Molina Healthcare Inc

NYSE:MOH

Earnings Call Transcript 2019-Q1

[Operator]

Good morning, ladies and gentlemen. And welcome to the Molina Healthcare First Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded.

At this time, I would now like to turn the conference over to Ryan Kubota, Director of Investor Relations. Please go ahead, sir.

[Ryan Kubota, VP, IR]

Thank you, operator. Hello, everyone, and thank you for joining us. The purpose of this call is to discuss Molina Healthcare's financial results for the first quarter ended March 31, 2019. The company issued its earnings release reporting first quarter of 2019 results last night after the market closed, and this release is now posted for viewing on our company website.

On the call with me today are Joe Zubretsky, our President and Chief Executive Officer; and Tom Tran, our Chief Financial Officer. After the completion of our prepared remarks, we will open the call to take your questions. If you have multiple questions, we ask that you get back into the queue so that others can have the opportunity to ask their questions.

Our comments today will contain forward-looking statements under the Safe Harbor provisions of the Private Securities Litigation Reform Act. All of our forward-looking statements are based on our current expectations and assumptions, which are subject to numerous risk factors that could cause our actual results to differ materially.

A description of such risk factors can be found in our earnings release and in our reports filed with the Securities and Exchange Commission, including our Form 10-K Annual Report, our Form 10-Q Quarterly Reports, and our Form 8-K Current Reports. These reports can be accessed under the Investor Relations tab of our company website, or on the SEC's website.

All forward-looking statements made during today's call represent our judgment as of April 30, 2019, and we disclaim any obligation to update such statements, except as required by the securities laws. This call is being recorded, and a 30-day replay of the conference call will be available at our company's website, molinahealthcare.com.

I would now like to turn the call over to our Chief Executive Officer, Joe Zubretsky.

[Joseph Zubretsky, President and CEO]

Thank you, Ryan, and thank you all for joining us this morning. Last night, we reported earnings per diluted share for the first quarter of $2.99. Pretax earnings of $260 million and after-tax earnings of $198 million resulting in pretax and after-tax margins of 6.3% and 4.8% respectively on a reported basis. These results demonstrate we can sustain the attractive margin position we built in 2018. While certainly not conclusive, our first quarter results validate our position that durable, financial and operational infrastructure improvement can and should allow us to sustain these margins all while we begin to grow the top line again.

Our first quarter results represent a strong start to the year and a significant improvement over the $1.64 earnings per diluted share we reported in the first quarter of 2018. As you will recall, this time last year, we were just beginning to execute on our profit improvement plan, which had yet to manifest itself in earnings. While the year-over-year improvement in the first quarter is significant, for the remainder of our prepared remarks, we will largely compare our quarterly performance to our own expectations.

Our strong first quarter operational performance and the trajectory of our profit improvement initiatives have allowed us to raise full-year guidance to a range of $10.50 to $11 of earnings per diluted share on a GAAP basis, an increase of $1.25 from the midpoint of our guidance issued in February. Highlighting our results for the quarter on a consolidated basis, premium revenue of nearly $4 billion was better than expected due to better marketplace membership retention, coupled with slower membership attrition during the quarter. As expected, premium revenue has decreased sequentially due to lower Medicaid membership as we transitioned out of New Mexico as of December 31st and exited out of all but two regions in Florida as previously announced.

Our medical care ratio of 85.3% was favorable to our expectations as the result of favorable prior year reserve development but more importantly improvement in our claims payment integrity process, frontline utilization management, quality and risk adjustment effort and the repricing benefit of our newly re-contracted pharmacy agreement. Our first quarter 2019 performance was positively impacted by our continued focused on medical cost management and a stable trend environment. Taken together, these factors produced favorable prior-year development of nearly $55 million or approximately $0.65 per diluted share, which we did not forecast in our initial 2019 guidance.

These trends have continued in 2019 and as such our 2019 medical cost baseline and the trend off of that baseline so far have proven to be conservatively stated. We managed to a G&A ratio of 7.3% which was better than our expectations. We continued to effectively manage our expenses in the quarter despite the headwinds associated with lower premium revenue. As a reminder, we typically see higher G&A expenses in the latter part of the year due to costs associated with our profit improvement initiatives, as well as sales and marketing expense for the Medicare and marketplace open enrollment.

Combined, the favorable medical care ratio and G&A ratio enabled us to deliver an after-tax margin of 4.8%. Now I will comment on our first quarter trends by line of business. The Medicaid business achieved an 88.5% Medical Care ratio and an after-tax margin of 2.8% in the quarter squarely in the range of the target margins we have forecasted for this business. Let me provide some additional insight into the favorable performance of the Medicaid business. TANF and ABD performed better than expected. While expansions slightly underperformed our expectations in the quarter due to some plans specific dynamics, which we will comment on later.

Medical cost trends in general remain well-managed. Specialty and pharmacy cost trends ran lower sequentially, and we retained more quality, incentive in other revenue withholds. Our Medicaid business is performing well, producing top-tier margins and well positioned to grow. Our Medicare business comprising our DSNP and MMP products also started the year strong, managing to a medical care ratio of 84.7%, we produced an after-tax margin of approximately 7.5%, outperforming our expectations.

More specifically on Medicare, both product lines, DSNP and MMP produced favorable results. We continue to demonstrate excellence and managing high acuity members by providing access to high quality healthcare at a reasonable cost. This includes our market leading management of LTSS benefits which are embedded in our MMP product. We are beginning to see the results of our quality and risk adjustment efforts as our Medicare risk scores are becoming more commensurate with the acuity of this population and risk adjustment revenue has increased.

This excellent start to the year gives us even more confidence in our 2020 bidding strategy, and the competitive pricing and enhanced benefits we need as we expand this business by a 150 new counties in 2020.

Finally, our marketplace business continues to perform well. Recall that for the 2019 underwriting year, we took a conservative rating posture to maintain our attractive margin position. We now have a scaled and profitable business that we plan to grow in 2020 and beyond. First quarter marketplace performance had the following highlights. We ended the quarter with approximately 330,000 members, which was better than our original expectations. We are generating and continue to generate more accurate risk scores and as a result we will likely pay less into the risk pool than expected.

Our medical care ratio was 62.2% which compares favorably year-over-year and sequentially. Texas continues to be our stronghold, while California and Washington have both improved significantly over both periods. And we again forecast a seasonality to this business and as profitability as front-loaded due to benefit in product design. In some and most notably our current marketplace performance trajectory and margin profile give us flexibility to pursue profitable 2020 growth.

Now I will comment on the first quarter through the lens of our locally operated health plans. Our health plan portfolio has started the year strong. As for the quarter 13 of 15 plans are meeting or exceeding their target margins. Our operating model continues to pay dividends as we empower local health plans to drive frontline decision-making with strong support from centralized services and disciplined corporate oversight. A few comments on our health plans performance.

California, Illinois, Michigan and Texas, four of our largest plans had very solid quarters. Florida was a significant out performer in the quarter as it effectively managed the transition of it's across regions. In Ohio, our Medicaid MCR increased by 300 basis points from the fourth quarter, primarily due to a shift in the Medicaid expansion risk pool and a newly carved in behavioral health benefit, both of which were not adequately rated.

We expect both phenomena to soon be reflected in our rates. Washington experienced higher medical costs from the Medicaid line-of-business compared to the fourth quarter of 2018 as a direct result of the new members we gained in our successful re-procurement and the plan wide carve-in of the behavioral benefit. This cost pressure will abate as the new members and new benefit mature.

Turning now to our balance sheet and capital structure. We delivered approximately $290 million of dividends to the parent company in the first quarter. We expect to obtain approximately $500 million of additional parent company dividends for the balance of the year, including the excess statutory surplus from Florida and New Mexico. We have continued to improve the balance sheet retiring additional debt. Approximately $78 million of face value of 2020 convertible notes remain outstanding, as we continue to reduce our exposure to these expensive in the money converts that negatively impact our share count.

In summary, we are very pleased with our first quarter performance across all of our operating metrics, product lines and health plans, and with respect to capital management.

Now I will address our updated and increased 2019 earnings guidance. We are increasing our earnings per share guidance to a range of $10.50 to $11 with a midpoint of $10.75. This midpoint increase of $1.25 or more than 13% represents a solid $0.80 out performance for the quarter and a $0.45 raise for the remainder of the year. The $0.80 earnings per share first quarter out performance comprise $0.65 of favorable prior year reserve development, which we do not forecast as a matter of practice. And $0.15 of first quarter performance above our original first quarter forecast.

The $0.45 raised for the balance of the year is backed by the momentum we have in all of our product lines as we project to exceed all of our previous guidance after-tax margin targets.

I will now provide a quick update on the initiatives we are executing in 2019 for 2020 top-line growth. As a side note, we will spend more time on this topic at our upcoming Investor Day on May 30th. We have filed to expand our DSNP footprint in approximately 150 new counties for 2020. We are currently executing our 2020 marketplace pricing strategy and remain committed to measured growth ensuring that overall profit dollars grow even if that means lower overall marketplace margins.

We are actively preparing for the Kentucky Medicaid RFP with resources deployed locally/ We have our certificate of authority and are building a network. We continue to expect incremental membership growth in our Illinois and Mississippi health plans in 2020, and we continue to have confidence in successful Texas Star Plus and STAR CHIP Awards in the coming months. Our successful margin recovery efforts have enabled us to focus additional effort on growth opportunities. We continue to evaluate new opportunities through state procurements, acquisitions of small health plans, benefit carve-ins and adjacent product expansion in our existing geographies.

Let me briefly highlight what we plan to present for a week from now. We will provide you with a granular and detailed view of our top-line growth strategy, along with details of what we will sell, to whom and where in each of our product lines. We will provide you with our outlook for long-term revenue after tax margins and earnings per share. And you will hear from our executive leadership team about our ability to sustain our attractive margin position, our tactical approach to top-line growth initiatives, our robust capital allocation model, and other topics that support our continual drive to create shareholder value.

In conclusion, we are very pleased with our first quarter results and our strong start to the year. Margin sustainability, the second part of our three-part plan is off to a good start. We have already launched the phase three, the top-line revenue growth phase and we are excited for what awaits us for the remainder of 2019 and beyond.

I look forward to sharing more about our future growth plans and longer-term strategy at our upcoming Investor Day on May 30th in New York City.

With that I will turn the call over to Tom Tran for more detail on the financials. Tom?

[Thomas Tran, CFO]

Thank you Joe and good morning. As described in our earnings release, we report first quarter earnings per diluted share of $2.99 and adjusted earnings per diluted share of $3.04 excluding the amortization of intangible assets. GAAP's earning per share of $1.64 in the first quarter of 2018 includes favorable non runway items of $0.38 per share, yielding pure performance earning per share of $1.26.

First, I will note that the two non-recurring items that occur in a quarter net to zero, resulting in first quarter pure performance earnings equal to reported earnings per diluted share of $2.99. Specifically, we recorded $3 million of restructuring expenses, primarily related to costs associated with our ongoing IT restructuring plan and a $3 million gain as part of the repurchase of the 2020 convertible notes and related embedded co-option terminations.

Next, I would like to make some comments on our first quarter earnings performance. First, I'll continue focus on medical management combined with a stable trend environment result in favorable prior year reserve development in a first quarter of approximately $55 million pre-tax. Second, each line of business performs at or above our expectations. Third, administrative costs in the first quarter were lower than expected primarily due to the timing of certain expenditures. We expect administrative costs for the balance of the year to increase with higher cost from investment in infrastructure and increase sales marketing costs associated with open enrollment in Medicare and marketplace.

Turning to our balance sheet, cash flow and cash position for the quarter. Our reserve approach is consistent with prior quarters and our reserve position remains strong. As we have stated in a past, at quarter end, we remain consistent without reserving approach and practice that result in favorable prior year reserve development in a first quarter. Days and claim payable was down one day sequentially to 52 days. Operating cash flow was strong in the first quarter and sequentially at approximately $250 million. As a reminder, cash flow from operations is impacted by change in working capital and a timing of large payments and government related balances.

We are projecting strong operating cash flow for the full year. Turning to capital actions. As of March 31, 2019, we had unrestricted cash and investments of approximately $440 million at the parent company. We harvest $290 million of dividends in the first quarter and planned to harvest approximately $500 million of additional dividends for the balance of the year, including the excess capital in New Mexico and Florida.

In a first quarter, we repurchased $46 million of the convertible notes leaving $206 million of face value outstanding. In April, we repurchase an additional $128 million of the convertible notes leaving $78 million of outstanding face value at approximately $240 million of current market value. That will be retired by this time next year. As of March 31, 2019 ,our health plans have aggregated statutory capital and surplus of approximately $2.3 billion which represents approximately 460% % of risk-based capital which is yet another indication of the strong near-term parent company dividend harvesting opportunity.

Last week Moody's upgrade our senior unsecured debt rating to B2 from B3 and improve the company outlook to positive from stable. This upgrade is a testament to our focus on operational excellence, as well as the discipline and rigorous financial management processes, we have instilled across the enterprise. We are pleased that Moody's had recognized the progress we have made in a last year-and-a-half. We have continued to look for opportunities to delever the balance sheet. Our action in a quarter to retire certain convertible bonds reduces average diluted shares outstanding to $66.2 million at the end of the first quarter of 2019 from $66.6 million at the end of the fourth quarter of 2018.

Shifting to 2019 revised guidance of $10.75 per diluted share at the midpoint of the provided range or an increase of $1.25 per diluted share. We outperformed our first quarter expectation by approximately $0.80. Approximately $0.65 was related to favorable prior year reserve development, which we did not forecast as a matter of practice. The remaining $0.15 was performance above our expectations for the quarter across all product lines. The remaining $0.45 is an increase to guidance for the remainder of 2019. Favorable medical cost trends, favorable first quarter results, along with our growing profit improvement initiatives suggest that the momentum and trajectory of the business have improved.

Our practice is not to provide quarterly guidance, however, some framing comments are in order due to the shifting mix of our business and a ramping effect about profit improvement initiatives throughout the year. Our guidance suggests approximately $7.75 of earnings per diluted share for the remaining three quarters of 2019. The second quarter is forecast to be slightly lower than one-third of that nine months total.

Finally, our 2019 guidance does not assume any additional impact from prior year development positive or negative for the rest of the year. All things being equal, if we have favorable prior year development as we did in the first quarter, our forecasts result will be higher and conversely a prior year development is unfavorable, our forecasts result will be lower.

This concludes our prepared remarks. Operator, we are now ready to take questions.

[Operator]

[Operator Instructions]

The first questions will be from Justin Lake of Wolfe Research. Please go ahead.

[ShehryarAmir]

Hi. Shehryar Amir on per Justin. So Washington recently approved a public auction plan for the Washington exchanges where Molina participates. Could you give us your preliminary thoughts on this? How this new system will impact Molina? And how the economics will work? And whether the government plan will be completely outsourced? Thank you.

[JosephZubretsky]

This is Joe Brodsky. Obviously, there are various proposals at the state and federal level for public options single-payer Medicare-for-all type arrangements. Right now, we're considering most of these positions to be political rhetoric and at the discussion phase. I would call them more conceptual statements and philosophies rather than plans and until such time the plans become more substantive with real facts and real analysis to assess what the implementation would be, we're just continuing with the business as usual and as more facts come out we respond accordingly.

[Operator]

The next question will be from Ana Gupte of SBB Leerink. Please go ahead.

[AnaGupte]

Hey, thanks. Good morning, Joe, Tom, Ryan. So I appreciate all the fantastic quarter, appreciate all the comments on margin sustainability. I mean you're just crushing it, if you will, but I mean prior to you taking this on Joe, it was like very low single-digit net margins. Now you're almost 5%. You're guiding to 4.1 to 4.3. What is the sustainability number one on the prior development? And should we include that in our baseline as we go into 2020. Then secondly, your points around payment integrity, you had this announcement on Evercore specialty, your PBM margins and all of that.

Is this all sustainable or will you trade some of this off as you go for more growth top-line into the 2020 plan year.

[JosephZubretsky]

Thanks, Ana. And let me first comment on the prior year development. Every month every quarter we become more effective at managing our medical costs, and as you're managing your medical costs trend downward, reserves are likely to restate favorably. This trend has continued into 2019 which means the medical cost base line and the trend off of that baseline that we use to forecast our 2019 results have also proven to be conservatively stated.

So the prior-year development is real and it's real testament to the fact that we are becoming better and better at managing our medical costs through increased focus on frontline utilization management, and re-engineered and revamped payment integrity routines. To that second point on payment integrity, the team has done a great job updating and making their modern, the stacks of technology we have to perform our claim at it. And it's creating real value without creating provider abrasion.

The third part of your question was on specialty UM with Evercore. We have a new arrangement with Evercore. It's part of our co-sourcing and rent-to-own model of making sure we have access to best-in-class resources. They are going to manage about $600 million to $800 million of medical cost spend across a variety of specialty categories. And we're certain that over time that will create real value for us. The last part of your -- actually the first part of your question, but I'll address it last were the sustainability of the margins.

We continue to generate profit improvement through the inventory of initiatives we've shared with you in the past. We are in a reasonable and stable rate environment. And our management team continues to execute with a great deal of discipline and rigor. And I would attribute the margin position that we have achieved and we believe can sustain to those to the confluence of those three factors.

[Operator]

The next question will be from Matthew Borsch of BMO Capital Markets. Please go ahead.

[MatthewBorsch]

Yes. Joe and Tom, if I could just ask in terms of the competitive landscape. Are you viewing any new competitors getting into your markets given not only your success and profitability, but some of other peer companies and given the backdrop that a lot of competitors were driven out by the initial exchange implementation?

[JosephZubretsky]

Thanks, Matt. Are you referring to the marketplace or broad --

[MatthewBorsch]

I'm sorry, yes, the marketplace is what I meant.

[JosephZubretsky]

Well, the term marketplace can mean many things to many different companies. Our niche is to service the working poor. We operate in the demographic where 25% of our memberships are fully subsidized and 95% have a very ample subsidy. It's a pure leverage off of our Medicaid network and it's pure leverage off of the Medicaid pricing in our network. So we consider our marketplace business to be a mere extension, and a very valuable extension of our Medicaid franchise. Others that might be chasing some of this business might be operating with the mass affluent that a self-employed architect or accountant who might be making $200,000 to $250,000 a year.

That's not where we are playing. This is a pure extension of our Medicaid franchise. And is creating real value for us. And as people move in to Medicaid, Medicaid expansion and marketplace and move up and down the spectrum based on their income, we have products that can capture that member and keep them in the Molina family.

[MatthewBorsch]

But maybe I could just ask an extension to that. Do you have any plans currently to go up in the income hierarchy in terms of your marketing approach going into 2020?

[JosephZubretsky]

No, not for the marketplace, but let me put a point on that. We do not plan to go up market into higher affluence in a more affluent demographic, but we do plan to grow the business in 2020. If you recall at this time last year before we had visibility into the profitability that we --that emerged in 2018, we were sort of compelled to put conservative prices into the marketplace, which actually proved to be very rich and it cost us some membership. Next year now that we have good visibility, 330,000 members we know where the margins are.

We're going rating region by rating region, analyzing our price point versus the competition. If we need network changes will make them and we're very comfortable that with these margins and our competitive position as exists today, we can put a price into the market that grows membership, eases up on the margin percentage ,but grows the overall profit pool in 2020.

[Operator]

The next question will be from Joshua Raskin of Nephron Research. Please go ahead.

[JoshuaRaskin]

Hi, thanks. Good morning. First one just on guidance just a couple of quick clarifications from last quarter. I think you mentioned some stranded overhead in New Mexico and Florida of $0.75 and sounded like Florida was outperforming. So just want to confirm if that $0.75 is still there that comes off next year. And I think you'd mentioned sort of this negative spread between the Medicaid trends in the yield of almost $0.90 and again sounds like things are running better, so curious where we are on those two to start.

[JosephZubretsky]

Sure, Josh. On Florida and New Mexico I would say that the stranded overhead was merely to help investors bridge the progress from 2018 to 2019. If you recall when we gave guidance originally for 2019, we were projecting a 60 basis point increase to our G&A ratio, half of which was due to the stranded overhead for Florida and New Mexico. We're going to sort of stop referring to it as stranded overhead, it's in the baseline. It's in our SG&A and we're going to continue to chip away at it and manage it very effectively.

The over performance in Florida was really managing the tail of the runoff claims more effectively than we had originally projected. In terms of the spread issue, I would say, first of all, the rate environment is very reasonable. We're generally able to obtain the trend and acuity factors that we need in rating when benefits are carved in and out generally the right amount of premium is moving in and out of our portfolio. And, yes, where we actually thought that rates were going to be challenged to maintain pace with trend due to our increased ability and efficiency in managing medical costs.

I would say for the most part, our medical cost trend appears to be coming in on top of rate.

[JoshuaRaskin]

Okay, so that explains better and then my other --my real question here is just with the pending Centene-WellCare transaction, I'm just curious as you guys think about that in terms of opportunities for Molina. Do you think about divestiture opportunities should those arise? Any specific markets where their consolidation would have a direct impact on the states that you guys are operating. I'm just curious as you think about 2020 what do you guys thinking in terms of the potential opportunities for you?

[JosephZubretsky]

Sure. Well, in terms of sort of long term, one of the factors we look at, if you take on average that a state has on average four major players on their Medicaid panel. And let's say on average there are six major players chasing those four spots. It obviously makes the bidding map more likely for us to succeed as we try to plant new flags in new territories. So the bidding dynamics do change as one very capable competitor is now combined with another.

That's the long-term view. The short-term view, look, everybody is written on the speculation of which assets in that combination might have to be divested. I would say this, if that is true and assets have to be divested, if we are invited in to participate and looking at those assets and we are not in and of ourselves conflicted then we certainly would want to compete to secure some of those assets.

[JoshuaRaskin]

Okay and then just Joe, last one here. Any markets where you see potential market share increases for those two on a combined basis maybe not precipitating a divestiture, but where there's an opportunity for membership to shift as the market sort of rebalances.

[JosephZubretsky]

There are and I think we spoke about this actually earlier this morning. It would be really speculated about me to try to infer what a state might do due to the pending merger. Texas comes to mind, Kentucky comes to mind. There's going to be all kinds of-- Florida comes to mind. Interesting dynamics as this pending transaction unfolds. I would just say that we're confident in our ability to grow our business. We're confident in our ability to win new territories. And if the dynamics of this combination actually enhance our chances, well, then all the better.

[Operator]

The next question will be from Sarah James of Piper Jaffray. Please go ahead.

[SarahJames]

Thank you. You talked about moving exchange pricing this year to target mid 60s to low 70s MCR based on what you know so far do you think that's where you'll end up in 2019?

[JosephZubretsky]

Well, we're certainly, Sarah, not going to give a forecast, but given where we're performing what I would say is that performing at the level we are performing currently with mid-teens pre-tax and still double-digit after-tax margins, gives us the flexibility to look at our price points versus the competition in various these rating regions, both on a gross basis and a net of subsidy basis, and tweak our pricing without the sacrifice of material margin position.

So we can ease up on our margins. We can grow membership given the price point, the competitive price points that we have today. And that we can continue to have, given that we have all this margin to sort of play with. So the bottom line is we are going to grow membership, tend to grow membership next year. The margin lease up. The loss ratio will probably move up and our profit pool is projected to grow. And that's what we're going to attempt to do.

And I think this very attractive margin position we've carved for ourselves gives us the flexibility to achieve that.

[StéphaneHouri]

Got it. That's helpful. And a couple questions on Ohio. First, with the behavioral health carve-in that you said wasn't rated correctly, but you expect to be fixed. If part of that retroactive fix or is it only go forward? Then last quarter you talked about expecting in Ohio RFP to be released later this year. Do you think that could include the LTSS product or are you just expecting it to be a repeat of what is already contracted out? Thank you.

[JosephZubretsky]

Our latest intelligence suggests that the RFP will be a Medicaid only and not include an LTSS benefit going managed that's our latest intelligence. I believe there was actually a legislative proposal that determined that. With respect to BH, the benefit was carved in --the entire benefit was carved in 2018 and then they opened up the benefit to some IMD facilities, which everybody started using and it put pressure into our margins. And the state recognizes that. The state actuaries have recognized that. And we believe it will be included in the rate base.

There's always a mid-year conversation with Ohio. So it could go in mid-year, affected mid-year, best case would be to go in mid-year retroactively to the beginning of the year. We're not certain that's going to happen in the worst cases, it goes into the annual rating cycle that happens at 1/1/20. So Ohio is doing just fine. It had some cost pressure due to those two factors in the quarter, but it's doing just fine and effectively those costs wind up in rates.

[Operator]

The next question will be from Kevin Fischbeck of Bank of America. Please go ahead.

[KevinFischbeck]

Great, thanks. I wanted to follow up on your comments about 2020 growth. I think you talked about 150 DSNP counties in 2020. I think last quarter though you're talking about 170 new markets. What was the change in that outlook?

[JosephZubretsky]

Just as you pursue the various counties, look at your network, look at density of population, which is critical. We decided to move forward with 150 rather than 170, which is not a material change at all. The DSNP product is very important to us. We manage it very, very well and we believe the product line is a growth catalyst for the company.

So we're very bullish on that marketplace. We have the high acuity management skills. We have the distribution network. We've got a great Medicare team and we're very bullish on the product line, but the difference in 150- 170 is not material and it was really density of population, ability to build the network.

[KevinFischbeck]

Okay and then as far as the margin commentary, I think you're doing a lot of this outsourcing. I wanted to say, last quarter you guys have talked a bit about how some of these outsourcing is going to impact 2020 more than it was impacting 2019. I wasn't sure if any of the margin improvement that you're seeing is kind of pulling forward some of that benefit or you still expect a lot of these initiatives to keep adding significant additional cost saves going forward.

[JosephZubretsky]

Now the timing is really, really important. If you look at our first quarter results, the only outsourcing co-sourcing or rent own capabilities that actually had an impact in the first quarter were the repricing of our pharmacy contract clearly. And secondly our payment integrity technology stack and thirdly our improvement in risk adjustment and our relationship with Inovalon. The rent own capabilities that are being executed that have not yet manifested themselves in earnings, our IT outsourcing arrangements with Infosys and the arrangement that we just struck with Evercore for specialty UM.

So more to come on that and every month that goes by the value, builds and compounds and that $500 million profit improvement portfolio we shared with you a few months ago is still alive and well and being executed upon.

[KevinFischbeck]

But those arrangements aren't incrementally new versus the last guidance. I just want to make sure that you aren't after signing those things now including those in your outlook for Q3 and Q4, those are still kind of on the coming 2020?

[JosephZubretsky]

Yes. They have not yet provided benefits. They are -- they have been singed. They are being implemented but have not yet manifested themselves in the earning stream. That's correct.

[Operator]

The next question will be from Dave Windley of Jefferies. Please go ahead.

[DaveStyblo]

Hi, good morning. It's Dave Styblo in for Dave Windley. First question I had been is if you guys could give us an update on the guidance, where you talked about net margins being better across all three businesses. Is there a specific point that you could give us for those lines, as well as an update on --of the $550 million? How much of that is now in the 2019 guidance?

[JosephZubretsky]

Sure. If you look at our margin achievement pattern for the first quarter and what's implied in our full-year guidance, I'd give you the tails of tape as follows. Medicaid came in with a solid 2.8% after-tax margin, and it's projected in our guidance to be approximately 3%. Medicare came in the first quarter at a solid 7.5%, clearly an out performer. But we're projecting approximately 6% for the full year and marketplace came in at rather outsized 16% and we're projecting it to be solid double-digit at around 11% for the year all blending to the 4.2% at a midpoint that we conveyed to you.

What was the second part of your questions?

[DaveStyblo]

Right the second part there is of the $500 million -- $550 million cost base the out year, how much of that is now expected to be captured in 2019 guidance?

[JosephZubretsky]

Well, we're not going to start parsing that every single quarter. We'll talk about it qualitatively. I would tell you that the risk adjustment, the payment integrity and the pharmacy contract clearly added value in the first quarter. Our specialty UM and IT outsourcing arrangements have not yet, but I think the numbers we gave you when we originally gave you guidance of $200 million and $100 million nett is still a good framework, that's included in our overall results, and will update you on the portfolio at our Investor Day in a few weeks.

[DaveStyblo]

Great and then just the last one, I know, Joe, you talked about moving into phase three of the plan and looking for more growth and you sort of highlighted a few things between the exchange opportunities and the DSNP expansion. I'm curious what other carving opportunities are there adjacencies or other new re-procurements. Can you provide more visibility or color on for us?

[JosephZubretsky]

Sure. And I can give you some color around what you're going to hear in a few weeks time. We look at the growth phase very clearly coming from our existing footprint. How to leverage the core business in our existing footprint, with our existing states as new product lines are introduced into these markets. That in it of itself with our very wide geographic distribution and now 15 territories with not all of the product lines in the market and certainly under penetrated compared to some of our largest competitors. We believe it gives us ample room to grow in our existing territories.

We then have new states and new territories and with our rebuilt new business development engine, with our recent success at renewing business that we had with great proposal writing. We are very confident that we can start to win new territories as well. We'll talk about that a little bit, but very bullish on the growth of this business. We're in the right product lines. We're in the right segments and hope we will convey to an Investor Day that now that margin recovery and sustainability is well underway that we can start to grow the top-line again very handsomely.

[Operator]

The next question will be from Stephen Cano of Goldman Sachs.. Please go ahead.

[StephenCano]

Good morning. I guess I just had one more follow-up on the after-tax margin. So for just looking at the change in the guidance I guess Medicare is where you have the biggest sort of uptick. Can you give us a flavor for what's coming in so much better there? Is that obviously a very strong rate update 2019, but is that more about cost trend or things you're doing anything specific to call out in Medicare?

[ThomasTran]

Stephen, Tom here. There are really two factors primarily. One Joe mentioned a few minutes ago that we have done a much better job now. We're scoring with adjustment that also applied to a Medicare line of business and secondly is that we've been very effective in managing the cost line as well, primarily on a medical cost size. So it really impacts both sides of the house.

[StephenCano]

Perfect, maybe just one follow up, Tom, and this is probably more for you. Just the PYD, the $55 million pre-tax call out, $0.65 to EPS and then of course there's a table in the release which is I think our best way to try and track this that shows $189 million of a favorable prior period development. Is the difference between those two numbers sort of the offset, or would view as reserve building in Q1 and is there any way we can sort of see that number in any of the filings or try to track to it or is that -- am I thinking about that right and how should you --how would you tell us to keep tabs on all this?

[ThomasTran]

Sure. And obviously in the table you refer to now release also we'll see that in 10-Q when we file today as well. Essentially, you see the walk over from one quarter to the next and that includes the margin release each quarter and our intention every quarter to be consistent without reserve approach is a rebuild at margin. So if you net out the prior your development from that number the essentially the remaining piece is primarily the reserve margin that we intend to reinstitute.

[StephenCano]

Got it. Okay that's just not disclosed anywhere separately there right? So that that's sort of what really on these calls for it, I take it.

[ThomasTran]

That's correct.

[StephenCano]

Got it, okay. And maybe one last quick one, Joe, more for you on the marketplace. Just the commentary around sort of viewing it as --I think you said a pure extension of Medicaid obviously a very different margin profile right now and so how do you sort of bridge that in your head. Is --what's sort of the right level, if there is such a thing for the marketplace business or is it truly just what the market will support and how do you think about that long term?

[JosephZubretsky]

Well, as we mentioned many times both when we gave original guidance two months ago and just recently, we do believe that the right equilibrium can be struck where we can begin to grow the overall profit pool at a lower margin but at a faster rate. We were forced into this conservative posture because the business needed to be repriced two years ago, if you recall the 60% price increase on average I went into the market. And in last year, if you recall with only three months under our belt before putting new prices into the market, we had yet to see the very robust profit picture emerge in 2018.

Now that we've seen the risk pool settle, we understand who the 330,000 members we have and what their cost profile is. We can then use that as a great launching point to begin to grow the overall profit pool once again. Ease up on the price, ease up on the margin, create the right equilibrium, we have highly subsidized members where the price isn't as sensitive to their buying decision as it would be for a mass affluent individual. And it's a great business for us and except for the fact that it's brokered and run by the DOI in the States and looks more like an insurance product, it really is servicing the working poor who have incomes that don't qualify them for Medicaid.

So in that way it is a pure extension of our Medicaid business and does really well for us. So the overall profit pool should grow at a lower margin and we think we have the flexibility to pull that off got.

[Operator]

The next question will be Peter Costa of Wells Fargo Securities. Please go ahead.

[PeterCosta]

Hi, Joe and Tom, nice quarter, thanks. Can you talk about where the PYD is in this quarter? What business lines is really coming from? In particular I'm interested in how much relates to the exchange business and how much relates to the states that you're doing less business?

[JosephZubretsky]

Sure. We don't disclose PYD by product segment but it would be fair to say that with Medicaid being the lion share of our business, you see a good chunk of that within that line of business.

[PeterCosta]

And does that relate to the states that you are doing less business in?

[ThomasTran]

Florida and New Mexico is a component of that, so we don't parse that out but Joe comment before we managed to run out very well. So a component of that probably you is developing this part of those two states.

[PeterCosta]

Okay, thanks. And then the G&A expense in the quarter, how much of that improvement is really sort of just delayed G&A expense towards later in the year versus your expectations from before?

[ThomasTran]

Sure. There are a number of different factors here. One is that we continue to manage our expense well from Q4 for Q1, you see expense went down roughly about $30 million in total. However, the ratio gone up a little bit maybe 20 basis or so. And then comparing to our own expectation is actually running a little bit better than our expectation and we manage our cost well. There's some timing of spending on infrastructure that will appear in second to fourth quarter. These primarily relating to investment in capabilities to grow our business.

Joe mentioned DSNP marketplace investment in really provider and member enhancement to their experience as well as building up really upgrading a number of our technology facility as well. So that's how you're going to see that step play out over the next couple quarters as well.

[PeterCosta]

So let me put words your mouth relative to your prior expectation is just a little more skewed to the back half of the year than this first quarter.

[ThomasTran]

That's right.

[Operator]

The next question will be from Steven Valiquette of Barclays. Please go ahead.

[StevenValiquette]

Hi, thanks. Good morning. Joe and Tom. I’ll echo the sentiments of everyone else that these results continue to be impressive. The MLR trend in Medicaid in 1Q was pretty solid. I think everyone on this call has heard some other managed care companies talk about some pockets of elevated cost trends in Medicaid in 2018 that may have lingered a little bit into early 2019. It doesn't seem like Molina is really seeing that basing your results or maybe just perhaps you can comment on your view around this concept of pockets of elevated Medicaid costs versus industry dynamics around Medicaid costs overall? Thanks.

[JosephZubretsky]

Right, yes. I think the two cost pressures we observed in the quarter were really more related to incidents and events rather than trends in our view. So you take on 30,000 new members in Washington due to a very successful re-procurement and handle a newly carved in behavioral benefit, you're going to get some cost pressure. We believe this will abate in the upcoming months.

In Ohio, we did observe a moving of membership off the Medicaid rolls late in 2018 due to a very focused re-eligibility re-determination efforts. And as many suspect and is generally true, it is healthier people that go back to work meaning that you're left with a slightly higher acuity risk pool and we saw some cross pressure there. And as I said before the state of Ohio actuaries have already recognized that this is clearly a phenomenon that needs to be rated.

So we believe these cost pressures are temporal. They will be effectively rated and those two businesses do really well for us and our two of our better run health plans.

[Operator]

The next question will be from Scott Fidel of Stephens. Please go ahead.

[ScottFidel]

Hi. Thanks. So it looks like CMS maybe trying to breathe some new life into the duals pilots with this recent letter that they sent to the state Medicaid directors. So, Joe, just interested in your thoughts on some of the concepts that CMS discussed in that letter and whether you think this could be a catalyst here for some improved growth momentum around those pilots.

[JosephZubretsky]

Well, I think two things, Scott. One is CMS has voiced increasing support for the integrated approach, the MMP product whether it's a demonstration or permanent. And with $2 billion of Medicare revenue, $1.4 billion of which is in the MMP demonstrations. We're very well positioned no matter which way they pivot. So the fact that they voiced support for this fully integrated approach is certainly a strategic coupe for us.

In terms of some of the rating factors and the way they're going to manage the program whether they are a profit caps, et cetera remains to be seen how all that plays out. Well, we've done very well with the MMP product line. We're absolutely certain that if it expands we'll play there. If they convert it to more of a permanent type of DSNP program, we're well positioned to capture it. And we're just really good at managing these high acuity populations no matter what the wrapper they choose to put it in. And that's what we're focused on right now.

So we're following the regulations closely. We've been able to be adaptable and flexible in dealing with every regulation that's been thrown at us in the past. We have a great team and we know we'll be able to implement whatever changes are put to us and we'll manage it very effectively.

[ScottFidel]

Got it. And then just had a follow-up question. Just going back to that Washington public plan and totally got you in terms that are being tons of different rhetoric and proposals and lot of them don't have meat on the bone, but just had one specific question on that one since in the bill they did talk to sort of the reimbursement levels that would be included in the public plan and talk to a 135% for primary care, first Medicare and then a cap of 160% for hospital and other. Just interested in terms of competitively how that may compare to how reimbursement rates tend to be negotiated in the exchange market. I know that it's around 167% on average for the overall commercial market, but I would assume that given the tighter networks in the exchanges, it's probably more comparable with some of those ranges that were in the Washington Bill, but just interested in your thoughts on that.

[JosephZubretsky]

Scott, I will claim not to have caught up with the specifics of the Washington Bill. But more generally to the point you're making, we find it rather plausible and realizable that when we are putting together a network for the Marketplace off of our Medicaid network, that negotiating up from a Medicaid rate actually proves to be more cost efficient than a commercial player coming in and negotiating down from a commercial rate, which means that our network plays well, because it's the working poor, but it's also priced right. So I think that's the point you were referring to. We continue to be successful in managing and leveraging our Medicaid network into the Marketplace due to the highly subsidized nature of the population and it's priced right as evidenced by the margins we're achieving and the amount of margin we'll be able to put back into pricing to grow the business again.

[Operator]

The next question will be from Charles Rhyee of Cowen. Please go ahead.

[CharlesRhyee]

Yes. Thanks for taking the question. I just wanted to follow up on earlier comments, Joe. When you talked about -- I appreciate the comments you said about potential for gains through divestiture is obviously from some of the potential transactions out there, but you also made -- is that what you were talking about in your earlier comments when you were kind of referring to some opportunities for M&A in the future or were you talking more separately about just general opportunities you see to expand traffic areas?

[JosephZubretsky]

Charles, we were actually referring to both. Certainly, the specific M&A transaction you're referring to, let's wait and see how it unfolds and we'd hope to be invited in and take a serious look at those assets. But more generally speaking, we do have a business development team here, one that I've used in the past. They're very good at what they do. And as we look at new geographies or expanding existing geographies, there are many, as you know, small provider-own plans, by the 1C3 scattered across the United States that dabble in Medicaid. Many of these plans are under-managed, sort of orphaned. They're hard to find, but they can be incredibly valuable if you can absorb someone's membership on top of our cost structure that we've proven to be best-in-class. These can be tremendously [Technical Difficulty]. They're not going to make major headlines, because most of the names are nondescript, but we are looking at plans around the country in existing geographies and to light up new geographies.

[CharlesRhyee]

Great. Sorry about that. Just a follow-up though. When we think about these kind of opportunities should we think about them as a potential 2019 event or is this really as we think about 2020?

[JosephZubretsky]

We're looking at opportunities now. And obviously without anything announced in the time to close, I would say that anything we would even action this year is likely not to have benefit for until 2020. As I said, we never do project the benefits from inorganic or pseudo inorganic growth assuming other plans. They're hard to do. It's a bi-party or sometimes a tri-party transaction. They're hard to predict, but we're actively at it and looking for these sometimes value-creating opportunities. We've done it before and the team I have knows how to execute.

End of Q&A

[Operator]

And ladies and gentlemen, this will conclude our question-and-answer session and will also conclude the conference call for today. We thank you for attending today's presentation. And at this time, you may disconnect your lines.