Molina Healthcare, Inc. (MOH) Q1 2009 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Molina Healthcare’s first quarter conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. (Operator instructions) I would now like to turn the conference over to Juan Jose Orellana, Vice President of Investor Relations. Juan José Orellana: Hello, everyone, and thank you for joining us. The purpose of this call is to discuss Molina Healthcare's financial results for the first quarter ended March 31, 2009. 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. 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. James Howatt, our Chief Medical Officer; and Joseph White, our Chief Accounting Officer. After the completion of our prepared remarks, we will open the call and 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 April 29, 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.molinahealthcare.com. I would also like to take a minute to point out a few changes to our investor relations activities for the remainder of 2009. Although healthcare conferences represent a great opportunity to interact with the investment community, our time with investors during such conferences is limited, and the scope of topics that we can cover about our company is narrow. Given these dynamics, we will be cutting back on the number of conferences that Molina will attend for the remainder of the year. However, this does not mean that the company will be limiting its interaction or communications with the investment community. We remain committed to transparency and to access to management and as an alternative, we will be supplementing our attendance at such conferences by implementing a second investor day this year. We believe this will provide an enhanced opportunity to get to know our company better. The date for our second investor day has been set for May 28, 2009, in New York City. More details will be shared with you in the upcoming days. We look forward to seeing you there. I would now like to turn the call over to Dr. Mario Molina.

Hello everyone, and thank you for joining us today. We are pleased to report another quarter of solid financial results. Highlights from the first quarter include diluted EPS of $0.46 versus $0.44 a year ago, membership that grew by 10% when compared to the first quarter of 2008, and also premium revenues that increased by 18% year over year. Our first quarter results exceeded consensus expectations and are clearly a positive towards our financial objectives for the full year. John will review the details of our financial performance in a few minutes, but needless to day, this was a good quarter under any circumstances, but especially when you consider the environment we’re dealing with today. Rising unemployment is expected to increase the number of people eligible for Medicaid. While this growth in the number of Medicaid beneficiaries represents a tailwind for our business, it must be weighed within the context of state budgetary constraints, rising medical costs, and lower interest rates, all of which can have the short-term effect of shrinking margins. However, I believe that one of the keys to delivering the type of results we published today even in a challenging economic environment is the focus of our team. Throughout the first quarter, our team has maintained its focus on building on the momentum from 2008, while the positioning the company for success in 2009 and beyond. We remain committed to be prudent stewards of public funds, a hallmark of our company, to managing our medical costs and to improving our capital allocation. All of these efforts relate back to our basic strategy, and we’re very pleased with the outcomes. Our management efforts have resulted in a strong core business. Except for California, most of our health plans performed well in the first quarter of 2009. We’re encouraged by the progress of our Ohio health plan, and we’re confident that the efforts that led to the improvement in Ohio can be replicated in California. You may recall that inadequate premium rates, rising unit costs, and high utilization due to pent-up demand in Ohio resulted in a drag to our earnings throughout 2008, but starting last year, around the third quarter, our contracting efforts produced new contracts with significant savings. Furthermore, through extended conversations with the state, we’ve been able to document the need for rate increases. Our approach was successful, and our Ohio health plan received a 5% rate increase effective January 1, 2009. As a result of getting improved rates from the state, our contracting efforts, and by managing utilization, the medical care ratio in Ohio declined by 600 basis points from a year ago. Our founder, Dr. David Molina, said this is a business of nickels. By this, he meant that we must pay attention to detail. We strive to provide quality healthcare at a low cost. Our Ohio plan has done just that—lowering costs while upholding high standards of care. In seeking to meet the demands of an evolving marketplace while improving the cost effectiveness and care in Ohio, I’m pleased to report that we have always kept our focus on quality healthcare. Molina embraces the philosophy that quality healthcare and cost effectiveness need not be mutually exclusive, and we’re especially proud that our focus on quality in Ohio has attracted national attention. During the first quarter of 2009, Molina Healthcare of Ohio met the rigorous accreditation standards established by the National Committee for Quality Assurance, and earned a 3-year new health plan accreditation from NCQA. I want to thank everyone at the Ohio Health Plan for their hard work and dedication leading to this achievement. In California, low premium rate increases, higher unit costs, and pent-up demand among new members resulted in medical cost trends that exceeded premium growth. The challenges in California are neither new, nor entirely unanticipated. Some California providers have responded to the current economic conditions in the state by increasing their bill charges, or in the case of a handful of providers that are essential to our network demanding steep rates in order to participate in our network. We are working diligently to address these challenges. I want to highlight the good results that we’re seeing across some of our other state health plans. Michigan, Missouri, Texas, Washington, and Utah have been performing well. Medical margin, which is the difference between premium revenue and medical costs and also represents a measure of the efficiency of healthcare delivery increased by 16% over the first quarter of last year. We’re pleased to see that our diversification strategy is working. As we shared with you during our investor day, we believe that during these difficult times, Medicaid managed care is a proven and compelling solution to covering the uninsured and alleviating states’ rising Medicaid budgets. Serving the healthcare needs of vulnerable populations is not for every company. It requires a real understanding of this population and a depth of expertise to make a difference in patients’ lives. It is in our experience, cultural orientation and nearly 30 years of experience in Medicaid managed care that allow us to flourish in this challenging environment. We remain optimistic about the long-term growth potential of our business, and I look forward to seeing you at our investor day next month. I would now like to turn the call over to John now.

As Mario noted, we’re pleased with our first quarter results. Net income of $12.2 million was only slightly less than last year’s $12.5 million. Earnings per share actually increased to $0.46 per share from $0.44 per share. We owe this success to increased enrollment, careful capital management, and tight administrative cost control. It is worth nothing that if investment income had not fallen by about $4 million between Q1 of 2008 and Q1 of 2009, EPS would have been another $0.09 higher this quarter. This means the results from our underlying operations are stronger this year than they were a year ago. Enrollment grew by 2.4% between December and March even without the benefit of our Florida market entry. This enrollment growth which was consistent with our announced guidance for 2009 enabled us to overcome a slight increase in our medical care ratio compared to 2008. Even with the slight increase in our medical care ratio, we were able to grow our medical margin by 16% year over year. We took advantage of equity market conditions to continue the repurchase of both our common shares and our senior convertible debt. This focus on capital allocation allowed us to increase earnings per share in the first quarter despite the $3.9 million decrease in investment income I mentioned a minute ago. Finally, tight control of administrative costs again consistent with our announced guidance for 2009 allowed us to leverage our enrollment growth and reduce our core general and administrative expenses to 7.6% of total revenue. Nearly all of our health plans—Michigan, Missouri, Ohio, Texas, Utah, and Washington—performed well. The improvement at our Ohio health plan is particularly satisfying. That improvement represents the culmination of three years of efforts to bring both effective and cost-efficient health care to members there. We’re especially pleased to have demonstrated both economic efficiency and care quality during the same quarter. The first quarter financial results we’re discussing for Ohio today are more meaningful because we achieved accreditation from the National Committee for Quality Assurance. While we face challenges in California, we continue to believe our presence there will prove to be a strategic advantage over the long run. California has the largest Medicaid population of any state in the nation and is second in the nation in annual Medicaid expenditures. We will maintain the same focus on quality and efficiency in California as we have in Ohio and our other markets. We believe that over time changes in provider contracting, utilization management, administrative efficiency, collaboration with state agencies, and a constant focus on quality will lead to success in California, just as they have done in Ohio. Cash flow provided by operating activities for the quarter ended March 21, 2009, was $67 million, compared with cash used by operating activities totaling $23 million for the same period in 2008—an improvement of $90 million. The increase was due primarily to two factors. First, we had a $91 million favorable change in deferred revenue in Ohio. Secondly, medical claims and benefits payable increased by approximately $19 million. These increases were offset increased receivables of approximately $24 million, primarily in California and Utah. At March 31, 2009, the company had cash and investments of approximately $707 million. At March 31, 2009, our parent company had cash and investments of approximately $70 million. Cash and investments at the parent company were up slightly from December 31, 2008, despite the repurchase of nearly $25 million in common stock and senior convertible notes during the quarter. Given our strong cash position, our board has authorized management to buy additional shares and convertible bonds back. Days in claims payable increased sequentially to 42 days at March 31, 2009, up from 41 days at December 31, 2008. We are confirming our guidance issued on January 22, 2009, of earnings per diluted share between $2.20 and $2.40 for the full year of 2009. Finally, I want to take a moment to remind everyone of the changes in our investor relations activities that Juan José discussed at the beginning of the call. We look forward to seeing at your investor day in New York next month. I will now turn the call over Dr. Jim Howatt who’ll be making some remarks related to the recent flu outbreak.

Molina Healthcare is closely following the developing situation around a possible flu pandemic and actively taking steps so that we are fully prepared for whatever may develop. As you’re likely aware, there has been international spread of a new and unique flu strain that appears to have first emerged in Mexico. With over 150 deaths reported thus far, the strain clearly has lethal potential. We’re preparing in two ways—one way with regards to our members and one way in regards to our personnel. First, we’re working closely with public health agencies in the spirit of cooperation and collaboration that will lead to the most effective intervention. All our state plans are reviewing their programs to ensure access to care and pharmaceuticals as appropriate should this outbreak progress. In addition, we’re working to ensure business continuity in an environment where a significant portion of our workforce may fall ill, be absent for their positions, caring for ill family members, or asked to stay home as part of a strategy of social distancing. The work we’ve done previously in the face of the threat from avian flu we believe will greatly assist us in our current preparations. The overall likely impact on our health costs from this virus is currently uncertain. There are two antiviral medications, Tamiflu and Relenza which appear to be effective against the virus. Vaccines are also being developed. Cost to treat and eventually vaccinate against the flu will likely be substantial and will probably be borne in part by government programs. Molina Healthcare is prepared to be an active participant and partner to the overall healthcare systems of the states in which we manage care for our members. All of us should keep in mind the important behaviors that will help minimize the spread of the virus—wash hands frequently, avoid touching eyes, mouth, and nose, stay home when you or family members are ill, avoid contact with ill people, cover coughs and sneezes, and practice good health habits including adequate rest and nutrition. This concludes our prepared remarks. Operator, we are now ready to take questions.

(Operator instructions) Our first question comes from the line of Tom Carroll – Stifel Nicolaus. Tom Carroll – Stifel Nicolaus: I wondered if you could give us a little more commentary on the ABD program in Ohio that saw the sizeable sequential drop in the medical loss ratio. A competitor of yours in the same market had a similar drop, and I’m wondering if there was a sizeable possible development in the quarter or something else that you could maybe tell us a little bit more about.

No, Tom. It wasn’t a sizeable development. I think the ABD is where we had probably the biggest swings in terms of some of the contracting efforts. Also, as you recall, last year we brought the behavior health in house, and the majority of those costs were for the ABD population.

Tom, I’ll just add that our ABD enrollment grew toward the latter part of last year. We had members new for the first time, and as we implemented our program, some of those costs came out, but our contract renegotiation and our medical management efforts were really across both product lines. Tom Carroll – Stifel Nicolaus: Secondly, could you maybe give us some comment on your reserving practices, which will probably be a similar conversation like we had in the past, but it’s just been a topic of discussion recently with Molina.

Reserving methods haven’t changed, Tom.

Your next question comes from the line of Joshua Raskin – Barclays Capital. Joshua Raskin – Barclays Capital: With Florida, how are you accruing medical expenses now that you’re live on risk basis there?

Like we’ve talked about before, we’re just accruing those at 90% of premium until the claims have had time to develop. Joshua Raskin – Barclays Capital: I noticed there was a slight deviation from that. That was the only reason I asked. Is there something in the math that makes that…

Yes. It’s just the way the math worked out frankly. No real change in facts as we know them. Joshua Raskin – Barclays Capital: The $0.04 gain in the quarter, is that now included in the guidance and should we think about there being some 4-cent offset adverse with California or something, or should we just think about, look, we’ve got a 20-cent range, it’s 4 cents. Maybe we’ll be towards the higher end now or something like that?

You hit the nail on the head Josh. That’s exactly why we give a pretty broad range. Joshua Raskin – Barclays Capital: So, not necessarily will be towards the high end, but rather that’s why we give a big range?

That’s correct. The latter part, and that’s why we give a high range. We’re not going to adjust guidance or pull anything out or put in anything back right now. Joshua Raskin – Barclays Capital: On California, obviously it’s a challenge there, and I guess I’m just curious in light of the heightened MLR, the prospect that isn’t particularly great from a budget perspective there, is the plan profitable, and then in terms of remediation, you guys are really patient I think in Ohio, and that’s clearly shown benefits this year, but is this sort of a 3-year plan to get it to adequate margins? Is that a reasonable timeframe, or can things be done quicker there? I know obviously you have a lot more infrastructure there.

Well, we’re certainly hoping that things will turn around in California more quickly than 3 years. We have benefited from the experience in Ohio, and we’re taking a similar approach in California, and it’s really a combination of things. We need to work with the state on the premium rates. We need to be more selective in our contracting, and we need to continue working on utilization of services, and it’s pretty straight forward. Part of this came about because we have not gotten, I don’t think, the rate increases that we really needed given the rising medical costs in California, so that has had an effect on the margins. Joshua Raskin – Barclays Capital: Maybe I’ll ask you in a different way, Mario. How patient are you going to be with the state?

Well, as we pointed out, California is the largest Medicaid market in the country in terms of numbers. It’s the second largest in terms of dollars, and so we think that this is a very important market for us to be in.

Your next question comes from the line of John Rex – J.P. Morgan. John Rex – J.P. Morgan: On the Washington, I know you had a couple of rate cuts there in the 1Q, but MCR held in very steady. Anything going on there? In particular, shouldn’t we expect that to be trending up here in light of the rate cuts at some point?

John, I think part of the rate cut was based on some provider cuts that flowed through, so I wouldn’t expect it to trend up too much.

I would just add remember that that rate cut came in two steps—1% on January 1, another roughly 2.5% which was as John mentioned partly offset by provider cuts on February 1, so these financials don’t show the full impact of the cuts yet. John Rex – J.P. Morgan: Are you suggesting also that the flow through was aligned in terms of the rate decrease actuarially reflected, so that there was complete pass through to providers?

John, it’s not going to be complete pass-through, but we’re trying to take other efforts to mitigate looking at utilization, looking at provider contracts to see where we can maximize the provider contracts and have most favorable rates to us.

Also John, let me just add that two other things that we’re working on in terms of medical management this year that Jim has been talking a lot about is our effort to decrease readmissions on the DRGs and our continuing work on lowering emergency room utilization. John Rex – J.P. Morgan: On the Florida startup, just maybe some commentary on how that’s going. At the investor day I think you said you were 23,000 a couple of months ago, and I think you ended the quarter at 17 or something like that, and I guess we had been looking for it to maybe actually grow. Just a little commentary on that maybe.

Let’s talk about it in two parts—the first is that you’ll see that we have experienced a drop in that initial enrollment. Most of that is attributed to members switching back to the fee for service provider side which is still in place, because the managed care is not mandatory at this time, but secondly, we’re still rolling in the other counties, so we expect to still achieve the year-end target that we projected as these counties roll in, but initially we did see a drop by those transferring back into the fee for service program. John Rex – J.P. Morgan: So what would’ve been your gross add in the quarter to think about what kind of retention you’re having as you bring them in?

It’s difficult to say because it’s really too soon for us to know what the overall attrition rate is going to be. John Rex – J.P. Morgan: I was wondering maybe if we started at 23 in January and would have been 35, so like essentially opted out of the system or so roughly.

It depends a lot on how the rollover goes, and we’re still in that process, so until we get to a more stable point where all the members have been transferred over as we go into more counties, it’s really too soon to say.

And I’ll give you one other variable. These are different geographic areas that are rolling in, so the initial area was Dade County, but as we move on to the other counties, that could have a completely different percentage in relation to the providers in the network, the attitude of the members, etc., so it’s really difficult to predict.

Your next question comes from the line of Justin Bowers – Deutsche Bank. Justin Bowers – Deutsche Bank: I was just curious if you could give us a sense of how your enrollment has progressed since quarter end just given that the economy does seem to be weakening a little bit and if you’re seeing a noticeable pick-up in any states.

All I would say at this point is that the enrollment growth is consistent with the guidance we provided, and we remain on track. Justin Bowers – Deutsche Bank: Relative to Florida, do you have a target for you enrollment there for year end?

The target is 50,000. Justin Bowers – Deutsche Bank: DCPs and claims inventory were up sequentially. Should we think about 42 or 40 as a floor? Have you pretty much bottomed out there?

I think it’s probably fair to say that the DCP is going to hand around where it’s at right now. We closed the quarter at 42. It’s not going to get up much or very far below that number, barring something unforeseen.

Your next question comes from the line of Carl Mcdonald – Oppenheimer. Carl Mcdonald – Oppenheimer: Just wanted to check to see if you had an updated view in terms of the impact of new membership. It may still be a little bit early in terms of actually seeing those members joining the plan, but there was the question in some prior quarters in terms of where there’d be an increased amount of utilization initially.

I think it’s probably too early to tell. Traditionally, new members tend to have higher utilization, higher costs, and then they go down after about 2 quarters, the compacting factor of it being the first quarter where seasonality suggests that utilization was higher than normal anyways, so it’s a bit early to tell.

Your next question comes from the line of Darren Miller – Goldman Sachs. Darren Miller – Goldman Sachs: I have a question on the Ohio MCR. Given the seasonality we typically see in the first quarter, do you think we can actually see some improvement in the MCR going into the second and third quarter?

We hate to peg the MCRs, Darren. It’s going to be a functioning of maintaining good utilization management and then ensuring that we direct the patients to the most cost effective providers.

The other that makes it difficult is that we haven’t really had a stable population. I mean over the past year we had a lot of new patients being rolled in, so we’re finally I think reaching a stable equilibrium where we can begin to see what the seasonal trends look like in Ohio. Daryn Miller – Goldman Sachs: Question on SG&A leverage. How much more improvement do you guys think you can see there?

If you go back to our first investor day, we had discussed having about a 10% “organic growth” and bringing our admin down to about 7.5%, and for this quarter, we’re 7.6%, so we’re right on around where we want to be. Daryn Miller – Goldman Sachs: Expectations in terms of picking up any SCHIP enrollment, what states do you think you have the best opportunity to get some of that enrollment and have you gotten anything so far?

Well, California is the state that has the biggest SCHIP population for us. In some states such as New Mexico and Ohio, the SCHIP is sort of buried within the Medicaid, so you really don’t see it separated it out. We think we are well positioned in all the states that we’re in to pick up additional membership as it comes on. Daryn Miller – Goldman Sachs: What states do you think are going to come on sooner or first?

I don’t think you can say that there is any one state that’s more likely than the others. I think the program is nationwide. The economic downturn is affecting all states, and part of this will depend on state’s willingness to invest more money in the CHIP program because it is matching program. Daryn Miller – Goldman Sachs: Can you just remind me where we are in terms of your rate activity and what were the last changes that were made in California rates?

As we shared with you at our investor day in January, there have really been no changes since then. We took a rate reduction in Los Angeles in October ’08. That continues through October ’09. Riverside, San Bernardino, and then San Diego had increases in October ’08 and back in 07/08, and our Sacramento rate increase is still pending, so no change from January 22nd.

Your next question comes from the line of Greg Nersessian with Credit Suisse. Greg Nersessian – Credit Suisse: I just had one on the Michigan and Missouri RFPs. Could you just give us an update on the timing in both of those states, maybe any changes that either of those states are considering and your view on whether or not you see that as an opportunity to take share, status quo, or perhaps lose share in each of those states.

I’ll start with the facts of submissions, and then others may want to comment. In Missouri, we are awaiting news of the results of that RFP. It has been submitted, and we’ve returned comments. We are confident that as an incumbent we’ll continue, but we’ll know about that shortly, and the Michigan RFP is in process. We’re in the process of putting together a response, and that’ll be for an October 1 effective date as is Missouri for an October 1 effective date.

There are no big programmatic changes that should effect enrollment significantly. Greg Nersessian – Credit Suisse: Any sense on the number of other bidders or any new market entrance going after those?

We’re not seeing anything, but that doesn’t mean that there won’t be. Greg Nersessian – Credit Suisse: Any other rate activity going on either in Michigan or any of your other states worth highlighting?

I don’t think there been any change since the investor day in January. No new news.

Your next question comes from the line of Matt Perry with Wachovia Capital Markets. Matt Perry – Wachovia Capital Markets: At some point in ’09 as a lot of people who have lost their jobs may begin to qualify for Medicaid programs in various states, is this a population when they may enroll in your plan, would expect their behavior and utilization patterns to be very similar to your current membership or would there be any reason why they might utilize more or less services?

I think going back to what John said earlier, we typically see higher utilization in the first 6 months on the plan, pretty much regardless of the A category, so we don’t think that the pattern of utilization is really going to change, and we think that we are already seeing that because we’ve seen growth in 2008, which is continuing in 2009 consistent with the downturn in the economy and the increase in the number of Medicaid beneficiaries. Matt Perry – Wachovia Capital Markets: I know the Medicaid population has little or no cost sharing or co-pays, but is there any recession-related changes you’d expect in your current membership’s behavior patterns at all?

No.

(Operator Instructions) Your next question is a followup from the line of Tom Carroll with Stifel Nicolaus. Tom Carroll – Stifel Nicolaus: A quick followup related to Greg’s question as well. Did you guys evaluate the Mississippi RFP looking at the chronically ill population at all?

You know, Tom, it is our practice not to comment on potential growth opportunities whether they be new RFPs or acquisitions. Tom Carroll – Stifel Nicolaus: Secondly, you guys are in Texas, not one of your biggest markets, but did you see or have you been able to tease out any higher level of claim activity related to the flu given the high prevalence of the flu in Texas this year?

Nothing that we’re aware of. Nothing we’ve come across. No.

Mr. Molina, there are no further questions at this time. I will now turn the call back to you.

Thank you very much. We appreciate you participating on our call, and we look forward to seeing you at our next investor day in May in New York.

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