Molina Healthcare Inc (MOH) — Q1 2018 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 first quarter ended March 31, 2018. The company issued its release reporting first quarter 2018 results earlier this morning 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 in the queue, so that others have the 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 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 30, 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, Joseph Zubretsky.

Thank you, Ryan, and thank you all for joining us this morning. The financial results that we announced today reflect a good first step toward our goal of sustainable margin recovery. First quarter earnings were $1.64 per diluted share and included $0.38 of net favorable impact not contemplated in our original preliminary guidance. These results are a significant improvement over 2017 and are favorable to our expectations. As a result of these developments, we have increased our full-year 2018 guidance to a range of $4 to $4.50 per diluted share. When we analyze the business by key operating metrics, product line, or local health plan, we met or exceeded our expectations, modest as they were along nearly all dimensions. To summarize the key takeaways from the first quarter, our Medicaid Medicare products combined performed well. This improvement, despite a higher than normal flu season, was primarily due to our medical cost management initiative and better than expected retention of at-risk revenue. The performance of our marketplace business exceeded our expectations as the significant price increases replaced in the market were more than competitive and allowed us to surpass our membership forecast particularly in Texas, our most profitable market. From a local market perspective, our large high-performing plans continue to perform well in the aggregate despite higher than expected medical costs in Washington. In our underperforming markets, our newly implemented intense and rigorous performance improvement processes began to show signs of success particularly in Florida and Illinois. Our administrative cost improvement plan continued to reflect favorably in our results as evidenced by our lower administrative expense ratio. Finally, our focus on balance sheet discipline not only avoided the unfavorable prior year reserve development that we saw throughout 2017 but rather produced significant favorable prior year development in the quarter as a result of a more conservative approach to estimating our claims liability at December 31. We attempted to maintain that same degree of conservatism when we established reserves at the end of the first quarter, and if time proves we were successful in doing so, the net impact of prior period development on our first quarter results will have been minimal. Taking a step back, we see an emerging theme. Our operating metrics on a consolidated basis developed favorably with respect to revenue, medical care ratio, and G&A profile by both product line and local health plan. Reviewing the results from these different vantage points helps us test and evaluate the quality of earnings and the sustainability of our first quarter trajectory. After this multi-dimensional review, I will then consider the company's revenue and growth profile and conclude my remarks with a discussion of revised guidance. First, revenue; premium revenue decreased approximately 7% when compared with the first quarter of 2017. This decrease was a direct result of the membership declines related to the significant marketplace price increases that we implemented as part of our margin improvement and sustainability plan. We now have over 450,000 marketplace members which exceeds our forecast as our prices, while having increased by an average of nearly 60%, remained competitive. Medicare and Medicaid revenues were essentially flat as a slight membership decline in Medicaid was offset by low single-digit rate increases and favorable at-risk revenue retention. Second, our medical care ratio, removing the impact of the 2017 CSR benefit recorded in the quarter, our consolidated medical care ratio improved to 87.7% from 88.4% in the first quarter of 2017. This improvement reflects stronger medical management performance resulting in favorable medical cost trends that were partially offset by a lower mix of marketplace revenue. On balance inpatient and physician utilization, as well as unit costs were well managed in the quarter while pharmacy costs ran higher than expected. This netted to an overall favorable medical cost trend despite the higher pharmacy costs and approximately $18 million of above-normal flu expense. We have also started to see some of the early benefits from contracting efforts that we undertook last year in California, Florida, South Carolina, and Texas where we eliminated or renegotiated high-cost provider contracts for inpatient and ancillary services. To round out the review by product, now with respect to the marketplace business. Marketplace is off to a stronger start this year compared to last and has performed above our expectations. The medical care ratio for the marketplace business decreased to approximately 67% excluding the impact of the 2017 CSR benefit recorded in the quarter down from 75% in the first quarter of 2017. This 800 basis point improvement is a direct result of our pricing strategy. When considering this improvement, it is important to note several factors. First, approximately 70% of our members this year are renewing members from 2017. And as such, we believe we have a more stable risk pool. Second, member demographics, risk scores and acuity all generally came in within the assumptions used in our pricing, which as you recall targeted a 4.6% pre-tax margin. Third, while it is still early in the year and our membership remains largely similar to last year, we have seen a change in composition to more brands and fewer still members. Since we have priced all of our products to the same target margin on a standalone basis, this shift should be margin neutral. I turn now to the fourth dimension of my review of the quarter: a review by geography of the individual performance of our local health plans. The majority of our large health plans have produced and continued to produce after-tax margins that exceed our target. The combined performance of these large well-performing health plans, California, Michigan, Ohio, Texas, and Washington remain consistent with our expectations. Ohio's performance improved over the first quarter of 2017 across all products. While we saw pressure in Washington related to high acuity inpatient cases.

Thank you, Joe and hello everyone. Today we reported earnings per diluted share of $1.64 and adjusted earnings per diluted share of $1.71. As Joe mentioned these results reflect a good first step toward our goal of sustainable margin recovery. I will briefly discuss the items we called out in the earnings release, prior year development of our claims reserves, our March 31 balance sheet, and our revised guidance before we open up the call to take questions. We have highlighted three significant items in today's release that were not included in the preliminary guidance we shared with you in February. First, we recognize the benefit of approximately $70 million or $0.83 per diluted share and reduced medical expense related to 2017 when the Federal Government confirmed that the reconciliation of 2017 marketplace CSR is up to date will be performed on an annual basis. In the fourth quarter of 2017, we had assumed a nine-month reconciliation of this item pending confirmation from CMS. Second, we recorded a $10 million charge for the retirement of an additional $97 million of face value of our 2044 convertible notes. This action had the double benefit of strengthening our balance sheet while also reducing the volatility in our earnings caused by the optionality of convertible debt. As part of this transaction, we issued 1.8 million shares of common stock. On a time-weighted basis, these additional 1.8 million shares added 0.5 million to average shares outstanding for the quarter and 1.4 million to average shares outstanding for the full year when calculating our revised full-year 2018 guidance. Third, we recorded $25 million in restructuring charges in the quarter; these charges primarily related to the write-down of capitalized costs for an in-flight software implementation that did not meet our needs. Let me now spend a few minutes discussing prior year development of our claims reserves. As you can see from the roll-forward table in today's release, we have had about $240 million of favorable prior year development this quarter. This favorable claims development is the expected result of the more conservative approach we took to the estimation of reserves during the second half of 2017. We have attempted to include the same level of caution and conservatism in our first quarter balance sheet as we did in our year-end balance sheet. We have done this through the application of a consistent reserving methodology in both periods. Days in claims payable are down one day sequentially and are up eight days from the first quarter of 2017. While days in claims payable are a gauge rather than a measure of reserve adequacy, the slight movement in this metric quarter-over-quarter supports the view that prior year claims development did not have a significant impact on first quarter earnings. Nevertheless, we will not be able to fully determine the impact, if any, of prior year development on our first quarter results for some time.

Hi. Thanks. Good morning guys. Just wanted to talk about Florida, New Mexico briefly from a balance sheet perspective. And I don't know if you guys have specific goodwill totals associated with those plans and maybe help us with the timing of when a write-off would come, is that after all of the appeals are done or is that kind of done now? And I guess part of that is, what's the expected sort of debt-to-cap what do you think your leverage looks like post those changes?

Josh, it's Joe. We wrote off the goodwill associated with Florida and New Mexico when it was announced we lost the contracts in the fourth quarter of last year. So there would be no additional goodwill or intangible write-offs in those particular markets. Obviously, with nearly $400 million of capital as the reserves run-off and premium flow stop, we'll approach each of the state regulators with the dividend plan to dividend that cash to the parent company to provide excess capital, which is used to retire debt should have a meaningful impact on our leverage ratio next year. So, obviously disappointed, we lost the contracts but additional capital will be released from those entities.

Nice. That's a positive. And then, the Texas reprocurement could you just walk us through the timing in terms of award dates and contract dates? And then, what's Molina's current run rate in terms of revenues on that business?

The Texas Starplus program bid was submitted. Awards will be announced in October of 2018, with a January 2019 inception date to the contract. Bear in mind, we are only in six regions in Texas and we are bidding on all 13, so we actually view this as a potential revenue upside for us. Any comments on the tactics…

The question I have for Joe is about the total revenues you are currently generating from the Starplus portion in Texas. What is the run rate today?

It's approximately $1.5 billion.

Got you. And then, just last quick one on the flu, I know you said the $18 million was that relative to prior year or relative to guidance?

Both. We expected a normal flu season, which averages between $15 million and $20 million and it came $18 million higher, which is about 40 basis points in the MLR for the quarter.

Thanks. Good morning. First question is on the marketplace. Can you talk to us about what the updated margins assumed in your new guidance for the marketplace for the full year? And then, any early thoughts on your marketplace footprint for 2019?

On the marketplace results, Justin, we're still taking a very cautious view of the balance of the year. We beat our expectations in the first quarter with a 67% adjusted, MLR adjusted for the CSR benefits, an 800 basis point improvement over last year. Obviously, the result of nearly 60% price increases we put into the marketplace. And as we said, we will confirm that those prices perhaps will be uncompetitive, but they weren't. And we beat our membership forecast by 50,000 members. We now have 450,000 members and a significant portion of that beat was in Texas, our most profitable state. The reason for the cautious approach is utilization is very back-ended into the last three quarters of the year as each quarter progresses, you have special enrollment members utilizing enrollment generally is of healthier members during the year. And of course benefit design out-of-pockets and out-of-pocket maxes and co-pays obviously have an impact on the back half of the year. But, we want to make sure that we have our seasonality projection correct. And we also want to make sure that our estimates of risk-adjusted revenue are accurate. As you know, we haven't been as accurate as we needed to be in prior years.

Okay. So is there a margin? I think you mentioned that you expected 4.6 for the full year on your bids, but your guidance was for margins to be flat or maybe slightly positive. I'm just trying to figure out where you are in that cycle.

You recall when we did our preliminary guidance when we announced our fourth quarter. We said that the marketplace had a low single-digit loss last year. And in our guidance, we reversed the loss and basically forecasted a breakeven result even though we price to a 4.6% target margin. And what I would say in our revised guidance is the first quarter beat in the marketplace is in our guidance, but certainly not a lot of improvement in the back half of the year. So we want to wait and see the second quarter before we get a really robust forecast of what the marketplace is likely to produce this year. But the target is still 4.6% on gross revenue.

And then, any early thoughts on marketplace footprint for 2019? Thanks.

Yes. We are obviously in the process of developing our preliminary rate bids, which as go in early June. We have decisions to make in Florida and New Mexico, if we lose our Medicaid contracts marketplace will be the only substantial business we have in those markets. Florida is seeing improvement this year and New Mexico is doing really well. It is possible we would resubmit rates in Utah and Wisconsin. And certainly, the other states are performing well so there's no reason to believe that we wouldn't still be successful in our other states such as Washington, Ohio, Michigan, and California.

Thanks for the question and congrats on the quarter. I want to circle back on the comments in Washington state. It sounded like it was within the expected variability. Just wanted to understand a little bit more what happened in the quarter those related at all to some of the expansion you had into the north central region starting this year. And if that's something that could occur in other states similarly as we progress through the year?

It really wasn't related to the two regions that we procured. In the fourth quarter of 2017, we began to see the emergence of high acuity inpatient cases. We thought we had captured it in our reserves, but early in 2018, we saw some negative development in Washington related to high acuity inpatient. That trend continued for the first quarter date of service. I will tell you that inpatient cases are over $50,000 in total cost. The reported number of those cases increased by over 65% in the quarter. And I also think we dropped our guard a little bit on some of our utilization controls. In those cases hit the stop-loss threshold and revert to build charges you need intense concurrent review procedures and the resources to make sure that you're paying appropriate amounts. And I would say that our concurrent review resources in Washington will not keep pace with the additional volume. So we of course corrected that and we project Washington to have better performance in each of the next three quarters than we had in the first, but probably not back to our full year annual expectation.

Hey, guys. That's helpful. Thanks. And then, as you've brought in outside consultants to help with your RFP process. Can you contrast it all where you are now in that process as you look forward versus maybe when you were on the last quarter call and it sounded like you're just recently started engaging them?

Well, I think the way I would characterize the entire process has been reengineered not just with external resources, but now that we have new leadership of our health plan operations bringing more local knowledge and subject matter expertise there and writing the proposals. It's just a better and more robust process that it will get better with time. So it's been reengineered from the bottoms up and we have a high degree of confidence that our Texas, Washington and Puerto Rico bid submissions were written in a high-quality manner very responsive to what the state wanted to hear about our capabilities and service profile.

Yes, thank you. Good morning. My first question is about the guidance. It seems like you've included the full impact of the workforce reduction in the estimates, especially regarding the marketplace and Medicaid, with not much else considered for the PBM. You are around 35 basis points with an increase in your net margin guidance. I wanted to understand if, assuming everything goes well, you might achieve your original target net margins of 1.5 to 2 this year, and could you discuss the trajectory for 2019? Is there potential for any additional upside there with different strategies?

The way we think about it is, if you just ignore the $0.38 which are one-time operating items that we raised our guidance by $0.60 to $0.65, and we view that as a $0.40 beat on the first quarter. And $0.20, $0.25 raise on the rest for the year. That's just a cautious approach we're taking not only on marketplace, but across all our business lines, we want to see another quarter of positive experience emerge. As you know our previous guidance on net margin basis was 1.1 to 1.3. That's now 1.3 to 1.5 adjusted for the CSR. And if that's the starting point for a trajectory marching toward our 2% after-tax goal, we think that's a great starting point. And we'll talk more at Investor Day about what profit levers we will pull to make up the rest of the way. So, if we can hit it, it's a great starting place. Keep in mind that this is the year where we got the benefit of a tax rate decrease and premium rates were already set. So there could be some 'tax windfall' in our current profitability and we're mindful of that. But, if we could hit that net after-tax margin included in our guidance, a great starting place to get to our ultimate goal of 2%.

Okay, great. Thanks. On the risk adjustment, I noticed you had raised your payable estimate a little over $200 million from the fourth quarter and is that contemplate any third-party data with weekly, you said you have a new methodology? And is that assuming the 350,000-ish that you have now on marketplace membership and do you feel it's adequately conservative?

Sure. It's Joe White speaking. We continue to improve our methods for estimating risk adjustment liability. We have maintained our basic processes, including our internal estimates and third-party estimates, which we combine to create an estimate at any given time. However, we are taking a more conservative stance. This approach dates back to last year when we deemed it appropriate to be more cautious based on our experiences. Consequently, the balance has slightly increased this year due to our conservative strategy for 2018 and some adjustments from 2017. We feel confident in the current numbers.

Maybe one final one, on Florida with Region 11, you had the ITN, was this something partly driven even by you and that you didn't want to incur any more runoff G&A and the state reduced the rates as well or was something else that came up during the negotiation process that caused you to not…

First of all, we don't actually know yet why we were not awarded a contract in Region 11. We will potentially learn the reasons, but we don't know yet. But no, in full transparency, we went in attempting to secure the region, whether it be the service profile and rates. And we were not awarded the contract. So as we learn more, I will certainly communicate that. And as I said, we're pursuing all avenues available to us to learn why we weren’t selected and if there is anything we can do to reverse the decision?

Thank you and congratulations on a great quarter. You've mentioned a few times today that there are multiple points of conservatism in your guidance. You've flagged specifically development in tax, so just wanted to make sure, if there are any other points that you feel you're being conservative as you view guidance now. And then, can you frame up the potential tax windfall for us. I know that the tax rate is variable, but maybe you can help us with the framework around the scale of variability there?

Regarding the tax windfall, our preliminary guidance suggests about 40 basis points from the margin, assuming all else remains constant. This does not imply that it will be included in future rates. I want to emphasize that the premium rates were established prior to the tax regime change. We're taking a cautious and conservative approach across our entire portfolio, especially in the marketplace segment. I wouldn’t point to any specific product or region. While we experienced some outperformance this quarter, we did not anticipate that level of outperformance to continue for the rest of the year. Given our company's history of missing estimates and inaccurate forecasting, we prefer to remain cautious. However, with solid data from the second quarter, we expect to provide updated guidance at the end of the quarter that accurately reflects our expectations for the full year.

Great. You talked about hitting margin targets through achieving medical management with an eye on SG&A cost maybe using external vendors or rent-to-buy strategy. Then, today you announced the termination of utilization and care management project. So I'm wondering is that the start of outsourcing some of this analytics work and can you provide any details on to what the alternative plan is for the start of the new project.

Sure. The first thing I want to mention is that the technology platform we were implementing did not align with our goals and objectives. It was aimed at improving administrative efficiency, but it did not prioritize clinical effectiveness, utilization management, care management, and disease management. Our goal is to ensure that our business processes and technology platforms are focused on managing our members' health care effectively while maintaining a competitive medical loss ratio. If it ends up saving some overhead costs, that's a bonus. However, the platform we were rolling out was not aligned with this primary goal. We will not outsource our core proprietary care management functions, as they set us apart from our competitors. Our emerging strategy is centered on who can effectively manage high-acuity members better than others. While there may be technology and administrative processes that could be outsourced, the essential clinical functions of the company are proprietary and will continue to be owned and operated by Molina.

Hi, it's Joe White speaking. The impact of the IHSS carve-out in 2018 was already reflected in our preliminary guidance and isn't particularly substantial anyway.

Sorry. Yes, thank you. Could you just a question on Texas and the marketplace in particular, I just noticed you cited the Texas market particularly for improvement and yet there's also a market where your enrollment expanded where it dropped very significantly in some others. So I'm just trying to understand is that, it looks a little contrary to what I might have expected. What is it about the Texas situation that's different?

I think Texas, Matt, is simply a combination of two things. One, a very good and highly leveraged provider network and a stable risk pool. You have a combination of those two factors and you can actually make your target margins in this business with a great deal of predictability. And Texas has been the outstanding performer in the marketplace since we launched this business a few years ago and continues to be. So with 245,000 members up from 196,000, 197,000 last year, it's adding meaningfully to our earnings profile.

Great. And also if I can just confirm, I think you had suggested that both Florida and New Mexico are pretty sure New Mexico are running net unprofitable, is that correct?

Are you referring to the marketplace, Matt?

Oh, I'm sorry Joe. I was referring to overall.

Overall? New Mexico struggled on Medicaid due to higher behavioral costs, but did well in the marketplace. Florida did as expected as you know it was in our list of turnaround plans and it performed better in the first quarter than prior year and in line with our expectations and the marketplace did show signs of improvement in Florida.

Hi, good morning. Just a couple of questions. One just looking at the California revenue run rate, is that just going back to the in-home support services, is that 100 million plus revenue drop just pass-through and that's why the revenue is down, but the MLR is fine.

It's a combination. It's Joe speaking. Hi, Gary. It's a combination of that along with the fact we took a pretty substantial Medicaid expansion cut, I think in the neighborhood of 10% effective July last year. So it's those two factors.

Okay. And then that's great. That goes to my next question, when we look at the Medicaid expansion revenue is down about 8% versus enrollment down 3%, you took that cut in July, but the per member per month for Medicaid expansion were kind of flat to down slightly 3Q, 4Q now suddenly they are down a fair amount? It looks more like something happened in the first quarter or is there some nuance to that?

Not that I'm aware of that Gary. We'll have to go back and look at that. Again that we don't see the major cut was for Medicaid expansion in California was in July. So essentially if you have some of what you're talking about essentially a mix issue among the states.

Great. Thanks. Wanted to go back to the tax reform comments that you made sustainability when you mentioned the 40 basis points to margins from taxes, was that an overall benefit to the business in 2018 or is that a comment that that's kind of what potentially that risk because you look at just the exchange in the Medicare business and potentially seeing pricing pressure on that into next year?

Hi, Kevin. It's Joe White speaking. That's just basically an arithmetic calculation of moving from a 35% effective tax rate to 21% that 40% drop in the tax rate would move up 1.5% after-tax returns in the neighborhood of 1.8% and 2% to the neighborhood of 2.4%. So that just would apply to anybody measuring the tax benefit on an after-tax basis, is purely arithmetic going from 35% to 21%.

Is there a way for you to quantify the potential tax impact? I'm unclear about what you're assuming regarding the 2018 benefit that might be recovered by the states this year. Could you provide some insight into your expectations for tax-adjusted normalization? Additionally, do you have long-term tax rates in mind that might be recouped by the states? Where do you estimate your run rate earnings for this year to be? We want to understand the base number for this year, especially if there isn't a significant headwind affecting us next year.

Well, you have the right question, the question that needs to be answered that is, what's the rate setting process going to take into consideration going forward? And as you know we are rate takers in this business, taxes are not as explicitly cited in rate reconciliations, but they could be taken into consideration as states are projecting either what they're allowing for medical cost trend or management. Now that the 21% tax rate is in the run rate of the business, I think we can stop talking about it and talk about rate adequacy going forward. And we'll certainly give you a view of what potential stresses there are from rate adequacy going forward as we talk about our future on Investor Day and how much of that we can erode through profit improvement initiatives. As our MCRs, as you can see by our disclosure are still running much higher than our competitors. So there's plenty of room for opportunity.

Thank you all for joining us today. And we appreciate the time.