Molina Healthcare Inc (MOH) 2012 Q2 法說會逐字稿

Welcome to the Molina Healthcare Second Quarter 2012 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded Thursday, July 26, 2012. I would now like to turn the conference over to Mr. Juan Jose Orellana, Vice President of Investor Relations. Please go ahead.

Thank you, Kim. 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, 2012. The Company's earnings release reporting its results was issued today after the market closed and is now posted for viewing on our Company website.

Participating for Molina today will be Dr. Mario Molina, our CEO; John Molina, our CFO; Terry Bayer, our COO; and Joseph White, our Chief Accounting Officer. After the completion of our prepared remarks, we will open the call to take your questions. If you have multiple questions, we ask that you get back in the queue so that others can have an opportunity to ask their questions.

Our comments today will contain forward-looking statements under the Safe Harbor provisions of the Private Securities Litigation Reform Act, including but limited to, statements regarding the Ohio Medicaid and duals-RFA contract awards and pending appeals; Medicaid enrollment growth projections and the implementation of dual-eligibles integration demonstration projects; our medical cost containment initiatives in Texas, and the finalization of a rate increase in Texas effective September 1, 2012; Wisconsin rates and premium deficiency reserves with respect to estimated losses in Texas and Wisconsin.

All of our forward-looking statements are based on our current expectations and assumptions, which are subject to numerous risk factors that could cause our actual results to differ materially. A description of such risk factors can be found in our earnings release and in our reports filed with the Securities and Exchange Commission, including our Form 10-K annual report for fiscal 2011, our Form 10-Q quarterly reports, and our Form 8-K current reports. These reports can be accessed under the Investor Relations tab of our Company website, or on the SEC's website.

All forward-looking statements made during today's call represent our judgment as of July 26, 2012, 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 molinahealthcare.com. I would now like to turn the call over to Dr. Mario Molina.

Thank you, Juan Jose. Hello, everyone, and thank you for joining our call today. Considering the positive trends experienced in a number of previous quarters, Molina's results for the second quarter were a disappointment to us. Despite increasing revenue by 32% and enrollment by 13%, the continuation of higher than expected medical costs at our Texas Health Plan significantly contributed to the net loss of $0.80 per share that we reported today.

The factors affecting medical costs in Texas included higher than anticipated utilization of long-term care services, unfavorable unit costs, and inadequate premiums to cover the medical costs associated with Star Plus members in the Hidalgo and El Paso service areas.

John will be describing shortly some of our efforts to get us back on track in Texas in the second half of 2012. I want to emphasize that the second quarter also included key developments that will notably contribute to driving long-term value for our shareholders. Let me take a moment to review the most significant developments.

First, our protest filing in the Ohio Medicaid RFA was upheld by the Ohio Department of Jobs and Family Services, also known as ODJFS. This outcome results in the retention of our existing business in Ohio, which constitutes approximately 20% of the Company's premium revenue. It also enables us to expand to 38 new counties previously not served by our health plan.

The market opportunity in these 38 counties is comprised of approximately 750,000 CFC, or (inaudible) beneficiaries, and 64,000 ABD beneficiaries. Although the contract is currently delayed as the new awards are being litigated by other applicants, the rescoring of the RFP resulted in a score for Molina that ranked third out of the five selected health plans, firmly positioning our application among the top scorers.

Another key development during the second quarter was the Supreme Court's ruling in the Affordable Care Act. The court upheld the Medicaid expansion but included a new twist. The federal government may not threaten the states that don't participate in the expansion with the loss of their existing Medicaid funding. The ruling, which effectively makes expansion optional, transforms Medicaid expansion from a legal issue into primarily a political one.

Although we don't know which states will ultimately opt out, our working assumption is that some state governments will choose to participate. A report released by the Congressional Budget Office earlier this week supports this assumption. The CBO's updated estimate, which incorporates the Supreme Court decision, now size the Medicaid enrollment opportunity at 11 million new beneficiaries by the year 2022, down 6 million from previous estimates. Although this expansion figures are lower than what was initially expected, it still represents considerable potential growth for companies like Molina.

Our strategy remains the same. We continue to forge ahead in our reform readiness for January of 2014. We are scaling the Company for growth opportunities both before and after that January 2014 date, and we also remain focused on the pursuit of near-term opportunities such as the dual-eligibles integration pilot programs.

On June 28, ODJFS announced the preliminary scoring results for all seven regions of its dual-eligible RFA. The RFA covers over 114,000 beneficiaries and the contracts are scheduled to begin on April 2013. We are pleased that Molina Healthcare of Ohio received the highest scores in the three regions where nearly 53,000, or 43% of Ohio's dual-eligibles reside.

As a reminder, these regions reflect our current covered families and children, or CFC, and ABD footprints. According to ODJFS, once the scoring protest period is complete, the top two scorers in each region are expected to be awarded a contract with a maximum of three regions awarded per health plan. The final tentative health plan selections are expected after August 7.

You may recall that last April, Molina Healthcare was selected by the California Department of Healthcare Services to participate as an integrated health plan in a proposed dual-eligible demonstration project in San Diego County, and as a subcontractor in Los Angeles County. These two counties have approximately 449,000 dual-eligibles.

During the month of June, the California legislature approved Governor Brown's expansion of the dual-eligible demonstration project from four counties to eight. The four additional counties are Alameda, Riverside, San Bernardino and Santa Clara. Our California Health Plan currently participates in the Medicaid program in two of these counties -- Riverside and San Bernardino, where 101,000 dual-eligibles reside. We presently operate our Medicare Advantage Special Needs Plans in Los Angeles, Riverside, San Bernardino and San Diego Counties.

A key feature of the California dual-eligible proposal is that initial participation in the program is restricted to health plans that currently participate in the state's Medicaid program. The state's proposal still needs federal approval from CMS and is expected to be implemented in April of 2013 with a phased-in enrollment process.

As we have discussed before, the dual-eligible patients present complex problems, but we are gaining experience and we're confident that we will be well positioned to serve these patients as we move forward. Our experience with provider benefits ranging from acute to long-term care for Medicare and Medicaid will be critical to serving the dual-eligible patients.

As we have learned from our recent experience in Texas, it is critically important that a managed care organization understand the environment and healthcare drivers affecting the coordination of Medicaid long-term care benefits with the traditional Medicare benefits that we will be responsible for in the future.

We continue to hone our dual-eligible care coordination expertise by capturing the knowledge we have gained through our implementation of both small demonstration programs, as well as large implementations. For example, in Florida, we have begun providing home and community-based services in lieu of nursing home placement for Medicaid and Medicare beneficiaries in two counties.

In Washington, we continue to participate in the Washington Medicaid Integration Partnership, or the ABDs, which integrates medical, mental health, chemical dependency treatment services, and long-term care services in Snohomish County.

On a larger scale, our growing understanding of long-term care with the Texas Star Plus program and the data we are capturing will enable us to emerge from the current situation with a deeper understanding of the challenges inherent in caring for the dual-eligible member.

In Texas, about 70% of our current Star Plus members are dual-eligible. Washington and California are two other large states where we are learning from the transition of thousands of ABD patients from fee-for-service to managed care.

We believe our participation in both small and large programs will provide us with a tested strategy for addressing the challenges for the upcoming dual-eligible implementation. However, experience in assisting these complex patients, seamlessly integrated coordination of care and medical management are only part of the solution. Actuarially sound rate-setting and expectations on program savings compared to fee-for-service will also play a very important role in the success of dual-eligible integration programs.

As we have now seen in the state of Texas, when states develop premium rates for health plans with cost-saving assumptions that prove to be too aggressive, it can have a destabilizing effect on members, providers and health plans.

CMS estimates that in some states the savings target should be up to 5% by the end of the third year. In California, the Department of Healthcare Services estimated savings from 3% to 6% by year three with full implementation. We still need to work more diligently with states to set actuarially sound and adequate rates.

Finally, let me turn to a couple of other key developments. We are very pleased that our Medicaid Management Information System, or MMIS contract in New Jersey was renewed for another four years. And then in Idaho we received full federal certification for our MMIS from the Centers for Medicare and Medicaid Services.

As a result of the certification, the state can now claim 75% federal reimbursement for ongoing operations retroactive to June 1, 2010. The system serves over 230,000 beneficiaries and handles over 140,000 claims per week. Idaho joins Maine as the second state where our system is federally certified since Molina acquired the fiscal agent business in 2010. Our systems are now certified in all five states where we currently operate as fiscal agent -- Idaho, Louisiana, Maine, New Jersey, and West Virginia.

I would like to take this opportunity to recognize the staff of our fiscal agent subsidiary, Molina Medicaid Solutions, on a job well done.

We are also very pleased to share with you that despite all the challenges in Texas, our focus on quality in that state has not been compromised. We received the final results of our 2012 NCQA accreditation survey last week, and the accreditation of our Texas Health Plan has been extended for three more years. Congratulations to our Texas team on a great achievement.

The second quarter of 2012 has illustrated both the opportunities and the challenges facing Molina Healthcare today. I want to reassure you that we are not standing still and that we have redoubled our efforts to get us back on track in the second half of 2012 and beyond.

While we're disappointed that our financial results fell short of our earlier expectations, none of these setbacks have changed our view regarding the favorable long-term prospects for our Company. I would now like to turn the call over to John.

Thank you, Mario. Good afternoon, everyone. Today we reported a loss in the second quarter of $37 million, or $0.80 per diluted share, compared with net income of $17 million, or $0.38 per diluted share for the same quarter last year. Although these results were not what we had hoped for, I want to emphasize that we believe the problems we've seen this quarter are isolated and resolvable.

If we look beyond Texas, Missouri and Wisconsin, we can see the rest of the Company is performing about the way we expected it to perform. Missouri has been a disappointment this quarter, but the termination of our contract effective June 30 has brought an end to this problem.

Wisconsin was another trouble spot. However, enrollment there is small enough such that its impact on the Company is limited while we work with the state to develop more sustainable rates.

I'll talk in more detail about Texas in a minute, but for now let me say that starting September 1, we expect to have a rate increase in Texas that will take us about half the way to break even. We are in the process of implementing cost containment initiatives that should bring us the rest of the way to break even on a run rate basis by the end of the year.

Turning to overall performance for a minute, premium revenues for the second quarter grew to $1.5 billion, representing a 32% increase over the second quarter of 2011. Revenue grew due to membership increases, a shift in member mix to populations like the ABD, which generate higher premium revenues, and due to increased revenue linked to benefit expansion such as the pharmacy benefit carbon in Ohio, and the inpatient and pharmacy benefits in Texas that were added effective March 1, 2012.

Aggregate membership grew to 1.85 million, or 13% year-over-year, with the bulk of the sequential enrollment gains coming from Texas. However, as things settled down in Texas, we do expect to lose some enrollment there. Our Ohio and Washington plans also contributed large enrollment gains when compared to last year.

I want to remind everyone that as of July 1, we will not be reporting any enrollment in Missouri since our contract with the State expired on June 30. We expect a decline in membership from Missouri will be partially offset by enrollment gains in Washington, which is coming in above expectations.

As of July, the Washington plan had grown by additional 41,000 new members from the number which we are reporting today, including 12,000 new ABD members, which are also higher than we anticipated.

This increase in our ABD enrollment in Washington highlights the shift in patient mix that we are experiencing. Overall, our ABD enrollment reached nearly 253,000. ABD enrollment grew by nearly 93,000 members, or 58% year-over-year led by Texas and California, which grew by 59,000 and 24,000, respectively.

In addition, our Medicare plans, which are comprised primarily of dual-eligible members, grew by 6,500 members, or approximately 25% year-over-year, giving us more experience in serving complex populations. We now have 109,000 dual-eligible beneficiaries enrolled through various contracts, even though we're not getting the combined revenue for these members.

To give you a sense of how significant the ABDs are becoming to our business, in Texas our ABD membership represents approximately 37% of our total enrollment there, but it generates approximately 70% of our revenues in that state. Because the revenues of the Texas Health Plan constitute nearly 25% of the Company's consolidated premium revenue for the second quarter of 2012, the high medical care ratio in that state had a disproportionate impact on our results.

Our consolidated medical care ratio increased to 92.3% during the second quarter, compared with 84.1% in the same period last year. Again, if we look beyond Texas, Missouri and Wisconsin, we can see the rest of the Company is performing about the way we had expected it to perform. Excluding Texas, Missouri and Wisconsin, our medical care ratio in the quarter would have been 85.3%.

The sharp increase in Missouri's medical care ratio was a result of higher inpatient utilization and high dollar claims from premature infants. However, since the Missouri contract concluded at the end of June, we do not anticipate this will be an issue in the second half of 2012.

In Wisconsin, our health plan reported a medical care ratio for the second quarter of 121% compared with 81% in the same quarter last year. We believe the premium rates in Wisconsin are not adequate to cover our costs, and as a result we recorded a premium deficiency reserve for the Wisconsin Health Plan at June 30 of $3 million. Our Wisconsin Health Plan is expected to receive new premium rates effective January 1, 2013. We will work with the State to make sure that those rates are actuarially sound and sustainable. In the meantime, we are renegotiating hospital contracts and undertaking efforts to improve profitability in Wisconsin.

Now let's spend some time on Texas. The medical care ratio of the Texas plan for the second quarter was 109.4% compared with 95% for the same quarter last year. We have recorded a premium deficiency reserve of the Texas plan at June 30 of $10 million. Additionally, second quarter results were adversely impacted by $14 million of unfavorable of prior period development of claims reserves from our estimate at March 31, 2012.

In estimating expenses and setting claims reserves for the first quarter, we had to rely heavily upon historical data provided by the state Medicaid agency in place of our own claims payment experience, which was almost nonexistent, for the new regions and benefits.

We now have the benefit of four months of claims experience since the regional benefit expansion was launched on May 1 of this year -- March 1, excuse me. Our own experience has demonstrated that our reserve estimates at the close of the first quarter were too low, but that same experience gives us much greater confidence in the adequacy of our reserves at June 30. Absent this unfavorable prior period development and the $10 million premium deficiency reserve, the medical care ratio for the Texas plan would have been 102.7% for the second quarter.

We believe the premium rates associated with the ABD contracts specifically in El Paso and Hidalgo service areas are not adequate to cover the medical costs associated with serving those members. The utilization of long-term care services, including personal attendants to help with activities of daily living, is currently far exceeding the utilization elsewhere in the state, and is also far exceeding the assumptions used by the State of Texas to determine the premium rates.

Furthermore, our ABD market share in these two regions amplifies the impact on results. As of June 30, 2012, Molina served more than 13,000 Star Plus members in the El Paso service area, accounting for 56% of the market, where there are two plans. And Molina served approximately 32,000 Star Plus members in the Hidalgo service area, accounting for 43% of the market, where there are three plans.

Based on preliminary information from the State, we expect to lose some Star Plus membership in August. We estimate our monthly loss in Texas before taxes to be approximately $14 million. The State of Texas has released preliminary rates which we estimate will add an additional $7.4 million in premium revenue each month effective September 1.

In addition, we believe the various initiatives aimed at reducing utilization and unit costs will improve profitability by approximately $6.6 million each month by the end of the year. These initiatives include changes in provider contracts, changes in the way we pay our hospitals, and the implementation of prior authorizations.

We are required to establish premium deficiency reserves for any of our contracts whenever we believe the estimated future costs of serving that contract exceed the estimated revenues to be derived from that contract. In other words, when our operational improvements alone are not enough to reach profitability, we must record a premium deficiency reserve.

As a practical matter, we test for premium deficiency at the state level for all of our Medicaid and CHIP contracts combined. The period we test for the deficiency is the time from the measurement date -- in this case, June 30, 2012, through the end of the rate year.

For our Wisconsin HMO, since rates will not be adjusted until January 1, 2013, we have estimated the excess costs over premiums for the period July 1, 2012 through December 31, 2012, specifically, we estimated the cost will exceed revenue by $3 million over that six-month period.

For our Texas HMO, where rates will be adjusted effective September 1, 2012, we have estimated the excess costs over premiums for the period of July 1, 2012 through August 31, 2012 to be $10 million.

By establishing premium deficiency reserves, we have brought into the second quarter of 2012 losses that otherwise would have been reported in the third and fourth quarters of 2012. Regardless, our recording of a premium deficiency reserve does not represent a change in our perspective regarding the long-term performance of either Texas or Wisconsin health plans.

General and administrative expenses for the quarter increased to 8.6% of total revenue compare with 8.3% of total revenue for the same quarter last year. Principal factors behind the increase in the percentage of our revenue spent on general and administrative costs were a $1.1 million charge related to a decline in the value of the interest rate swap on our corporate office building; higher business development costs for both our health plan and MMS segments; higher legal costs incurred in the course of our appeal of the Missouri contract award; and higher advertising costs.

Cash flow provided by operating activities was $236 million for the six months ended June 30, 2012, compared with nearly $115 million for the same period last year. Higher medical claims and benefits payable mainly in Texas were the main reasons for the increased cash flow provided by operating activities, followed by an increase in deferred revenue.

Medical claims and benefits payable were a source of $123 million in 2012 compared with the use of $13 million in 2011.

Deferred revenue was a source of operating cash amounting to $125 million in 2012 compared with $38 million in 2011. This is primarily due to timing issues in the receipt of payments from Michigan and Washington.

In addition, $50 million was drawn on our credit facility to meet the increased net worth requirement associated with the growth of our Texas Health Plan.

For the first time, the Company had cash and investments in excess of $1 billion. The parent Company had cash and investments of $40 million. Days of claims payable remain flat sequentially at 44 days. Year-over-year days of claims payable increased from 39 days to 44 days.

Performance at our MMS subsidiary improved for the three months and six months ended June 30, 2012, due to the stabilization of our Idaho and main operations. We were also very pleased with the federal certification of our Idaho claims processing system. The federal certification is an important strategic milestone for Molina Medicaid Solutions, as it should more favorably position our subsidiary to an additional MMIS procurement in new and existing states.

As we have discussed in the past, certification triggers revenue and expense recognition. However, the additional revenue will be offset by an equivalent increase in costs. The current contract in Idaho runs through November 2014.

Because of the uncertainties related to the timing of Texas improvements, the Company is not updating its earnings guidance, which was withdrawn on June 30, 2012. Operator, that concludes our prepared remarks. We are now ready to take questions.

Thank you. (Operator Instructions) And our first question comes from the line of Josh Raskin with Barclays. Please go ahead.

Hi, thanks. I guess the good news is we didn't hear about quintuplets again or something. So, let's start with a bunch of different things. Let's start with capital needs. Do you think there is any short-term or even intermediate term needs for capital? And I guess for maybe Mario and John, is this a time where you start thinking about larger diversified, well capitalized companies as partners?

Josh, let me answer the first part of your question regarding capital needs. There is no need for us to go out and raise capital. However, I think as we saw, frankly, when we had the $1 million hit because of the interest rate swap that we put on this building, interest rates continue to be all-time lows. So, while there may not be a need, we are certainly look at is it time to get the cash. Because as the Company grows inevitably there will be some need either for additional acquisitions or to fund especially the growth coming from the duals.

But you're just talking specifically around debt, there is a need for capital. You're only thinking about debt at this point.

That's right.

Our next question comes from the line of Justin Lake with JPMorgan. Please go ahead.

Hey, guys, it's Ken. How are you? It looks like Josh got cut off there. But maybe just in the meantime, could you talk just a little bit about the lives that are switching out of Texas in the ABD lives and going to another plan? Could you maybe just talk about what the drivers are there for the particular members switching out and what the MLR is on those lives relative to the rest of the Star Plus lives in Texas?

We don't know what the reason is and we don't know what the MLR is. We just got a preliminary report from the State, and, frankly, given the dynamics, there are three very good plans in Hidalgo; it makes sense that over time enrollment would even out.

And as you kind of look at your run rate earnings now in Texas, what are they, about $14 million monthly thing. Is that based off -- is that kind of where we stand right now or is it the average in the second quarter? Just given the continuity of care provisions kind of ended at the start of June, just kind of wondering what the $14 million starting point is there.

Well, first off, let me clarify the continuity of care provisions. There is a mixture of continuity of care provisions. The continuity of care provisions for acute services is 90 days, but the majority of our problem is not with acute care services, it is with the long-term care services. The continuity of care provision for long-term care services is six months. So, we have to honor the state's prior authorized services for six months or until we can get in and reassess the patients ourselves. And we are undertaking that, but it is a difficult task, because it takes a nurse going into the home and filling out a complex form. We can probably get one to two of those done per nurse per day, so that is not a quick turnaround. And while we are prior authorizing things like inpatient stays, that's not where the real cost problem lies.

So, Ken, getting back to your question about the $14 million loss was pretty much the same each of the three months of the quarter.

Okay. And how does that connect to the $10 million premium deficiency, I guess, for July and August? It would just seem that they are just doubling the $14 million, just if you can kind of connect that to only the $10 million premium deficiency, and that's (inaudible).

Sure. I'll let Joe talk about the (inaudible) ,but some of the initiatives that we have undertaken, we expect to gain traction in July and August. Joe, you want to comment further?

Yes, I think that's the best way to look at it. First of all, when we talk about a $14 million loss as a base, that includes certain indirect costs that are not included in part of a premium deficiency reserve. You factor that in with the savings we think have already started kicking in in July, and that's how you work down to that number.

Okay, great. That's all I had. Thank you.

Our next question comes from the line of Josh Raskin with Barclays. Please go ahead.

Welcome back, Josh.

Thank you. Thinking about RFP pipeline and other big dual contracts, based on what's going on now and the amount of resources I assume you need in Texas and Wisconsin, etc., are you thinking about perhaps waiting on some of these RFPs, or even not negotiating contracts for things that you may already have won, etc.?

Well, Josh, this is Mario. I'm not sure that's really an option. The expansion in California involves the existing health plans, and since we are an existing contractor, we're going to have to meet that. We have already responded to the RFP in Ohio. The good news there is that the regions where we came in first are the same regions where we currently have our operations. So, we feel pretty comfortable about that since it doesn't involve new service areas. Remember that we went into a new service area in Hidalgo, where we had no experience.

And, Josh, let me add one other very important point, and that is with Texas and to a lesser extent Wisconsin, our troubles are primarily rate related. And when we look at the duals in California, for example, the governor in his budget proposal put out the expectation that dual savings would amount to 3%, I think after the third year. CMS also has put out some expectations where they believe the savings will be 1% or 2%. In Hidalgo, the State expected Star Plus would be 20% day one, and that's comprised of various components, but they expected a 30% decrease in the long-term care services from day one.

We had an 11% decrease in the Wisconsin plan effective last year. So, we don't think that the pricing problems that we run into in Texas and Wisconsin are going to be carried over to some of the duals.

I guess, John, but you call it a rate issue, but maybe it's a data issue, right? I mean, Texas seems to be bad data. There is no way you'd be off by that much in terms of just a savings. It seems like they just have their data wrong. So, California doesn't have the greatest track record around rates. My understanding is you're still working on that rate decrease. I don't think you've gotten final rates that will have to come back retroactively once you report Q3, etc. So, it just seems like there is higher risks. I'm just wondering how you guys are thinking about is it, I guess maybe in some of these states it's not feasible to slow it down, but are you going to slow down sort of future RFPs beyond that?

I think that's a great question, Josh, and here, I think, is one of the differences. In California, we are operating in the existing markets. We do have data on the Medicare side, so we do have better, I think, utilization data. When we look at Texas, specifically in Hidalgo, the State gave us no utilization data despite our asking for it. They simply gave us a PMPM.

So, we made our estimates based on what was happening in the rest of the state in the markets that we had already been serving. And what we saw was the utilization, the number of beneficiaries utilizing long-term care services in our other markets ranged from 11% on the low end to 20% on the high end.

So, when we looked at it and said are the rates adequate, we thought they would be, assuming that the same percentage of people in Hidalgo were using it in other areas, which led us to believe that it was really an over-utilization of services. What we found once we got in there was that 60% of the people in Hidalgo are utilizing long-term care services. It's a much different issue that we have to tackle, because we have to go out now on every one of those people and do a home visit.

So, you are absolutely right, that data, our ability to see data, our ability to analyze the data will be critical, and in each of our discussions with the states, that's what we've been talking to them about. We have experienced it in California. Ohio, we're fortunate that they have probably the best rate-setting experience of any state we're in. They are totally transparent.

And then in Michigan, which is another dual state that we're looking at, we currently have experience because the State enrolled the duals into Medicaid health plans for their Medicaid non-long-term care benefits. So, again, we're getting actual experience, which I think will help us.

All right. I think that all makes sense. And then just lastly, one of your peers, when they reduced their guidance, there were some relatively large offsets in the G&A that they were able to save, some of those incentive comps, etc. I'm just curious, are you guys seeing any of those business operating costs or SG&A cost reductions that could be helping out a little bit in the short term?

We are certainly looking at things like variable comp and reducing it in order to help meet our targets.

But no sizing of that or --

No. We generally don't size out variable comp.

All right, that's perfect. Thank you.

Our next question comes from the line of Chris Rigg with Susquehanna. Please go ahead.

Thanks, guys. Can you just flesh out the long-term care, continuity of care period and what you guys can change versus you can't change? So, if someone under the fee-for-service system was sort of prescribed to a nursing home, now that they're in the facility during the entire six months, what can you do and what can't you do?

Well, first of all -- this is Mario -- the patients that we are covering under long-term care are not institutionalized. So, these are patients receiving community-based long-term care services, and we must ensure continuation of prior authorized services for up to six months after the operational start date or until we have conducted a new assessment and new authorizations are issued.

So, as John points out, a lot of this is going into the home and doing a reassessment, but for the problem service, which is long-term care services, the period is six months, not 90 days. We are prior authorizing all the services that we have the ability to prior authorize, and we have been doing that since day one.

For example, in patient acute stays. That is something that we have been able to deal with, but the real problem are these in-home health services and there is a six-month continuity of care provision in the contract.

But they can't be at this point, even though you're not six months into it, there cannot be any new services, in-home services prescribed without you guys pre-approving them, is that correct?

That's correct. And the problem is not the new services; the problem is the services that we inherited from the State. As John pointed out, about 18% of the beneficiaries in the Star Plus program in other regions of the state are receiving these services. It's close to 60% in the Hidalgo service area, so it's more than three times the utilization rate that is in other parts of the state.

Okay. And have you guys looked into -- I know Centene talked about that, but see any unusual activity in terms of sort of, I guess I would call it prescribing of services right before -- and I know you guys weren't officially the managed care company, but is there any evidence of sort of aggressive provider behavior at this point?

Well, I would say yes and no. Are we aware of any aggressive provider behavior? No. Do we believe that the Hidalgo service area is an outlier as compared to the rest of the state? And the answer would be clearly yes.

Okay. And then to switch gears onto California, can you just remind us the rate cycle there? And I know the timing is somewhat difficult to sort of figure out in terms of the rate, so what do you have in hand now in terms of rate changes for the state, and what should we expect coming down the pike in the next three to six months?

Okay. We have essentially two contract types in California. One is the two plan model, which would be Riverside, San Bernardino counties, and Los Angeles County. And then the GMC program, which is San Diego and also Sacramento County. In the GMC contract cycle, the rates begin in January 1; in the two plan model counties, the rates go into effect October 1. We have not received any written communication on rates from the states so far, so we really don't have anything. And the fellow that is responsible for rates for the State of California is on vacation until August 1, so we don't expect to get anything before then.

Okay, and then just real quick and I'll step back, but what's the membership rate now between the two cycles, or better, the revenue breakdown between the two cycles in California?

Well, the revenue breakdown, I think what you're saying is the PMPM premium rates, they're similar in both programs, they're just slightly different in terms of how the State does the contracts and when they deliver the rates to us. Is that what you mean? So, about 70% of our members are in two plan.

Okay. All right. Thanks a lot.

Our next question comes from the line of Sarah James with Wedbush. Please go ahead.

Thank you. I understand how cumbersome some of the in-home visits to reevaluate can be, but is there any flexibility available in temporarily staffing up nurses? I think earlier you mentioned each nurse can do two per day, so is there anything that you could be working on from that front to sort of get through that bottleneck?

Sarah, it's Terry Bayer. First of all, recognize that there is a certification, a RUG certification that is required for the nurses, so it isn't just any nurse. On some of the assessments that have to do with determining which program a patient should be participating in, so it's not as simple as just adding bodies. We are sending out some of the services. We are pulling resources from other parts of the state, and we're doing what we can to get these folks reassessed as quickly as we can.

The reassessments, I think back to the earlier comment, these are about determining whether the services are appropriate. And it's really about matching the hours that are assigned with that patient's needs, and secondarily being certain that they are in the proper program. And by being in the right program there are funding differences. So, the assessments become very important.

This is John, let me follow-up on that. That's another rate-related issue that we really didn't highlight because the fix is longer term. But when Terry talks about getting people into the right program, the State assumed a certain split of membership into what they call the waiver versus non-waiver programs. We did not get that same level of enrollment. So, when they created the rates, they assumed X percent of our patients would be waiver and Y percent will be non-waiver. That pricing difference to us really cost us, costing soft, really resulted in $2 million of less revenue than what the State expected us to get. So, that also added onto our problems in Q2.

Got it. That makes sense. And then the Wisconsin, I just wanted to understand what was going on with rates there specifically, because last quarter it was highlighted as one of the legacy states that is doing well. I think in the first quarter of '11 you took a premium deficiency reserve in that state. Was the difference now just that premium deficiency reserve rolling off and that's why you had to take another one, and is this something that is inherent to the negotiations with this state, that it could be a pattern that recurs?

We're hoping that it's not going to be a pattern that recurs, because I think the State has seen how their rate-setting has affected the plans. In fact, one of our competitors is exiting a couple of regions with a significant population because they couldn't get the rates that they wanted, and the State is struggling to find other folks that will sign up, other plans that would sign up. So, we have had a lot of discussions with the State. It's a small state, and because of that there is a lot of volatility in the medical costs. And so it was at this time that we looked out at what we expected the future to be for this rate year and decided to take the premium deficiency reserve.

And then last question is, I was looking over budget proposals for Louisiana, and one of the proposed items was a $1 million cut for the MMIS contract there. And I'm just wondering from an operational perspective, I know that when there is cuts within managed care there can be some offsets with the fee schedule where it's passed through. Is that same opportunity, are there pass-throughs that are available with that type of contract to maintain margin, and do you know if that has been finalized?

Sarah, it's Terry. The only comment I have is that sometimes changes to an MMIS vendor are tied to service changes. So, the State takes back things and then the MMIS vendor isn't required to do it anymore. So, there are adjustments that are occurring, but it is generally by either claims processing or authorization programs, or other things that the vendor does on behalf of the State, and I do know Louisiana is under an effort to really contain its costs and is looking to take back some smaller functionality. But then we would reduce our cost as a vendor. We wouldn't have the same obligations. As far as the pass-through aspect of that, I don't have any information.

Okay, thank you.

Our next question comes from the line of Scott Green with Bank of America. Please go ahead.

Hi. Thanks. Appreciate you taking my questions. Could you give us an update on how the Dallas Star Plus market is faring, maybe what the MLR there was in the quarter and what progress you might be managing on long-term care services in that county?

Hi, Scott, this is Mario. We don't break out reporting at that level. Suffice it to say, the primary problem that we have in Texas is with the Star Plus members in the Hidalgo and the El Paso service area.

Okay, so suggesting that Dallas might be improving from where it had been running in the last few quarters, then? Because that would -- I'm just trying to think about to the extent you are showing progress there on those same services that could give people optimism that you can achieve those same medical management efficiencies elsewhere in the state.

Well, clearly we had problems when we first got into the Dallas Star Plus market. I think things there had stabilized. But one of the big differences is, 18% of the Star Plus patients in the Dallas service area are receiving personal attendant services. 58% of the patients in the Hidalgo service area are receiving the same services. So, it's really an apples-and-oranges comparison. The utilization is markedly different.

Okay. The provider contract changes in Texas that you outlined in the press release, is that -- have you already announced those or implemented those? I guess what's the status? Can we count on them as kind of signed, sealed and delivered, if you could explain that?

This is Mario again. It's on a rolling basis. There was one large hospital recontracting effort that was completed in June. There is another one that is underway, but we have terminated that hospital system and that will take about two more months before we see the results of that. There were a number of other contract changes that went into effect July 15. So, they are being phased in over time, but many of them are already in place.

Okay, all right. And then maybe could you speak to the management team in Michigan? I think you might have moved some of that personnel into Texas. I don't know if that may or may not have been related to the step-up in MLR sequentially in Michigan, but just how you feel about that market going forward?

Sure, this is Terry. Just to clarify for everyone, I think we announced Craig Bass, who was the president of our Michigan Health Plan, was one of our strongest president, showed interest in going back to Texas, where we had actually recruited him from. And he was able to step up and become our new plan president in Texas. Our changes in Michigan were driven by asking Craig and his agreeing to take the lead where he's been able to move forward with all of the plans in place. Now, again, we were fortunate, we were able to move our health plan president from Wisconsin over to Michigan. This is an individual, Stephen Harris, who has been with us for a number of years, a native of Michigan, and we're just -- that plan is continuing. It was a very smooth transition, and we'll be announcing a replacement for Wisconsin shortly.

Also, I think, John, do you want to comment on the changes in Michigan related to the premium tax?

I'll let Joe.

Hi, Scott. Yes, essentially Michigan changed its premium tax regimen effective April 1, 2012, where essentially they eliminated the premium tax and reduced premium rates essentially dollar-for-dollar. So, what you are going to see is that impact was about 5%. So, all other things being equal, you would see about a 5% increase in MCR in Michigan between Q1 of this year and Q2.

But on a PMPM basis, the medical costs are basically flat in Michigan.

That would wash out by the time you got into admin and removed the premium tax.

Okay, okay, got it. And, lastly, could you talk about the SG&A ratio. So, your original guidance was 7.8 for the year and it's about 8.75 to date. How much of that do you think might be potentially nonrecurring in nature as we head into next year, maybe if it's initial medical management efforts that once in place you won't need to allocate the same resources, or litigation matters in Ohio or Missouri?

Hi, Scott, this is Mario. One of the things that we're learning about with the ABDs and the duals is that while they're also high utilizers of medical services, they also drive up the admin costs a little bit. For example, we know that they use telephone advice lines about five times more than the TANF members, and that the calls are markedly longer. So, we have more people spending more time on the phone with those members. Also, they generate a lot more claims, and so it's creating additional work in the claims system. So, there is some ramp-up with the ABDs and the duals that will come on the admin side as well.

Actually, I just thought of one more just real quick, if that's okay. I just wanted to make sure that are any of your cash flows or receivables, would any of that be potentially at risk in San Bernardino with its bankruptcy filing?

No. We deal with the state, and that's the city of San Bernardino that is filing for bankruptcy.

Okay, all right. Thank you very much.

Our next question comes from the line of Peter Costa with Wells Fargo Securities. Please go ahead.

I just want to get back to the $14 million operating loss in Texas and what you're doing to improve that. I want to make sure I understand it completely. You also had a $14 million of unfavorable PPD and $10 million premium deficiency charge in the quarter. Just to be clear, that $24 million of extra cost, that's not included in the $14 million operating; is that correct?

That is correct.

Okay. And in terms of the operating loss, in terms of getting that back to break-even, you have the management services fees included in that. Are there profits to Molina inside that management services contract so that the goal was only to get it back to break-even in Texas, or do you want to see Texas get to profitability eventually?

This is Joe speaking. Of course we intend to get Texas to profitability, but to your first question, there is no profit margin built into our management service fees. They are priced at cost.

Okay. So, if we just look at the steps that you've outlined to get yourselves back to sort of break-even in Texas, it sort of takes us to December of this year. Can you explain what's going to happen when we get past December into 2013, what additional steps are there, and is it hurdles for you, just from the provider contract changes and the other initiatives that you talk about here, getting back to break-even? Is it a big step? Is it little steps that you're doing? And is there more you can do in 2013? And how complicated is it to make Texas become a profitable market sometime in 2013?

Well, I think the first step is let's get it to break-even, and we've laid out that plan. The second thing that we know is utilization changes tend to take longer than changing contracts. So, Mario talked about some of the utilization initiatives that we've undertaken on the acute care side. It's going to take us longer to get utilization down on the long-term care side.

In addition, I talked about the revenue adjustments based on getting more people from one program to another, assuming that they qualify, but the state data suggests that we have an imbalance there. And I think that the utilization changes that we're implementing will have a long-term positive effect and bring us above break-even, but to what extent we can bake those in by the end of the year, we don't know, which is why we've left guidance where we have.

So, you are sort of giving me a good read on sort of how complicated you think it is just to get it to break even. Is that -- are you moving mountains to get that done? Are you doing some simple blocking and tackling? Where is that relative to what you need to do down the road to get this thing back to something that is earning money for the Company?

Hey, Peter, this is Mario. First of all, I want to thank you and everybody else on the call for your patience. It's a very difficult task because, as John pointed out, the problems are not unit cost related as much as they are utilization. A lot of this is in the long-term care service area, where we have to go in and re-evaluate people on a member-by-member basis, and you're talking about tens of thousands of members that are eligible for these services.

There are other things that we will do, and we have sort of outlined some of the major things that we're doing to get us back to a break-even point. We do have the rate increase coming September 1. We are looking at other services as well, and I think that over the long term that is where the final difference will be made, things like inpatient hospital services, laboratory services, physical therapy. But the major thrust for us right now is to bring down the costs on the personal attendant services, and that means doing a lot of reassessments.

Now, as John also mentioned, we have been told by the State to expect to lose about 8,000 of the Star Plus members in August. I think Centene mentioned on their call they are picking up about 5,000. So, certainly some of the patients are being redistributed from Molina to the other health plans. That will lighten our load a little bit, but it's going to put a greater strain on other health plans who are going to have to go in and do the same kinds of one-on-one, in-home evaluations.

That's helpful. So, I'm looking at sort of, I guess the 3.2 million on the other initiatives. That's really sort of only partway there in terms of the one-on-one evaluations, and you've still got more of that to do in 2013.

Yes, I also think that one of the things that will help us when we eventually get the full funding for the duals is being able to manage the Medicare portion. We're not getting the Medicare premiums, and frankly we have done a pretty good job in the past of managing acute medical services both for Medicaid and Medicare. So, as we get more revenue on the acute side service, when we get the full revenue stream for the duals, I think that will help as well.

Okay. And lastly in Michigan --

Peter, I don't want to beat this too much, but recall, we do believe that the initiatives that we've got in place, plus the rate increase, will allow us to get to break-even by year-end. So, that's still a pretty short time frame to get back to break-even, and then some of the longer-term initiatives hopefully will start gaining traction, but they'll carry us through to 2013.

Okay. And then back to Michigan. Even without the premium tax, it looks like that deteriorated a little bit from the first quarter to the second quarter. Is there anything more to that, or what else is going on there?

Yes, it's Joe speaking. It was -- we normally don't delve into components ,but they certainly, the Medicare lives were a bit expensive in second quarter. We also had higher hospital utilization for the quarter. I don't think it was anything out of the -- it wasn't welcome, but I don't think it was anything representing a serious trend.

Okay. Thank you.

Our next question is from the line of Dave Windley with Jefferies. Please go ahead.

Hi. Thanks. I just wanted to clarify a little bit more on Texas. So, it seems like we have referred to Hidalgo a lot. I want to make sure I understand that basically your issues, the elevated long-term care services, the longer continuity of care provisions are applicable to both of these regions -- Hidalgo and El Paso; is that correct?

That's correct.

Okay. And then in terms of your losses in the state, it looks like, following the financials, $14,000 a month -- $14 million a month, excuse me, and then only a portion of that is matching that up against your premium and medical cost schedule. It looks like your losses in the quarter on an underwriting basis were about $10 million. Your losses overall would have been about $42 million, and the difference is indirect costs; is that correct?

Sorry, I'm not following that calculation.

So, if I look at your -- maybe I can take that one offline. I'll just take that one offline.

That might be a good idea.

What is your borrowing availability? Josh asked a question about capital, but what's your current borrowing availability?

We have a $170 million revolver. We've drawn $50 million of that as noted in the press release. The remainder would be free.

Okay, sorry I missed that. And then finally, on the Texas prior period development, it sounds like that mostly arose because you were using kind of theoretical numbers as opposed to actual claims data. I'm just wondering how confident you are that your reserves as they're stated at June 30 are adequate to not have prior period development unfavorable beyond this point?

Sure, that's a good observation. I think if you look back historically, when we have data available, we typically run positive prior period development. So, our expectation, now that we have four months' worth of data in the new service areas and the new benefits is that we are adequately reserved and we should start to see positive prior period development next quarter, as has been our history.

And the claims, just to clarify on this point, the claims on the long-term care services that are running high, are those fast cycle claims or slow?

They tend to be fast cycle --

(Inaudible) on those pretty quick?

Yes.

All right, thank you. Thanks.

Our next question comes from the line of Melissa McGinnis with Morgan Stanley. Please go ahead.

Hi. Thanks for the question. Maybe switching focus from Texas for a little bit. Can you talk a bit about your commentary on Washington? It sounded like things are going better than some of your very conservative guidance in that state that you put out at the beginning of the year. And I just wanted to better understand what's helping Molina defend market share there, or at the same time what's challenging some of your new competitors to gaining scale or like quickly?

Well, the enrollment has come in a little higher than anticipated. We initially projected some losses in enrollment. Beyond that, I wouldn't draw too many conclusions. In terms of competitive position, I think that we have been in that state for many years and have very strong networks and deep provider relationships. And that's what, I think, has been the most helpful to us.

Okay, great. And then can you just remind us, we went through quite a reprocurement cycle with Molina this year, and can you remind us, I think there is one more reprocurement coming out with New Mexico, but when exactly is that coming up? And then are there any others on the time horizon that we need to be watching?

This is Terry. For New Mexico, you know, it's always -- we're just relying on the latest information we have from the state is that it will be out in the fall, so we expect it quite soon. And on other information on any other reprocurements of our existing business.

Okay. And then a final one, just thinking about the duals and thinking about some of the challenges this year in Texas, in your initial conversations with the various states where you've already like bid on business or been in conversations about contracts that are going to be put in force next year, what are the views around continuity of care provisions there? Some people early on were thinking continuity of care would be even stricter with the dual-eligible population, and are you comfortable with what might be assumed in rates and then how much your hands are tied early on in those contracts?

I would just say this. I think part of the problem in Texas -- this is Mario again -- was a mismatch between the actuaries and the policy people. So, I think the actuaries made certain assumptions and the policy people made certain decisions, and they weren't in concert. I would be careful about extrapolating too much from Texas. I think that this is an important state, and I think that the other states are watching this and they're learning from this.

CMS has come out with some guidelines where they are expecting savings on the duals to be 1% to maybe 5% over the period of three years. The State of California has mentioned that they think that in their initiatives here in California, they're taking 3% to 6% over three years. So, I think people are being -- are watching what's happened in Texas and learning from it.

Great. Thanks.

Our next question comes from the line of Brian Wright. Please go ahead.

Thanks. How many nurses are currently involved in doing the in-home assessments at Hidalgo and El Paso?

Brian, there are lots and lots of nurses on the ground doing these things. This has been probably our single highest priority in Texas, and we began this shortly after the go-live date. We were initially surprised that we got more members than we had anticipated, but we didn't -- so, we saw this coming, we just didn't see it coming to the magnitude that we did. And as Terry points out, you have to have trained nurses. It's not just any nurse.

I'm just trying to get a better kind of gauge on how many people you could see over the next couple months to incrementally improve things between now and the end of the year.

I'm not going to estimate how many evaluations we're going to be doing on a daily or weekly basis. Suffice it to say, we recognize the problem. We're putting as many resources on this as we can, and it's just going to take some time.

Okay. And then I know you're not giving guidance, but just to help us, because we have to model something, given the one time miss kinds of things, whether it be unfavorable prior development or premium deficiency reserves, I mean, that looks like about $35 million, roughly, in the quarter. Should we be thinking about a positive EBITDA in the next quarter?

Brian, I know you guys can't model and we withdrew that kind of guidance, so we can't give it to you. I think we've given you the inputs on what we think is going to be one time, and where our plan is to get back largely in Texas to profitability. But beyond that we really can't comment.

Okay. Not even directionally?

We think things are going to get better.

When do we get to talk about Kentucky?

(Inaudible) All right. Thank you.

(Operator Instructions) Our next question comes from the line of Carl McDonald with Citigroup. Please go ahead.

Thank you. What's the latest thinking on the investment spending that you're planning on in California ahead of the dual eligible rollout? And then just in the magnitude, if you've got a sense of the timing and anything that is sort of included in -- I know you're not giving guidance, but included in the current forecast versus would be additive to that?

You know, Carl, a lot of that is baked in, that's why admin costs are running higher right now, because we're preparing for the duals that are going to come, we think, second quarter of 2013. In California it's not an RBC state, it's a little bit different, so we do have to make sure that we're going to have adequate reserves. But the formula is a little bit different than it is in other states. Suffice to say, Terry, Lisa Rubino, who is the regional vice president, and Richard Chambers, who is our current California president, are working very diligently to prepare us for that.

And anything new on the California dual process that you think is worth highlighting. For example, any update on rate development and/or how the subcontracting with Health Net will work in terms of the (inaudible) --

We don't have a lot of new information yet Carl, and the reason I say that is that right now the state is still negotiating with CMS over the parameters of the plan. So, until they finish their negotiations, we're not going to get to the details of how the plan will roll out or what the rates are going to be.

I do want to just jump in here and remind everybody that in addition to LA and San Diego, in this latest budget the State of California has included San Bernardino and Riverside. So, we are in the three most populous counties, or four of the eight most populous counties that will participate.

And then a separate question on California. WellPoint mentioned on their call that they come to verbal agreement with the State on some new rates. I heard the bit about you guys haven't heard what your updated rates will look like, but be interested how you've been booking your rates. WellPoint also mentioned that the higher rates they'd be getting would be retroactive and that they had been booking to a lower reimbursement that would give them some additional upside. To the extent that your rates are higher and retroactive, would you also expect to see some upside relative to what you've been accruing?

So, Carl, this is John. Let me go back. Recall last year, the State put in some rate decreases. The providers protested, some of the advocates protested, and that has gone up to the Supreme Court and then back down. We booked our revenue as though the provider rate decreases were intact, so we have a liability. If the State came back and said that they were not going to take -- they were not going to change the provider rates, then theoretically our rates on a retroactive basis would go up and we would be able to book that. We have not heard that that is within their plan right now. Maybe what WellPoint is talking about is a good sign for us.

Okay, thank you.

There are no further questions at this time. I'll now turn the call back over to you, Dr. Molina.

Well, thank you for joining us today, and thank you for your patience in getting through all of those calls. I want to remind you that we have our investor day coming up in September, and invite you to attend that. We'll have more color on Texas, I'm sure, at that point. And while this has been a difficult quarter, we're not happy with the results, I think in the long run we're well positioned. We're gaining a lot of experience with the ABDs and the duals. We're in markets where we're going to see a lot of growth even without any kind of Medicaid expansion in the Affordable Care Act. So, we have an optimistic outlook on the future. So, we'll see you at investor day.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Have a good day, everyone.