the state to see how they determine the decrease, and we feel that the fee schedule adequately covers the decrease in our premiums so that our cost to go down at the metro level.

This is Mario. I want to add a little bit to that. A lot of times when the states are calculating their rates they come up with certain assumptions and it is an aggregate across all health plans. Sometimes you will see differences between health plans within a state, depending on things like utilization patterns and case mix. So it can vary, and you can see this kind of thing when rates are readjusted. If the actuaries for the state have done their job properly, these things should be neutral.

As John points out, we think the next cut that they have made to the fee schedule should be neutral to us. We always examine these things, but it is difficult to be 100% sure.

So you don't think that phenomenon, if you will, is going to continue July 1, 09 through the remainder of the Washington contract period?

I think generally the states are getting better in terms of the actuarial soundness requirement and setting the rates properly.

Okay, I will stop there. Thank you.

Carl McDonald, Oppenheimer & Co.

I would be interested if you think there is any specific initiatives you can do, particularly thinking around the physician and outpatient costs. So if you take the emergency room data that you cited, is there anything you can do from your end to try to bring the levels back down to what you have seen historically, or is that something that plays out on its own?

This is Mario. I think there are things that we can do. And we are really trying to get after the outpatient costs. One of the things that we're trying to do is get more people to use the nurse advice line and triage patients that don't need to go to the emergency room to urgent care centers.

A lot of this is educational. Remember, we've got 112,000 new members on the plan this year, and it takes time to change people's habits and behavior. We are also looking at opening up perhaps some other clinics in other areas to catch some of this overflow from the emergency rooms and redirect people away from the higher cost facilities.

The other thing that I think we need to do is examine the records to see if this is simply a matter of up-coding or if this people are sicker and going to the ER. And then finally, as I think Mike pointed out, or maybe it was John, there is some concern that the media promoted some of this, because people were panicking over the flu and they heard about patients dying. So people that had colds that might otherwise have stayed home and said, it is a bad cold, either went to their doctor or went to the emergency room, and that increased utilization.

On a positive side, I think we saw an increase in preventive care services. And that is something we have been trying to encourage, which should benefit us on our HEDIS scores. In the reprocurement of the Michigan contract there was 125 point total per county. If you look at the scores that we got, you will see that we received 60 points -- the full 60 points, for the quality points, and we were the only health plan to get all five of the value added points. So right there our efforts in terms of improving our quality and HEDIS scores is helping us with our contract renewal. I think that is the kind of thing that we will see you more of in the future with RFPs from states on Medicaid contracts.

Specifically on that Michigan contract, when you look at the counties where you are added and the other counties where you were taken away, and the same thing with the competitors, will there be any significant shifts in the membership?

It is hard to say if there are going to be big shift in the membership, but we think there is definitely some upside potential for us. We have some competitors that lost some counties, and so we will have fewer competitors in some of the counties. At the same time I think we have added some counties, so there may be some upside there. We will just have to see how it plays out.

But I also think that our HEDIS scores, which helped drive the enrollment algorithm in Michigan, are definitely going to move us up in the enrollment algorithm. In some of the counties we have been at tier 3, we are moving now moving up to Tier 1.

(Operator Instructions). Scott Fidel, Deutsche Bank.

First question just back to medical costs. And just interested in how utilization looked for your existing membership, maybe the longer tenured membership as compared to the newer membership, where clearly there were higher cost there. I guess thinking about utilization on the longer membership, did you see an increase there too? And maybe if you parse out swine flu, just sort of a secular increase on the longer tenured membership?

It is Mario. It is a little bit difficult to tease that out, especially at this point. But we have done a couple of studies, and it does vary a little bit from state to state, but there are some clear trends. One of the most pronounced trends is in California, where we see that the members definitely have higher utilization and the breakpoint comes at about nine months. So to the extent that we can retain members beyond nine months, their cost do come down and we should get some benefit from that. But at this point it would be a little bit premature to break out the new members we received in 2009 versus the more longer existing members.

Okay just --.

Do you follow me?

Yes, yes. I do. Just a second question on just the exit from Kings County in Washington you mentioned for January. How many members will be impacted by that, or how many members do you have enrolled in that county currently?

This is Terry Bayer. It is 10,000 members in the [Basa-Cal] contract that we are exiting.

Then just one last question. Just on the commentary that you had, just on the tax benefits in the quarter, you had just referenced a couple of changes to voluntary accounting methods. Maybe, Joe, if you could just give us some details on exactly what changes your made in the accounting methods there?

Sure. The biggest item was a settle up of a purchase accounting issue, which per FAS 141R results -- from a tax perspective results in a P&L impact. That was about -- of the $4.4 million, that was about $3.5 million of the benefit. The remaining $900,000 of the benefit related to changes in terms of accounting practices. And the biggest one was we now file as an insurance company. So between that and a few other small items, we picked up about $900,000 of benefit from accrued interest related to those tax positions.

Okay, thank you.

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

I will close by saying, thank you for joining us, and we look forward to talking to you again next quarter.

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