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EX-32.1 - EXHIBIT 32.1 - MOLINA HEALTHCARE INCc23602exv32w1.htm
EX-31.2 - EXHIBIT 31.2 - MOLINA HEALTHCARE INCc23602exv31w2.htm
Table of Contents

 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-Q
 
(Mark One)
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2011
Or
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number: 001-31719
 
Molina Healthcare, Inc.
(Exact name of registrant as specified in its charter)
     
Delaware
(State or other jurisdiction of
incorporation or organization)
  13-4204626
(I.R.S. Employer
Identification No.)
     
200 Oceangate, Suite 100    
Long Beach, California   90802
(Address of principal executive offices)   (Zip Code)
(562) 435-3666
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
             
Large accelerated filer o   Accelerated filer þ   Non-accelerated filer o   Smaller reporting company o
        (Do not check if a smaller reporting company)    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
The number of shares of the issuer’s Common Stock outstanding as of October 21, 2011, was approximately 45,696,400.
 
 

 

 


 

MOLINA HEALTHCARE, INC.
Index
         
       
 
       
       
 
       
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    51  
 
       
    52  
 
       
    53  
 
       
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT

 

 


Table of Contents

PART I — FINANCIAL INFORMATION
Item 1.  
Financial Statements.
MOLINA HEALTHCARE, INC.
CONSOLIDATED BALANCE SHEETS
                 
    September 30,     December 31,  
    2011     2010  
    (Amounts in thousands,  
    except per-share data)  
    (Unaudited)          
ASSETS
Current assets:
               
Cash and cash equivalents
  $ 487,492     $ 455,886  
Investments
    324,902       295,375  
Receivables
    180,039       168,190  
Income tax refundable
    5,781        
Deferred income taxes
    14,096       15,716  
Prepaid expenses and other current assets
    22,285       22,772  
 
           
Total current assets
    1,034,595       957,939  
Property and equipment, net
    127,657       100,537  
Deferred contract costs
    52,839       28,444  
Intangible assets, net
    84,495       105,500  
Goodwill and indefinite-lived intangible assets
    212,484       212,228  
Auction rate securities
    18,112       20,449  
Restricted investments
    50,494       42,100  
Receivable for ceded life and annuity contracts
    23,696       24,649  
Other assets
    13,932       17,368  
 
           
 
  $ 1,618,304     $ 1,509,214  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
               
Medical claims and benefits payable
  $ 361,055     $ 354,356  
Accounts payable and accrued liabilities
    141,688       137,930  
Deferred revenue
    101,701       60,086  
Income taxes payable
          13,176  
 
           
Total current liabilities
    604,444       565,548  
Long-term debt
    168,109       164,014  
Deferred income taxes
    22,948       16,235  
Liability for ceded life and annuity contracts
    23,696       24,649  
Other long-term liabilities
    17,287       19,711  
 
           
Total liabilities
    836,484       790,157  
 
           
Stockholders’ equity (1):
               
Common stock, $0.001 par value; 80,000 shares authorized; outstanding:
45,690 shares at September 30, 2011 and 45,463 shares at December 31, 2010
    46       45  
Preferred stock, $0.001 par value; 20,000 shares authorized, no shares issued and outstanding
           
Additional paid-in capital
    260,166       251,612  
Accumulated other comprehensive loss
    (1,762 )     (2,192 )
Retained earnings
    523,370       469,592  
 
           
Total stockholders’ equity
    781,820       719,057  
 
           
 
  $ 1,618,304     $ 1,509,214  
 
           
     
(1)  
All applicable share and per-share amounts reflect the retroactive effects of the three-for-two common stock split in the form of a stock dividend that was effective May 20, 2011.
See accompanying notes.

 

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Table of Contents

MOLINA HEALTHCARE, INC.
CONSOLIDATED STATEMENTS OF INCOME
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2011     2010     2011     2010  
    (Amounts in thousands, except  
    net income per share)  
    (Unaudited)  
Revenue:
                               
Premium revenue
  $ 1,138,230     $ 1,005,115     $ 3,348,438     $ 2,947,020  
Service revenue
    37,728       32,271       111,290       53,325  
Investment income
    764       1,760       3,804       4,880  
 
                       
Total revenue
    1,176,722       1,039,146       3,463,532       3,005,225  
 
                       
Expenses:
                               
Medical care costs
    959,158       845,937       2,822,049       2,508,366  
Cost of service revenue
    34,584       27,605       105,020       41,859  
General and administrative expenses
    99,610       88,660       290,967       245,619  
Premium tax expenses
    36,374       35,037       110,633       104,578  
Depreciation and amortization
    13,430       11,954       38,587       33,234  
 
                       
Total expenses
    1,143,156       1,009,193       3,367,256       2,933,656  
 
                       
Operating income
    33,566       29,953       96,276       71,569  
Interest expense
    4,380       4,600       11,666       12,056  
 
                       
Income before income taxes
    29,186       25,353       84,610       59,513  
Provision for income taxes
    10,236       9,180       30,832       22,171  
 
                       
Net income
  $ 18,950     $ 16,173     $ 53,778     $ 37,342  
 
                       
Net income per share (1):
                               
Basic
  $ 0.41     $ 0.38     $ 1.18     $ 0.94  
 
                       
Diluted
  $ 0.41     $ 0.38     $ 1.16     $ 0.93  
 
                       
Weighted average shares outstanding (1):
                               
Basic
    45,834       42,177       45,693       39,767  
 
                       
Diluted
    46,296       42,546       46,334       40,203  
 
                       
     
(1)  
All applicable share and per-share amounts reflect the retroactive effects of the three-for-two common stock split in the form of a stock dividend that was effective May 20, 2011.
See accompanying notes.

 

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Table of Contents

MOLINA HEALTHCARE, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2011     2010     2011     2010  
    (Amounts in thousands)  
    (Unaudited)  
Net income
  $ 18,950     $ 16,173     $ 53,778     $ 37,342  
Other comprehensive income, net of tax:
                               
Unrealized (loss) gain on investments
    (165 )     (68 )     430       (295 )
 
                       
Other comprehensive (loss) income
    (165 )     (68 )     430       (295 )
 
                       
Comprehensive income
  $ 18,785     $ 16,105     $ 54,208     $ 37,047  
 
                       
See accompanying notes.

 

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MOLINA HEALTHCARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
                 
    Nine Months Ended  
    September 30,  
    2011     2010  
    (Amounts in thousands)  
    (Unaudited)  
Operating activities:
               
Net income
  $ 53,778     $ 37,342  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    52,414       40,485  
Deferred income taxes
    8,069       4,463  
Stock-based compensation
    12,723       7,268  
Non-cash interest on convertible senior notes
    4,095       3,800  
Amortization of premium/discount on investments
    5,300       1,023  
Amortization of deferred financing costs
    2,451       1,278  
Unrealized gain on trading securities
          (4,170 )
Loss on rights agreement
          3,807  
Tax deficiency from employee stock compensation
    (647 )     (676 )
Changes in operating assets and liabilities:
               
Receivables
    (11,789 )     (64,896 )
Prepaid expenses and other current assets
    (1,819 )     (7,707 )
Medical claims and benefits payable
    6,699       33,347  
Accounts payable and accrued liabilities
    246       15,131  
Deferred revenue
    42,600       (64,337 )
Income taxes
    (18,957 )     3,327  
 
           
Net cash provided by operating activities
    155,163       9,485  
 
           
Investing activities:
               
Purchases of equipment
    (45,921 )     (31,918 )
Purchases of investments
    (258,209 )     (162,620 )
Sales and maturities of investments
    226,413       184,170  
Net cash paid in business combinations
    (3,253 )     (127,231 )
Increase in deferred contract costs
    (32,765 )     (20,616 )
Increase in restricted investments
    (8,394 )     (8,513 )
Change in other noncurrent assets and liabilities
    (533 )     2,340  
 
           
Net cash used in investing activities
    (122,662 )     (164,388 )
 
           
Financing activities:
               
Amount borrowed under credit facility
          105,000  
Proceeds from common stock offering, net of issuance costs
          111,246  
Repayment of amount borrowed under credit facility
          (105,000 )
Treasury stock purchases
    (7,000 )      
Credit facility fees paid
    (1,125 )     (1,671 )
Proceeds from employee stock plans
    5,640       1,862  
Excess tax benefits from employee stock compensation
    1,590       420  
 
           
Net cash (used in) provided by financing activities
    (895 )     111,857  
 
           
Net increase (decrease) in cash and cash equivalents
    31,606       (43,046 )
Cash and cash equivalents at beginning of period
    455,886       469,501  
 
           
Cash and cash equivalents at end of period
  $ 487,492     $ 426,455  
 
           
See accompanying notes.

 

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MOLINA HEALTHCARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS — (continued)
                 
    Nine Months Ended  
    September 30,  
    2011     2010  
    (Amounts in thousands)  
    (Unaudited)  
Supplemental cash flow information:
               
Cash paid during the period for:
               
Income taxes
  $ 43,550     $ 12,129  
 
           
Interest
  $ 5,026     $ 7,175  
 
           
Schedule of non-cash investing and financing activities:
               
Common stock used for stock-based compensation
  $ 3,751     $ 2,173  
 
           
Details of business combinations:
               
Increase in fair value of assets acquired
  $ (256 )   $ (161,862 )
(Decrease) increase in fair value of liabilities assumed
    (1,045 )     25,880  
(Decrease) increase in payable to seller
    (1,952 )     8,751  
 
           
Net cash paid in business combinations
  $ (3,253 )   $ (127,231 )
 
           
See accompanying notes.

 

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MOLINA HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 2011
1. Basis of Presentation
Organization and Operations
Molina Healthcare, Inc. provides quality and cost-effective Medicaid-related solutions to meet the health care needs of low-income families and individuals and to assist state agencies in their administration of the Medicaid program.
Our Health Plans segment comprises health plans in California, Florida, Michigan, Missouri, New Mexico, Ohio, Texas, Utah, Washington, and Wisconsin. As of September 30, 2011, these health plans served approximately 1.7 million members eligible for Medicaid, Medicare, and other government-sponsored health care programs for low-income families and individuals. The health plans are operated by our respective wholly owned subsidiaries in those states, each of which is licensed as a health maintenance organization, or HMO.
Our Molina Medicaid Solutions segment, which we acquired during the second quarter of 2010, provides business processing and information technology development and administrative services to Medicaid agencies in Idaho, Louisiana, Maine, New Jersey, and West Virginia, and drug rebate administration services in Florida.
On June 9, 2011, Molina Medicaid Solutions received notice from the state of Louisiana that the state intends to award our contract for a replacement Medicaid Management Information System, or MMIS, to another firm. Our revenue under the Louisiana MMIS contract from May 1, 2010, the date we acquired Molina Medicaid Solutions, through December 31, 2010, was approximately $32 million. For the nine months ended September 30, 2011, our revenue under the Louisiana MMIS contract was approximately $36 million. Until the replacement MMIS is designed, developed, and implemented, we will continue to perform under the existing MMIS contract, a period which we expect to last at least two years.
Consolidation and Interim Financial Information
The consolidated financial statements include the accounts of Molina Healthcare, Inc. and all majority owned subsidiaries. In the opinion of management, all adjustments considered necessary for a fair presentation of the results as of the date and for the interim periods presented have been included; such adjustments consist of normal recurring adjustments. All significant intercompany balances and transactions have been eliminated in consolidation. The consolidated results of operations for the current interim period are not necessarily indicative of the results for the entire year ending December 31, 2011. Financial information related to subsidiaries acquired during any year is included only for periods subsequent to their acquisition.
The unaudited consolidated interim financial statements have been prepared under the assumption that users of the interim financial data have either read or have access to our audited consolidated financial statements for the fiscal year ended December 31, 2010. Accordingly, certain disclosures that would substantially duplicate the disclosures contained in the December 31, 2010 audited consolidated financial statements have been omitted. These unaudited consolidated interim financial statements should be read in conjunction with our December 31, 2010 audited financial statements.
Adjustments and Reclassifications
We have adjusted all applicable share and per-share amounts to reflect the retroactive effects of the three-for-two stock split in the form of a stock dividend that was effective May 20, 2011.
We have reclassified certain amounts in the 2010 consolidated statement of cash flows to conform to the 2011 presentation.

 

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2. Significant Accounting Policies
Recognition of Service Revenue and Cost of Service Revenue — Molina Medicaid Solutions Segment
The payments received by our Molina Medicaid Solutions segment under its state contracts are based on the performance of three elements of service. The first of these is the design, development and implementation, or DDI, of a Medicaid Management Information System, or MMIS. The second element, following completion of the DDI element, is the operation of the MMIS under a business process outsourcing, or BPO, arrangement. While providing BPO services, we also provide the state with the third contracted element — training and IT support and hosting services (training and support).
Because they include these three elements of service, our Molina Medicaid Solutions contracts are multiple-element arrangements. The following discussion applies to our contracts with multiple elements entered into prior to January 1, 2011, before our prospective adoption of Accounting Standards Update, or ASU, No. 2009-13, Revenue Recognition (Accounting Standards Codification, or ASC, Topic 605) — Multiple-Deliverable Revenue Arrangements.
For those contracts entered into prior to January 1, 2011, we have no vendor specific objective evidence, or VSOE, of fair value for any of the individual elements in these contracts, and at no point in the contract will we have VSOE for the undelivered elements in the contract. We lack VSOE of the fair value of the individual elements of our Molina Medicaid Solutions contracts for the following reasons:
   
Each contract calls for the provision of its own specific set of products and services, which vary significantly between contracts; and
   
The nature of the MMIS installed varies significantly between our older contracts (proprietary mainframe systems) and our newer contracts (commercial off-the-shelf technology solutions).
The absence of VSOE within the context of a multiple element arrangement prior to January 1, 2011 requires us to delay recognition of any revenue for an MMIS contract until completion of the DDI phase of the contract. As a general principle, revenue recognition will therefore commence at the completion of the DDI phase, and all revenue will be recognized over the period that BPO services and training and support services are provided. Consistent with the deferral of revenue, recognition of all direct costs (such as direct labor, hardware, and software) associated with the DDI phase of our contracts is deferred until the commencement of revenue recognition. Deferred costs are recognized on a straight-line basis over the period of revenue recognition.
Provisions specific to each contract may, however, lead us to modify this general principle. In those circumstances, the right of the state to refuse acceptance of services, as well as the related obligation to compensate us, may require us to delay recognition of all or part of our revenue until that contingency (the right of the state to refuse acceptance) has been removed. In those circumstances we defer recognition of any revenue at risk (whether DDI, BPO services, or training and support services) until the contingency has been removed. When we defer revenue recognition we also defer recognition of incremental direct costs (such as direct labor, hardware, and software) associated with the revenue deferred. Such deferred contract costs are recognized on a straight-line basis over the period of revenue recognition.
However, direct costs in excess of the estimated future net revenues associated with a contract may not be deferred. In circumstances where estimated direct costs over the life of a contract exceed estimated future net revenues of that contract, the excess of direct costs over revenue is expensed as a period cost.
In Idaho, revenue recognition is expected to begin during the second half of 2012. Consistent with the deferral of revenue, we have deferred recognition of a portion of the direct contract costs associated with that revenue. Deferred contract costs, if any, deferred through the date revenue recognition begins will be recognized simultaneously with revenue. As noted above, direct costs in excess of the estimated future net revenues associated with a contract may not be deferred. For the three and nine months ended September 30, 2011, we recorded $2.5 million and $9.5 million, respectively, of direct contract costs associated with our Idaho contract. We were not able to defer these direct contract costs because estimated future net revenues as of each measurement date did not exceed estimated future direct costs of the contract. We currently expect the Idaho contract to perform financially at a break even basis through its initial term. So long as we continue to defer revenue recognition under the contract, we will also continue to defer direct costs associated with the agreement. If our break-even assumptions were to change, we may not be able to continue to defer direct contract costs.

 

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We began to recognize revenue and the related deferred costs associated with our Maine contract in September 2010.
Molina Medicaid Solutions’ deferred revenue was $53.1 million at September 30, 2011, and $10.9 million at December 31, 2010, and unamortized deferred contract costs were $52.8 million at September 30, 2011, and $28.4 million at December 31, 2010.
For all new or materially modified revenue arrangements with multiple elements entered into on or after January 1, 2011, we apply the guidance contained in ASU No. 2009-13. For these arrangements, we allocate total arrangement consideration to the elements of the arrangement, which are expected to be DDI, BPO, and training and support services, because this is consistent with the current elements included in our Molina Medicaid Solutions contracts. The arrangement allocation is performed using the relative selling-price method. When determining the selling price of each element, VSOE should first be used, if available. Since VSOE is unavailable under our contracts, we will attempt to use third-party evidence, or TPE, of vendors selling similar services to similarly situated customers on a standalone basis, if available. If TPE is not available, we use our best estimate of the selling price for each element.
We then evaluate whether, at each stage in the life cycle of the contract, we are able to recognize revenue associated with that element. To the extent that our revenue arrangements have provisions that allow our state customers to refuse acceptance of services performed, we are still required to defer revenue recognition until such state customers accept our performance. Once this acceptance is achieved, we immediately recognize the revenue associated with any delivered elements, which differs from our current practice for arrangements entered into prior to January 1, 2011, where the revenue associated with delivered elements is recognized over the final service element of the arrangement because VSOE for the other elements does not exist. As such, we expect that the adoption of ASU No. 2009-13 will result in an overall acceleration of revenue recognition with respect to any multiple-element arrangements entered into on or after January 1, 2011. We have entered into no new or materially modified revenue arrangements with multiple elements since January 1, 2011.
Premium Deficiency Reserve
We assess the profitability of each contract by state for providing medical care services to our members and identify any contracts where current operating results or forecasts indicate probable future losses. Anticipated future premiums are compared to anticipated medical care costs, including the cost of processing claims. If the anticipated future costs exceed the premiums, a loss contract accrual is recognized. In the first quarter of 2011, our Wisconsin health plan recorded a premium deficiency reserve in the amount of $3.35 million to medical claims and benefits payable. As of September 30, 2011, the reserve balance was zero.
Income Taxes
The provision for income taxes is determined using an estimated annual effective tax rate, which is generally greater than the U.S. federal statutory rate primarily because of state taxes. The effective tax rate may be subject to fluctuations during the year as new information is obtained. Such information may affect the assumptions used to estimate the annual effective tax rate, including factors such as the mix of pretax earnings in the various tax jurisdictions in which we operate, valuation allowances against deferred tax assets, the recognition or derecognition of tax benefits related to uncertain tax positions, and changes in or the interpretation of tax laws in jurisdictions where we conduct business. We recognize deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of our assets and liabilities, along with net operating loss and tax credit carryovers.
The total amount of unrecognized tax benefits was $10.9 million, and $11.0 million as of September 30, 2011 and December 31, 2010, respectively. Approximately $8.4 million of the unrecognized tax benefits recorded at September 30, 2011, relate to a tax position claimed on a state refund claim that will not result in a cash payment for income taxes if our claim is denied. The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate was $7.6 million as of September 30, 2011. We expect that during the next 12 months it is reasonably possible that unrecognized tax benefit liabilities may decrease by as much as $8.8 million due to the expiration of statute of limitations and the resolution to the state refund claim described above.

 

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Our continuing practice is to recognize interest and/or penalties related to unrecognized tax benefits in income tax expense. As of September 30, 2011, and December 31, 2010, we had accrued $61,000 and $82,000, respectively, for the payment of interest and penalties.
Recent Accounting Pronouncements
Revenue Recognition. In late 2009, the Financial Accounting Standards Board, or FASB, issued the following accounting guidance relating to revenue recognition. Effective for interim and annual reporting beginning on or after December 15, 2010, we adopted this guidance in full effective January 1, 2011.
   
ASU No. 2009-13, Revenue Recognition (ASC Topic 605) — Multiple-Deliverable Revenue Arrangements, a consensus of the FASB Emerging Issues Task Force. This guidance modifies previous requirements by requiring the use of the “best estimate of selling price” in the absence of vendor-specific objective evidence (“VSOE”) or verifiable objective evidence (“VOE”) (now referred to as “TPE” or third-party evidence) for determining the selling price of a deliverable. A vendor is now required to use its best estimate of the selling price when more objective evidence of the selling price cannot be determined. By providing an alternative for determining the selling price of deliverables, this guidance allows companies to allocate arrangement consideration in multiple deliverable arrangements in a manner that better reflects the transaction’s economics. In addition, the residual method of allocating arrangement consideration is no longer permitted under this new guidance. We have adopted this guidance effective January 1, 2011, and will apply it on a prospective basis for all new or materially modified revenue arrangements with multiple deliverables entered into on or after January 1, 2011. Because we did not enter into any new or materially modified agreements with multiple elements and fixed payments in the nine months ended September 30, 2011 that would have been impacted by this guidance, the adoption did not have a material impact on the timing or pattern of revenue recognition.
     
For the year ended December 31, 2010, there would have been no change in revenue recognized relating to multiple-element arrangements if we had adopted this guidance retrospectively for contracts entered into prior to January 1, 2011.
Goodwill Impairment Testing. The FASB issued the following guidance which modifies goodwill impairment testing.
   
ASU No. 2011-08, Intangibles—Goodwill and Other (ASC Topic 350) — Testing Goodwill for Impairment, a consensus of the FASB Emerging Issues Task Force. This guidance allows an entity the option to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under that option, an entity would no longer be required to calculate the fair value of a reporting unit unless the entity determines, based on the qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. We do not expect the adoption of this guidance to impact our consolidated financial position, results of operations or cash flows. This guidance is effective for interim and annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011.
   
ASU No. 2010-28, Intangibles—Goodwill and Other (ASC Topic 350) — When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts, a consensus of the FASB Emerging Issues Task Force. This guidance modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The adoption of this guidance did not impact our consolidated financial position, results of operations or cash flows. Effective for interim and annual reporting beginning on or after December 15, 2010, we adopted this guidance in full effective January 1, 2011.

 

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Presentation of Financial Statements. In June 2011, the FASB and International Accounting Standards Board, or IASB, issued the following guidance which modifies how other comprehensive income, or OCI, is reported under U.S. Generally Accepted Accounting Principles, or GAAP, and International Financial Reporting Standards, or IFRS. This guidance is effective for interim and annual reporting beginning on or after December 15, 2011.
   
ASU No. 2011-05, Comprehensive Income (ASC Topic 220) — Presentation of Comprehensive Income, a consensus of the FASB Emerging Issues Task Force. This guidance eliminates the option to present components of OCI as part of the statement of changes to stockholders’ equity. All filers are required to present all non-owner changes in stockholders’ equity in a single statement of comprehensive income or in two separate but consecutive statements. We do not expect the adoption of this guidance to impact our consolidated financial position, results of operations or cash flows.
Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the American Institute of Certified Public Accountants, or AICPA, and the Securities and Exchange Commission, or SEC, did not have, or are not believed by management to have, a material impact on our present or future consolidated financial statements.
3. Earnings per Share
The denominators for the computation of basic and diluted earnings per share were calculated as follows:
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2011     2010     2011     2010  
    (In thousands)  
Shares outstanding at the beginning of the period
    46,062       38,717       45,463       38,410  
Weighted-average number of shares repurchased
    (235 )           (160 )      
Weighted-average number of shares issued
    7       3,460       390       1,357  
 
                       
Denominator for basic earnings per share
    45,834       42,177       45,693       39,767  
Dilutive effect of employee stock options and stock grants (1)
    462       369       641       436  
 
                       
Denominator for diluted earnings per share (2)
    46,296       42,546       46,334       40,203  
 
                       
 
     
(1)  
Options to purchase common shares are included in the calculation of diluted earnings per share when their exercise prices are below the average fair value of the common shares for each of the periods presented. For the three months ended September 30, 2011, and 2010, there were approximately 316,000 and 708,000 antidilutive weighted options, respectively. For the nine months ended September 30, 2011, and 2010, there were approximately 126,000 and 738,000 antidilutive weighted options, respectively. Restricted shares are included in the calculation of diluted earnings per share when their grant date fair values are below the average fair value of the common shares for each of the periods presented. For the three months ended September 30, 2011 and 2010, there were approximately 57,000 and 9,000 antidilutive weighted restricted shares, respectively. For the nine months ended September 30, 2011 there were no antidilutive restricted shares. For the nine months ended September 30, 2010, there were approximately 9,000 antidilutive restricted shares.
 
(2)  
Potentially dilutive shares issuable pursuant to our convertible senior notes were not included in the computation of diluted earnings per share because to do so would have been anti-dilutive for the three month and nine month periods ended September 30, 2011 and 2010.

 

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4. Share-Based Compensation
At September 30, 2011, we had employee equity incentives outstanding under three plans: (1) the 2011 Equity Incentive Plan; (2) the 2002 Equity Incentive Plan; and (3) the 2000 Omnibus Stock and Incentive Plan (from which equity incentives are no longer awarded). On March 1, 2011, our chief executive officer, chief financial officer, and chief operating officer were awarded 150,000 shares, 112,500 shares, and 27,000 shares, respectively, of restricted stock with performance and service conditions. Each of the grants shall vest on March 1, 2012, provided that: (i) the Company’s total operating revenue for 2011 is equal to or greater than $3.7 billion, and (ii) the respective officer continues to be employed by the Company as of March 1, 2012. In the event both vesting conditions are not achieved, the equity compensation awards shall lapse. As of September 30, 2011, we expect these awards to vest in full.
Charged to general and administrative expenses, total stock-based compensation expense was as follows for the three month and nine month periods ended September 30, 2011 and 2010:
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2011     2010     2011     2010  
    (In thousands)  
Restricted stock awards
  $ 4,004     $ 2,367     $ 11,742     $ 6,113  
Stock options (including shares issued under our employee stock purchase plan)
    345       393       981       1,155  
 
                       
Total stock-based compensation expense
  $ 4,349     $ 2,760     $ 12,723     $ 7,268  
 
                       
As of September 30, 2011, there was $17.7 million of total unrecognized compensation expense related to unvested restricted stock awards, which we expect to recognize over a remaining weighted-average period of two years. As of September 30, 2011, there was no remaining unrecognized compensation expense related to unvested stock options.
Unvested restricted stock and restricted stock activity for the nine months ended September 30, 2011 is summarized below:
                 
            Weighted  
            Average  
            Grant Date  
    Shares     Fair Value  
Unvested balance as of December 31, 2010
    1,253,624     $ 15.55  
Granted
    759,300       23.52  
Vested
    (483,735 )     17.39  
Forfeited
    (69,531 )     15.44  
 
             
Unvested balance as of September 30, 2011
    1,459,658       19.09  
 
             
The total fair value of restricted shares granted during the nine months ended September 30, 2011 and 2010 was $17.9 million and $11.9 million, respectively. The total fair value of restricted shares vested during the nine months ended September 30, 2011 and 2010 was $11.5 million and $6.1 million, respectively.
Stock option activity for the nine months ended September 30, 2011 is summarized below:
                                 
                            Weighted  
            Weighted             Average  
            Average     Average     Remaining  
            Grant Date     Intrinsic     Contractual  
    Shares     Fair Value     Value     term  
                    (In thousands)     (Years)  
Stock options outstanding as of December 31, 2010
    770,421     $ 20.39                  
Exercised
    (185,672 )     19.23                  
Forfeited
    (21,700 )     21.45                  
 
                             
Stock options outstanding as of September 30, 2011
    563,049       20.74     $ 204       4.2  
 
                         
Stock options exercisable and expected to vest as of September 30, 2011
    562,965       20.74     $ 204       4.2  
 
                         
Exercisable as of September 30, 2011
    560,799       20.73     $ 204       4.2  
 
                         

 

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5. Fair Value Measurements
Our consolidated balance sheets include the following financial instruments: cash and cash equivalents, investments, receivables, trade accounts payable, medical claims and benefits payable, long-term debt, and other liabilities. We consider the carrying amounts of cash and cash equivalents, receivables, other current assets and current liabilities to approximate their fair value because of the relatively short period of time between the origination of these instruments and their expected realization or payment. For a comprehensive discussion of fair value measurements with regard to our current and non-current investments, see below.
The carrying amount of the convertible senior notes was $168.1 million and $164.0 million as of September 30, 2011, and December 31, 2010, respectively. Based on quoted market prices, the fair value of the convertible senior notes was approximately $179.2 million and $188.4 million as of September 30, 2011, and December 31, 2010, respectively.
To prioritize the inputs we use in measuring fair value, we apply a three-tier fair value hierarchy as follows:
 
Level 1 — Observable inputs such as quoted prices in active markets: Our Level 1 securities consist of government-sponsored enterprise securities (GSEs) and U.S. treasury notes. Level 1 securities are classified as current investments in the accompanying consolidated balance sheets. These securities are actively traded and therefore the fair value for these securities is based on quoted market prices on one or more securities exchanges.
 
 
Level 2 — Inputs other than quoted prices in active markets that are either directly or indirectly observable: Our Level 2 securities consist of corporate debt securities, municipal securities, and certificates of deposit, and are classified as current investments in the accompanying consolidated balance sheets. Our investments in securities classified as Level 2 are traded frequently though not necessarily daily. Fair value for these securities is determined using a market approach based on quoted prices for similar securities in active markets or quoted prices for identical securities in inactive markets.
 
 
Level 3 — Unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions: We hold investments in auction rate securities which are designated as available-for-sale, and are reported at fair value of $18.1 million (par value of $21.3 million) as of September 30, 2011. Our investments in auction rate securities are collateralized by student loan portfolios guaranteed by the U.S. government. We continued to earn interest on substantially all of these auction rate securities as of September 30, 2011. Due to events in the credit markets, the auction rate securities held by us experienced failed auctions beginning in the first quarter of 2008. As such, quoted prices in active markets were not readily available during the majority of 2008, 2009, and 2010, and continued to be unavailable as of September 30, 2011. To estimate the fair value of these securities, we used pricing models that included factors such as the collateral underlying the securities, the creditworthiness of the counterparty, the timing of expected future cash flows, and the expectation of the next time the security would have a successful auction. The estimated values of these securities were also compared, when possible, to valuation data with respect to similar securities held by other parties. We concluded that these estimates, given the lack of market available pricing, provided a reasonable basis for determining the fair value of the auction rate securities as of September 30, 2011. For our investments in auction rate securities, we do not intend to sell, nor is it more likely than not that we will be required to sell, these investments before recovery of their cost.
As a result of changes in the fair value of auction rate securities designated as available-for-sale, we recorded pretax unrealized gains of $0.9 million and pretax unrealized losses of $0.5 million to accumulated other comprehensive income (loss) for the nine months ended September 30, 2011, and 2010, respectively. Any future fluctuation in fair value related to these instruments that we deem to be temporary, including any recoveries of previous write-downs, would be recorded to accumulated other comprehensive income (loss). If we determine that any future valuation adjustment was other-than-temporary, we would record a charge to earnings as appropriate.

 

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Until July 2, 2010, we held certain auction rate securities (designated as trading securities) with an investment securities firm. In 2008, we entered into a rights agreement with this firm that (1) allowed us to exercise rights (the “Rights”) to sell the eligible auction rate securities at par value to this firm between June 30, 2010 and July 2, 2012, and (2) gave the investment securities firm the right to purchase the auction rate securities from us any time after the agreement date as long as we received the par value. On June 30, 2010, and July 1, 2010, all of the eligible auction rate securities remaining at that time were settled at par value. During 2010, the aggregate auction rate securities (designated as trading securities) settled amounted to $40.9 million par value (fair value $36.7 million). Substantially all of the difference between par value and fair value on these securities was recovered through the rights agreement. For the nine months ended September 30, 2010, we recorded pretax gains of $4.2 million on the auction rate securities underlying the Rights.
We accounted for the Rights as a freestanding financial instrument and, until July 2, 2010, recorded the value of the Rights under the fair value option. For the nine months ended September 30, 2010, we recorded pretax losses of $3.8 million on the Rights, attributable to the decline in the fair value of the Rights. When the remaining eligible auction rate securities were sold at par value on July 1, 2010, the value of the Rights was zero.
Our assets measured at fair value on a recurring basis at September 30, 2011, were as follows:
                                 
    Total     Level 1     Level 2     Level 3  
    (In thousands)  
Corporate debt securities
  $ 215,875     $     $ 215,875     $  
Government-sponsored enterprise securities (GSEs)
    45,224       45,224              
Municipal securities
    36,088             36,088        
U.S. treasury notes
    24,454       24,454              
Certificates of deposit
    3,261             3,261        
Auction rate securities
    18,112                   18,112  
 
                       
 
  $ 343,014     $ 69,678     $ 255,224     $ 18,112  
 
                       
In prior periods we reported our investments in corporate debt securities, municipal securities and certificates of deposit in Level 1. Upon re-evaluation of the inputs used to measure fair value within the fair value hierarchy, we have determined that these investments should be reported in Level 2, and have reclassified the tabular disclosure accordingly.
The following table presents our assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3):
         
    (Level 3)  
    (In thousands)  
Balance at December 31, 2010
  $ 20,449  
Total gains (realized or unrealized):
       
Included in other comprehensive income
    913  
Settlements
    (3,250 )
 
     
Balance at September 30, 2011
  $ 18,112  
 
     
 
       
The amount of total gains for the period included in other comprehensive income attributable to the change in unrealized gains relating to assets still held at September 30, 2011
  $ 913  
 
     
In 2010, we recorded a $2.8 million liability for contingent consideration related to the acquisition of our Wisconsin health plan. In the first quarter of 2011, we determined that there was no liability for contingent consideration relating to the acquisition. The liability for contingent consideration related to this acquisition was measured at fair value on a recurring basis using significant unobservable inputs (Level 3). The following table presents a roll forward of this liability for 2011:
         
    (Level 3)  
    (In thousands)  
Balance at December 31, 2010
  $ (2,800 )
Total gains included in earnings
    2,800  
 
     
Balance at September 30, 2011
  $  
 
     

 

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6. Investments
The following tables summarize our investments as of the dates indicated:
                                 
    September 30, 2011  
            Gross     Estimated  
            Unrealized     Fair  
    Cost     Gains     Losses     Value  
    (In thousands)  
Corporate debt securities
  $ 219,955     $ 98     $ 4,178     $ 215,875  
GSEs
    45,338       44       158       45,224  
Municipal securities (including non-current auction rate securities)
    57,477       165       3,442       54,200  
U.S. treasury notes
    24,323       136       5       24,454  
Certificates of deposit
    3,261                   3,261  
 
                       
 
  $ 350,354     $ 443     $ 7,783     $ 343,014  
 
                       
                                 
    December 31, 2010  
            Gross     Estimated  
            Unrealized     Fair  
    Cost     Gains     Losses     Value  
    (In thousands)  
Corporate debt securities
  $ 179,124     $ 193     $ 1,388     $ 177,929  
GSEs
    59,790       293       370       59,713  
Municipal securities (including non-current auction rate securities)
    55,247       78       4,313       51,012  
U.S. treasury notes
    23,864       114       60       23,918  
Certificates of deposit
    3,252                   3,252  
 
                       
 
  $ 321,277     $ 678     $ 6,131     $ 315,824  
 
                       
The contractual maturities of our investments as of September 30, 2011 are summarized below:
                 
            Estimated  
    Cost     Fair Value  
    (In thousands)  
Due in one year or less
  $ 159,060     $ 156,445  
Due one year through five years
    170,494       168,888  
Due after ten years
    20,800       17,681  
 
           
 
  $ 350,354     $ 343,014  
 
           
Gross realized gains and gross realized losses from sales of available-for-sale securities are calculated under the specific identification method and are included in investment income. Total proceeds from sales and maturities of available-for-sale securities were $105.0 million and $52.0 million for the three months ended September 30, 2011, and 2010, respectively. Total proceeds from sales and maturities of available-for-sale securities were $226.4 million and $143.3 million for the nine months ended September 30, 2011, and 2010, respectively. Net realized investment gains for the three months ended September 30, 2011, and 2010 were $153,000 and $21,000 respectively. Net realized investment gains for the nine months ended September 30, 2011, and 2010 were $331,000 and $81,000 respectively.
We monitor our investments for other-than-temporary impairment. For investments other than our municipal securities, we have determined that unrealized gains and losses at September 30, 2011, and December 31, 2010, are temporary in nature, because the change in market value for these securities has resulted from fluctuating interest rates, rather than a deterioration of the credit worthiness of the issuers. So long as we hold these securities to maturity, we are unlikely to experience gains or losses. In the event that we dispose of these securities before maturity, we expect that realized gains or losses, if any, will be immaterial.

 

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Approximately 33% of our investment in municipal securities consists of auction rate securities. As described in Note 5, “Fair Value Measurements,” the unrealized losses on these investments were caused primarily by the illiquidity in the auction markets. Because the decline in market value is not due to the credit quality of the issuers, and because we do not intend to sell, nor is it more likely than not that we will be required to sell, these investments before recovery of their cost, we do not consider the auction rate securities that are designated as available-for-sale to be other-than-temporarily impaired at September 30, 2011.
The following tables segregate those available-for-sale investments that have been in a continuous loss position for less than 12 months, and those that have been in a loss position for 12 months or more as of September 30, 2011.
                                                 
    In a Continuous Loss     In a Continuous Loss        
    Position     Position        
    for Less than 12 Months     for 12 Months or More     Total  
    Estimated             Estimated             Estimated        
    Fair     Unrealized     Fair     Unrealized     Fair     Unrealized  
    Value     Losses     Value     Losses     Value     Losses  
    (In thousands)  
Corporate debt securities
  $ 169,582     $ 3,625     $ 17,720     $ 553     $ 187,302     $ 4,178  
GSEs
    18,522       78       1,167       80       19,689       158  
Municipal securities
    22,731       188       21,055       3,254       43,786       3,442  
U.S. treasury notes
    4,705       5                   4,705       5  
 
                                   
 
  $ 215,540     $ 3,896     $ 39,942     $ 3,887     $ 255,482     $ 7,783  
 
                                   
The following table segregates those available-for-sale investments that have been in a continuous loss position for less than 12 months, and those that have been in a loss position for 12 months or more as of December 31, 2010.
                                                 
    In a Continuous Loss     In a Continuous Loss        
    Position     Position        
    for Less than 12 Months     for 12 Months or More     Total  
    Estimated             Estimated             Estimated        
    Fair     Unrealized     Fair     Unrealized     Fair     Unrealized  
    Value     Losses     Value     Losses     Value     Losses  
    (In thousands)  
Corporate debt securities
  $ 103,225     $ 1,060     $ 10,490     $ 328     $ 113,715     $ 1,388  
GSEs
    13,014       71       7,539       299       20,553       370  
Municipal securities
    18,884       117       25,271       4,196       44,155       4,313  
U.S. treasury notes
    5,480       40       6,806       20       12,286       60  
 
                                   
 
  $ 140,603     $ 1,288     $ 50,106     $ 4,843     $ 190,709     $ 6,131  
 
                                   
7. Receivables
Health Plans segment receivables consist primarily of amounts due from the various states in which we operate. Such receivables are subject to potential retroactive adjustment. Because all of our receivable amounts are readily determinable and our creditors are in almost all instances state governments, our allowance for doubtful accounts is immaterial. Any amounts determined to be uncollectible are charged to expense when such determination is made. Accounts receivable were as follows:
                 
    September 30,     December 31,  
    2011     2010  
    (In thousands)  
Health Plans segment:
               
California
  $ 31,742     $ 46,482  
Michigan
    11,265       13,596  
Missouri
    24,025       22,841  
New Mexico
    9,722       18,310  
Ohio
    27,901       21,622  
Washington
    11,766       14,486  
Wisconsin
    7,777       5,437  
Others
    7,029       5,187  
 
           
Total Health Plans segment
    131,227       147,961  
Molina Medicaid Solutions segment
    48,812       20,229  
 
           
 
  $ 180,039     $ 168,190  
 
           

 

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During the second quarter of 2011, we settled certain claims we had made against the state of Utah regarding the savings share provision of our contract in effect from 2003 through June of 2009. Additionally, we recognized a liability for certain overpayments received from the state for the period 2003 through 2009. As a result of these developments, we recognized $6.9 million in premium revenue without any corresponding charge to expense during the second quarter of 2011.
8. Restricted Investments
Pursuant to the regulations governing our Health Plan subsidiaries, we maintain statutory deposits and deposits required by state Medicaid authorities in certificates of deposit and U.S. treasury securities. Additionally, we maintain restricted investments as protection against the insolvency of certain capitated providers. The following table presents the balances of restricted investments by health plan, and for our insurance company:
                 
    September 30,     December 31,  
    2011     2010  
    (In thousands)  
California
  $ 372     $ 372  
Florida
    8,196       4,508  
Insurance Company
    4,672       4,689  
Michigan
    1,000       1,000  
Missouri
    505       508  
New Mexico
    15,902       15,881  
Ohio
    9,077       9,066  
Texas
    3,500       3,501  
Utah
    2,799       1,279  
Washington
    151       151  
Wisconsin
          260  
Other
    4,320       885  
 
           
 
  $ 50,494     $ 42,100  
 
           
The contractual maturities of our held-to-maturity restricted investments as of September 30, 2011 are summarized below.
                 
    Amortized     Estimated  
    Cost     Fair Value  
    (In thousands)  
Due in one year or less
  $ 45,281     $ 45,292  
Due one year through five years
    5,213       5,266  
 
           
 
  $ 50,494     $ 50,558  
 
           

 

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9. Long-Term Debt
Credit Facility
On September 9, 2011, we entered into a credit agreement for a $170 million revolving credit facility (the “Credit Facility”) with various lenders and U.S. Bank National Association, as LC Issuer, Swing Line Lender, and Administrative Agent. The Credit Facility will be used for general corporate purposes.
The Credit Facility has a term of five years under which all amounts outstanding will be due and payable on September 9, 2016. Subject to obtaining commitments from existing or new lenders and satisfaction of other specified conditions, we may increase the Credit Facility to up to $195 million. As of September 30, 2011 there was no outstanding principal balance under the Credit Facility. However, as of September 30, 2011, our lenders had issued two letters of credit in the aggregate principal amount of $10.3 million in connection with the Molina Medicaid Solutions contracts with the states of Maine and Idaho, which reduces the amount available under the Credit Facility.
Borrowings under the Credit Facility will bear interest based, at our election, on the base rate plus an applicable margin or the Eurodollar rate. The base rate is, for any day, a rate of interest per annum equal to the highest of (i) the prime rate of interest announced from time to time by U.S. Bank or its parent, (ii) the sum of the federal funds rate for such day plus 0.50% per annum and (iii) the Eurodollar rate (without giving effect to the applicable margin) for a one month interest period on such day (or if such day is not a business day, the immediately preceding business day) plus 1.00%. The Eurodollar rate is a reserve adjusted rate at which Eurodollar deposits are offered in the interbank Eurodollar market plus an applicable margin. In addition to interest payable on the principal amount of indebtedness outstanding from time to time under the Credit Facility, we are required to pay a quarterly commitment fee of 0.25% to 0.50% (based upon our leverage ratio) of the unused amount of the lenders’ commitments under the Credit Facility. The initial commitment fee shall be set at 0.35% until our delivery of its financials for the quarter ended September 30, 2011. The applicable margins range between 0.75% to 1.75% for base rate loans and 1.75% to 2.75% for Eurodollar loans, in each case, based upon our leverage ratio.
Our obligations under the Credit Facility are secured by a lien on substantially all of our assets, with the exception of certain of our real estate assets, and by a pledge of the capital stock or membership interests of our operating subsidiaries and health plans (with the exception of the California health plan).
The Credit Facility includes usual and customary covenants for credit facilities of this type, including covenants limiting liens, mergers, asset sales, other fundamental changes, debt, acquisitions, dividends and other distributions, capital expenditures, and investments. The Credit Facility also requires us to maintain a ratio of total consolidated debt to total consolidated EBITDA of not more than 2.75 to 1.00 as of the end of each fiscal quarter and a fixed charge coverage ratio of not less than 1.75 to 1.00. At September 30, 2011, we were in compliance with all financial covenants under the Credit Facility.
In the event of a default, including cross-defaults relating to specified other debt in excess of $20 million, the lenders may terminate the commitments under the Credit Facility and declare the amounts outstanding, including all accrued interest and unpaid fees, payable immediately. In addition, the lenders may enforce any and all rights and remedies created under the Credit Facility or applicable law.
In connection with our entrance into the Credit Facility, on September 9, 2011, we terminated our existing credit agreement with Bank of America, dated March 9, 2005, as amended to date, which had provided us with a $150 million revolving credit facility. As of September 30, 2011 and December 31, 2010, there was no outstanding principal balance under this credit agreement.
Convertible Senior Notes
As of September 30, 2011, $187.0 million in aggregate principal amount of our 3.75% Convertible Senior Notes due 2014 (the “Notes”) remain outstanding. The Notes rank equally in right of payment with our existing and future senior indebtedness. The Notes are convertible into cash and, under certain circumstances, shares of our common stock. The initial conversion rate is 31.9601 shares of our common stock per one thousand dollar principal amount of the Notes. This represents an initial conversion price of approximately $31.29 per share of our common stock. In addition, if certain corporate transactions that constitute a change of control occur prior to maturity, we will increase the conversion rate in certain circumstances.

 

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The proceeds from the issuance of the Notes have been allocated between a liability component and an equity component. We have determined that the effective interest rate of the Notes is 7.5%, principally based on the seven-year U.S. treasury note rate as of the October 2007 issuance date, plus an appropriate credit spread. The resulting debt discount is being amortized over the period the Notes are expected to be outstanding, as additional non-cash interest expense. As of September 30, 2011, we expect the Notes to be outstanding until their October 1, 2014 maturity date, for a remaining amortization period of 36 months. The Notes’ if-converted value did not exceed their principal amount as of September 30, 2011. At September 30, 2011, the equity component of the Notes, net of the impact of deferred taxes, was $24.0 million. The following table provides the details of the liability amounts recorded:
                 
    As of     As of  
    September 30,     December 31,  
    2011     2010  
    (In thousands)  
Details of the liability component:
               
Principal amount
  $ 187,000     $ 187,000  
Unamortized discount
    (18,891 )     (22,986 )
 
           
Net carrying amount
  $ 168,109     $ 164,014  
 
           
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2011     2010     2011     2010  
    (In thousands)  
Interest cost recognized for the period relating to the:
                               
Contractual interest coupon rate of 3.75%
  $ 1,753     $ 1,753     $ 5,259     $ 5,259  
Amortization of the discount on the liability component
    1,384       1,291       4,095       3,800  
 
                       
Total interest cost recognized
  $ 3,137     $ 3,044     $ 9,354     $ 9,059  
 
                       
10. Stockholders’ Equity
Securities Repurchase Program. Effective as of October 26, 2011, our board of directors has authorized the repurchase of $75 million in aggregate of either our common stock or our convertible senior notes due 2014 (see Note 9, “Long-Term Debt”). The repurchase program will be funded with working capital or the Company’s credit facility, and repurchases may be made from time to time on the open market or through privately negotiated transactions. The repurchase program extends through October 25, 2012, but the Company reserves the right to suspend or discontinue the program at any time.
On July 27, 2011, our board of directors approved a stock repurchase program of up to $7 million to be used to purchase shares of our common stock under a Rule 10b5-1 trading plan. Under this program, we purchased approximately 400,000 shares of our common stock for $7 million (average cost of approximately $17.47 per share) during August 2011. These purchases did not materially impact diluted earnings per share for the three months or nine months ended September 30, 2011. Subsequently, we retired the $7.0 million of treasury shares purchased, which reduced additional paid-in capital as of September 30, 2011.
Stock Split. On April 27, 2011, we announced that our board of directors authorized a 3-for-2 stock split of our common stock to be effected in the form of a stock dividend of one share of our stock for every two shares outstanding. The dividend was distributed on May 20, 2011.
Stock Plans. In connection with the plans described in Note 4, “Share-Based Compensation,” we issued approximately 627,000 shares of common stock, net of shares used to settle employees’ income tax obligations, for the nine months ended September 30, 2011. Stock plan activity resulted in a $15.6 million increase to additional paid-in capital for the same period.

 

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11. Segment Reporting
Our reportable segments are consistent with how we manage the business and view the markets we serve. In the second quarter of 2010, we added a segment to our internal financial reporting structure as a result of the acquisition of Molina Medicaid Solutions. We report our financial performance based on two reportable segments: Health Plans and Molina Medicaid Solutions.
We rely on an internal management reporting process that provides segment information to the operating income level for purposes of making financial decisions and allocating resources. The accounting policies of the segments are the same as those described in Note 2, “Significant Accounting Policies.” The cost of services shared between the Health Plans and Molina Medicaid Solutions segments is charged to the Health Plans segment.
Molina Medicaid Solutions was acquired on May 1, 2010; therefore, the nine months ended September 30, 2010 include only five months of operating results for this segment. Operating segment revenues and profitability for the three months and nine months ended September 30, 2011 and 2010 were as follows:
                         
            Molina        
            Medicaid        
    Health Plans     Solutions     Total  
    (In thousands)  
Three months ended September 30, 2011
                       
Premium revenue
  $ 1,138,230     $     $ 1,138,230  
Service revenue
          37,728       37,728  
Investment income
    764             764  
 
                 
Total revenue
  $ 1,138,994     $ 37,728     $ 1,176,722  
 
                 
Operating income (loss)
  $ 33,773     $ (207 )   $ 33,566  
 
                 
 
                       
Nine months ended September 30, 2011
                       
Premium revenue
  $ 3,348,438     $     $ 3,348,438  
Service revenue
          111,290       111,290  
Investment income
    3,804             3,804  
 
                 
Total revenue
  $ 3,352,242     $ 111,290     $ 3,463,532  
 
                 
Operating income (loss)
  $ 100,273     $ (3,997 )   $ 96,276  
 
                 
 
                       
Three months ended September 30, 2010
                       
Premium revenue
  $ 1,005,115     $     $ 1,005,115  
Service revenue
          32,271       32,271  
Investment income
    1,760             1,760  
 
                 
Total revenue
  $ 1,006,875     $ 32,271     $ 1,039,146  
 
                 
Operating income
  $ 28,796     $ 1,157     $ 29,953  
 
                 
 
                       
Nine months ended September 30, 2010
                       
Premium revenue
  $ 2,947,020     $     $ 2,947,020  
Service revenue
          53,325       53,325  
Investment income
    4,880             4,880  
 
                 
Total revenue
  $ 2,951,900     $ 53,325     $ 3,005,225  
 
                 
Operating income
  $ 65,407     $ 6,162     $ 71,569  
 
                 

 

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Reconciliation to Income before Income Taxes
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2011     2010     2011     2010  
    (In thousands)  
Segment operating income
  $ 33,566     $ 29,953     $ 96,276     $ 71,569  
Interest expense
    4,380       4,600       11,666       12,056  
 
                       
Income before income taxes
  $ 29,186     $ 25,353     $ 84,610     $ 59,513  
 
                       
Segment Assets
                         
            Molina        
            Medicaid        
    Health Plans     Solutions     Total  
    (In thousands)  
As of September 30, 2011
  $ 1,389,940     $ 228,364     $ 1,618,304  
 
                 
As of December 31, 2010
  $ 1,333,599     $ 175,615     $ 1,509,214  
 
                 
12. Commitments and Contingencies
Legal
The health care industry is subject to numerous laws and regulations of federal, state, and local governments. Compliance with these laws and regulations can be subject to government review and interpretation, as well as regulatory actions unknown and unasserted at this time. Penalties associated with violations of these laws and regulations include significant fines, exclusion from participating in publicly funded programs, and the repayment of previously billed and collected revenues.
We are involved in various legal actions in the normal course of business, some of which seek monetary damages, including claims for punitive damages, which are not covered by insurance. These actions, when finally concluded and determined, are not likely, in our opinion, to have a material adverse effect on our business, consolidated financial position, cash flows, or results of operations.
Provider Claims
Many of our medical contracts are complex in nature and may be subject to differing interpretations regarding amounts due for the provision of various services. Such differing interpretations have led certain medical providers to pursue us for additional compensation. The claims made by providers in such circumstances often involve issues of contract compliance, interpretation, payment methodology, and intent. These claims often extend to services provided by the providers over a number of years.
Various providers have contacted us seeking additional compensation for claims that we believe to have been settled. These matters, when finally concluded and determined, will not, in our opinion, have a material adverse effect on our business, consolidated financial position, results of operations, or cash flows.
Regulatory Capital and Dividend Restrictions
Our health plans are subject to state laws and regulations that, among other things, require the maintenance of minimum levels of statutory capital, as defined by each state, and restrict the timing, payment, and amount of dividends and other distributions that may be paid to us as the sole stockholder. To the extent the subsidiaries must comply with these regulations, they may not have the financial flexibility to transfer funds to us. The net assets in these subsidiaries (after intercompany eliminations) which may not be transferable to us in the form of loans, advances, or cash dividends was $456.2 million at September 30, 2011, and $397.8 million at December 31, 2010.
The National Association of Insurance Commissioners, or NAIC, adopted rules effective December 31, 1998, which, if implemented by the states, set minimum capitalization requirements for insurance companies, HMOs, and other entities bearing risk for health care coverage. The requirements take the form of risk-based capital (RBC) rules. Michigan, Missouri, New Mexico, Ohio, Texas, Utah, Washington, and Wisconsin have adopted these rules, which may vary from state to state. California and Florida have not yet adopted NAIC risk-based capital requirements for HMOs and have not formally given notice of their intention to do so. Such requirements, if adopted by California and Florida, may increase the minimum capital required for those states.

 

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As of September 30, 2011, our health plans had aggregate statutory capital and surplus of approximately $463.1 million compared with the required minimum aggregate statutory capital and surplus of approximately $273.9 million. All of our health plans were in compliance with the minimum capital requirements at September 30, 2011. We have the ability and commitment to provide additional capital to each of our health plans when necessary to ensure that statutory capital and surplus continue to meet regulatory requirements.
13. Related Party Transactions
We have an equity investment in a medical service provider that provides certain vision services to our members. We account for this investment under the equity method of accounting because we have an ownership interest in the investee that confers significant influence over operating and financial policies of the investee. As of September 30, 2011, and December 31, 2010, our carrying amount for this investment amounted to $3.9 million, and $3.8 million, respectively. For the three months ended September 30, 2011 and 2010, we paid $5.0 million, and $6.0 million, respectively, for medical service fees to this provider. For the nine months ended September 30, 2011 and 2010, we paid $16.8 million, and $15.7 million, respectively, for medical service fees to this provider.
14. Subsequent Events
Effective as of October 26, 2011, our board of directors has authorized the repurchase of $75 million in aggregate of either our common stock or our convertible senior notes due 2014 (see Note 9, “Long-Term Debt”). The repurchase program will be funded with working capital or the Company’s credit facility, and repurchases may be made from time to time on the open market or through privately negotiated transactions. The repurchase program extends through October 25, 2012, but the Company reserves the right to suspend or discontinue the program at any time.

 

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Item 2.  
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Forward Looking Statements
This quarterly report on Form 10-Q contains forward-looking statements regarding our business, financial condition and results of operations within the meaning of Section 27A of the Securities Act of 1933, or Securities Act, and Section 21E of the Securities Exchange Act of 1934, or Securities Exchange Act. We intend such forward-looking statements to be covered by the safe harbour provisions for forward-looking statements contained in the Private Securities Litigation reform Act of 1995, and we are including this statement for purposes of complying with these safe harbour provisions. All statements, other than statements of historical facts, included in this quarterly report may be deemed to be forward-looking statements for purposes of the Securities Act and the Securities Exchange Act. Without limiting the foregoing, we use the words “anticipate(s),” “believe(s),” “estimate(s),” “expect(s),” “intend(s),” “may,” “plan(s),” “project(s),” “will,” “would,” “could,” “should” and similar expressions to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We cannot guarantee that we will actually achieve the plans, intentions, or expectations disclosed in our forward-looking statements and, accordingly, you should not place undue reliance on our forward-looking statements. There are a number of important factors that could cause actual results or events to differ materially from the forward-looking statements that we make. You should read these factors and the other cautionary statements as being applicable to all related forward-looking statements wherever they appear in this quarterly report. We caution you that we do not undertake any obligation to update forward-looking statements made by us. Forward-looking statements involve known and unknown risks and uncertainties that may cause our actual results in future periods to differ materially from those projected, estimated, expected, or contemplated as a result of, but not limited to, risk factors related to the following:
 
significant budget pressures on state governments which cause them to lower rates unexpectedly or to rescind expected rates increases, or their failure to maintain existing benefit packages or membership eligibility thresholds or criteria;
 
uncertainties regarding the impact of the Patient Protection and Affordable Care Act, including its possible repeal, judicial overturning of the individual insurance mandate or Medicaid expansion, the effect of various implementing regulations, and uncertainties regarding the impact of other federal or state health care and insurance reform measures;
 
management of our medical costs, including costs associated with unexpectedly severe or widespread illnesses such as influenza, and rates of utilization that are consistent with our expectations;
 
the success of our efforts to retain existing government contracts and to obtain new government contracts in connection with state requests for proposals (RFPs) in both existing and new states (including in Washington, Ohio, and Missouri), and our ability to grow our revenues consistent with our expectations;
 
the accurate estimation of incurred but not reported medical costs across our health plans;
 
risks associated with the continued growth in new Medicaid and Medicare enrollees;
 
retroactive adjustments to premium revenue or accounting estimates which require adjustment based upon subsequent developments, including the California rate cut expected to be retroactive to July 1, 2011, and Medicaid pharmaceutical rebates;
 
the continuation and renewal of the government contracts of both our health plans and Molina Medicaid Solutions and the terms under which such contracts are renewed;
 
the timing of receipt and recognition of revenue and the amortization of expense under the state contracts of Molina Medicaid Solutions in Maine and Idaho;

 

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reductions to revenue, additional administrative costs and the potential payment of additional amounts to providers and/or the state by Molina Medicaid Solutions as a result of MMIS implementation issues in Maine and/or Idaho;
 
government audits and reviews, including the audit of our Medicare plans by the Centers for Medicare and Medicaid Services, or CMS;
 
changes with respect to our provider contracts and the loss of providers;
 
the establishment, interpretation, and implementation of a federal or state medical cost expenditure floor as a percentage of the premiums we receive, administrative cost and profit ceilings, and profit sharing arrangements;
 
the interpretation and implementation of at-risk premium rules regarding the achievement of certain quality measures;
 
the successful integration of our acquisitions;
 
approval by state regulators of dividends and distributions by our health plan subsidiaries;
 
changes in funding under our contracts as a result of regulatory changes, programmatic adjustments, or other reforms;
 
high dollar claims related to catastrophic illness;
 
the favorable resolution of litigation, arbitration, or administrative proceedings, and the costs associated therewith;
 
restrictions and covenants in our credit facility;
 
the relatively small number of states in which we operate health plans;
 
the availability of financing to fund and capitalize our acquisitions and start-up activities and to meet our liquidity needs and the costs and fees associated therewith;
 
a state’s failure to renew its federal Medicaid waiver;
 
an inadvertent unauthorized disclosure of protected health information by us or our business associates;
 
changes generally affecting the managed care or Medicaid management information systems industries;
 
increases in government surcharges, taxes, and assessments;
 
changes in general economic conditions, including unemployment rates.
Investors should refer to Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2010, as updated in Part II, Item 1A—Risk Factors, in our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2011 and in Part II, Item 1A—Risk Factors, of this report for a discussion of certain risk factors that could materially affect our business, financial condition, cash flows, or results of operations. Given these risks and uncertainties, we can give no assurance that any results or events projected or contemplated by our forward-looking statements will in fact occur.
This document and the following discussion of our financial condition and results of operations should be read in conjunction with the accompanying consolidated financial statements and the notes to those statements appearing elsewhere in this report and the audited financial statements and Management’s Discussion and Analysis appearing in our Annual Report on Form 10-K for the year ended December 31, 2010.
Adjustments
We have adjusted all applicable share and per-share amounts to reflect the retroactive effects of the three-for-two stock split in the form of a stock dividend that was effective May 20, 2011.

 

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Overview
Molina Healthcare, Inc. provides quality and cost-effective Medicaid-related solutions to meet the health care needs of low-income families and individuals, and to assist state agencies in their administration of the Medicaid program. Our business comprises our Health Plans segment, consisting of licensed health maintenance organizations serving Medicaid populations in ten states, and our Molina Medicaid Solutions segment, which provides design, development, implementation, and business process outsourcing solutions to Medicaid agencies in an additional five states. We also have a direct delivery business that currently consists of primary care community clinics in California and Washington; additionally, we manage three county-owned primary care clinics under a contract with Fairfax County, Virginia.
We report our financial performance based on the following two reportable segments: Health Plans; and Molina Medicaid Solutions.
Our Health Plans segment comprises health plans in California, Florida, Michigan, Missouri, New Mexico, Ohio, Texas, Utah, Washington, and Wisconsin, and includes our direct delivery business. This segment served approximately 1.7 million members eligible for Medicaid, Medicare, and other government-sponsored health care programs for low-income families and individuals as of September 30, 2011. The health plans are operated by our respective wholly owned subsidiaries in those states, each of which is licensed as a health maintenance organization, or HMO.
On May 1, 2010, we acquired a health information management business which we now operate under the name, Molina Medicaid SolutionsSM. Our Molina Medicaid Solutions segment provides design, development, implementation, and business process outsourcing solutions to state governments for their Medicaid Management Information Systems, or MMIS. MMIS is a core tool used to support the administration of state Medicaid and other health care entitlement programs. Molina Medicaid Solutions currently holds MMIS contracts with the states of Idaho, Louisiana, Maine, New Jersey, and West Virginia, as well as a contract to provide drug rebate administration services for the Florida Medicaid program.
Composition of Revenue and Membership
Health Plans Segment
Our Health Plans segment derives its revenue, in the form of premiums, chiefly from Medicaid contracts with the states in which our health plans operate. Premium revenue is fixed in advance of the periods covered and, except as described in “Critical Accounting Policies” below, is not generally subject to significant accounting estimates. For the nine months ended September 30, 2011, we received approximately 94% of our premium revenue as a fixed amount per member per month, or PMPM, pursuant to our Medicaid contracts with state agencies, our Medicare contracts with the Centers for Medicare and Medicaid Services, or CMS, and our contracts with other managed care organizations for which we operate as a subcontractor. These premium revenues are recognized in the month that members are entitled to receive health care services. The state Medicaid programs and the federal Medicare program periodically adjust premium rates.
For the nine months ended September 30, 2011, we received approximately 6% of our premium revenue in the form of “birth income” — a one-time payment for the delivery of a child — from the Medicaid programs in all of our state health plans except New Mexico. Such payments are recognized as revenue in the month the birth occurs.
The amount of the premiums paid to us may vary substantially between states and among various government programs. PMPM premiums for the Children’s Health Insurance Program, or CHIP, members are generally among our lowest, with rates as low as approximately $75 PMPM in California. Premium revenues for Medicaid members are generally higher. Among the Temporary Assistance for Needy Families, or TANF, Medicaid population — the Medicaid group that includes mostly mothers and children — PMPM premiums range between approximately $110 in California to $250 in Missouri. Among our Medicaid Aged, Blind or Disabled, or ABD, membership, PMPM premiums range from approximately $325 in Utah to $1,000 in Ohio. Contributing to the variability in Medicaid rates among the states is the practice of some states to exclude certain benefits from the managed care contract (most often pharmacy, inpatient, behavioral health and catastrophic case benefits) and retain responsibility for those benefits at the state level. Medicare membership generates the highest PMPM premiums, at approximately $1,200 PMPM.

 

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The following table sets forth the approximate total number of members by state health plan as of the dates indicated:
                                 
    September 30,     June 30,     December 31,     September 30,  
    2011     2011     2010     2010  
Total Ending Membership by Health Plan:
                               
California
    350,000       348,000       344,000       349,000  
Florida
    67,000       66,000       61,000       57,000  
Michigan
    217,000       220,000       227,000       225,000  
Missouri
    78,000       80,000       81,000       79,000  
New Mexico
    89,000       89,000       91,000       91,000  
Ohio
    256,000       245,000       245,000       241,000  
Texas
    148,000       129,000       94,000       96,000  
Utah
    82,000       82,000       79,000       78,000  
Washington
    350,000       345,000       355,000       353,000  
Wisconsin (1)
    41,000       41,000       36,000       28,000  
 
                       
Total
    1,678,000       1,645,000       1,613,000       1,597,000  
 
                       
Total Ending Membership by State for our Medicare Advantage Plans (1):
                               
California
    6,500       6,000       4,900       4,300  
Florida
    700       600       500       500  
Michigan
    7,600       7,100       6,300       5,700  
New Mexico
    800       700       600       600  
Ohio
    100       200              
Texas
    600       600       700       600  
Utah
    7,400       7,000       8,900       8,600  
Washington
    4,500       4,000       2,600       2,300  
 
                       
Total
    28,200       26,200       24,500       22,600  
 
                       
Total Ending Membership by State for our Aged, Blind or Disabled Population:
                               
California
    23,700       17,000       13,900       13,500  
Florida
    10,400       10,300       10,000       9,500  
Michigan
    31,600       31,600       31,700       31,400  
New Mexico
    5,600       5,600       5,700       5,700  
Ohio
    29,900       28,700       28,200       27,900  
Texas
    61,800       52,000       19,000       18,900  
Utah
    8,300       8,300       8,000       7,900  
Washington
    4,700       4,400       4,000       3,700  
Wisconsin (1)
    1,700       1,700       1,700       1,700  
 
                       
Total
    177,700       159,600       122,200       120,200  
 
                       
 
     
(1)  
We acquired the Wisconsin health plan on September 1, 2010. As of September 30, 2011, the Wisconsin health plan had approximately 2,200 Medicare Advantage members covered under a reinsurance contract with a third party; these members are not included in the membership tables herein.

 

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Molina Medicaid Solutions Segment
Molina Medicaid Solutions’ MMIS contracts extend over a number of years, and cover the life of the MMIS from inception through at least the first five years of its operation. The contracts are subject to extension by the exercise of an option, and also by renewal of the base contract. The contracts have a life cycle beginning with the design, development, and implementation of the MMIS and continuing through the operation of the system. Payment during the design, development, and implementation phase of the contract, or the DDI phase, is generally based upon the attainment of specific milestones in systems development as agreed upon ahead of time by the parties. Payment during the operations phase typically takes the form of either a flat monthly fee or payment for specific measures of capacity or activity, such as the number of claims processed, or the number of Medicaid beneficiaries served by the MMIS. Contracts may also call for the adjustment of amounts paid if certain activity measures exceed or fall below certain thresholds. In some circumstances, revenue recognition may be delayed for long periods while we await formal customer acceptance of our products and/or services. In those circumstances, recognition of a portion of our costs may be deferred.
Under our contracts in Louisiana, New Jersey, and West Virginia, we provide primarily business process outsourcing and technology outsourcing services, because the development of the MMIS solution has been completed. Under these contracts, we recognize outsourcing service revenue as earned. In Maine we completed the DDI phase of our contract effective September 1, 2010 and are recognizing DDI revenue on a straight line basis over the remaining term of the contract. In Idaho, we expect to complete the DDI phase of our contract in 2011. We began revenue and cost recognition for our Maine contract in September 2010, and expect to begin revenue and cost recognition for our Idaho contract in the second half of 2012.
Composition of Expenses
Health Plans Segment
Operating expenses for the Health Plans segment include expenses related to the provision of medical care services, G&A expenses, and premium tax expenses. Our results of operations are impacted by our ability to effectively manage expenses related to medical care services and to accurately estimate medical costs incurred. Expenses related to medical care services are captured in the following four categories:
   
Fee-for-service — Expenses paid for specific encounters or episodes of care according to a fee schedule or other basis established by the state or by contract with the provider.
   
Capitation — Expenses for PMPM payments to the provider without regard to the frequency, extent, or nature of the medical services actually furnished.
   
Pharmacy — Expenses for all drug, injectible, and immunization costs paid through our pharmacy benefit manager.
   
Other — Expenses for medically related administrative costs of approximately $76.3 million, and $61.9 million, for the nine months ended September 30, 2011 and 2010, respectively, including certain provider incentive costs, reinsurance, costs to operate our medical clinics, and other medical expenses.
Our medical care costs include amounts that have been paid by us through the reporting date as well as estimated liabilities for medical care costs incurred but not paid by us as of the reporting date. See “Critical Accounting Policies” below for a comprehensive discussion of how we estimate such liabilities.
Molina Medicaid Solutions Segment
Cost of service revenue consists primarily of the costs incurred to provide business process outsourcing and technology outsourcing services under our contracts in Idaho, Louisiana, Maine, New Jersey, West Virginia, and Florida. General and administrative costs consist primarily of indirect administrative costs and business development costs.
In some circumstances we may defer recognition of incremental direct costs (such as direct labor, hardware, and software) associated with a contract if revenue recognition is also deferred. Such deferred contract costs are amortized on a straight-line basis over the remaining original contract term, consistent with the revenue recognition period. We began to recognize deferred contract costs for our Maine contract in September 2010, at the same time we began to recognize revenue associated with that contract. In Idaho, we expect to begin recognition of deferred contract costs in the second half of 2012, in a manner consistent with our anticipated recognition of revenue.

 

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Third Quarter Performance Summary
The following table and narrative briefly summarizes our financial and operating performance for the three and nine months ended September 30, 2011. Comparable metrics for the third quarter of 2010 are also shown. All ratios, with the exception of the medical care ratio and the premium tax ratio, are shown as a percentage of total revenue. The medical care ratio and the premium tax ratio are computed as a percentage of premium revenue because there are direct relationships between premium revenue earned, and the cost of health care and premium taxes.
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2011     2010     2011     2010  
    (Dollar amounts in thousands, except per share data)  
Earnings per diluted share
  $ 0.41     $ 0.38     $ 1.16     $ 0.93  
Premium revenue
  $ 1,138,230     $ 1,005,115     $ 3,348,438     $ 2,947,020  
Service revenue
  $ 37,728     $ 32,271     $ 111,290     $ 53,325  
Operating income
  $ 33,566     $ 29,953     $ 96,276     $ 71,569  
Net income
  $ 18,950     $ 16,173     $ 53,778     $ 37,342  
Total ending membership
    1,678,000       1,597,000       1,678,000       1,597,000  
 
                               
Premium revenue
    96.7 %     96.7 %     96.7 %     98.1 %
Service revenue
    3.2       3.1       3.2       1.8  
Investment income
    0.1       0.2       0.1       0.1  
 
                       
Total revenue
    100.0 %     100.0 %     100.0 %     100.0 %
 
                       
 
                               
Medical care ratio
    84.3 %     84.2 %     84.3 %     85.1 %
General and administrative expense ratio
    8.5 %     8.5 %     8.4 %     8.2 %
Premium tax ratio
    3.2 %     3.5 %     3.3 %     3.5 %
Operating income
    2.9 %     2.9 %     2.8 %     2.4 %
Net income
    1.6 %     1.6 %     1.6 %     1.2 %
Effective tax rate
    35.1 %     36.2 %     36.4 %     37.3 %
Compared with the third quarter of 2010, our third quarter of 2011 was marked by improved performance of our Health Plans segment due to a 13% increase in premium revenue, partially offset by a decrease in the profitability of our Molina Medicaid Solutions segment. Earnings per share in the third quarter of 2011 were up 8% over the third quarter of 2010, operating income was up 12%, and membership on a member-month basis grew by 8%. Our larger and more established health plans performed the strongest in the quarter, with each of Michigan, Ohio, and Utah having lower medical care ratios compared with the third quarter of 2010. Medicare enrollment exceeded 28,000 members at September 30, 2011, and Medicare premium revenue for the quarter was $101.5 million compared with $70.7 million in the third quarter of 2010.
Improved performance of our health plans segment, partially offset by a decrease in the profitability of our Molina Medicaid Solution segment, also led to improved performance for the nine months ended September 30, 2011 compared with the nine months ended September 30, 2010. Earnings per share in the nine months ended September 30, 2011 were up 25% over the comparable period in 2010, premium revenues were up 14%, operating income was up 35%, and membership on a member-month basis grew by 10%. Medicare premium revenue for the nine months ended September 30, 2011 was $282.3 million compared with $188.6 million for the nine months ended September 30, 2010.
In October 2011, our Missouri health plan received a “Commendable” rating from the National Committee for Quality Assurance, or NCQA. Nine of our ten health plans have now been accredited by NCQA, and our Wisconsin health plan will be seeking accreditation in the future.
Our Florida, Texas and Wisconsin health plans continue to face challenges. We have undertaken a number of measures—focused on both utilization and unit cost reductions—to improve the profitability of these health plans. All three health plans reported lower medical care ratios in the third quarter of 2011 than in the second quarter of 2011; and Florida and Wisconsin reported lower medical care ratios in the third quarter of 2011 than in the third quarter of 2010. The medical care ratio of the California health plan declined sequentially, as a result of an estimated 6% rate reduction that will be retroactive to July 1, 2011. The amount reserved for the estimated rate reduction was approximately $7.5 million.

 

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We remain concerned about state budget deficits, which are not expected to improve during the remainder of 2011. Accordingly, the rate environment for our health plans remains uncertain, and we have received several rate reductions effective to date in 2011, including a blended 6% reduction in California retroactive to July 1, 2011, a 2.5% reduction in New Mexico effective July 1, 2011, a 2% reduction in Utah effective July 1, 2011, and a 2% rate reduction in Texas effective September 1, 2011. For the remainder of 2011, we anticipate a 1% reduction in California effective October 1, 2011. However, we have also received notifications of rate increases, including a 5% blended rate increase at our Missouri health plan effective July 1, 2011, a 7.5% rate increase at our Florida plan effective September 1, 2011, and a 1% rate increase at our Michigan plan effective October 1, 2011.
With respect to our Molina Medicaid Solutions business, our system stabilization efforts in Idaho and Maine are taking longer and are more costly than we had anticipated. However, our profit margins in our fiscal agent contracts in New Jersey, Louisiana, and West Virginia remain stable, and we believe that the profitability of the Molina Medicaid Solutions segment will improve as system development and stabilization costs in Idaho and Maine decline.
The state of Idaho has sent their formal request for system certification to CMS, and we anticipate certification review late in 2011 or early 2012, with formal certification in the second half of 2012. The certification process for our MMIS in Maine is also currently underway.
Results of Operations
Three Months Ended September 30, 2011 Compared with the Three Months Ended September 30, 2010
Health Plans Segment
Premium Revenue
In the three months ended September 30, 2011, compared with the three months ended September 30, 2010, premium revenue grew 13% due to a membership increase of approximately 8% (on a member-month basis), and PMPM revenue increase of approximately 5%. Medicare premium revenue was $101.5 million for the three months ended September 30, 2011, compared with $70.7 million for the three months ended September 30, 2010. In addition to the $7.5 million reduction to revenue in the third quarter of 2011 for the estimated premium reduction in California, we reduced revenue by $5.9 million in the third quarter of 2011 due to a minimum medical cost floor in New Mexico and a profit cap in Texas. In the third quarter of 2010 we reduced certain accruals for these items, resulting in an increase to revenue of $2.9 million.
Medical Care Costs
The following table provides the details of consolidated medical care costs for the periods indicated (dollars in thousands except PMPM amounts):
                                                 
    Three Months Ended September 30,  
    2011     2010  
                    % of                     % of  
    Amount     PMPM     Total     Amount     PMPM     Total  
Fee-for-service
  $ 698,995     $ 140.55       72.9 %   $ 601,836     $ 130.60       71.1 %
Capitation
    129,315       26.00       13.5       136,425       29.61       16.1  
Pharmacy
    89,191       17.93       9.3       76,049       16.50       9.0  
Other
    41,657       8.39       4.3       31,627       6.87       3.8  
 
                                   
Total
  $ 959,158     $ 192.87       100.0 %   $ 845,937     $ 183.58       100.0 %
 
                                   

 

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The ratio of medical care costs to premium revenue (the medical care ratio, or MCR) was essentially flat, increasing to 84.3% in the three months ended September 30, 2011, compared with 84.2% for the three months ended September 30, 2010. Total medical care costs increased approximately 5% PMPM.
   
Fee-for-service and capitation costs combined increased approximately 4%. Excluding the disproportionate impact of the Texas health plan, where we have experienced high utilization and unit costs for both physician and outpatient services (which include personal care services), fee-for-service costs were flat PMPM.
   
Capitation costs decreased approximately 12% PMPM, primarily due to the transition of members in Michigan and Washington into fee-for-service networks.
   
Fee-for-service costs increased approximately 8% PMPM, partially due to the transition of members from capitated provider networks into fee-for-service networks.
   
Pharmacy costs increased approximately 9% PMPM.
   
Hospital utilization decreased approximately 7%.
The medical care ratio of the California health plan increased to 88.8% in the three months ended September 30, 2011, from 80.3% in the three months ended September 30, 2010. The California health plan reduced premium revenue by approximately $7.5 million in the third quarter of 2011 for premium reductions estimated to be retroactive to July 1, 2011. The California Department of Health Care Services has indicated that it will reduce certain provider payments by approximately 10% retroactive to July 1, 2011. We believe that this reduction to provider payments will translate into a premium reduction of approximately 6% for the California health plan. At September 30, 2011 the California health plan had not recorded any potential recovery of provider payments related to this estimated premium reduction. Also in the third quarter of 2011, the California health plan added approximately 7,000 new ABD members with an average premium revenue of approximately $450 PMPM.
The medical care ratio of the Florida health plan decreased to 89.2% in the three months ended September 30, 2011, from 97.2% in the three months ended September 30, 2010, primarily due to initiatives implemented to reduce pharmacy and behavioral health costs. The Florida health plan received a premium rate increase of approximately 7.5% effective September 1, 2011.
The medical care ratio of the Michigan health plan decreased to 82.0% in the three months ended September 30, 2011, from 85.7% in the three months ended September 30, 2010, primarily due to improved Medicare performance and lower capitation and physician/outpatient costs combined. The Michigan health plan received a premium rate increase of approximately 1% effective October 1, 2011.
The medical care ratio of the Missouri health plan decreased to 78.1% in the three months ended September 30, 2011, from 86.7% in the three months ended September 30, 2010. Medical costs were flat compared to the prior period, while the health plan received a premium rate increase of approximately 5% effective July 1, 2011.
The medical care ratio of the New Mexico health plan increased to 84.2% in the three months ended September 30, 2011, from 83.5% in the three months ended September 30, 2010. The New Mexico health plan received a premium rate reduction of approximately 2.5% effective July 1, 2011. Premium revenues were further reduced due to a 1% increase in the minimum contractual amount the plan is required to spend on medical costs effective July 1, 2011. As a result of a minimum medical cost floor in our contract with the state of New Mexico, we reduced premium revenue by $4.4 million in the third quarter of 2011. In the third quarter of 2010, we reduced the accrual for the minimum medical cost floor, resulting in the recognition of an additional $2.8 million of revenue.
The medical care ratio of the Ohio health plan decreased to 78.4% in the three months ended September 30, 2011, from 81.2% in the three months ended September 30, 2010, due to an increase in Medicaid premium PMPM of approximately 4.5% effective January 1, 2011, while fee for service costs have increased by only 2.0%.

 

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The medical care ratio of the Texas health plan increased to 93.7% in the three months ended September 30, 2011, from 89.5% in the three months ended September 30, 2010. Effective September 1, 2011, the Texas health plan added approximately 8,000 ABD members and 3,000 TANF members in the Jefferson service area, and effective September 1, 2010, we added approximately 54,000 members state-wide who are covered under the Children’s Health Insurance Program, or CHIP. Costs associated with ABD contracts, particularly in the Dallas-Fort Worth region, are running substantially higher than in our other markets, due to both high utilization and high unit costs. We have undertaken a number of measures — focused on both utilization and unit cost reductions — to improve the profitability of the Texas health plan. The medical care ratio of the Texas health plan fell from 95.0% in the second quarter of 2011 to 93.7% in the third quarter of 2011. Profitability of the CHIP line of business was proportionally higher in Texas, leading to a $1.5 million reduction of revenue as a result of a profit cap in our contract with the state of Texas. That profit cap is applied on a product by product basis. In the third quarter of 2010, we reduced the accrual for the profit cap, resulting in the recognition of an additional $0.1 million of revenue. The Texas health plan received a premium rate reduction of approximately 2% effective September 1, 2011.
The medical care ratio of the Utah health plan decreased to 79.3% in the three months ended September 30, 2011, from 84.9% in the three months ended September 30, 2010, primarily due to a reduction in inpatient utilization and a shift in member mix. The Utah health plan received a premium rate reduction of approximately 2% effective July 1, 2011.
The medical care ratio of the Washington health plan increased to 82.8% in the three months ended September 30, 2011, from 79.4% in the three months ended September 30, 2010. Higher fee-for-service and pharmacy costs more than offset lower capitation costs. The Washington health plan received a premium rate reduction of approximately 1% effective October 1, 2011.
The medical care ratio of the Wisconsin health plan (acquired September 1, 2010) was 79.1% in the three months ended September 30, 2011. The Wisconsin health plan recorded a premium deficiency reserve of $3.35 million in the first quarter of 2011. Based on improvements in the health plan’s earnings forecast through the end of the contract period, this reserve was relieved during the second and third quarters. Absent the premium deficiency reduction, the Wisconsin plan’s medical care ratio would have been approximately 88.1% in the three months ended September 30, 2011. We have undertaken a number of measures — focused on both utilization and unit cost reductions — to improve the profitability of the Wisconsin health plan.
Health Plans Segment Operating Data
The following table summarizes member months, premium revenue, medical care costs, medical care ratio, and premium taxes by health plan for the periods indicated (PMPM amounts are in whole dollars; member months and other dollar amounts are in thousands):
                                                         
    Three Months Ended September 30, 2011  
    Member     Premium Revenue     Medical Care Costs     Medical     Premium Tax  
    Months(1)     Total     PMPM     Total     PMPM     Care Ratio     Expense  
California
    1,049     $ 144,888     $ 138.11     $ 128,596     $ 122.58       88.8 %   $ 1,114  
Florida
    199       51,569       258.96       46,009       231.04       89.2       (17 )
Michigan
    656       165,636       252.46       135,899       207.13       82.0       9,644  
Missouri
    234       58,196       248.80       45,428       194.22       78.1        
New Mexico
    267       79,644       297.82       67,043       250.70       84.2       2,084  
Ohio
    745       232,616       312.55       182,363       245.02       78.4       18,072  
Texas
    414       105,577       255.25       98,954       239.24       93.7       1,613  
Utah
    243       69,763       286.47       55,293       227.05       79.3        
Washington
    1,043       211,131       202.49       174,912       167.76       82.8       3,776  
Wisconsin(2)
    123       17,269       139.95       13,656       110.67       79.1        
Other(3)
          1,941             11,005                   88  
 
                                               
 
    4,973     $ 1,138,230     $ 228.88     $ 959,158     $ 192.87       84.3 %   $ 36,374  
 
                                               

 

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    Three Months Ended September 30, 2010  
    Member     Premium Revenue     Medical Care Costs     Medical     Premium Tax  
    Months(1)     Total     PMPM     Total     PMPM     Care Ratio     Expense  
California
    1,046     $ 128,350     $ 122.75     $ 103,002     $ 98.51       80.3 %   $ 1,888  
Florida
    169       43,485       256.25       42,258       249.02       97.2       (14 )
Michigan
    675       156,609       232.05       134,238       198.90       85.7       9,655  
Missouri
    236       52,952       224.63       45,930       194.84       86.7        
New Mexico
    274       93,602       341.38       78,121       284.92       83.5       2,170  
Ohio
    715       210,651       294.55       171,051       239.18       81.2       16,734  
Texas
    180       48,188       267.95       43,129       239.82       89.5       861  
Utah
    234       67,566       289.28       57,381       245.67       84.9        
Washington
    1,051       195,578       186.03       155,307       147.73       79.4       3,622  
Wisconsin(2)
    28       6,310       224.18       6,154       218.65       97.5        
Other(3)
          1,824             9,366                   121  
 
                                               
 
    4,608     $ 1,005,115     $ 218.12     $ 845,937     $ 183.58       84.2 %   $ 35,037  
 
                                               
 
     
(1)  
A member month is defined as the aggregate of each month’s ending membership for the period presented.
 
(2)  
We acquired the Wisconsin health plan on September 1, 2010.
 
(3)  
“Other” medical care costs also include medically related administrative costs at the parent company.
Days in Medical Claims and Benefits Payable
The days in medical claims and benefits payable were as follows:
                                 
    Sept. 30,     June 30,     Dec. 31,     Sept. 30,  
(Dollars in thousands)   2011     2011     2010     2010  
Days in claims payable — fee-for-service only
  39 days     39 days     42 days     42 days  
Number of claims in inventory at end of period
    132,200       121,900       143,600       110,200  
Billed charges of claims in inventory at end of period (dollars in thousands)
  $ 187,000     $ 205,800     $ 218,900     $ 158,900  
Molina Medicaid Solutions Segment
Molina Medicaid Solutions was acquired on May 1, 2010. Performance of the Molina Medicaid Solutions segment was as follows:
                 
    Three Months Ended September 30,  
    2011     2010  
    (In thousands)  
Service revenue before amortization
  $ 39,273     $ 34,926  
Amortization recorded as reduction of service revenue
    (1,545 )     (2,655 )
 
           
Service revenue
    37,728       32,271  
Cost of service revenue
    34,584       27,605  
General and administrative costs
    2,069       2,195  
Amortization of customer relationship intangibles recorded as amortization
    1,282       1,314  
 
           
Operating (loss) income
  $ (207 )   $ 1,157  
 
           
We are currently deferring recognition of all revenue as well as all direct costs (to the extent that such costs are estimated to be recoverable) in Idaho until the Medicaid Management Information System, or MMIS, in that state receives certification from the Centers for Medicare and Medicaid Services, or CMS. Cost of service revenue includes $2.5 million of direct costs associated with the Idaho contract that would otherwise have been recorded as deferred contract costs. We were not able to defer these direct contract costs because estimated future net revenues as of each measurement date did not exceed estimated future direct costs of the contract. We currently expect the Idaho contract to perform financially at a break even basis through its initial term. So long as we continue to defer revenue recognition under the contract, we will also continue to defer direct costs associated with the agreement. If our break-even assumptions were to change, we may not be able to continue to defer direct contract costs.

 

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Financial results remain strong under our Louisiana, New Jersey, and West Virginia MMIS contracts. Based upon our cost experience, we believe that the contract pricing agreed to by our predecessor under the Idaho and Maine MMIS contracts was inappropriately low. However, we believe that the profitability of the Molina Medicaid Solutions segment will improve as system development and stabilization costs in those two states decline.
Consolidated Expenses
General and Administrative Expenses
General and administrative, or G&A, expenses, were $99.6 million, or 8.5% of total revenue, for the three months ended September 30, 2011, compared with $88.7 million, or 8.5% of total revenue, for the three months ended September 30, 2010.
Premium Tax Expenses
Premium tax expense decreased to 3.2% of premium revenue in the three months ended September 30, 2011, from 3.5% in the three months ended September 30, 2010, due to a shift in revenue to states with comparatively low premium tax rates.
Interest Expense
Interest expense decreased to $4.4 million for the three months ended September 30, 2011, from $4.6 million for the three months ended September 30, 2010. Interest expense includes non-cash interest expense relating to our convertible senior notes, which amounted to $1.4 million and $1.3 million for the three months ended September 30, 2011, and 2010, respectively.
Income Taxes
Income tax expense is recorded at an effective rate of 35.1% for the three months ended September 30, 2011 compared with 36.2% for the three months ended September 30, 2010. The lower rate in 2011 is primarily due to differences in the amount of discrete tax benefits recorded during the respective periods.
Nine Months Ended September 30, 2011 Compared with the Nine Months Ended September 30, 2010
Health Plans Segment
Premium Revenue
In the nine months ended September 30, 2011, compared with the nine months ended September 30, 2010, premium revenue grew 14% due to a membership increase of approximately 10% (on a member-month basis), and PMPM revenue increase of approximately 4%. Medicare premium revenue was $282.3 million for the nine months ended September 30, 2011, compared with $188.6 million for the nine months ended September 30, 2010. Reductions to revenue due to a minimum medical cost floor in New Mexico and a profit cap in Texas amounted to $12.2 million for the nine months ended September 30, 2011. For the nine months ended September 30, 2010 we reduced certain accruals for these items, resulting in an increase to revenue of $0.1 million.

 

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Medical Care Costs
The following table provides the details of consolidated medical care costs for the periods indicated (dollars in thousands except PMPM amounts):
                                                 
    Nine Months Ended September 30,  
    2011     2010  
                    % of                     % of  
    Amount     PMPM     Total     Amount     PMPM     Total  
Fee-for-service
  $ 2,050,430     $ 138.40       72.7 %   $ 1,763,675     $ 130.55       70.3 %
Capitation
    383,955       25.92       13.6       410,321       30.37       16.4  
Pharmacy
    268,637       18.13       9.5       241,290       17.86       9.6  
Other
    119,027       8.03       4.2       93,080       6.89       3.7  
 
                                   
Total
  $ 2,822,049     $ 190.48       100.0 %   $ 2,508,366     $ 185.67       100.0 %
 
                                   
The medical care ratio decreased to 84.3% in the nine months ended September 30, 2011, compared with 85.1% for the nine months ended September 30, 2010. Total medical care costs increased less than 3% PMPM.
   
Pharmacy costs (adjusted for the state’s retention of the pharmacy benefit in Ohio effective February 1, 2010) increased approximately 6% PMPM.
   
Capitation costs decreased approximately 15% PMPM, primarily due to the transition of members in Michigan and Washington into fee-for-service networks.
   
Fee-for-service costs increased approximately 6% PMPM, partially due to the transition of members from capitated provider networks into fee-for-service networks.
   
Fee-for-service and capitation costs combined increased approximately 2% PMPM.
   
Hospital utilization decreased approximately 7%.
The medical care ratio of the California health plan increased to 85.9% in the nine months ended September 30, 2011, from 84.0% in the nine months ended September 30, 2010. As noted above in “Three Months Ended September 30, 2011 Compared with the Three Months Ended September 30, 2010,” the California health plan reduced premium revenue by approximately $7.5 million in the third quarter of 2011 for premium reductions estimated to be retroactive to July 1, 2011.
The medical care ratio of the Florida health plan increased to 94.2% in the nine months ended September 30, 2011, from 93.6% in the nine months ended September 30, 2010, primarily due to higher fee-for-service and capitation costs, which more than offset lower pharmacy and behavioral health costs. We have undertaken a number of measures — focused on both utilization and unit cost reductions — to improve the profitability of the Florida health plan. As noted above in “Three Months Ended September 30, 2011 Compared with the Three Months Ended September 30, 2010,” profitability of the Florida health plan improved significantly in the third quarter of 2011.
The medical care ratio of the Michigan health plan decreased to 80.6% in the nine months ended September 30, 2011, from 84.4% in the nine months ended September 30, 2010, primarily due to improved Medicare performance, lower inpatient facility costs, and lower capitation and physician/outpatient costs combined.
The medical care ratio of the Missouri health plan increased to 87.1% in the nine months ended September 30, 2011, from 86.5% in the nine months ended September 30, 2010. The Missouri health plan received a premium rate increase of approximately 5% effective July 1, 2011. As noted above in “Three Months Ended September 30, 2011 Compared with the Three Months Ended September 30, 2010,” profitability of the Missouri health plan improved significantly in the third quarter of 2011.
The medical care ratio of the New Mexico health plan increased to 83.5% in the nine months ended September 30, 2011, from 80.2% in the nine months ended September 30, 2010. The New Mexico health plan received a premium rate reduction of approximately 2.5% effective July 1, 2011. Additionally premium revenues were reduced due to a 1% increase in the minimum contractual amount the plan is required to spend on medical costs effective July 1, 2011. As a result of a minimum medical cost floor in our contract with the state of New Mexico, we reduced premium revenue by $10.9 million in the nine months ended September 30, 2011. The minimum medical cost floor had no impact on premium revenue in the nine months ended September 30, 2010.

 

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The medical care ratio of the Ohio health plan decreased to 76.9% in the nine months ended September 30, 2011, from 80.7% in the nine months ended September 30, 2010, due to an increase in Medicaid premium PMPM of approximately 4.5% effective January 1, 2011, and modestly lower fee-for-service costs.
The medical care ratio of the Texas health plan increased to 93.4% in the nine months ended September 30, 2011, from 87.6% in the nine months ended September 30, 2010. Effective February 1, 2011, we added approximately 30,000 ABD members in the Dallas-Fort Worth area and effective September 1, 2011, we added approximately 8,000 ABD members and 3,000 TANF members in the Jefferson Service area, and effective September 1, 2010, we added approximately 54,000 members state-wide who are covered under CHIP. Costs associated with our ABD contracts, particularly in the Dallas-Fort Worth region, are running substantially higher than in our other markets, due to both high utilization and high unit costs. We have undertaken a number of measures — focused on both utilization and unit cost reductions — to improve the profitability of the Texas health plan. As a result of a profit cap in our contract with the state of Texas, we reduced premium revenue by $1.3 million in the nine months ended September 30, 2011. In the nine months ended September 30, 2010, we reduced the accrual for the profit cap, resulting in the recognition of an additional $0.1 million of revenue.
The medical care ratio of the Utah health plan decreased to 77.9% in the nine months ended September 30, 2011, from 94.1% in the nine months ended September 30, 2010, primarily due to reduced fee-for-service outpatient and physician costs and an increase in Medicaid premium PMPM of approximately 7% effective July 1, 2010. Lower fee-for-service costs were the result of both lower unit costs and lower utilization. During the second quarter of 2011 we settled certain claims with the state regarding the savings share provision of our contract in effect from 2003 through June of 2009. We settled for the contract years 2006 through 2009 and recognized $6.9 million in premium revenue without any corresponding charge to expense. The Utah health plan received a premium rate reduction of approximately 2% effective July 1, 2011.
The medical care ratio of the Washington health plan increased to 84.7% in the nine months ended September 30, 2011, from 84.2% in the nine months ended September 30, 2010. Higher fee-for-service and pharmacy costs more than offset lower capitation costs.
The medical care ratio of the Wisconsin health plan (acquired September 1, 2010) was 92.1% in the nine months ended September 30, 2011. The state of Wisconsin reduced capitation rates by 11% on January 1, 2011. We have undertaken a number of measures — focused on both utilization and unit cost reductions — to improve the profitability of the Wisconsin health plan.
Health Plans Segment Operating Data
The following table summarizes member months, premium revenue, medical care costs, medical care ratio, and premium taxes by health plan for the periods indicated (PMPM amounts are in whole dollars; member months and other dollar amounts are in thousands):
                                                         
    Nine Months Ended September 30, 2011  
    Member     Premium Revenue     Medical Care Costs     Medical     Premium Tax  
    Months(1)     Total     PMPM     Total     PMPM     Care Ratio     Expense  
California
    3,133     $ 418,961     $ 133.71     $ 359,844     $ 114.84       85.9 %   $ 4,937  
Florida
    588       150,561       256.13       141,872       241.35       94.2       34  
Michigan
    2,002       495,971       247.70       399,952       199.75       80.6       29,219  
Missouri
    722       169,988       235.45       148,135       205.18       87.1        
New Mexico
    808       246,223       304.71       205,659       254.51       83.5       6,472  
Ohio
    2,218       693,829       312.86       533,216       240.44       76.9       53,629  
Texas
    1,154       290,787       252.06       271,723       235.54       93.4       5,016  
Utah
    723       215,205       297.62       167,605       231.79       77.9        
Washington
    3,104       608,998       196.25       515,769       166.20       84.7       11,099  
Wisconsin(2)
    364       51,526       141.42       47,450       130.23       92.1       44  
Other(3)
          6,389             30,824                   183  
 
                                               
 
    14,816     $ 3,348,438     $ 226.01     $ 2,822,049     $ 190.48       84.3 %   $ 110,633  
 
                                               

 

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    Nine Months Ended September 30, 2010  
    Member     Premium Revenue     Medical Care Costs     Medical     Premium Tax  
    Months(1)     Total     PMPM     Total     PMPM     Care Ratio     Expense  
California
    3,158     $ 376,811     $ 119.32     $ 316,569     $ 100.24       84.0 %   $ 5,153  
Florida
    483       124,035       256.70       116,079       240.23       93.6       (2 )
Michigan
    2,029       468,723       230.98       395,450       194.87       84.4       29,305  
Missouri
    704       156,874       222.83       135,766       192.85       86.5        
New Mexico
    834       281,149       336.93       225,346       270.06       80.2       7,161  
Ohio
    2,083       641,683       308.11       517,951       248.70       80.7       50,251  
Texas
    426       130,881       307.51       114,593       269.24       87.6       2,247  
Utah
    685       191,040       278.99       179,816       262.60       94.1        
Washington
    3,080       562,836       182.75       473,609       153.78       84.2       10,278  
Wisconsin(2)
    28       6,310       224.18       6,154       218.65       97.5        
Other(3)
          6,678             27,033                   185  
 
                                               
 
    13,510     $ 2,947,020     $ 218.14     $ 2,508,366     $ 185.67       85.1 %   $ 104,578  
 
                                               
 
     
(1)  
A member month is defined as the aggregate of each month’s ending membership for the period presented.
 
(2)  
We acquired the Wisconsin health plan on September 1, 2010.
 
(3)  
“Other” medical care costs also include medically related administrative costs of the parent company.
Molina Medicaid Solutions Segment
Molina Medicaid Solutions was acquired on May 1, 2010; therefore, the nine months ended September 30, 2010 include only five months of operating results for this segment. Performance of the Molina Medicaid Solutions segment was as follows:
                 
    Nine Months Ended     Five Months Ended  
    September 30, 2011     September 30, 2010  
    (In thousands)  
Service revenue before amortization
  $ 116,567     $ 57,571  
Amortization recorded as reduction of service revenue
    (5,277 )     (4,246 )
 
           
Service revenue
    111,290       53,325  
Cost of service revenue
    105,020       41,859  
General and administrative costs
    6,421       3,161  
Amortization of customer relationship intangibles recorded as amortization
    3,846       2,143  
 
           
Operating (loss) income
  $ (3,997 )   $ 6,162  
 
           
Cost of service revenue for the nine months ended September 30, 2011 includes $9.5 million of direct costs associated with the Idaho contract that would otherwise have been recorded as deferred contract costs, for the same reasons discussed above, in “Three Months Ended September 30, 2011 Compared with the Three Months Ended September 30, 2010.”
Consolidated Expenses and Other
General and Administrative Expenses
General and administrative expenses were $291.0 million, or 8.4% of total revenue, for the nine months ended September 30, 2011, compared with $245.6 million, or 8.2% of total revenue, for the nine months ended September 30, 2010.
Premium Tax Expense
Premium tax expense decreased to 3.3% of premium revenue, in the nine months ended September 30, 2011, from 3.5% in the nine months ended September 30, 2010, due to a shift in revenue to states with comparatively low premium tax rates.

 

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Interest Expense
Interest expense decreased to $11.7 million for the nine months ended September 30, 2011, from $12.1 million for the nine months ended September 30, 2010. Interest expense includes non-cash interest expense relating to our convertible senior notes, which amounted to $4.1 million and $3.8 million for the nine months ended September 30, 2011 and 2010, respectively.
Income Taxes
Income tax expense is recorded at an effective rate of 36.4% for the nine months ended September 30, 2011, compared with 37.3% for the nine months ended September 30, 2010. The lower rate in 2011 is primarily due to discrete tax benefits recognized for statute closures and prior year tax return to provision reconciliations. Excluding the discrete tax benefits, the effective tax rate for the nine months ended September 30, 2011 was 37.3%.
Depreciation and Amortization
Depreciation and amortization related to our Health Plans segment is all recorded in “Depreciation and Amortization” in the consolidated statements of income. Depreciation and amortization related to our Molina Medicaid Solutions segment is recorded within three different headings in the consolidated statements of income as follows:
   
Amortization of purchased intangibles relating to customer relationships is reported as amortization within the heading “Depreciation and Amortization;”
   
Amortization of purchased intangibles relating to contract backlog is recorded as a reduction of “Service Revenue;” and
   
Depreciation is recorded within the heading “Cost of Service Revenue.”
The following table presents all depreciation and amortization recorded in our consolidated statements of income, regardless of whether the item appears as depreciation and amortization, a reduction of revenue, or as cost of service revenue.
                                 
    Three Months Ended September 30,  
    2011     2010  
            % of Total             % of Total  
    Amount     Revenue     Amount     Revenue  
    (Dollar amounts in thousands)  
Depreciation
  $ 8,234       0.7 %   $ 6,840       0.6 %
Amortization of intangible assets
    5,196       0.4       5,114       0.5  
 
                       
Depreciation and amortization reported as such in the
                               
consolidated statements of income
    13,430       1.1       11,954       1.1  
Amortization recorded as reduction of service revenue
    1,545       0.1       2,655       0.3  
Depreciation recorded as cost of service revenue
    2,837       0.2       1,964       0.2  
 
                       
Total
  $ 17,812       1.4 %   $ 16,573       1.6 %
 
                       

 

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    Nine Months Ended September 30,  
    2011     2010  
            % of Total             % of Total  
    Amount     Revenue     Amount     Revenue  
    (Dollar amounts in thousands)  
Depreciation
  $ 22,859       0.7 %   $ 19,963       0.7 %
Amortization of intangible assets
    15,728       0.5       13,271       0.4  
 
                       
Depreciation and amortization reported as such in the consolidated statements of income
    38,587       1.2       33,234       1.1  
Amortization recorded as reduction of service revenue
    5,277       0.1       4,246       0.1  
Depreciation recorded as cost of service revenue
    8,550       0.2       3,005       0.1  
 
                       
Total
  $ 52,414       1.5 %   $ 40,485       1.3 %
 
                       
Liquidity and Capital Resources
We manage our cash, investments, and capital structure to meet the short- and long-term obligations of our business while maintaining liquidity and financial flexibility. We forecast, analyze, and monitor our cash flows to enable prudent investment management and financing within the confines of our financial strategy.
Our regulated subsidiaries generate significant cash flows from premium revenue and investment income. Such cash flows are our primary source of liquidity. Thus, any future decline in our profitability may have a negative impact on our liquidity. We generally receive premium revenue in advance of the payment of claims for the related health care services. A majority of the assets held by our regulated subsidiaries are in the form of cash, cash equivalents, and investments. After considering expected cash flows from operating activities, we generally invest cash of regulated subsidiaries that exceeds our expected short-term obligations in longer term, investment-grade, marketable debt securities to improve our overall investment return. These investments are made pursuant to board approved investment policies which conform to applicable state laws and regulations. Our investment policies are designed to provide liquidity, preserve capital, and maximize total return on invested assets, all in a manner consistent with state requirements that prescribe the types of instruments in which our subsidiaries may invest. These investment policies require that our investments have final maturities of five years or less (excluding auction rate securities and variable rate securities, for which interest rates are periodically reset) and that the average maturity be two years or less. Professional portfolio managers operating under documented guidelines manage our investments. As of September 30, 2011, a substantial portion of our cash was invested in a portfolio of highly liquid money market securities, and our investments consisted solely of investment-grade debt securities. All of our investments are classified as current assets, except for our investments in auction rate securities, which are classified as non-current assets. Our restricted investments are invested principally in certificates of deposit and U.S. treasury securities.
Investment income decreased to $3.8 million for the nine months ended September 30, 2011, compared with $4.9 million for the nine months ended September 30, 2010. Our annualized portfolio yield for the nine months ended September 30, 2011 was 0.6% compared with 0.8% for the nine months ended September 30, 2010.
Investments and restricted investments are subject to interest rate risk and will decrease in value if market rates increase. We have the ability to hold our restricted investments until maturity and, as a result, we would not expect the value of these investments to decline significantly due to a sudden change in market interest rates. Declines in interest rates over time will reduce our investment income.
Cash in excess of the capital needs of our regulated health plans is generally paid to our non-regulated parent company in the form of dividends, when and as permitted by applicable regulations, for general corporate use.
Cash provided by operating activities for the nine months ended September 30, 2011 was $155.2 million compared with $9.5 million for the nine months ended September 30, 2010, an increase of $145.7 million. Deferred revenue, which was a source of operating cash amounting to $42.6 million in 2011, was a use of operating cash amounting to $64.3 million in 2010.
Cash provided by financing activities decreased due to $111.2 million net proceeds from our common stock offering in the third quarter of 2010, with no comparable activity in the current year.

 

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Reconciliation of Non-GAAP (1) to GAAP Financial Measures
EBITDA (2)
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2011     2010     2011     2010  
    (In thousands)  
Net income
  $ 18,950     $ 16,173     $ 53,778     $ 37,342  
Add back:
                               
Depreciation and amortization reported in the consolidated statements of cash flows
    17,812       16,573       52,414       40,485  
Interest expense
    4,380       4,600       11,666       12,056  
Provision for income taxes
    10,236       9,180       30,832       22,171  
 
                       
EBITDA
  $ 51,378     $ 46,526     $ 148,690     $ 112,054  
 
                       
 
     
(1)  
GAAP stands for U.S. generally accepted accounting principles.
 
(2)  
EBITDA is not prepared in conformity with GAAP because it excludes depreciation and amortization, as well as interest expense, and the provision for income taxes. This non-GAAP financial measure should not be considered as an alternative to the GAAP measures of net income, operating income, operating margin, or cash provided by operating activities, nor should EBITDA be considered in isolation from these GAAP measures of operating performance. Management uses EBITDA as a supplemental metric in evaluating our financial performance, in evaluating financing and business development decisions, and in forecasting and analyzing future periods. For these reasons, management believes that EBITDA is a useful supplemental measure to investors in evaluating our performance and the performance of other companies in our industry.
Capital Resources
At September 30, 2011, the parent company — Molina Healthcare, Inc. — held cash and investments of approximately $54.3 million, compared with approximately $65.1 million of cash and investments at December 31, 2010. This decline was primarily due to capital contributions and /or advances to our Florida, Texas, and Wisconsin health plans in the first quarter of 2011.
On a consolidated basis, at September 30, 2011, we had working capital of $430.2 million compared with $392.4 million at December 31, 2010. At September 30, 2011 we had cash and investments of $881.0 million, compared with $813.8 million of cash and investments at December 31, 2010.
On October 11, 2011, Molina Center LLC, our wholly owned subsidiary, entered into a purchase agreement to acquire the approximately 460,000 square foot office project located at 200 and 300 Oceangate, Long Beach, California. The purchase price under the agreement is $83 million, to be paid in cash at closing. The transaction is contingent upon the satisfactory completion of our due diligence review and other customary closing conditions. Any closing is expected to occur during December 2011 or the first quarter of 2012.
Effective as of October 26, 2011, our board of directors has authorized the repurchase of $75 million in aggregate of either our common stock or our convertible senior notes due 2014 (see discussion of “Convertible Senior Notes” below). The repurchase program will be funded with working capital or draws under our credit facility (see discussion of “Credit Facility” below).
On July 27, 2011, our board of directors approved a stock repurchase program of up to $7 million to be used to purchase shares of our common stock under a Rule 10b5-1 trading plan. Under this program, we purchased approximately 400,000 shares of our common stock for $7 million (average cost of approximately $17.47 per share) during August 2011. These purchases did not materially impact diluted earnings per share for the three months or nine months ended September 30, 2011. Subsequently, we retired the $7.0 million of treasury shares purchased, which reduced additional paid-in capital as of September 30, 2011.
We believe that our cash resources, Credit Facility, and internally generated funds will be sufficient to support our operations, regulatory requirements, and capital expenditures for at least the next 12 months.
Credit Facility
On September 9, 2011, we entered into a credit agreement for a $170 million revolving credit facility (the “Credit Facility”) with various lenders and U.S. Bank National Association, as LC Issuer, Swing Line Lender, and Administrative Agent. The Credit Facility will be used for general corporate purposes.

 

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The Credit Facility has a term of five years under which all amounts outstanding will be due and payable on September 9, 2016. Subject to obtaining commitments from existing or new lenders and satisfaction of other specified conditions, we may increase the Credit Facility to up to $195 million. As of September 30, 2011 there was no outstanding principal balance under the Credit Facility. However, as of September 30, 2011, our lenders had issued two letters of credit in the aggregate principal amount of $10.3 million in connection with the Molina Medicaid Solutions contracts with the states of Maine and Idaho, which reduces the amount available under the Credit Facility.
Borrowings under the Credit Facility will bear interest based, at our election, on the base rate plus an applicable margin or the Eurodollar rate. The base rate is, for any day, a rate of interest per annum equal to the highest of (i) the prime rate of interest announced from time to time by U.S. Bank or its parent, (ii) the sum of the federal funds rate for such day plus 0.50% per annum and (iii) the Eurodollar rate (without giving effect to the applicable margin) for a one month interest period on such day (or if such day is not a business day, the immediately preceding business day) plus 1.00%. The Eurodollar rate is a reserve adjusted rate at which Eurodollar deposits are offered in the interbank Eurodollar market plus an applicable margin. In addition to interest payable on the principal amount of indebtedness outstanding from time to time under the Credit Facility, we are required to pay a quarterly commitment fee of 0.25% to 0.50% (based upon our leverage ratio) of the unused amount of the lenders’ commitments under the Credit Facility. The initial commitment fee shall be set at 0.35% until our delivery of its financials for the quarter ended September 30, 2011. The applicable margins range between 0.75% to 1.75% for base rate loans and 1.75% to 2.75% for Eurodollar loans, in each case, based upon our leverage ratio.
Our obligations under the Credit Facility are secured by a lien on substantially all of our assets, with the exception of certain of our real estate assets, and by a pledge of the capital stock or membership interests of our operating subsidiaries and health plans (with the exception of the California health plan).
The Credit Facility includes usual and customary covenants for credit facilities of this type, including covenants limiting liens, mergers, asset sales, other fundamental changes, debt, acquisitions, dividends and other distributions, capital expenditures, and investments. The Credit Facility also requires us to maintain a ratio of total consolidated debt to total consolidated EBITDA of not more than 2.75 to 1.00 as of the end of each fiscal quarter and a fixed charge coverage ratio of not less than 1.75 to 1.00. At September 30, 2011, we were in compliance with all financial covenants under the Credit Facility.
In the event of a default, including cross-defaults relating to specified other debt in excess of $20 million, the lenders may terminate the commitments under the Credit Facility and declare the amounts outstanding, including all accrued interest and unpaid fees, payable immediately. In addition, the lenders may enforce any and all rights and remedies created under the Credit Facility or applicable law.
In connection with our entrance into the Credit Facility, on September 9, 2011, we terminated our existing credit agreement with Bank of America, dated March 9, 2005, as amended to date, which had provided us with a $150 million revolving credit facility. As of September 30, 2011 and December 31, 2010, there was no outstanding principal balance under this credit agreement.
Shelf Registration Statement
Under a shelf registration statement on Form S-3 that was filed with the Securities and Exchange Commission in December 2008, we have up to $182.5 million available for the issuance of our securities, including common stock, warrants, or debt securities, that may be publicly offered from time to time at prices and terms to be determined at the time of the offering.
Convertible Senior Notes
As of September 30, 2011, $187.0 million in aggregate principal amount of our 3.75% Convertible Senior Notes due 2014 (the “Notes”) remain outstanding. The Notes rank equally in right of payment with our existing and future senior indebtedness. The Notes are convertible into cash and, under certain circumstances, shares of our common stock. The initial conversion rate is 31.9601 shares of our common stock per $1,000 principal amount of the Notes. This represents an initial conversion price of approximately $31.29 per share of our common stock. In addition, if certain corporate transactions that constitute a change of control occur prior to maturity, we will increase the conversion rate in certain circumstances.

 

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Regulatory Capital and Dividend Restrictions
Our health plans are subject to state laws and regulations that, among other things, require the maintenance of minimum levels of statutory capital, as defined by each state, and restrict the timing, payment, and amount of dividends and other distributions that may be paid to us as the sole stockholder. To the extent the subsidiaries must comply with these regulations, they may not have the financial flexibility to transfer funds to us. The net assets in these subsidiaries (after intercompany eliminations) which may not be transferable to us in the form of loans, advances, or cash dividends was $456.2 million at September 30, 2011, and $397.8 million at December 31, 2010.
The National Association of Insurance Commissioners, or NAIC, adopted rules effective December 31, 1998, which, if implemented by the states, set minimum capitalization requirements for insurance companies, HMOs, and other entities bearing risk for health care coverage. The requirements take the form of risk-based capital (RBC) rules. Michigan, Missouri, New Mexico, Ohio, Texas, Utah, Washington, and Wisconsin have adopted these rules, which may vary from state to state. California and Florida have not yet adopted NAIC risk-based capital requirements for HMOs and have not formally given notice of their intention to do so. Such requirements, if adopted by California and Florida, may increase the minimum capital required for those states.
As of September 30, 2011, our health plans had aggregate statutory capital and surplus of approximately $463.1 million compared with the required minimum aggregate statutory capital and surplus of approximately $273.9 million. All of our health plans were in compliance with the minimum capital requirements at September 30, 2011. We have the ability and commitment to provide additional capital to each of our health plans when necessary to ensure that statutory capital and surplus continue to meet regulatory requirements.
Contractual Obligations
In our Annual Report on Form 10-K for the year ended December 31, 2010, we reported on our contractual obligations as of that date. There have been no material changes to our contractual obligations since that report.
Critical Accounting Policies
When we prepare our consolidated financial statements, we use estimates and assumptions that may affect reported amounts and disclosures. Actual results could differ from these estimates. Our most significant accounting policies relate to:
   
The determination of the amount of revenue to be recognized under certain contracts that place revenue at risk dependent upon the achievement of certain quality or administrative measurements, or the expenditure of certain percentages of revenue on defined expenses, or requirements that we return a certain portion of our profits to state governments;
   
The deferral of revenue and costs associated with contracts held by our Molina Medicaid Solutions segment; and;
   
The determination of medical claims and benefits payable.
Revenue Recognition — Health Plans Segment
Certain components of premium revenue are subject to accounting estimates, and are therefore subject to retroactive revision. Chief among these are:
   
Florida Health Plan Medical Cost Floor (Minimum) for Behavioral Health: A portion of premium revenue paid to our Florida health plan by the state of Florida may be refunded to the state if certain minimum amounts are not spent on defined behavioral health care costs. At September 30, 2011, we had not recorded any liability under the terms of this contract provision. If the state of Florida disagrees with our interpretation of the existing contract terms, an adjustment to the amounts owed may be required. Any changes to the terms of this provision, including revisions to the definitions of premium revenue or behavioral health care costs, the period of time over which performance is measured or the manner of its measurement, or the percentages used in the calculations, may affect the profitability of our Florida health plan.

 

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New Mexico Health Plan Medical Cost Floors (Minimums) and Administrative Cost and Profit Ceilings (Maximums): A portion of premium revenue paid to our New Mexico health plan by the state of New Mexico may be refunded to the state if certain minimum amounts are not spent on defined medical care costs, or if administrative costs or profit (as defined) exceed certain amounts. Our contract with the state of New Mexico requires that we spend a minimum percentage of premium revenue on certain explicitly defined medical care costs (the medical cost floor). Effective July 1, 2008, our New Mexico health plan entered into a new four-year contract that, in addition to retaining the medical cost floor, added certain limits on the amount our New Mexico health plan can: (a) expend on administrative costs; and (b) retain as profit. At September 30, 2011, we had recorded a liability of $16.5 million under the terms of these contract provisions. If the state of New Mexico disagrees with our interpretation of the existing contract terms, an adjustment to the amounts owed may be required. Any changes to the terms of these provisions, including revisions to the definitions of premium revenue, medical care costs, administrative costs or profit, the period of time over which performance is measured or the manner of its measurement, or the percentages used in the calculations, may affect the profitability of our New Mexico health plan.
   
New Mexico Health Plan At-Risk Premium Revenue: Under our contract with the state of New Mexico, up to 0.75% of our New Mexico health plan’s revenue may be refundable to the state if certain performance measures are not met. These performance measures are generally linked to various quality of care and administrative measures dictated by the state. For the state fiscal year ended June 30, 2011, our New Mexico health plan has received $2.6 million in at-risk revenue for state fiscal year 2011. We have recognized $1.9 million of that amount as revenue, and recorded a liability of approximately $0.7 million as of September 30, 2011, for the remainder. For the state fiscal year ended June 30, 2012 we have received $0.6 million in at-risk revenue. We have recognized $0.4 million as revenue, and have recorded a liability of $0.2 million for the remainder. If the state of New Mexico disagrees with our estimation of our compliance with the at-risk premium requirements, an adjustment to the amounts owed may be required.
   
Ohio Health Plan At-Risk Premium Revenue: Under our contract with the state of Ohio, up to 1% of our Ohio health plan’s revenue may be refundable to the state if certain performance measures are not met. Effective February 1, 2010 through June 30, 2011, an additional 0.25% of the Ohio health plan’s revenue became refundable if certain pharmacy specific performance measures were not met. These performance measures are generally linked to various quality-of-care measures dictated by the state. For the state fiscal year ended June 30, 2011, our Ohio health plan received $10.3 million in at-risk revenue. We have recognized $8.6 million of that amount as revenue, and recorded a liability of approximately $1.7 million for the remainder. To date for the state fiscal year ended June 30, 2012, we have received $2.7 million in at-risk revenue, of which $2.3 million has been recognized as revenue, and $0.4 million was recorded as a liability as of September 30, 2011. If the state of Ohio disagrees with our estimation of our compliance with the at-risk premium requirements, an adjustment to the amounts owed may be required. For example, during the third quarter of 2010, we reversed the recognition of approximately $3.3 million of at-risk revenue, of which $1.9 million and $1.4 million were initially recognized in 2010, and 2009, respectively.
   
Utah Health Plan Premium Revenue: Our Utah health plan was entitled to receive additional premium revenue from the state of Utah as an incentive payment for saving the state of Utah money in relation to fee-for-service Medicaid during the period 2003 through August 31, 2009.
 
     
During the second quarter of 2011 we settled all claims related to state contract years 2006 through 2009 and received payments amounting to $13.6 million in settlement of this matter. The state in turn has made demands upon us amounting to $9.6 million to recover alleged over payment of premium revenue to us for the period 2003 through 2009. We are disputing many of those claims and as of September 30, 2011 have recorded a liability of approximately $4.6 million in connection with the premium revenue overpayments.
   
Texas Health Plan Profit Sharing: Under our contract with the state of Texas there is a profit-sharing agreement, where we pay a rebate to the state of Texas if our Texas health plan generates pretax income, as defined in the contract, above a certain specified percentage, as determined in accordance with a tiered rebate schedule. The rebates, if any, are calculated separately for the TANF/CHIP and ABD products. We are limited in the amount of administrative costs that we may deduct in calculating the rebate, if any. As of September 30, 2011, we had an aggregate liability of approximately $1.3 million accrued pursuant to our profit-sharing agreement with the state of Texas for the 2011 and 2012 contract years (ending August 31st of each year). Because the final settlement calculations include a claims run-out period of nearly one year, an adjustment to the amounts owed may be required.

 

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Texas Health Plan At-Risk Premium Revenue: Under our contract with the state of Texas, up to 1% of our Texas health plan’s revenue may be refundable to the state if certain performance measures are not met. These performance measures are generally linked to various quality-of-care measures established by the state. The time period for the assessment of these performance measures previously followed the state’s fiscal year, but effective January 1, 2011, it follows the calendar year. The state of Texas has notified us that it has discontinued the program for the 2011 calendar year.
   
Wisconsin Health Plan incentive revenue: Under our contract with the state of Wisconsin, a portion of the capitation premiums are withheld by the state and placed into an incentive pool. The amounts withheld are 3.25% of revenue in the southeast region of the state for the Badger Care program and 1% for the remaining membership in the state. If certain performance measures are met, the plan may be eligible to receive these additional funds as an incentive payment. As of September 30, 2011 we have determined that there is persuasive evidence that at least a portion of these funds have been earned and a receivable $0.4 million is established accordingly.
   
Medicare Premium Revenue: Based on member encounter data that we submit to CMS, our Medicare revenue is subject to retroactive adjustment for both member risk scores and member pharmacy cost experience for up to two years after the original year of service. This adjustment takes into account the acuity of each member’s medical needs relative to what was anticipated when premiums were originally set for that member. In the event that a member requires less acute medical care than was anticipated by the original premium amount, CMS may recover premium from us. In the event that a member requires more acute medical care than was anticipated by the original premium amount, CMS may pay us additional retroactive premium. A similar retroactive reconciliation is undertaken by CMS for our Medicare members’ pharmacy utilization. That analysis is similar to the process for the adjustment of member risk scores, but is further complicated by member pharmacy cost sharing provisions attached to the Medicare pharmacy benefit that do not apply to the services measured by the member risk adjustment process. We estimate the amount of Medicare revenue that will ultimately be realized for the periods presented based on our knowledge of our members’ heath care utilization patterns and CMS practices. Based on our knowledge of member health care utilization patterns, we have recorded a liability of approximately $1.2 million related to the potential recoupment of Medicare premium revenue at September 30, 2011. To the extent that the premium revenue ultimately received from CMS differs from recorded amounts, we will adjust reported Medicare revenue.
Recognition of Service Revenue and Cost of Service Revenue — Molina Medicaid Solutions Segment
The payments received by our Molina Medicaid Solutions segment under its state contracts are based on the performance of three elements of service. The first of these is the design, development and implementation, or DDI, of a Medicaid Management Information System, or MMIS. The second element, following completion of the DDI element, is the operation of the MMIS under a business process outsourcing, or BPO, arrangement. While providing BPO services, we also provide the state with the third contracted element — training and IT support and hosting services (training and support).
Because they include these three elements of service, our Molina Medicaid Solutions contracts are multiple-element arrangements. The following discussion applies to our contracts with multiple elements entered into prior to January 1, 2011, before our prospective adoption of Accounting Standards Update, or ASU, No. 2009-13, Revenue Recognition (Accounting Standards Codification, or ASC, Topic 605) — Multiple-Deliverable Revenue Arrangements.

 

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For those contracts entered into prior to January 1, 2011, we have no vendor specific objective evidence, or VSOE, of fair value for any of the individual elements in these contracts, and at no point in the contract will we have VSOE for the undelivered elements in the contract. We lack VSOE of the fair value of the individual elements of our Molina Medicaid Solutions contracts for the following reasons:
   
Each contract calls for the provision of its own specific set of products and services, which vary significantly between contracts; and
   
The nature of the MMIS installed varies significantly between our older contracts (proprietary mainframe systems) and our newer contracts (commercial off-the-shelf technology solutions).
The absence of VSOE within the context of a multiple element arrangement prior to January 1, 2011 requires us to delay recognition of any revenue for an MMIS contract until completion of the DDI phase of the contract. As a general principle, revenue recognition will therefore commence at the completion of the DDI phase, and all revenue will be recognized over the period that BPO services and training and support services are provided. Consistent with the deferral of revenue, recognition of all direct costs (such as direct labor, hardware, and software) associated with the DDI phase of our contracts is deferred until the commencement of revenue recognition. Deferred costs are recognized on a straight-line basis over the period of revenue recognition.
Provisions specific to each contract may, however, lead us to modify this general principle. In those circumstances, the right of the state to refuse acceptance of services, as well as the related obligation to compensate us, may require us to delay recognition of all or part of our revenue until that contingency (the right of the state to refuse acceptance) has been removed. In those circumstances we defer recognition of any revenue at risk (whether DDI, BPO services, or training and support services) until the contingency has been removed. When we defer revenue recognition we also defer recognition of incremental direct costs (such as direct labor, hardware, and software) associated with the revenue deferred. Such deferred contract costs are recognized on a straight-line basis over the period of revenue recognition.
However, direct costs in excess of the estimated future net revenues associated with a contract may not be deferred. In circumstances where estimated direct costs over the life of a contract exceed estimated future net revenues of that contract, the excess of direct costs over revenue is expensed as a period cost.
In Idaho, revenue recognition is expected to begin during the second half of 2012. Consistent with the deferral of revenue, we have deferred recognition of a portion of the direct contract costs associated with that revenue. Deferred contract costs, if any, deferred through the date revenue recognition begins will be recognized simultaneously with revenue. As noted above, direct costs in excess of the estimated future net revenues associated with a contract may not be deferred. For the three and nine months ended September 30, 2011, we recorded $2.5 million and $9.5 million, respectively, of direct contract costs associated with our Idaho contract. We were not able to defer these direct contract costs because estimated future net revenues as of each measurement date did not exceed estimated future direct costs of the contract. We currently expect the Idaho contract to perform financially at a break even basis through its initial term. So long as we continue to defer revenue recognition under the contract, we will also continue to defer direct costs associated with the agreement. If our break-even assumptions were to change, we may not be able to continue to defer direct contract costs.
We began to recognize revenue and the related deferred costs associated with our Maine contract in September 2010.
Molina Medicaid Solutions’ deferred revenue was $53.1 million at September 30, 2011, and $10.9 million at December 31, 2010, and unamortized deferred contract costs were $52.8 million at September 30, 2011, and $28.4 million at December 31, 2010.
For all new or materially modified revenue arrangements with multiple elements entered into on or after January 1, 2011, we apply the guidance contained in ASU No. 2009-13. For these arrangements, we allocate total arrangement consideration to the elements of the arrangement, which are expected to be DDI, BPO, and training and support services, because this is consistent with the current elements included in our Molina Medicaid Solutions contracts. The arrangement allocation is performed using the relative selling-price method. When determining the selling price of each element, VSOE should first be used, if available. Since VSOE is unavailable under our contracts, we will attempt to use third-party evidence, or TPE, of vendors selling similar services to similarly situated customers on a standalone basis, if available. If TPE is not available, we use our best estimate of the selling price for each element.

 

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We then evaluate whether, at each stage in the life cycle of the contract, we are able to recognize revenue associated with that element. To the extent that our revenue arrangements have provisions that allow our state customers to refuse acceptance of services performed, we are still required to defer revenue recognition until such state customers accept our performance. Once this acceptance is achieved, we immediately recognize the revenue associated with any delivered elements, which differs from our current practice for arrangements entered into prior to January 1, 2011, where the revenue associated with delivered elements is recognized over the final service element of the arrangement because VSOE for the other elements does not exist. As such, we expect that the adoption of ASU No. 2009-13 will result in an overall acceleration of revenue recognition with respect to any multiple-element arrangements entered into on or after January 1, 2011. We have entered into no new or materially modified revenue arrangements with multiple elements since January 1, 2011.
Medical Claims and Benefits Payable — Health Plans Segment
The following table provides the details of our medical claims and benefits payable as of the dates indicated:
                         
    Sept. 30,     Dec. 31,     Sept. 30,  
    2011     2010     2010  
    (In thousands)  
Fee-for-service claims incurred but not paid (IBNP)
  $ 283,160     $ 275,259     $ 271,285  
Capitation payable
    49,259       49,598       53,410  
Pharmacy
    16,615       14,649       14,663  
Other
    12,021       14,850       13,982  
 
                 
 
  $ 361,055     $ 354,356     $ 353,340  
 
                 
The determination of our liability for claims and medical benefits payable is particularly important to the determination of our financial position and results of operations in any given period. Such determination of our liability requires the application of a significant degree of judgment by our management.
As a result, the determination of our liability for claims and medical benefits payable is subject to an inherent degree of uncertainty. Our medical care costs include amounts that have been paid by us through the reporting date, as well as estimated liabilities for medical care costs incurred but not paid by us as of the reporting date. Such medical care cost liabilities include, among other items, unpaid fee-for-service claims, capitation payments owed providers, unpaid pharmacy invoices, and various medically related administrative costs that have been incurred but not paid. We use judgment to determine the appropriate assumptions for determining the required estimates.
The most important element in estimating our medical care costs is our estimate for fee-for-service claims which have been incurred but not paid by us. These fee-for-service costs that have been incurred but have not been paid at the reporting date are collectively referred to as medical costs that are “Incurred But Not Paid,” or IBNP. Our IBNP, as reported on our balance sheet, represents our best estimate of the total amount of claims we will ultimately pay with respect to claims that we have incurred as of the balance sheet date. We estimate our IBNP monthly using actuarial methods based on a number of factors. As indicated in the table above, our estimated IBNP liability represented $283.2 million of our total medical claims and benefits payable of $361.1 million as of September 30, 2011. Excluding amounts that we anticipate paying on behalf of a capitated provider in Ohio (which we will subsequently withhold from that provider’s monthly capitation payment), our IBNP liability at September 30, 2011, was $276.9 million.
The factors we consider when estimating our IBNP include, without limitation, claims receipt and payment experience (and variations in that experience), changes in membership, provider billing practices, health care service utilization trends, cost trends, product mix, seasonality, prior authorization of medical services, benefit changes, known outbreaks of disease or increased incidence of illness such as influenza, provider contract changes, changes to Medicaid fee schedules, and the incidence of high dollar or catastrophic claims. Our assessment of these factors is then translated into an estimate of our IBNP liability at the relevant measuring point through the calculation of a base estimate of IBNP, a further reserve for adverse claims development, and an estimate of the administrative costs of settling all claims incurred through the reporting date. The base estimate of IBNP is derived through application of claims payment completion factors and trended PMPM cost estimates.
For the fifth month of service prior to the reporting date and earlier, we estimate our outstanding claims liability based on actual claims paid, adjusted for estimated completion factors. Completion factors seek to measure the cumulative percentage of claims expense that will have been paid for a given month of service as of the reporting date, based on historical payment patterns.

 

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The following table reflects the change in our estimate of claims liability as of September 30, 2011 that would have resulted had we changed our completion factors for the fifth through the twelfth months preceding September 30, 2011, by the percentages indicated. A reduction in the completion factor results in an increase in medical claims liabilities. Dollar amounts are in thousands.
         
    Increase (Decrease) in  
    Medical Claims and  
(Decrease) Increase in Estimated Completion Factors   Benefits Payable  
(6%)
  $ 113,904  
(4%)
    75,936  
(2%)
    37,968  
2%
    (37,968 )
4%
    (75,936 )
6%
    (113,904 )
For the four months of service immediately prior to the reporting date, actual claims paid are not a reliable measure of our ultimate liability, given the inherent delay between the patient/physician encounter and the actual submission of a claim for payment. For these months of service, we estimate our claims liability based on trended PMPM cost estimates. These estimates are designed to reflect recent trends in payments and expense, utilization patterns, authorized services, and other relevant factors. The following table reflects the change in our estimate of claims liability as of September 30, 2011 that would have resulted had we altered our trend factors by the percentages indicated. An increase in the PMPM costs results in an increase in medical claims liabilities. Dollar amounts are in thousands.
         
    Increase (Decrease) in  
    Medical Claims and  
(Decrease) Increase in Trended Per member Per Month Cost Estimates   Benefits Payable  
(6%)
  $ (61,288 )
(4%)
    (40,859 )
(2%)
    (20,429 )
2%
    20,429  
4%
    40,859  
6%
    61,288  
The following per-share amounts are based on a combined federal and state statutory tax rate of 37.5%, and 46.3 million diluted shares outstanding for the nine months ended September 30, 2011. Assuming a hypothetical 1% change in completion factors from those used in our calculation of IBNP at September 30, 2011, net income for the nine months ended September 30, 2011 would increase or decrease by approximately $11.9 million, or $0.26 per diluted share. Assuming a hypothetical 1% change in PMPM cost estimates from those used in our calculation of IBNP at September 30, 2011, net income for the three months ended September 30, 2011 would increase or decrease by approximately $6.4 million, or $0.14 per diluted share. The corresponding figures for a 5% change in completion factors and PMPM cost estimates would be $59.3 million, or $1.28 per diluted share, and $31.9 million, or $0.69 per diluted share, respectively.
It is important to note that any change in the estimate of either completion factors or trended PMPM costs would usually be accompanied by a change in the estimate of the other component, and that a change in one component would almost always compound rather than offset the resulting distortion to net income. When completion factors are overestimated, trended PMPM costs tend to be underestimated. Both circumstances will create an overstatement of net income. Likewise, when completion factors are underestimated, trended PMPM costs tend to be overestimated, creating an understatement of net income. In other words, errors in estimates involving both completion factors and trended PMPM costs will usually act to drive estimates of claims liabilities and medical care costs in the same direction. If completion factors were overestimated by 1%, resulting in an overstatement of net income by approximately $11.9 million, it is likely that trended PMPM costs would be underestimated, resulting in an additional overstatement of net income.

 

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After we have established our base IBNP reserve through the application of completion factors and trended PMPM cost estimates, we then compute an additional liability, once again using actuarial techniques, to account for adverse developments in our claims payments which the base actuarial model is not intended to and does not account for. We refer to this additional liability as the provision for adverse claims development. The provision for adverse claims development is a component of our overall determination of the adequacy of our IBNP. It is intended to capture the potential inadequacy of our IBNP estimate as a result of our inability to adequately assess the impact of factors such as changes in the speed of claims receipt and payment, the relative magnitude or severity of claims, known outbreaks of disease such as influenza, our entry into new geographical markets, our provision of services to new populations and regions such as the ABD population in the Dallas-Fort Worth area, changes to state-controlled fee schedules upon which a large proportion of our provider payments are based, modifications and upgrades to our claims processing systems and practices, and increasing medical costs. Because of the complexity of our business, the number of states in which we operate, and the need to account for different health care benefit packages among those states, we make an overall assessment of IBNP after considering the base actuarial model reserves and the provision for adverse claims development. We also include in our IBNP liability an estimate of the administrative costs of settling all claims incurred through the reporting date. The development of IBNP is a continuous process that we monitor and refine on a monthly basis as additional claims payment information becomes available. As additional information becomes known to us, we adjust our actuarial model accordingly to establish IBNP.
On a monthly basis, we review and update our estimated IBNP and the methods used to determine that liability. Any adjustments, if appropriate, are reflected in the period known. While we believe our current estimates are adequate, we have in the past been required to increase significantly our claims reserves for periods previously reported, and may be required to do so again in the future. Any significant increases to prior period claims reserves would materially decrease reported earnings for the period in which the adjustment is made.
In our judgment, the estimates for completion factors will likely prove to be more accurate than trended PMPM cost estimates because estimated completion factors are subject to fewer variables in their determination. Specifically, completion factors are developed over long periods of time, and are most likely to be affected by changes in claims receipt and payment experience and by provider billing practices. Trended PMPM cost estimates, while affected by the same factors, will also be influenced by health care service utilization trends, cost trends, product mix, seasonality, prior authorization of medical services, benefit changes, outbreaks of disease or increased incidence of illness, provider contract changes, changes to Medicaid fee schedules, and the incidence of high dollar or catastrophic claims. As discussed above, however, errors in estimates involving trended PMPM costs will almost always be accompanied by errors in estimates involving completion factors, and vice versa. In such circumstances, errors in estimation involving both completion factors and trended PMPM costs will act to drive estimates of claims liabilities (and therefore medical care costs) in the same direction.
Assuming that base reserves have been adequately set, we believe that amounts ultimately paid out should generally be between 8% and 10% less than the liability recorded at the end of the period as a result of the inclusion in that liability of the allowance for adverse claims development and the accrued cost of settling those claims. However, there can be no assurance that amounts ultimately paid out will not be higher or lower than this 8% to 10% range, as shown by our results for the year ended December 31, 2010, when the amounts ultimately paid out were less than the amount of the reserves we had established as of the beginning of that year by 15.7%.
As shown in greater detail in the table below, the amounts ultimately paid out on our liabilities in fiscal years 2010 and through September 30, 2011 were less than what we had expected when we had established our reserves. While the specific reasons for the overestimation of our liabilities were different in each of the periods presented, in general the overestimations were tied to our assessment of specific circumstances at our individual health plans which were unique to those reporting periods.
We recognized a benefit from prior period claims development in the amount of $49.5 million for the nine months ended September 30, 2011 (see table below). This amount represents our estimate as of September 30, 2011 of the extent to which our initial estimate of medical claims and benefits payable at December 31, 2010 exceeded the amount that will ultimately be paid out in satisfaction of that liability. The overestimation of claims liability at December 31, 2010 was due primarily to the following factors:
   
We overestimated the impact of an increase in pending high dollar claims at our Ohio health plan.
   
We underestimated the lower cost associated with changes to provider fee schedules (primarily for outpatient facility costs) in New Mexico effective November 1, 2010.

 

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The following developments partially offset the overestimation of our claims liability at December 31, 2010:
   
In Missouri, delays in claims processing late in the fourth quarter of 2010 led us to underestimate the size of our claims liability at December 31, 2010.
   
We underestimated the costs associated with our assumption of risk for a new population in Texas (rural CHIP members) effective September 1, 2010.
We recognized a benefit from prior period claims development in the amount of $49.4 million for the year ended December 31, 2010 (see table below). This was primarily caused by the overestimation of our liability for claims and medical benefits payable at December 31, 2009. The overestimation of claims liability at December 31, 2009 was the result of the following factors:
   
In New Mexico, we underestimated the degree to which cuts to the Medicaid fees schedule would reduce our liability as of December 31, 2009.
   
In California, we underestimated the extent to which various network restructuring, provider contracting, and medical management initiatives had reduced our medical care costs during the second half of 2009, thereby resulting in a lower liability at December 31, 2009.
In estimating our claims liability at September 30, 2011, we adjusted our base calculation to take account of the following factors which we believe are reasonably likely to change our final claims liability amount:
   
The assumption of risk for new populations by our Texas health plan; Dallas-Fort Worth area ABD members effective February 1, 2011; Jefferson service area members effective September 30, 2011.
   
The transition of certain members by our Washington and Michigan health plans from full-risk capitated provider arrangements to fee-for-service providers effective December 31, 2010. This change had the effect of transferring back to the Company risk that had previously been assumed by capitated medical providers.
   
A substantial decline in Medicaid claims inventory at our Ohio health plan and for our overall Medicare membership.
   
A substantial increase in Medicaid claims inventory in Missouri and New Mexico.
The use of a consistent methodology in estimating our liability for claims and medical benefits payable minimizes the degree to which the under- or overestimation of that liability at the close of one period may affect consolidated results of operations in subsequent periods. Facts and circumstances unique to the estimation process at any single date, however, may still lead to a material impact on consolidated results of operations in subsequent periods. Any absence of adverse claims development (as well as the expensing through general and administrative expense of the costs to settle claims held at the start of the period) will lead to the recognition of a benefit from prior period claims development in the period subsequent to the date of the original estimate. In 2010 and through September 30, 2011, the absence of adverse development of the liability for claims and medical benefits payable at the close of the previous period resulted in the recognition of substantial favorable prior period development. In both years, however, the recognition of a benefit from prior period claims development did not have a material impact on our consolidated results of operations because the amount of benefit recognized in each year was roughly consistent with that recognized in the previous year.

 

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The following table presents the components of the change in our medical claims and benefits payable for the periods presented. The negative amounts displayed for “Components of medical care costs related to: Prior periods” represent the amount by which our original estimate of claims and benefits payable at the beginning of the period exceeded the actual amount of the liability based on information (principally the payment of claims) developed since that liability was first reported.
                                         
                    Six     Three        
                    Months     Months     Year  
    Nine Months Ended     Ended     Ended     Ended  
    Sept. 30,     Sept. 30,     June 30,     March 31,     Dec. 31,  
    2011     2010     2011     2011     2010  
    (Dollars in thousands, except  
    per-member amounts)  
Balances at beginning of period
  $ 354,356     $ 315,316     $ 354,356     $ 354,356     $ 315,316  
Balance of acquired subsidiary
                            3,228  
Components of medical care costs related to:
                                       
Current period
    2,871,515       2,554,579       1,908,289       957,909       3,420,235  
Prior periods
    (49,466 )     (46,213 )     (45,398 )     (44,377 )     (49,378 )
 
                             
Total medical care costs
    2,822,049       2,508,366       1,862,891       913,532       3,370,857  
 
                             
Payments for medical care costs related to:
                                       
Current period
    2,522,374       2,219,896       1,584,636       646,428       3,085,388  
Prior periods
    292,976       250,446       290,998       270,078       249,657  
 
                             
Total paid
    2,815,350       2,470,342       1,875,634       916,506       3,335,045  
 
                             
Balances at end of period
  $ 361,055     $ 353,340     $ 341,613     $ 351,382     $ 354,356  
 
                             
Benefit from prior period as a percentage of:
                                       
Balance at beginning of period
    14.0 %     14.7 %     12.8 %     12.5 %     15.7 %
Premium revenue
    1.5 %     1.6 %     2.1 %     4.1 %     1.2 %
Total medical care costs
    1.8 %     1.8 %     2.4 %     4.9 %     1.5 %
Claims Data:
                                       
Days in claims payable, fee for service
    39       42       39       41       42  
Number of members at end of period
    1,678,000       1,597,000       1,645,000       1,647,000       1,613,000  
Number of claims in inventory at end of period
    132,200       110,200       121,900       185,300       143,600  
Billed charges of claims in inventory at end of period
  $ 187,000     $ 158,900     $ 205,800     $ 250,600     $ 218,900  
Claims in inventory per member at end of period
    0.08       0.07       0.07       0.11       0.09  
Billed charges of claims in inventory per member at end of period
  $ 111.44     $ 99.50     $ 125.11     $ 152.16     $ 135.71  
Number of claims received during the period
    12,864,800       10,701,900       8,715,200       4,342,200       14,554,800  
Billed charges of claims received during the period
  $ 10,573,900     $ 8,615,500     $ 6,963,300     $ 3,386,600     $ 11,686,100  
Inflation
We use various strategies to mitigate the negative effects of health care cost inflation. Specifically, our health plans try to control medical and hospital costs through contracts with independent providers of health care services. Through these contracted providers, our health plans emphasize preventive health care and appropriate use of specialty and hospital services. There can be no assurance, however, that our strategies to mitigate health care cost inflation will be successful. Competitive pressures, new health care and pharmaceutical product introductions, demands from health care providers and customers, applicable regulations, or other factors may affect our ability to control health care costs.
Compliance Costs
Our health plans are regulated by both state and federal government agencies. Regulation of managed care products and health care services is an evolving area of law that varies from jurisdiction to jurisdiction. Regulatory agencies generally have discretion to issue regulations and interpret and enforce laws and rules. Changes in applicable laws and rules occur frequently. Compliance with such laws and rules may lead to additional costs related to the implementation of additional systems, procedures and programs that we have not yet identified.

 

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Item 3.  
Quantitative and Qualitative Disclosures About Market Risk
Concentrations of Credit Risk
Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash and cash equivalents, investments, receivables, and restricted investments. We invest a substantial portion of our cash in the PFM Fund Prime Series — Institutional Class, and the PFM Fund Government Series. These funds represent a portfolio of highly liquid money market securities that are managed by PFM Asset Management LLC (PFM), a Virginia business trust registered as an open-end management investment fund. Our investments and a portion of our cash equivalents are managed by professional portfolio managers operating under documented investment guidelines. No investment that is in a loss position can be sold by our managers without our prior approval. Our investments consist solely of investment grade debt securities with a maximum maturity of five years and an average duration of two years or less. Restricted investments are invested principally in certificates of deposit and U.S. treasury securities. Concentration of credit risk with respect to accounts receivable is limited due to payors consisting principally of the governments of each state in which our Health Plans segment and our Molina Medicaid Solutions segment operate.
Item 4.  
Controls and Procedures
Evaluation of Disclosure Controls and Procedures: Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, has concluded, based upon its evaluation as of the end of the period covered by this report, that the Company’s “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act ”)) are effective to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
Changes in Internal Control Over Financial Reporting: During the fiscal quarter ended June 30, 2011, we completed the implementation of a new enterprise resource planning, or ERP, software system. This system is used in the preparation of, among other things, our financial statements and required reports. There has been no change in our internal control over financial reporting during the fiscal quarter ended September 30, 2011 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

 

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PART II — OTHER INFORMATION
Item 1.  
Legal Proceedings
The health care industry is subject to numerous laws and regulations of federal, state, and local governments. Compliance with these laws and regulations can be subject to government review and interpretation, as well as regulatory actions unknown and unasserted at this time. Penalties associated with violations of these laws and regulations include significant fines, exclusion from participating in publicly-funded programs, and the repayment of previously billed and collected revenues.
We are involved in various legal actions in the normal course of business, some of which seek monetary damages, including claims for punitive damages, which are not covered by insurance. Based upon the evaluation of information currently available, we believe that these actions, when finally concluded and determined, are not likely to have a material adverse effect on our business, financial condition, cash flows, or results of operations.
Item 1A.  
Risk Factors
Certain risk factors may have a material adverse effect on our business, financial condition, cash flows, or results of operations, and you should carefully consider them. In addition to the other information set forth in this report, the following risk factors were identified by the Company during the third quarter of 2011 and is a supplement to the risk factors identified in Part I, Item 1A — Risk Factors, in our Annual Report on Form 10-K for the year ended December 31, 2010, as updated in Part II, Item 1A — Risk Factors in our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2011. The risk factors described herein and in our Annual Report on Form 10-K, as updated by our quarterly report on Form 10-Q for the quarterly period ended June 30, 2011, are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially adversely affect our business, financial condition, cash flows, or results of operations.
Restrictions and covenants in our credit facility may limit our ability to make certain acquisitions or reduce our liquidity and capital resources.
On September 9, 2011, we terminated our credit agreement with Bank of America which had provided us with a $150 million revolving credit facility and entered into a credit agreement for a $170 million revolving credit facility with various lenders and U.S. Bank National Association. The credit facility imposes numerous restrictions and covenants, including, but not limited to, prescribed consolidated leverage and fixed charge coverage ratios, net worth requirements, and acquisition and disposition limitations that restrict our financial and operating flexibility, including our ability to make certain acquisitions above specified values and declare dividends and other distributions without lender approval. Our ability to comply with these covenants may be affected by events beyond our control. As a result of the restrictions and covenants imposed under our credit facility, our growth strategy may be negatively impacted by our inability to react to market conditions, finance our operations, engage in strategic acquisitions or disposals, act with complete flexibility, or to use our credit facility in the manner intended. In addition, our credit facility matures in September 2016. If we are in default at a time when funds under the credit facility are required to finance an acquisition, or if a proposed acquisition does not satisfy the pro forma financial requirements under our credit facility, or if we are unable to renew or refinance our credit facility prior to its maturity, and if the default is not cured or waived, we may be unable to use the credit facility in the manner intended, and our operations, liquidity, and capital resources could be materially adversely affected.

In the event the expected reduction in the rates paid to our California health plan is not finally implemented, is not made effective retroactive to July 1, 2011, or is otherwise modified, our results of operations may be affected.

California Assembly Bill 97, or AB 97, is legislation that was signed by Governor Jerry Brown on March 24, 2011. Among other things, AB 97 proposes to effect a 10% reduction in Medi-Cal provider rates. The California Department of Health Care Services has indicated that the 10% rate reduction will be effective retroactive to July 1, 2011.  The Company believes that this reduction in provider payments, if effected, will translate into a premium reduction of approximately 6% for the California health plan. Because of the expected reduction in its rates effective July 1, 2011, the California health plan reduced its recognized premium revenue by approximately $7.5 million in the third quarter of 2011.  However, at September 30, 2011, the California health plan had not recorded any potential recovery of provider payments related to this estimated premium reduction.

The proposed rate reduction was submitted for approval to CMS, and CMS had requested additional information from the state in support of the rate cut. On October 27, 2011, CMS indicated its general approval of the rate cut. However, the immediate effect of that approval is unclear, and it is anticipated that litigation will be commenced by providers or others to enjoin the implementation of the rate cut.

If the proposed rate cut is not finally implemented, if it is not made retroactive to July 1, 2011, or if it is otherwise modified from its current form, the results of our California health plan could be affected. In addition, recoveries from providers related to any final implemented rate cut could also affect the results of our California health plan.

 

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On July 27, 2011, our board of directors approved a stock repurchase program of up to $7 million to be used to purchase shares of our common stock under a Rule 10b5-1 trading plan. Under this program, we purchased approximately 400,000 shares of our common stock for $7 million (average cost of approximately $17.47 per share) during August 2011. This repurchase program was funded with working capital.
Effective as of October 26, 2011, our board of directors has authorized the repurchase of $75 million in aggregate of either our common stock or our convertible senior notes due 2014. The repurchase program will be funded with working capital or the Company’s credit facility, and repurchases may be made from time to time on the open market or through privately negotiated transactions. The repurchase program extends through October 25, 2012, but the Company reserves the right to suspend or discontinue the program at any time. No repurchases have been made by the Company pursuant to this repurchase plan during the quarter ended September 30, 2011.
Purchases of common stock made by or on behalf of the Company during the quarter ended September 30, 2011, including shares withheld by the Company to satisfy our employees’ income tax obligations, are set forth below:
                                 
                    Total Number of   Maximum Number (or
                    Shares Purchased as   Approximate Dollar Value)
    Total Number           Part of Publicly   of Shares That May Yet Be
    of Shares   Average Price   Announced Plans or   Purchased Under the Plans
    Purchased (a)   Paid per Share   Programs (b)(c)   or Programs (b)(c)(d)
July 1 — July 31
    1,361 (e)   $ 27.77           $ 7,000,000  
August 1 — August 31
    402,800 (e)   $ 17.50       399,900     $  
September 1 — September 30
    644 (e)   $ 18.79           $  
 
                               
Total
    404,805 (e)   $ 17.53       399,900          
 
                               
  (a)  
During the three months ended September 30, 2011, we did not repurchase any shares of our common stock outside of our publicly announced stock repurchase program except 4,905 shares of common stock withheld to settle our employees’ income tax obligations.
  (b)  
On July 27, 2011, our board of directors approved a stock repurchase program of up to $7 million to be used to purchase shares of our common stock under a Rule 10b5-1 trading plan. Our repurchases under this program were completed in August 2011.
  (c)  
Effective as of October 26, 2011, our board of directors has authorized the repurchase of $75 million in aggregate of either our common stock or our convertible senior notes due 2014. The repurchase program extends through October 25, 2012, but the Company reserves the right to suspend or discontinue the program at any time. No repurchases have been made by the Company pursuant to this repurchase plan during the quarter ended September 30, 2011.
  (d)  
As the repurchase plan effective October 26, 2011 was not in effect during the quarter ended September 30, 2011, this column does not include the maximum value of shares that may be purchased pursuant to this plan.
  (e)  
Includes shares withheld by the Company to satisfy our employees’ income tax withholdings.

 

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Item 6.  
Exhibits
         
Exhibit No.   Title
  31.1    
Certification of Chief Executive Officer pursuant to Rules 13a-14(a)/15d-14(a) under the Securities Exchange Act of 1934, as amended.
       
 
  31.2    
Certification of Chief Financial Officer pursuant to Rules 13a-14(a)/15d-14(a) under the Securities Exchange Act of 1934, as amended.
       
 
  32.1    
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
       
 
  32.2    
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
       
 
101.INS (1)  
XBRL Taxonomy Instance Document.
       
 
101.SCH (1)  
XBRL Taxonomy Extension Schema Document.
       
 
101.CAL (1)  
XBRL Taxonomy Extension Calculation Linkbase Document.
       
 
101.DEF (1)  
XBRL Taxonomy Extension Definition Linkbase Document.
       
 
101.LAB (1)  
XBRL Taxonomy Extension Label Linkbase Document.
       
 
101.PRE (1)  
XBRL Taxonomy Extension Presentation Linkbase Document.
 
     
(1)  
Pursuant to Rule 406T of Regulation S-T, XBRL (eXtensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

 

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
         
  MOLINA HEALTHCARE, INC.
(Registrant)
 
 
Dated: October 28, 2011  /s/ JOSEPH M. MOLINA, M.D.    
  Joseph M. Molina, M.D.   
  Chairman of the Board, Chief Executive Officer and President
(Principal Executive Officer)
 
 
     
Dated: October 28, 2011  /s/ JOHN C. MOLINA, J.D.    
  John C. Molina, J.D.   
  Chief Financial Officer and Treasurer
(Principal Financial Officer)
 
 

 

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EXHIBIT INDEX
         
Exhibit No.   Title
  31.1    
Certification of Chief Executive Officer pursuant to Rules 13a-14(a)/15d-14(a) under the Securities Exchange Act of 1934, as amended.
       
 
  31.2    
Certification of Chief Financial Officer pursuant to Rules 13a-14(a)/15d-14(a) under the
       
Securities Exchange Act of 1934, as amended.
       
 
  32.1    
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
       
 
  32.2    
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
       
 
101.INS (1)  
XBRL Taxonomy Instance Document.
       
 
101.SCH (1)  
XBRL Taxonomy Extension Schema Document.
       
 
101.CAL (1)  
XBRL Taxonomy Extension Calculation Linkbase Document.
       
 
101.DEF (1)  
XBRL Taxonomy Extension Definition Linkbase Document.
       
 
101.LAB (1)  
XBRL Taxonomy Extension Label Linkbase Document.
       
 
101.PRE (1)  
XBRL Taxonomy Extension Presentation Linkbase Document.
 
     
(1)  
Pursuant to Rule 406T of Regulation S-T, XBRL (eXtensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

 

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