MOLINA HEALTHCARE, INC. quarterly report, Q2 FY2014

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Molina Healthcare, Inc. — Q2 2014 Form 10-Q

Reporting period: Three and six months ended June 30, 2014. Amounts below are in U.S. dollars; financial amounts are in millions unless noted.

Business context and reporting period

Molina provides Medicaid-related health plans and Medicaid information-processing services. It reports two segments: Health Plans and Molina Medicaid Solutions. Its health plans operated in 11 states and served approximately 2.3 million members at quarter-end. Membership growth reflected Medicaid expansion, the launch of South Carolina’s full-risk program, and prior acquisitions; Marketplace membership was fewer than 20,000.

Financial performance

  • Revenue: Q2 total revenue was $2,312 million, up 44% from $1,606 million; premium revenue rose 44% to $2,167 million. For the first half, total revenue was $4,381 million, up 37%.
  • Profit: Q2 operating income was $32 million versus $46 million; continuing-operations income was $7.7 million versus $15.8 million. Consolidated net income, including discontinued operations, was $7.8 million versus $24.6 million. First-half continuing-operations income was $12.6 million versus $46.3 million; consolidated net income was $12.3 million versus $54.5 million.
  • Per share: Q2 diluted EPS from continuing operations was $0.16 versus $0.34; first-half diluted EPS was $0.26 versus $1.00.
  • Medical costs and margins: Q2 medical care costs increased 49% to $1,934 million, faster than premium revenue growth. The medical care ratio rose to 89.3% from 86.2%; operating margin fell to 1.4% from 2.9%, and continuing-operations net margin to 0.3% from 1.0%. For the first half, the medical care ratio was 89.0% versus 86.1%, and operating margin was 1.3% versus 3.6%.
  • Segments: Q2 Health Plans operating income declined to $22.0 million from $40.2 million. Molina Medicaid Solutions operating income increased to $10.4 million from $6.3 million, reflecting lower service and administrative costs. First-half segment operating income was $36.0 million and $20.7 million, respectively.
  • Cash flow: First-half operating cash flow was $235 million, compared with cash used of $112 million in 2013. Investing used $102 million and financing used $42 million; cash increased $91 million to $1,027 million. Operating cash flow benefited materially from the $254 million increase in medical claims payable.
  • Liquidity: At June 30, cash and cash equivalents were $1,027 million, current investments $741 million, and restricted investments $84 million. Working capital was $741 million. Cash and investments, including restricted investments, totaled $1,864 million.
  • Debt and obligations: Notes had $737 million aggregate principal: $187 million of 3.75% convertible notes due October 2014 and $550 million of 1.125% cash-convertible notes due January 2020. The balance sheet reported $185 million of current debt maturities and $426 million carrying value for the 1.125% notes. Lease financing obligations totaled approximately $200 million.

Material changes versus the prior comparable period

  • Health Plans membership increased to 2.255 million from 1.847 million a year earlier. Management attributed premium growth to higher member months and higher revenue per member per month, including expansion populations and South Carolina enrollment.
  • Medical costs grew faster than premiums, pushing the medical care ratio higher. Management described higher or less favorable ratios in several plans, including Utah, Texas, Washington and Florida; new and expanding populations also had limited claims experience.
  • General and administrative expenses declined as a share of revenue: 8.4% in Q2 versus 10.1%, and 8.7% for the first half versus 9.5%. The effective tax rate increased to 58.0% in Q2 and 56.5% for the first half, primarily due to the nondeductible health insurer fee.
  • Company-defined adjusted continuing-operations net income was $34.2 million in Q2 versus $43.0 million, and $64.4 million for the first half versus $93.2 million. These non-GAAP measures exclude specified items and should not be viewed as substitutes for GAAP results.

Outlook, commentary, risks and unusual items

  • Health insurer fee: Molina estimated an $88.3 million 2014 fee, payable September 30, and said the non-deductible assessment reduced earnings by approximately $16 million in Q2 and $32 million in the first half. As of June 30, reimbursement contract amendments covered about 50% of the Medicaid-related fee. By July 30, Florida, Illinois, Ohio, Washington and Wisconsin had committed to reimburse the full economic impact in their states. Management remained guardedly optimistic about securing further agreements by year-end; failure to obtain full reimbursement could materially affect results.
  • Quality incentives and retroactive revenue: Nonrecognition of a portion of Texas quality incentive revenue reduced earnings by approximately $7 million in Q2 and $13 million in the first half. Management was guardedly optimistic that most Texas quality revenue could be recognized before year-end. Q2 included an approximately $25 million benefit from certain premium revenue, including $15 million relating to 2013 and $5 million to Q1 2014.
  • Claims estimates: Medical claims payable rose to $924 million from $670 million at year-end. Favorable prior-period claims development was $37.1 million in the first half. Management highlighted estimation uncertainty for Medicaid expansion members, new South Carolina members, retroactively enrolled New Mexico members and disputed Texas claims.
  • Liquidity constraints: Management believed available cash and internally generated funds were sufficient for operations, regulatory needs and capital expenditures for at least 12 months. However, state rules restricted approximately $663 million of subsidiary net assets from transfer to the parent; parent-company cash, cash equivalents and investments were $299.8 million.
  • Legal and other contingencies: Washington authorities demanded $14.4 million and $5.8 million for alleged overpayments; Molina disputed the claims and said liability was not probable or estimable. Louisiana filed a suit alleging an incorrect pharmaceutical-claims reimbursement formula for 1989–2012; Molina said liability was not probable or estimable. A Florida False Claims Act complaint was served in July 2014; federal and state authorities declined to intervene, and Molina said liability was not probable or estimable. The filing cautions that adverse legal or regulatory outcomes could materially affect the company.
  • Other items: The 3.75% notes were convertible beginning July 1 and due October 1, 2014. Auction-rate securities of $11.0 million remained illiquid after failed auctions dating to 2008. A related-party office lease involved entities associated with senior executives and their family.
  • The filing provides no specific full-year earnings or revenue guidance. Management cited risks including state reimbursement and rate adequacy, medical-cost trends and claims reserving, Medicaid expansion execution, contract renewals, government audits, and regulatory limits on subsidiary dividends.

Important facts for investors to verify

  • Progress and timing of state reimbursement for the health insurer fee, including the tax gross-up, and recognition of Texas quality incentives.
  • Whether medical-cost ratios stabilize as expansion and newly enrolled populations develop claims history; monitor claims payable and reserve development.
  • Repayment, conversion or refinancing of the $187 million notes due October 2014, and the company’s resulting liquidity and interest expense.
  • Developments in the Washington, Louisiana and Florida legal matters, plus other government reviews and provider disputes.
  • Cash availability at the parent company versus regulated subsidiaries, required statutory capital, and any effect of state restrictions on funding or dividends.