Molina Healthcare Inc (MOH) — Q4 2017 Earnings Call Transcript

Thank you, operator. Hello, everyone, and thank you for joining us. The purpose of this call is to discuss Molina Healthcare's financial results for the fourth quarter and year-ended December 31, 2017, and preliminary guidance for the full year 2018. The company issued its earnings release reporting 2017 results and full year preliminary guidance yesterday after the market closed, and this release is now posted for viewing on our company website. On the call with me today are Joseph Zubretsky, our President and Chief Executive Officer, and Joe White, our Chief Financial 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 into 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. 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, our Form 10-Q Quarterly Reports, and our Form 8-K Current Reports. These reports can be accessed under our 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 February 13, 2018, and we disclaim any obligation to update such statements except as required by the securities laws. This call is being recorded and a 30-day replay of the conference call will be available at our company's website, molinahealthcare.com. I would now like to turn the call over to our Chief Executive Officer, Joe Zubretsky.

Thank you, Ryan, and thank you all for joining us this morning. This quarter's results reflect a significant transition we are undertaking here at Molina. The disappointing contract losses in New Mexico and Florida, and the related goodwill impairment charges, the continued expenses for restructuring, and the cash up adjustments related to the poor-performing marketplace business are all legacy issues that we believe are now behind us. The performance of the core business, however, which we define as Medicaid and Medicare, was respectable and, when viewed on a run rate and full year basis, provides a solid baseline from which to achieve our margin recovery and sustainability plan. We are squarely focused on improving our operating margins and creating an earnings profile that is less volatile and more sustainable. Only when we have accomplished this will we be able to reap the full benefits of this franchise, with its strong revenue base, across well-diversified geographies and product lines. This morning, I will be discussing the sustainability of our revenue base, the key operating and financial results from the fourth quarter and the full year, and connecting them to our 2018 preliminary guidance, and to the vision that I provided at a presentation to investors last month. First, with respect to the disappointing news related to the re-procurement of our Florida Medicaid contract, we are taking urgent and focused actions to secure this revenue base. Today, we operate in eight of eleven regions throughout Florida, serving approximately 350,000 Medicaid members, with $1.5 billion of annualized revenue. The entire state is currently up for re-procurement, effective January 1, 2019. As we announced last week, we have been selected to negotiate the award of a managed care contract in only one region of the state, that region, Region 11, comprises Miami-Dade and Monroe County, where we currently serve 59,000 Medicaid members. This outcome poses significant challenges, as a first step, we will do our best to secure the contract at Region 11. Beyond that, we will pursue the various protested appeals as appropriate. In New Mexico, we were surprised last month that the state chose not to invite us into the next round of the re-procurement process. Our New Mexico health plan has a long history of offering high-quality service to our members. Upon review of the procurement materials made available, we have concluded that our re-procurement loss was primarily based on the rating factor in the bid and not the service aspect of the bid. With that in mind, we are currently working through the appeals process in an effort to retain this business. That said, if the current decisions regarding our Medicaid participation in either Florida or New Mexico stand, they would have a significant negative impact on the company's revenue. Although our Florida and New Mexico health plans have been unprofitable in 2017, to say that their loss is therefore not challenging would ignore the more significant issue. The lost opportunity of returning those health plans to profitability is of serious concern. Our plan with respect to Florida and New Mexico is as follows. First, it is critical that we manage our 2018 operations in both states to achieve our 2018 plan. We will launch the appropriate protested appeals necessary to ensure that we have exhausted every avenue available to us for retaining these contracts. If the outcome of these RFPs proves to be unsuccessful, we will transition our operations in an orderly fashion and in a financially responsible way and then we will adjust our cost structure accordingly to mitigate any percentage margin impact on the consolidated enterprise. The long-term headwind therefore is not against our target margin percentage, but against the absolute value of operating profit we can achieve. We are particularly sensitive to this situation, as we prepare for two other near-term re-procurements, Texas and Washington, where we will compete vigorously to win. We have always taken major steps to improve our RFP response process to better articulate and present the Molina value proposition. First, we have marshaled more internal and external resources to support these efforts. We have engaged a broader and deeper array of very senior subject matter experts, including clinical, operational, regulatory, and financial experts. We have infused more local market knowledge into the process and we have retained outside experts in Medicaid procurement to pre-score our proposals and conduct market reviews. While this may sound like we are blocking and tackling, it is precisely these technical qualities that are the foundation for successful bids. The combination of a well-executed proposal leveraged with our deep community ties, long history of quality service in these states, and our two recent wins in Washington give us confidence in successful outcomes. Now turning back to our earnings, we reported a net loss for the quarter of $4.59 per diluted share and $9.07 for the full year. Looking more deeply into these unacceptable headline numbers, I would like to call out three important dimensions of our fourth quarter and full year performance. First, we incurred $342 million for the quarter and $704 million for the full year of impairment and restructuring costs. Second, we experienced poor marketplace performance as demonstrated by a quarterly medical care ratio of 102.1% for the fourth quarter and 88.1% for the full year. Our product that should run at 78% or below based on 2017 pricing. Finally, looking over the entire year and stripping away a number of legacy items, we were able to develop a clear view of the underlying earnings base of our core business. I would characterize that underlying earnings base as stable. Allow me to spend a little more time on each of these dimensions. First, the impairment charges were the result of the unfortunate combination of expensive legacy acquisitions giving rise to significant intangible assets and the unsuccessful re-procurements relating to those same geographies. Relatedly, the restructuring charges were the result of the company growing its cost structure beyond its profit capability, and this lack of discipline has now been corrected with improved monitoring and control. Second, with respect to the marketplace, we have taken significant actions to improve performance in 2018, as well as to reduce our overall exposure to this business. Specifically, we had implemented premium increases averaging 59% effective January 1, 2018. Those premium increases included a 20% increase due to the absence of federal funding of CSR subsidies and a further 39% increase for medical cost trend anti-selection risk, demographics, and a variety of other rating factors. These price increases, along with our market exits in Utah and Wisconsin, have resulted in substantially lower membership. So in response to our marketplace challenges, we have increased premium rates significantly, eliminated our exposure to uncertainties around CSR funding and reconciliation, and priced up with the full expectation that we will reduce our overall membership. Finally, the fourth quarter performance in our core business was respectable. Our medical care ratio, excluding marketplace, declined 210 basis points to 88.8% when compared to the third quarter of 2017, reflecting decreased inpatient utilization as compared to the third quarter. This improvement was achieved despite an increase in flu-related costs estimated to be $20 million. Looking at 2017 on a full-year basis, it is important to remember that our medical care ratio of 90.6% is burdened by substantial unfavorable out of period or nonrecurring items. These include approximately $150 million of unfavorable prior period claims development and another $90 million of unfavorable marketplace items, most notably the lack of CSR reimbursement in the fourth quarter. Absent these items, our medical care ratio for 2017 would have been approximately 89.3%. In that context, I would like to provide some commentary on our core business portfolio. Looking at our core business by product line for the full year 2017, TANF represented approximately 40% of our total Medicaid revenue and had a medical care ratio of 92%, which was above our 2017 target of approximately 90%. Improving profitability for this product will require more effective utilization controls and care management, particularly with respect to High-Risk Pregnancy, reducing unit costs of high-cost providers, and more effective rate efficacy. Our Aged, Blind, and Disabled product represents approximately 37% of our total Medicaid revenue, and had a medical care ratio of 94.7% for the full year, as opposed to our 2017 target of approximately 91%. Keys to improving ABD performance include improved care management in coordination of services for high acuity populations, focusing on the integration of behavioral and physical health services, targeting high-risk members for care management intervention, and more comprehensive documentation of medical conditions as well as improved management of community and other long-term care services for members in this product line. Expansion represented 23% of our total Medicaid revenue and has a medical care ratio of 84.9%, which was above our 2017 target of approximately 83%. Expansion continues to contribute favorably to our overall profitability and was responsible for approximately 40% of our total Medicaid medical margin for 2017. While premiums and margins for expansion have been declining in recent years, the rating environment appears to have stabilized. States generally look at rate adequacy holistically across all of Medicaid. Strategically, this product may be an important companion product to our marketplace business as certain states contemplate merging the two markets. In 2017, Medicare and MMP combined generated approximately $2 billion of revenue and had a medical care ratio of 88.4%, which was below our 2017 target of approximately 92%. These products are important because they present opportunities for the integration of care, on an even more comprehensive basis than is the case with many of our ABD members. The MMD plans, in particular, provide the opportunity to demonstrate that all aspects of care—behavioral health, physical health, and long-term care services—can be delivered more efficiently through managed care. As I presented to investors last month, we have a very well-diversified geographic portfolio, the majority of which is already operating at our target margin level, and the minority of which is profitable, but below target, and the remainder is unprofitable. Moving from a product line view of our company to a geographic view, I have the following commentary. Of our four largest health plans that generated over $2 billion annually in core business premium revenue, three—California, Ohio, and Washington—operated at medical care ratios that were at least 200 basis points below our consolidated core medical care ratio of 91%. Texas is the fourth of our health plans with core business revenue over $2 billion and has a heavy concentration of members receiving long-term care services, which explains why its core medical care ratio of 92% exceeds the company's overall average. These plans are operating at target margins and have long tenured and experienced management teams, excellent product diversification mix, and excellent standings in their respective states. Although it is mid-sized, I would also include Michigan on this list of well-performing plans. Our underperforming plans—Florida, New Mexico, Puerto Rico, and Illinois—are under intense review for performance improvement, irrespective of their re-procurement status. New Mexico's performance improved in the last half of 2017 and is projected to be marginally profitable in 2018. Florida's issues largely stemmed from aggressive marketplace membership growth in 2016 and 2017, which combined with Medicaid challenges overtaxed many core operations. With its reduced marketplace profile in 2018, combined with our improvement initiatives already in flight, this business should improve. Puerto Rico's performance, and that of the entire island, was impacted by the hurricane as utilization abated dramatically and then bounced back. In the back half of the year, performance stabilized, and to note the entire island will be re-procured this spring. In Illinois, we had significant unfavorable prior period development due to a variety of issues. In 2018, with a new statewide contract, we will start the year with a slight premium revenue increase. We are working toward rebuilding relationships with the providers in the central part of the state as we reenter those areas at the beginning of the year. Our fourth quarter SG&A ratio of 7.4% represented a 20 basis point decline from the third quarter and was 60 basis points lower than the full year ratio of 8%. This improvement reflects the actions taken in 2017. The tighter controls in productivity standards that we've implemented will ensure that our costs stay in line with our revenue base, and we expect to continue to find additional savings above the $235 million we have already announced. Moving on to the subject of capital management, enhancing our balance sheet and staying capital disciplined are also key parts of our plan. We took a number of steps in this regard during the fourth quarter. We strengthened our liability for medical claims, marketplace CSR, and risk adjustment. In December, we repurchased a portion of our 2044 convertible debt in exchange for equity. This transaction enabled us to lower our total debt to capital ratio by approximately 5 percentage points, while also allowing us to release approximately $157 million of restricted cash for general purposes. Finally, we entered into a bridge loan that will provide funding in the event that our $550 million face value of convertible notes due in February 2020 are presented to us. While we think it is unlikely that those notes will be presented to us in the near future, we concluded that it was important to maintain this risk management strategy. Our total debt ratio remains too high, and we will continue to delever and improve our overall capital structure to achieve our target. I now turn to the preliminary 2018 guidance. We describe this guidance as preliminary because of the inherent uncertainty around the achievement and timing of our numerous profit improvement initiatives. While these initiatives extend across the various dimensions of managed care fundamentals that I described to investors last month, many are in the early stages of development and implementation and therefore not included in the guidance. Therefore, our guidance should be viewed as a preliminary estimate of what we expect to achieve until we see the profit improvement from these in-flight initiatives manifest themselves in the earnings stream. Once we have the benefit of first-quarter earnings and further insight into the execution of our profit improvement initiatives, we will be able to update you with a firmer view of our guidance. To provide for an appropriate amount of execution risk, our preliminary guidance has therefore been developed with appropriately conservative views of the medical cost baseline in 2017, medical cost trend for 2018, potential rate increases, and retained amounts of revenue at risk, and the turnaround of the marketplace business until we can observe the achievement of the margins implicit in our 2018 pricing. With that said, our preliminary guidance is as follows: for 2018, on a preliminary basis, we expect earnings per diluted share to be in the range of $3 to $3.50 on a GAAP basis. We expect premium revenue to decrease from $18.9 billion to approximately $17.5 billion. The vast majority of this decrease is driven by lower marketplace enrollment, which is only partially offset by higher premium rates. Our preliminary guidance anticipates that marketplace membership will begin the year at approximately 450,000 members from 815,000 at December 31st and decline to approximately 300,000 members by the end of 2018. We expect our 2018 medical care ratio to be approximately 89% compared to the 90.6% medical care ratio we reported for 2017. Although our preliminary guidance takes a cautious view of the medical cost improvement in 2018, we expect our 2018 performance to benefit from the absence of the unfavorable prior period claim development we experienced in 2017. That unfavorable prior period claim development in 2017 amounted to $150 million. We expect to manage our administrative cost ratio to approximately 7.3% for all of 2018. This reflects the full-year run rate value of the $235 million of savings that we announced last month as part of our restructuring efforts. We will update you with a firmer view of our 2018 preliminary guidance on our first-quarter earnings call and at our Investor Day. I have also spoken about the need to bring additional talent into our company. While we have many talented leaders at Molina, the rigorous demands of our turnaround require that we continue to assess our talent needs across the company and expand our leadership team. Mark Caim, our new Executive Vice President of Strategic Planning, Corporate Development, and Transformation, will be the chief architect of our continued restructuring and will lead the analysis of the business portfolio and work to unlock value in all of our major vendor and ancillary cost contracts. Mark's years of recent experience will surely create a significant amount of value. I would also like to announce the hiring of Pam Sedmak, Executive Vice President of Health Plan Operations. Pam will be responsible for health plan operations, turning around the underperformers, solidifying our re-procurement efforts, and executing on our margin recovery and sustainability plan across the fundamentals of managed care. Pam has a long and successful career in managed care, particularly in her role as President and CEO for Aetna Medicaid, where she oversaw 17 health plans, whose Medicaid business achieved over $9.5 billion in premium revenue. Most recently, Pam was a Senior Advisor at McKinsey & Company servicing clients in the healthcare servicing space. In closing, I am excited about 2018, and I look forward to providing more details on our longer-term strategic plans during our Investor Day on May 31st in New York. With that, I will turn the call over to Joe White for more detail on the financials.

Thank you, Joe, and hello everyone. Yesterday we reported a net loss for the quarter of $4.59 per diluted share, and a net loss of $4.52 per diluted share on an adjusted basis. As Joe mentioned, embedded in these results are several significant items outside of our normal operations that we are in further discussion about. First, we took a $73 million charge as a result of the federal government's decision to stop paying cost sharing reduction rebates, or CSRs, to health plans beginning in the fourth quarter of 2017. To be clear, we believe we are legally entitled to those payments and will pursue all available means to collect them. We recorded a further charge of $50 million to increase liabilities for marketplace risk adjustment and CSRs that relate to the first nine months of 2017. Our marketplace premium deficiency reserve was reduced to zero as of December 31, 2017. This was a $70 million benefit in the quarter. We recognized approximately $20 million in incremental flu costs in the quarter. We recognized $269 million of non-cash impairment losses at our Florida, New Mexico, and Illinois health plans. The impairments in Florida and New Mexico were a result of our recent contract losses. The Illinois impairment is purely an issue of historical costs. While we are confident that we can improve profitability in Illinois so that it is a meaningful contributor to our company, the current profit profile of the health plan does not support the purchase prices paid for certain membership years ago. We also recognized approximately $73 million of restructuring costs in the fourth quarter of 2017. In the fourth quarter, we also incurred approximately $14 million in expenses related to the exchange of equity for $141 million of face value of our 2044 convertible notes. Finally, we recognized approximately $54 million in additional tax expense during the fourth quarter due to the re-measurement of our deferred tax assets as a result of the Tax Cuts and Jobs Act of 2017. It is important to keep the transitory nature of these items in perspective as we continue to evaluate the business through the lens of the margin recovery and sustainability plan that we announced last month. A full understanding of our underlying business requires that we look beyond the disappointments of our 2017 marketplace performance, the items I outlined a minute ago, and the $150 million of unfavorable prior period development that we experienced in 2017. As Joe noted, we have five large health plans—California, Ohio, Washington, Texas, and Michigan—that are operating at target margins. Additionally, several of the health plans have good prospects for ultimately achieving their target margins. We also saw continued administrative cost improvements in the fourth quarter. The quarter benefited from about $60 million of the annualized administrative cost savings of $235 million that we achieved in 2017. Let me now take a few minutes to discuss our marketplace performance during the quarter. First, and keeping with our commitment to resolving legacy issues, we booked a $73 million expense for the termination of CSR reimbursement in the fourth quarter. As I said a moment ago, we believe we are legally entitled to these federal payments and we will pursue all available means to collect them. We also recorded $50 million of marketplace risk adjustment and CSR expenses related to the first three quarters of 2017, as a result of updated third-party data that we received during the fourth quarter. As a reminder, the estimates we book for risk adjustment are a result of our own member risk scores measured against those of the overall market. The blending of estimates for both our own and peer performance is necessary because the final true-up for risk adjustment is based on our performance relative to our peers. After the change in CSR and risk adjustment estimates, the $70 million premium deficiency reserve we accrued at September 30th for our fourth quarter performance would have been adequate. As Joe noted earlier, we have taken significant actions to improve marketplace performance in 2018, as well as to reduce our overall exposure to this aspect of our business. We believe that our more robust pricing in 2018 will lead to improved financial performance for our marketplace product. And keeping with our focus on enhancing our balance sheet and improving our capital management discipline, we have made it a priority to closely manage our subsidiary capital position and dividend excess statutory cash to the parent company when possible. In the fourth quarter, we were able to dividend approximately $150 million up from our subsidiaries, and as of December 31, 2017, the company had cash and investments of approximately $695 million at the parent. In addition, our days and claims payable at December 31, 2017 increased sequentially by four days to 54 days, approximately two days of this four-day sequential increase were due to the timing of provider payments, while the remainder was a result of our strengthening of claims reserves. Finally, I will add a few additional thoughts related to our 2018 preliminary guidance. As Joe said a few minutes ago, to provide for an appropriate amount of execution risk, our preliminary guidance has been developed with appropriately conservative views of the medical cost baseline in 2017, medical cost trend for 2018, potential rate increases, and retained amounts of revenue at risk, and the turnaround of the marketplace business until we can observe the achievement of the margins implicit in our 2018 pricing. Our 2018 preliminary guidance anticipates that our medical care ratio for the full year of 2018 will be approximately 89% compared to 90.6% for all of 2017. It is important to remember that our 2017 medical care ratio was burdened by approximately $150 million of unfavorable prior period claims development and a net $98 million of unfavorable impact from various marketplace CSR risk adjustment and premium deficiency reserve items. Absent these items, our medical care ratio for 2017 would have been approximately 89.3%. The relatively small improvement we are anticipating in our medical care ratio when compared to an adjusted 2017 medical care ratio reflects the conservatism built into our preliminary guidance. For example, we have taken a conservative position on the turnaround of the marketplace business by adding an appropriate level of contingency for not realizing the margins implicit in our pricing. Looking beyond our 2018 preliminary guidance, here are some important facts regarding what we know about our marketplace product today. We priced to a pre-tax margin of 4.6% and a medical care ratio of 65%. This compares to a pre-tax margin of 3% and a medical care ratio of 78% that was priced in 2017. Approximately 70% of 2018 members are renewals from 2017. Acuity of our 2018 membership appears to be within our pricing expectations. In general, 2018 marketplace membership appears to be tracking with our 2018 pricing, which would represent substantial improvement over 2017. Nevertheless, due to the volatility we experienced in 2017, we are taking no credit in our preliminary guidance for marketplace improvements until such improvements manifest themselves in our results. SG&A costs are expected to drop by approximately $200 million in 2018, broker and exchange fees associated with our marketplace products are expected to drop by approximately $150 million. The cost savings taken out from accounts in 2017 will reduce costs by another $160 million, on top of the $75 million already recognized in 2017. These savings will be partially offset by a replenishment of our variable compensation and employee merit increase pools and costs associated with new activities such as our Mississippi and Idaho startups. We have received a significant number of questions relating to our share count and our effective tax rate. We have observed that there is a wide range in estimated share count for our company, as well as a wide range in estimates of our effective tax rate for 2018. With that in mind, let me share the following assumptions that underlie our 2018 preliminary guidance. First, our preliminary guidance assumes a diluted weighted average share count of 67.3 million shares and is based on a share price of $100 per share. This share count may be higher than what some of you are expecting; it is primarily the result of the diluted nature of our convertible debt at higher share prices. For example, our convertible debt is not dilutive at a share price of $55, but at a share price of $100, that same convertible debt will add about 7.4 million shares to our diluted share count. As a further example, at an average share price of $80 for the year, our diluted share count would be 65 million shares; at an average share price of $120, our diluted share count for the year would be 68.8 million shares. Regardless of the assumptions you make around the dilutive impact of our convertible notes, please remember that we issued 2.6 million shares as part of our exchange of equity for $141 million of face value of our 2044 convertible notes last December. These additional 2.6 million shares should be included in our share count regardless of assumptions you may make around dilution caused by our convertible debt. Second, as many of you know, our effective tax rate is higher than the federal rate of 21% due to the non-deductibility of several items, but most notably the health insurance provider fee. Regarding the impact of tax reform, the preliminary guidance effective tax rate of 41% to 43% would have been approximately 64% based on our 2017 tax rate. On another note, our 2018 preliminary guidance assumes that state Medicaid agencies will reimburse us for both the ACA health insurance provider fee and the tax impact of that fee as non-deductible. Even if all Medicaid agencies ultimately reimburse for that fee, we will not be able to recognize the added revenue until we receive assurances from those agencies that the fee will indeed be reimbursed. Any delays in receiving such assurances will result in late recognition of the related revenue, which would sharply reduce our earnings until such assurances are received. Please keep this in mind as you assess our quarterly earnings reports in 2018. Finally, our 2018 preliminary guidance does not contemplate any restructuring charges. The costs and benefits associated with our restructuring activities in 2017 are now captured in our 2018 run rate. While we may undertake further restructuring activities in 2018 and beyond, the costs associated with those activities have not been fully scoped. While we can't say with certainty that we will not incur additional restructuring charges in the future, we have not contemplated additional charges in our 2018 preliminary guidance. As a reminder, we will be providing additional detail about our margin recovery and sustainability plan in preliminary guidance on May 31st in New York City. This concludes our prepared remarks. Operator, we are now ready to take questions.

Thank you. I appreciate the detailed information regarding the 2018 guidance. However, I would like to gain more clarity on a few aspects regarding the benefits of tax reform—what is the net amount? How much turnaround savings are we assuming if we consider flat performance? Is there still a negative impact from Pathways? Additionally, you previously mentioned a similar administrative cost for tax, but now it seems it might be offset by changes in compensation. How should we view the changes in the health contribution? Thank you.

Hi, Sarah, it’s Joe White. We struggled to hear you; could you ask those questions one at a time, please? Thank you. Good morning, by the way.

Sure, good morning. So, just trying to look through a few of the moving pieces on guidance that weren’t spelled out. The one being tax reform: how much benefit is realized due to tax reform?

Sure, hi Sarah, it’s Joe Zubretsky. On tax reform, if you just look at the 35% statutory rate versus the 21%, it created a $59 million benefit to our 2018 guidance, which is about $0.87 of earnings per share. I will remind everyone that as we either exceed our plan or miss it, for every dollar of earnings above or below, our marginal tax rate is 21%. And the reason our guidance is at about 42% is the result of the non-deductibility of the Health Insurance Fee. Another question we are often asked is did we change our spending outlook for 2018 because our rates were set when tax rates were 35% versus 21%. And I would say, no, we had a plan in place for our margin recovery and sustainability plan; it does require investments to be made. Those investments were fully baked in our SG&A roles for 2018 and we did not change the course of that spending as a result of the new tax rates.

Thank you. And the other moving piece I was hoping you could clarify is the flu. If there is any change from 2017 to 2018 on your assumptions there, the Pathways, which has been a drag in the past—is it assumed to continue? And then on exchanges in the past, you have talked about there being a tailwind from a lower admin load. I'm not sure if that is still assumed going forward.

With respect to flu, as we said, we recorded our $20 million top-up to our fourth quarter. As we observed pharmacy and physician costs higher than normal, particularly in the CTC hotspots. I would tell you that that trend continued into January; pharmacy and physician costs were higher than normal due to the flu season that we are experiencing and others are as well. With respect to Pathways and our other sort of non-core subsidiaries, the earnings picture is just not material and stable; they're performing well, and it's just not a material part of the story.

Got it. And one more clarification if I could, and then I'll hop off. You talked about unwinding Florida if the appeals are not successful. How long should you think about that taking? So how much time to get the SG&A overhang if no matching revenue if the appeal in Florida is unsuccessful?

Sure, if we are unsuccessful in Florida and/or New Mexico, then we have a plan in place where we will try to transition our service profile in those states in an orderly fashion. Whether we transition it to another incumbent or new player, or whether we just exit entirely. Obviously, when the revenue stops on January 1st, you still have a claims tail to service, you still have member calls that need to be serviced. And so we will have to hold onto part of the operating platform for the tail period. But we're not going to let the administrative costs and bringing those plans into runoff be a drag on our earnings. We'll have to manage that transition quickly, but there would be a slight drag on 2019 as we work the claims tail off.

Thank you.

Thanks, good morning. A few questions here. Just wanted to start off on the marketplace. You talked about the membership numbers and the pricing. So the math should be pretty straightforward there, but I want to make sure I got it right. I think your revenue was about $3 billion in premium in 2017. Can you give us the number there for 2018? Is it around $2 billion? And then it sounds like you said there was no improvement assumed in terms of the economics on the margin. And I think you lost about $100 million plus for 2017, is that the right ballpark for 2018?

Yes, Justin, the revenue number for 2018 contemplated in our guidance is about $1.5 billion. And you have the pricing right. I mean obviously at 102.1% for the quarter and 88% for the year against a target of 78%. We lost money in the marketplace this year. The way I would characterize our guidance is we cleared the clutter around 2017. Obviously getting the one-timers behind us and obtaining a cleansed claims view of the 2017 run rate projected forward, our pricing at the 4.6% target margin. But until we see the effects of our profit improvement initiatives and that pricing take hold in the market, we did not include a lot of that turnaround benefit in our guidance. We need to see it emerge in the first quarter before we can firm up our guidance for improved marketplace performance.

Okay. So the $1.5 billion of premium just sounds a little bit low relative to the declining membership and then adding in a 50% price increase. Am I missing something there or is it geographically biased to some of the lower premium states?

Justin, it’s Joe White speaking. There are a few issues at play there; one would be the shift downward to bronze relative to silver, the other would be geographic matters as we continue to see stronger enrollment in Texas.

Also, bearing in mind that we always project a 2% monthly decline in membership, so while we are starting the year at 450,000, it's going to end the year at about 300,000 at least in our projection.

Okay. And then just staying on premium guidance for a second, premium guidance going to be - it looks like it's down about $1.5 billion when you adjust for the reclassification of some of the HIF collection or I should say the HIF collection. So that makes sense to your point that the marketplace is a big part of that, but beyond that, it doesn't seem like there is any organic or same-store growth assumed in there, and I would have thought there would be 2% to 3% which should add up to $500 million to growth there. Am I missing anything besides the marketplace? Or are we just assuming kind of not much in the way of organic contract growth in 2018?

We have experienced a slight decline in Medicaid membership, especially in Michigan, where we are gaining market share. In Ohio, we're facing some minor redetermination challenges that are significant enough to impact our year-over-year metrics. Our Medicare membership has increased slightly; we are maintaining our membership levels and achieving favorable rates. Additionally, we are entering two new markets, such as Idaho, and starting our Mississippi TANF contract in October, which is expected to bring in about $200 million. Overall, Medicaid membership has dipped a bit, but we are expanding into new markets, and our Medicare sector is growing at a good pace.

Okay. If I could just ask one more numbers question, I think Sarah asked around flu. Is there a dollar number you can give us Joe in terms of what you think we could be looking at here relative to last year in terms of flu cost in the first quarter? Thanks.

Honestly, not yet. We just closed the books, just literally within the past few hours, and we've intentionally looked at the underlying trends in pharmacy and physician, which is where we need to look. While we know we're experiencing a higher-than-normal flu season continuing into 2018, I really can't peg a number for you right now, Justin.

Hi, thank you. If I could ask about Joe, your view on margin levels. I know you have your preliminary guidance out for 2018, and we appreciate getting that. I'm not looking for guidance for another year, but when you think about the net margin that we see at peer companies it's a little above 2%. Is that structurally a place that you think Molina can get to over time? Because prior to this year, the trailing five-year average is something like 0.5%. It just seems like there is then a structural barrier to getting to the margins that are comparable to peer companies.

Well Matt, I appreciate the question, but no, I really don't think there are any structural impediments in our portfolio. As I said to investors last month, this is clearly a question of performance and not a question of portfolio. We have many high-performing plans; we need to fix the hotspots. As I said in my prepared remarks, all of our products are just running slightly north of where they need to be to hit their target margins. You can book inside the numbers and you can go around the wheel of performance in terms of what you need to do with your network, what you need to do with utilization controls, what care management protocols for high acuity populations, and holding on to more of our revenue at risk. As I said to investors last month, we are holding on to fewer dollars of revenue at risk than we think our competitors are; we need to get better on risk scoring and quality scores to hold onto the quality withholds that the states hold out. So I clearly believe it's a question of performance, and if we look at the fundamentals of managed care, on a mix-adjusted basis, I still feel confident in saying we can get to the competitors range of 1.5% to 2% after tax.

That's great, thank you. And also just one more if I could. I don't—I may have missed it; did you touch on your diagnosis of the reasons for the downsizing of the Florida arrangement?

The reasons that we lost?

Yes, yes, sorry.

Well, we touched on New Mexico; we actually have the scoring and we're able to conclude pretty much that it was rates and not service and technical capabilities. In Florida, we have not seen the scoring yet. As part of the process, we will get the scoring, we will analyze it, and then structure our appeal or protest around the scoring parameters.

Thank you.

Good morning. Just wanted to get some clarification on the cost savings from the restructuring plan that are in 2018. It sounds like the run-rate savings achieved by the end of 2017 were $235 million; I mean, you're expecting $160 million to be realized this year with the delta being realized last year. Is that correct? And do you still think you're going to get the $300 million to $400 million target by the end of the year - run-rate target?

Those numbers are correct, $75 million in the third, $60 million in the fourth for a total of $135 million and incremental of $160 million for 2018. Bear in mind, when Joe and his team put out that longer-term target, that was not merely SG&A savings, but were cost structure savings across all the dimensions of managed care, including network and care management. And yes, the 1.5% to 2% after-tax margin and EBITDA margins north of 5% are in our future, which we predict they will be. Then yes, we have to achieve those types of cost savings over the next two years. As I mentioned previously, we have not included many of those cost structure improvements and performance improvement initiatives in our 2018 guidance; we'll wait to see them emerge before we adjust our guidance accordingly.

Great. And then along the same lines, in your prepared remarks you noted that you are in the process of retaining several subject matter experts to help you with upcoming re-procurement and maybe to even do a look back analysis on the state's rate and win. Are those people that should be employed full-time by Molina, or are these people probably like industry standards that normally are consultants? And are the costs associated with these experts in the guidance, or are they going to be treated as one-time items? Thanks.

All the costs are in the guidance. And yes, because these proposals are in flight, we decided to add to the complement of resources we have internally with outside resources. Ultimately, if we are going to turn on the new business and the re-procurement machine permanently, and begin growing again after we return to our target margin profile, then yes, we will build internal teams that are capable of routinely winning re-procurements and new bids. So, because that we are in flight, we went outside, but ultimately they need to be built inside.

Great, thanks a lot.

Good morning. And hi Joe, welcome back to the earnings conference call. I wanted to ask you a couple of questions. So first one is just, you have done a lot of talk about the MLRs for the marketplace business, but if we exclude the marketplace business and look at all the rest of the businesses, is your expectation to get to the 89% loss ratio that the MLR will improve or decrease for that business, or will it get worse?

If you look at—and again, 2017 was a very noisy year, so you have to sort of clear the clutter on 2017, where the reported MCR consolidated was 90.6%, 130 basis points of which was prior-period development. When you start looking in at the detailed product lines, TANF reported at 92%, ABD 94.7%, Expansion 84.9%, and so on and so forth. You can pro-forma and project network contracting, retaining more revenue, better utilization controls in care management to get to our 89% and beyond. So we were very cautious on our 2018 guidance not to include the results of those performance improvement initiatives, but they are in flight and we expect them to work. But because of this company's past history of execution, we were hesitant to put them in our guidance as being very comparable with the approximately 89% for 2018. When we see our performance initiatives manifest themselves in earnings, we would adjust accordingly.

So beyond the prior-period development going away, you're not expecting necessarily for the rest of the business to improve, is that correct?

Yes, that's a good assumption. Our guidance for 2018 is just slightly better than the prior-period for 2017.

Okay. And then moving on Joe, you've come from a background with having seen far more advanced systems. How difficult will it be to get Molina's systems to the point where you need them to be, so that you can avoid fighting hotspots and instead be proactive and be sure of the performance you have going forward?

Very logical question, and you're right. In this business, this is an information business primarily, and the veracity and velocity of medical cost trend information is critical to the lifeblood of a well-managed managed care company. The systems here are okay; we have many sources of data warehouses that create good medical insights. We have an actuarial community that I believe is very, very good. We can get better, and the investments needed to create higher velocity and more veracity of information are baked into our plans. I think as part of our margin recovery plan we contemplate getting better information on a real-time basis and reacting to the trends that are emerging in the marketplace more quickly than this company has reacted in the past. I am running this organization a lot flatter, and I'm closer to 13 health plans than the predecessor management, and with Joe and his team, Pam Sedmak on board, we're going to make sure that we serve and respond to the emerging trends more quickly and react to them on a more real-time basis.

Thank you.

Hi there, it's Dave Saddle on for Windley. Thanks for the questions and welcome back, Joe. I just want to come back to comments that you made at a prior conference kind of laying out the 1.5% to 2% in our debt margins. I'm just curious; do you have an updated view of that considering the negative fixed cost leverage that comes from the unexpected New Mexico and Florida RFP headwinds? Does that change your view about getting to those margins or perhaps the timing of being able to do that in the one to three-year target that you previously talked about?

Sure, Dave. Whatever we thought we were going to achieve. I still believe that 1.5% to 2% is achievable. Obviously, if there are some stranded fixed costs as a result of withdrawing from a market or two, that would create a headwind. But as we've analyzed this, I don't consider any cost to be fixed. The variable costs of the plans—the operations of the plans—are easy to identify and mitigate. Variable costs are very easy to identify, and we're going to right-size the enterprise to the new revenue base. So the headwind, in my opinion, is not in the percentage of target margin, but in the actual dollars of underwriting margin and operating profit we will produce, which to some extent has been compromised if we lose these two contracts. So no, I'm not backing off the long-term margin percentages. Although if there are fixed costs that need to come out and they become stranded, then we just need to work hard to get them out.

Okay. And just to be clear, is that target range excluding upside from tax reform or not?

Yes, we haven't updated our long-term view, because as I've said publicly, it's not clear to me. While there is no specific past line item in the rate development in state contracts, whether states at least contemplate or consider the new tax regime as they structure rates on the various rating factors, it’s not clear to me that rates are going to settle back to the after-tax margins that we are seeing today. Until we see that prove out, I am not going to increase the target; but certainly there would be upside if the rating environment does not consider the new tax regime?

Right. Got it, okay. And then apple to apple on the non-exchange MLR improvement of 210 basis points sequentially, I think my understanding is that Q4 had less unfavorable development than Q3, so maybe that explains some of the improvement. But I am curious what some of the other factors could have been there. I guess flu you spiked out, and that was something that you had to overcome, but is there some approach that you could provide to 3Q to 4Q MLR?

I'm going to turn it to Joe since he was obviously heavily involved in those quarters.

Sure, I think as you take a look at quarter-to-quarter fluctuations, you obviously have to be careful in this business about what you read into them. But I think it is fair to say that excluding marketplace where we made some out-of-period adjustments in Q4, I think your statement, Dave, that there was less unfavorable development in Q4 than Q3 is correct and reflects the general trend we have been making to improve the quality and sustainability of our reserves. I think there were also some pleasant surprises in patient utilization in a couple of parts of the business, particularly on the Medicare side. I also think in some cases in some of our plans that hadn't performed as well over time or recently as we would have liked, we are seeing the benefit of new management teams settling in. New Mexico showed some improvement in the second half of the year. Puerto Rico, while it continues to have some one-off issues related to provider-sharing accruals and things like that, it continues to show a positive trend. Overall, it reflects a general stabilization of the business, the benefits of certain cost take outs we achieved last year, and just getting the heavy lifting around the increasing of reserves behind us.

Thanks.

Hi, thanks. Good morning, guys. I wanted to touch on a longer-term revenue perspective, and not much organic change is expected in the current year. When we think about in New Mexico, I think you sized that at $1.5 billion, and in terms of could be your 2018 expectation—I don't think I heard a Florida expectation, maybe we should just assume the 2017 numbers pretty similar. But I want to understand, you talk about these changes—you are bringing in new hires, congrats to both of them as well—and hiring external, but I'm just curious what you think about revenue run rate once you kind of rebase the business. Take out, let’s call it $2.5 billion for the lost contracts in 2019, add back the HIF. So really just what do you think this business grows at? When do you think you will sort of be back in the RFP winning game? And then I guess on the side question—the marketplace, is that a business you are still in, in 2019 and beyond?

Sure, Josh, this is Joe. The revenue trajectory hasn't changed in my view, and all I said was we are pushing the pause button on new business growth while we repair and restore the margins to target. I am very hopeful that that’s a 2018 exercise. Meanwhile, during 2018, Pam, myself, and others will be rebuilding the new business procurement machine so that we can begin to participate in the 2019 pipeline. This is not a story without growth; we are just pushing the pause button on North Carolina and Kentucky and a few other opportunities until we can actually see the margin restored and start moving to target levels. For the long-term, I do not view this story as anything different from the growth story that any other Medicare and Medicaid company portrays. With respect to the marketplace, early on, there were all the strategic views of you needed to be in the marketplace if you were in Medicaid and vice-versa. I think the market has learned that while there are similarities in network configuration and costs, these two businesses are quite independent of each other, and that you can’t really warm transfer a member between the two markets; they go into the exchange, they go into exchange. I think the business has to produce a target margin and cash flows that fit with the portfolio, it stands on its own. Our marketplace business in Texas is incredibly profitable. It was Florida that was the problem, but in the five other markets, it’s not at its target, but it is still profitable. We’re going to finalize rates in April. We are going to see how our profitability emerges this year and will make that final call in August and September when we need to. We’re pretty confident that with 59% rate increases and a 4.6% pre-tax target margin, this could be and is a sustainable business for the enterprise.

Okay. And then just on New Mexico Joe, you made the comment that you know the loss was on the cost proposal portion. Certainly, looking at that, I think the average you guys were 150 points off the average, I think 275 points of the winners. So I concur with that, but there were some areas in technical that were noticeably below average around care coordination and post-systems and some of those. It didn’t look to me—I think you guys would have been fifth-place just looking at the technical scores didn’t look to me like Molina was really that well-positioned as an existing plan even if you threw the whole cost proposal out. So I assume as part of this RFP revamping and revitalization plan—there's more going into that. I was just curious if you could provide some color on how you kind of fix that sort of stuff. Is it capabilities or is it just the proposal responses that weren’t really perfectly written? I'm just curious what your thoughts are there.

First Josh, as we were going back and reverse engineer the scoring, we found ourselves actually closer to being third than fifth or sixth, as you suggested, when you remove pricing. But we're going to go back and forth all day long on that. The real issue, the one you suggested: I don’t think our proposals, as we go back and look at Florida and New Mexico, reflected the capabilities that we have. We’ve been in New Mexico a long time; we enjoyed a good relationship with the state. Our service to members and to providers has been very good, and I don't think we reflected our capabilities in the proposal well enough. Then clearly, when you're participating in a rate auction and purposely bid at the 75th or 80th percentile of the range—just pure auction theory—you are not going to win. During that period of time, there was a very unclear view of how New Mexico was performing; it was all types of backlog claims and prior period development and it wasn't performing well. The management team at the time bid higher in the range; hindsight maybe we would have or wouldn't, but clearly due to rates and that performance in our opinion were the key points. But we are revamping the entire proposal writing machine to better reflect the capabilities that we do have in these markets.

Okay, that's perfect. Thanks, Joe.

Hi, good morning. Just a couple of questions. One for 2018 marketplace of that $1.5 billion of premium you're talking about, how much of that would be in Florida, ballpark?

Of the 450,000 members, I believe Florida is projected to have around 50,000, down from over 200,000 in 2017. So I would tell you that it's probably between $300 million and $350 million.

Okay. And then my other question is, I guess I'm in the camp of one of those having a little trouble on the share count. I think I understand the convert dilution pretty well, but maybe I'm just missing where you ended the quarter. So 57.1 million average diluted shares for the quarter. Could you give us end of quarter basic and diluted kind of as the jumping-off point?

Sure, it's right around - end of quarter it's right around 60 million. I think what you are missing there is the impact of the exchange of equity we did for our some of our convertible notes in the middle of December, which involved issuing about 2.6 million shares.

Okay, thank you.