10-Q 1 moh-20140630x10q.htm 10-Q MOH-2014.06.30-10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
FORM 10-Q
 
 
 
 
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2014
OR
¨
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
 
13-4204626
(State or other jurisdiction of incorporation or organization)
 
(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  ý    No  ¨
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  ý    No  ¨
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
ý
Accelerated filer
¨
 
 
 
 
Non-accelerated filer
¨ (Do not check if a smaller reporting company)
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  ¨ No  ý
The number of shares of the issuer’s Common Stock, $0.001 par value, outstanding as of July 25, 2014, was approximately 46,508,000.



MOLINA HEALTHCARE, INC.
Form 10-Q

For the Quarterly Period Ended June 30, 2014
TABLE OF CONTENTS
 



PART I. FINANCIAL INFORMATION
Item 1.    Financial Statements
MOLINA HEALTHCARE, INC.
CONSOLIDATED BALANCE SHEETS
 
June 30,
2014
 
December 31,
2013
 
(Amounts in thousands,
except per-share data)
 
(Unaudited)
 
 
ASSETS
Current assets:
 
 
 
Cash and cash equivalents
$
1,027,351

 
$
935,895

Investments
740,874

 
703,052

Receivables
473,514

 
298,935

Income taxes refundable
16,726

 
32,742

Deferred income taxes
19,518

 
26,556

Prepaid expenses and other current assets
93,862

 
42,484

Total current assets
2,371,845

 
2,039,664

Property, equipment, and capitalized software, net
317,630

 
292,083

Deferred contract costs
47,969

 
45,675

Intangible assets, net
88,493

 
98,871

Goodwill
230,738

 
230,738

Restricted investments
84,440

 
63,093

Auction rate securities
11,025

 
10,898

Deferred income taxes
4,075

 

Derivative asset
250,160

 
186,351

Other assets
45,654

 
35,564

 
$
3,452,029

 
$
3,002,937

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
 
 
 
Medical claims and benefits payable
$
924,182

 
$
669,787

Accounts payable and accrued liabilities
475,358

 
319,965

Deferred revenue
45,945

 
122,216

Current maturities of long-term debt
185,451

 
182,008

Total current liabilities
1,630,936

 
1,293,976

Convertible senior notes
425,709

 
416,368

Lease financing obligations
160,121

 
159,394

Lease financing obligations – related party
39,436

 
27,092

Deferred income taxes

 
580

Derivative liability
250,038

 
186,239

Other long-term liabilities
28,719

 
26,351

Total liabilities
2,534,959

 
2,110,000

 
 
 
 
Stockholders’ equity:
 
 
 
Common stock, $0.001 par value; 150,000 shares authorized; outstanding: 46,494 shares at June 30, 2014 and 45,871 shares at December 31, 2013
46

 
46

Preferred stock, $0.001 par value; 20,000 shares authorized, no shares issued and outstanding

 

Additional paid-in capital
351,546

 
340,848

Accumulated other comprehensive income (loss)
40

 
(1,086
)
Retained earnings
565,438

 
553,129

Total stockholders’ equity
917,070

 
892,937

 
$
3,452,029

 
$
3,002,937

See accompanying notes.

1


MOLINA HEALTHCARE, INC.
CONSOLIDATED STATEMENTS OF INCOME
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
 
(Amounts in thousands, except net income per share)
(Unaudited)
Revenue:
 
 
 
 
 
 
 
Premium revenue
$
2,167,142

 
$
1,501,729

 
$
4,107,479

 
$
2,999,162

Service revenue
50,232

 
49,672

 
103,862

 
99,428

Premium tax revenue
70,120

 
46,883

 
121,813

 
83,883

Health insurer fee revenue
19,662

 

 
38,358

 

Investment income
1,945

 
1,628

 
3,574

 
3,144

Other revenue
2,938

 
5,922

 
6,196

 
10,616

Total revenue
2,312,039

 
1,605,834

 
4,381,282

 
3,196,233

Operating expenses:
 
 
 
 
 
 
 
Medical care costs
1,934,299

 
1,294,706

 
3,655,957

 
2,582,621

Cost of service revenue
37,107

 
39,305

 
77,764

 
79,075

General and administrative expenses
193,239

 
161,479

 
381,326

 
302,757

Premium tax expenses
70,120

 
46,883

 
121,813

 
83,883

Health insurer fee expenses
21,945

 

 
44,135

 

Depreciation and amortization
22,902

 
17,015

 
43,593

 
33,578

Total operating expenses
2,279,612

 
1,559,388

 
4,324,588

 
3,081,914

Operating income
32,427

 
46,446

 
56,694

 
114,319

Other expenses, net:
 
 
 
 
 
 
 
Interest expense
13,993

 
11,667

 
27,815

 
24,704

Other (income) expense, net
(9
)
 
3,502

 
(53
)
 
3,371

Total other expenses, net
13,984

 
15,169

 
27,762

 
28,075

Income from continuing operations before income tax expense
18,443

 
31,277

 
28,932

 
86,244

Income tax expense
10,702

 
15,481

 
16,357

 
39,926

Income from continuing operations
7,741

 
15,796

 
12,575

 
46,318

Income (loss) from discontinued operations, net of tax
70

 
8,775

 
(266
)
 
8,168

Net income
$
7,811

 
$
24,571

 
$
12,309

 
$
54,486

 
 
 
 
 
 
 
 
Basic net income per share:
 
 
 
 
 
 
 
Continuing operations
$
0.17

 
$
0.35

 
$
0.27

 
$
1.01

Discontinued operations

 
0.19

 

 
0.18

Basic net income per share
$
0.17

 
$
0.54

 
$
0.27

 
$
1.19

 
 
 
 
 
 
 
 
Diluted net income per share:
 
 
 
 
 
 
 
Continuing operations
$
0.16

 
$
0.34

 
$
0.26

 
$
1.00

Discontinued operations

 
0.19

 

 
0.17

Diluted net income per share
$
0.16

 
$
0.53

 
$
0.26

 
$
1.17

See accompanying notes.

2


MOLINA HEALTHCARE, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
 
(Amounts in thousands)
(Unaudited)
Net income
$
7,811

 
$
24,571

 
$
12,309

 
$
54,486

Other comprehensive income:
 
 
 
 
 
 
 
Unrealized investment gain (loss)
391

 
(4,045
)
 
1,817

 
(3,626
)
Effect of income taxes
(31
)
 
(1,537
)
 
691

 
(1,378
)
Other comprehensive income (loss), net of tax
422

 
(2,508
)
 
1,126

 
(2,248
)
Comprehensive income
$
8,233

 
$
22,063

 
$
13,435

 
$
52,238


See accompanying notes.


3


MOLINA HEALTHCARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Six Months Ended
 
June 30,
 
2014
 
2013
 
(Amounts in thousands)
(Unaudited)
Operating activities:
 
 
 
Net income
$
12,309

 
$
54,486

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
65,654

 
43,907

Deferred income taxes
1,692

 
(22,155
)
Stock–based compensation
10,456

 
12,150

Amortization of convertible senior notes and lease financing obligations
13,455

 
9,688

Amortization of premium/discount on investments
5,524

 
4,298

Amortization of deferred financing costs
1,301

 
2,366

Change in fair value of derivatives, net
(10
)
 
3,384

Change in fair value of contingent consideration liabilities
(4,199
)
 

Gain on disposal of property and equipment, net
(860
)
 

Tax deficiency from employee stock compensation
(33
)
 
(38
)
Changes in operating assets and liabilities:
 
 
 
Receivables
(174,579
)
 
(64,094
)
Prepaid expenses and other assets
(66,887
)
 
(22,856
)
Medical claims and benefits payable
254,395

 
(29,043
)
Accounts payable and accrued liabilities
177,497

 
(16,968
)
Deferred revenue
(76,271
)
 
(95,849
)
Income taxes
16,016

 
8,976

Net cash provided by (used in) operating activities
235,460

 
(111,748
)
Investing activities:
 
 
 
Purchases of investments
(368,304
)
 
(532,151
)
Proceeds from sales and maturities of investments
326,648

 
149,420

Purchases of equipment
(37,670
)
 
(35,229
)
Increase in restricted investments
(15,622
)
 
(12,834
)
Proceeds from sale of property and equipment
6,807

 

Change in deferred contract costs
(13,742
)
 
6,994

Change in other noncurrent assets and liabilities
(453
)
 
(8,012
)
Net cash used in investing activities
(102,336
)
 
(431,812
)
Financing activities:
 
 
 
Proceeds from issuance of 1.125% Notes, net of deferred financing costs

 
537,973

Proceeds from sale-leaseback transactions

 
158,694

Purchase of 1.125% Notes call option

 
(149,331
)
Proceeds from issuance of warrants

 
75,074

Treasury stock purchases

 
(50,000
)
Principal payments on term loan

 
(47,471
)
Repayment of amounts borrowed under credit facility

 
(40,000
)
Contingent consideration liabilities settled
(50,349
)
 

Proceeds from employee stock plans
7,617

 
4,852

Excess tax benefits from employee stock compensation
1,111

 
1,544

Settlement of interest rate swap

 
(875
)
Principal payments on lease financing obligations - related party
(47
)
 

Net cash (used in) provided by financing activities
(41,668
)
 
490,460

Net increase (decrease) in cash and cash equivalents
91,456

 
(53,100
)
Cash and cash equivalents at beginning of period
935,895

 
795,770

Cash and cash equivalents at end of period
$
1,027,351

 
$
742,670


4


MOLINA HEALTHCARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued)
 
Six Months Ended
 
June 30,
 
2014
 
2013
 
(Amounts in thousands)
(Unaudited)
Supplemental cash flow information:
 
 
 
 
 
 
 
Cash (received) paid during the period for:
 
 
 
Income taxes
$
(2,714
)
 
$
41,407

Interest
$
13,210

 
$
21,933

 
 
 
 
Schedule of non-cash investing and financing activities:
 
 
 
Retirement of treasury stock
$

 
$
53,000

Common stock used for stock-based compensation
$
8,453

 
$
5,669

Non-cash lease financing obligation – related party
$
12,447

 
$

 
 
 
 
Details of change in fair value of derivatives, net:
 
 
 
Gain on 1.125% Call Option
$
63,809

 
$
57,792

Loss on embedded cash conversion option
(63,799
)
 
(57,686
)
Loss on 1.125% Warrants

 
(3,923
)
Gain on interest rate swap

 
433

Change in fair value of derivatives, net
$
10

 
$
(3,384
)

See accompanying notes.


5


MOLINA HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
June 30, 2014
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. We report our financial performance based on two reportable segments: the Health Plans segment and the Molina Medicaid Solutions segment.
Our Health Plans segment consists of health plans in 11 states, and includes our direct delivery business. As of June 30, 2014, these health plans served approximately 2.3 million members eligible for Medicaid, Medicare, and other government-sponsored health care programs for low-income families and individuals. Additionally, we serve a small number of Health Insurance Marketplaces (Marketplaces) members, many of whom are eligible for government premium subsidies. The health plans are operated by our respective wholly owned subsidiaries in those states, each of which is licensed as a health maintenance organization (HMO). Our direct delivery business consists primarily of the operation of primary care clinics in California.
Our Molina Medicaid Solutions segment provides business processing and information technology development and administrative services to Medicaid agencies in Idaho, Louisiana, Maine, New Jersey, West Virginia, and the U.S. Virgin Islands, and drug rebate administration services in Florida.
We previously reported that our Medicaid managed care contract with the state of Missouri expired without renewal in 2012, and effective June 2013 the transition obligations associated with that contract terminated. Therefore, beginning in the second quarter of 2013, we classified the operations for our Missouri health plan as discontinued operations for all periods presented in our consolidated financial statements.
Consolidation and Interim Financial Information
The consolidated financial statements include the accounts of Molina Healthcare, Inc., its subsidiaries and variable interest entities in which Molina Healthcare, Inc. is considered to be the primary beneficiary. Such variable interest entities are insignificant to our consolidated financial position and results of operations. 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. The consolidated results of operations for the current interim period are not necessarily indicative of the results for the entire year ending December 31, 2014.
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, 2013. Accordingly, certain disclosures that would substantially duplicate the disclosures contained in the December 31, 2013 audited consolidated financial statements have been omitted. These unaudited consolidated interim financial statements should be read in conjunction with our December 31, 2013 audited consolidated financial statements.
Reclassifications
We have reclassified certain amounts in the 2013 consolidated statements of income to conform to the 2014 presentation of separately presenting premium tax revenue and premium revenue.
2. Significant Accounting Policies
Revenue Recognition
Premium Revenue – Health Plans Segment
Premium revenue is fixed in advance of the periods covered and, except as described below, is not generally subject to significant accounting estimates. Premium revenues are recognized in the month that members are entitled to receive health care services.
Certain components of premium revenue are subject to accounting estimates and fall into two categories:

6


(1)
Contractual provisions that may adjust or limit revenue or profit:
Health Plan Medical Cost Floors (Minimums), Medical Cost Corridors, and Administrative Cost Ceilings (Maximums): A portion of certain Medicaid, Medicare, and Marketplaces premiums received by our health plans may be returned if certain minimum amounts are not spent on defined medical care costs. In some cases, the health plans may receive additional premiums if amounts spent on medical care costs exceed a defined maximum threshold. In the aggregate, we recorded a liability under the terms of such contract provisions of $80.6 million and $1.4 million at June 30, 2014, and December 31, 2013, respectively. The increase is driven by contractual provisions relating to Medicaid expansion populations, which began to phase in during January 2014. Separately, in certain states we may be levied with non-monetary sanctions if certain minimum amounts are not spent on defined medical care costs, or if administrative costs exceed certain amounts.
Health Plan Profit Sharing and Profit Ceiling: Our contracts with the states of New Mexico, Texas, and Washington contain profit-sharing or profit ceiling provisions under which we refund amounts to the states if our health plans generate profit above a certain specified percentage, in some cases in accordance with a tiered rebate schedule. In some cases, we are limited in the amount of administrative costs that we may deduct in calculating the refund, if any. As a result of profits in excess of the amount we are allowed to fully retain, we recorded a liability of $19.2 million and $2.5 million at June 30, 2014 and December 31, 2013, respectively.
Medicare Revenue Risk Adjustment: Based on member encounter data that we submit to the Centers for Medicare and Medicaid Services (CMS), our Medicare premiums are 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. We estimate the amount of Medicare revenue that will ultimately be realized for the periods presented based on our knowledge of our members’ health care utilization patterns and CMS practices. Based on our knowledge of member health care utilization patterns and expenses we have recorded a net receivable of $34.1 million and $20.8 million for anticipated Medicare risk adjustment premiums at June 30, 2014, and December 31, 2013, respectively.
(2)
Quality incentives:
At our California, Illinois, New Mexico, Ohio, Texas, Washington and Wisconsin health plans, revenue ranging from approximately 1.00% to 5.00% of health plan premiums is earned if certain performance measures are met.
The following table quantifies the quality incentive premium revenue recognized for the periods presented, including the amounts earned in the periods presented and in prior periods. Although the reasonably possible effects of a change in estimate related to quality incentive premium revenue as of June 30, 2014 are not known, we have no reason to believe that the adjustments to prior years noted below are not indicative of the potential future changes in our estimates as of June 30, 2014.
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Maximum available quality incentive premium - current period
$
24,300

 
$
20,496

 
$
44,464

 
$
41,111

 
 
 
 
 
 
 
 
Amount of quality incentive premium revenue recognized in current period:
 
 
 
 


 
 
Earned current period
$
12,717

 
$
17,297

 
$
18,014

 
$
32,193

Earned prior periods
3,582

 
3,849

 
3,204

 
10,561

Total
$
16,299

 
$
21,146

 
$
21,218

 
42,754

 
 
 
 
 
 
 
 
Total premium revenue recognized for state health plans with quality incentive premiums
$
1,708,808

 
$
711,251

 
$
3,187,069

 
$
1,420,634


7


We recognized a benefit of approximately $25 million from the recognition in the second quarter of 2014 of certain premium revenues of which $15 million related to the year ended December 31, 2013, and $5 million related to the first quarter of 2014.
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 multiple services. The first of these is the design, development and implementation (DDI) of a Medicaid management information system (MMIS). An additional service, following completion of DDI, is the operation of the MMIS under a business process outsourcing (BPO) arrangement. When providing BPO services (which include claims payment and eligibility processing) we also provide the state with other services including both hosting and support, and maintenance. Because we have determined the services provided under our Molina Medicaid Solutions contracts represent a single unit of accounting, we generally recognize revenue associated with such contracts on a straight-line basis over the original contract term during which BPO, hosting, and support and maintenance services are delivered. There may be certain contractual provisions containing contingencies, however that require us to delay recognition of all or part of our service revenue until such contingencies have been removed.
Cost of service revenue consists primarily of the costs incurred to provide BPO and technology outsourcing services under our MMIS contracts. 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.
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, nondeductible health insurer fee expenses, nondeductible compensation and other general and administrative expenses. The effective tax rate may be subject to fluctuations during the year, particularly as a result of the mathematical impact of the level of pretax earnings, and also 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 the reversal of the recognition 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 $2.0 million and $8.0 million as of June 30, 2014 and December 31, 2013, respectively. The unrecognized tax benefits recorded at December 31, 2013 decreased by $6.0 million during the six months ended June 30, 2014 as a result of the execution of a state settlement agreement. This decrease had a nominal impact to the tax provision for the six months ended June 30, 2014. The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate was $1.8 million and $5.7 million as of June 30, 2014 and December 31, 2013, respectively. We expect that during the next 12 months it is reasonably possible that unrecognized tax benefit liabilities may decrease by as much as $0.2 million due to the expiration of statute of limitations.
Our continuing practice is to recognize interest and/or penalties related to unrecognized tax benefits in income tax expense. As of June 30, 2014 and December 31, 2013, we had accrued $0.08 million for the payment of interest and penalties.
During the three months ended June 30, 2014 and 2013, we recognized tax expense of $0.1 million and tax benefits of $10.0 million, respectively, related to discontinued operations. During the six months ended June 30, 2014 and 2013, we recognized tax benefits related to discontinued operations of $0.4 million and $10.1 million, respectively.
New Accounting Standards
Health Insurer Fee. In the first quarter of 2014, we adopted the guidance of the Financial Accounting Standards Board (FASB) related to accounting for the fees to be paid by health insurers to the federal government under the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 (collectively, the Affordable Care Act, or ACA). The ACA imposes an annual fee, or excise tax, on health insurers for each calendar year beginning on or after January 1, 2014. The health insurer fee (HIF) is imposed beginning in 2014 based on a company's share of the industry's net premiums written during the preceding calendar year, and is payable on September 30 of each year.
Effective January 1, 2014, we recorded our estimate of the 2014 liability to accounts payable and accrued liabilities. As of June 30, 2014, we expect the liability to amount to $88.3 million. We are recognizing this expense on a straight-line basis in

8


2014, and recorded $21.9 million and $44.1 million to health insurer fee expenses in the three months and six months ended June 30, 2014, respectively. As enacted, this federal premium-based assessment is non-deductible for income tax purposes.
Because we primarily serve individuals in government-sponsored programs, we must secure additional reimbursement from our state partners for this added cost. We recognize health insurer fee revenue when we have obtained a contractual commitment from a state to reimburse us for the full economic impact of the health insurer fee, including the effect of premium tax and federal non-deductibility. Such health insurer fee revenue is recognized ratably throughout the year.
Revenue Recognition. In May 2014, the FASB issued Accounting Standards Update (ASU) 2014-09 - Revenue from Contracts with Customers, which will supersede nearly all existing revenue recognition guidance under U.S. generally accepted accounting principles (GAAP). The core principal of this ASU is that an entity should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. This ASU will be effective for us in our first quarter of 2017. Early adoption is not permitted. The ASU allows for either full retrospective or modified retrospective adoption. We are evaluating the transition method that will be elected and the potential effects of the adoption of this ASU on our financial statements.
Discontinued Operations. In April 2014, the FASB issued ASU 2014-08 - Reporting Discontinued Operations and Disclosures of Disposal of Components of an Entity, which raises the threshold for disposals to qualify as discontinued operations by focusing on strategic shifts that have or will have a major effect on an entity’s operations and financial results. The guidance allows companies to have significant continuing involvement and continuing cash flows with the disposed component. The standard requires additional disclosures for discontinued operations and new disclosures for individually material disposal transactions that do not meet the definition of a discontinued operation. This ASU will be effective for us in our first quarter of 2015. The ASU is applied prospectively. Early adoption is permitted but only for disposals (or classifications as held for sale) that have not been reported in financial statements previously issued or available for issue. We are evaluating the potential effects of the adoption of the ASU on our financial statements.
Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the American Institute of Certified Public Accountants, and the Securities and Exchange Commission did not have, or are not believed by management to have, a material impact on our present or future consolidated financial statements.
3. Net Income per Share
The following table sets forth the calculation of the denominators used to compute basic and diluted net income per share:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Shares outstanding at the beginning of the period
46,263

 
45,415

 
45,871

 
46,762

Weighted-average number of shares repurchased

 

 

 
(1,248
)
Weighted-average number of shares issued
16

 
31

 
279

 
198

Denominator for basic net income per share
46,279

 
45,446

 
46,150

 
45,712

Dilutive effect of employee restricted stock awards and stock options
361

 
378

 
527

 
488

Dilutive effect of 3.75% Notes
1,363

 
683

 
1,147

 
306

Denominator for diluted net income per share
48,003

 
46,507

 
47,824

 
46,506

 
 
 
 
 
 
 
 
Potentially dilutive amounts excluded from calculations:
 
 
 
 
 
 
 
Stock options

 
60

 
45

 
43

1.125% Warrants (1)
13,490

 
13,490

 
13,490

 
10,434

______________________________
(1)
Potentially dilutive shares issuable pursuant to our 1.125% Warrants (defined in Note 12, "Derivative Financial Instruments") were not included in the computation of diluted net income per share because to do so would have been anti-dilutive.


9


4. Business Combinations
Health Plans Segment
South Carolina. In July 2013, we entered into an agreement with Community Health Solutions of America, Inc. (CHS) to acquire certain assets, including the rights to convert certain of CHS’ Medicaid members covered by South Carolina’s full-risk Medicaid managed care program. The conversion conditions under the agreement were satisfied by January 1, 2014, and on that date such Medicaid members were converted to the managed care program and enrolled with our South Carolina health plan. Because the number of Medicaid members we would ultimately convert was unknown as of the acquisition date in 2013, we recorded a contingent consideration liability for members we expected to enroll until the final purchase price was settled in the second quarter of 2014. The total purchase price for the converted Medicaid membership amounted to $57.2 million, of which $49.7 million was paid in the first half of 2014, and $7.5 million was paid when the agreement was executed in 2013. The total amount paid includes indemnification withhold funds transferred to restricted investments amounting to $5.7 million. If unused, such indemnification funds will become unrestricted on the one-year anniversary date of the conversion, or January 1, 2015.
As part of this transaction, we have also recorded a contingent consideration liability for dual-eligible members we expect to enroll in our Medicare-Medicaid Plan (MMP) implementation in South Carolina. The contingent consideration liability is remeasured to fair value at each quarter until the contingency is resolved with fair value adjustments, if any, recorded to operations. As of June 30, 2014, the fair value of the remaining contingent consideration liability for the MMP implementation amounted to $3.0 million.
The aggregate contingent consideration liability fair value adjustments for the South Carolina transaction have resulted in a gain of $2.7 million in the six months ended June 30, 2014.
New Mexico. In August 2013, our New Mexico health plan acquired the Lovelace Community Health Plan’s contract for the state of New Mexico's Medicaid program. In addition to Lovelace's Medicaid members, we also added membership previously covered under New Mexico’s State Coverage Insurance (SCI) program with Lovelace. Effective January 1, 2014, these SCI members were either a) enrolled in New Mexico's Medicaid program, or b) eligible to enroll in New Mexico’s Marketplace.
Because the number of SCI members we would ultimately retain was unknown as of the acquisition date in 2013, we recorded a contingent consideration liability for such members until the final purchase price was settled in the second quarter of 2014. The aggregate contingent consideration liability fair value adjustments for the New Mexico transaction have resulted in a gain of $1.5 million in the six months ended June 30, 2014.
5. Stock-Based Compensation
In March 2014, our named executive officers were granted a total of 356,292 restricted shares with service, market, and performance conditions. In the event the vesting conditions are not achieved, the awards will lapse. As of June 30, 2014, we expect the performance conditions to be met in full.
Charged to general and administrative expenses, total stock-based compensation expense was as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Restricted stock and performance awards
$
4,214

 
$
7,111

 
$
8,822

 
$
10,959

Employee stock purchase plan and stock options
646

 
618

 
1,634

 
1,191

 
$
4,860

 
$
7,729

 
$
10,456

 
$
12,150

As of June 30, 2014, there was $33.3 million of total unrecognized compensation expense related to unvested restricted stock awards, including those with performance conditions, which we expect to recognize over a remaining weighted-average period of 2.2 years. Also as of June 30, 2014, there was $0.4 million of total unrecognized compensation expense related to unvested stock options, which we expect to recognize over a weighted-average period of 1.6 years.

10


Restricted and performance stock activity for the six months ended June 30, 2014 is summarized below:
 
Shares
 
Weighted
Average
Grant Date
Fair Value
Unvested balance as of December 31, 2013
1,299,852

 
$
29.03

Granted
643,852

 
36.49

Vested
(574,708
)
 
27.35

Forfeited
(37,594
)
 
30.18

Unvested balance as of June 30, 2014
1,331,402

 
33.33

The total fair value of restricted and performance awards granted during the six months ended June 30, 2014 and 2013 was $23.5 million and $33.1 million, respectively. The total fair value of restricted awards, including those with performance and market conditions, vested during the six months ended June 30, 2014 and 2013 was $21.5 million and $16.2 million, respectively.
Stock option activity for the six months ended June 30, 2014 is summarized below:
 
Options
 
Weighted
Average
Exercise
Price
 
Aggregate
Intrinsic
Value
 
Weighted
Average
Remaining
Contractual
term
 
 
 
 
 
(In thousands)
 
(Years)
Outstanding as of December 31, 2013
379,221

 
$
24.14

 

 
 
Exercised
(81,300
)
 
23.37

 


 
 
Outstanding as of June 30, 2014
297,921

 
24.35

 
$
6,041

 
3.4
Stock options exercisable and expected to vest as of June 30, 2014
297,921

 
24.35

 
$
6,041

 
3.4
Exercisable as of June 30, 2014
262,921

 
23.16

 
$
5,644

 
2.8
6. Fair Value Measurements
Our consolidated balance sheets include the following financial instruments: cash and cash equivalents, investments, receivables, other assets, 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 (excluding contingent consideration) to approximate their fair values because of the relatively short period of time between the origination of these instruments and their expected realization or payment. For our financial instruments measured at fair value on a recurring basis, we prioritize the inputs used in measuring fair value according to a three-tier fair value hierarchy as follows:
Level 1 — Observable Inputs
Level 1 financial instruments recorded at fair value consist of investments including government-sponsored enterprise securities (GSEs) and U.S. treasury notes that are classified as current investments in the accompanying consolidated balance sheets. These financial instruments 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 — Directly or Indirectly Observable Inputs
Level 2 financial instruments recorded at fair value consist of investments including corporate debt securities, municipal securities, and certificates of deposit that are classified as current investments in the accompanying consolidated balance sheets. Such investments are traded frequently though not necessarily daily. Fair value for these investments 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
Derivative financial instruments. Derivative financial instruments include the 1.125% Call Option derivative asset and the embedded cash conversion option derivative liability. These derivatives are not actively traded and are valued based on an option pricing model that uses observable and unobservable market data for inputs. Significant market data inputs used to determine fair value as of June 30, 2014 included our common stock price, time to maturity of the derivative instruments, the risk-free interest rate, and the implied volatility of our common stock. As described further in Note 12, “Derivative Financial

11


Instruments,” the 1.125% Call Option asset and the embedded cash conversion option liability were designed such that changes in their fair values would offset, with minimal impact to the consolidated statements of income. Therefore, the sensitivity of changes in the unobservable inputs to the option pricing model for such instruments is mitigated.
Contingent consideration liability. Such liability relates to our South Carolina health plan acquisition described in Note 4, "Business Combinations," and is recorded in accounts payable and accrued liabilities. We applied discounted cash flow analysis to determine the fair value of this liability. Significant unobservable inputs primarily related to the probability weighted present values of the purchase price estimate for the projected membership.
Auction rate securities. Auction rate securities are designated as available-for-sale and are reported at fair value. To estimate the fair value of these securities we use valuation data from our primary pricing source, a third party who provides a marketplace for illiquid assets with over 10,000 participants. This valuation data is based on a range of prices that represent indicative bids from potential buyers. To validate the reasonableness of the data, we compare these valuations to data from other third-party pricing sources, which also provide a range of prices representing indicative bids from potential buyers. We have concluded that these estimates, given the lack of market available pricing, provide a reasonable basis for determining the fair value of the auction rate securities as of June 30, 2014.

12



Our financial instruments measured at fair value on a recurring basis at June 30, 2014, were as follows:
 
Total
 
Level 1
 
Level 2
 
Level 3
 
(In thousands)
Corporate debt securities
$
484,437

 
$

 
$
484,437

 
$

Municipal securities
96,898

 

 
96,898

 

GSEs
71,499

 
71,499

 

 

U.S. treasury notes
37,026

 
37,026

 

 

Certificates of deposit
51,014

 

 
51,014

 

Auction rate securities
11,025

 

 

 
11,025

1.125% Call Option derivative asset
250,160

 

 

 
250,160

Total assets measured at fair value on a recurring basis
$
1,002,059

 
$
108,525

 
$
632,349

 
$
261,185

 
 
 
 
 
 
 
 
Embedded cash conversion option derivative liability
$
250,038

 
$

 
$

 
$
250,038

Contingent consideration liability
3,000

 

 

 
3,000

Total liabilities measured at fair value on a recurring basis
$
253,038

 
$

 
$

 
$
253,038


Our financial instruments measured at fair value on a recurring basis at December 31, 2013, were as follows:
 
Total
 
Level 1
 
Level 2
 
Level 3
 
(In thousands)
Corporate debt securities
$
449,772

 
$

 
$
449,772

 
$

Municipal securities
113,330

 

 
113,330

 

GSEs
68,817

 
68,817

 

 

U.S. treasury notes
37,376

 
37,376

 

 

Certificates of deposit
33,757

 

 
33,757

 

Auction rate securities
10,898

 

 

 
10,898

1.125% Call Option derivative asset
186,351

 

 

 
186,351

Total assets measured at fair value on a recurring basis
$
900,301

 
$
106,193

 
$
596,859

 
$
197,249

 
 
 
 
 
 
 
 
Embedded cash conversion option derivative liability
$
186,239

 
$

 
$

 
$
186,239

Contingent consideration liabilities
57,548

 

 

 
57,548

Total liabilities measured at fair value on a recurring basis
$
243,787

 
$

 
$

 
$
243,787

The following table presents activity relating to our assets (liabilities) measured at fair value on a recurring basis using significant unobservable inputs (Level 3):
 
Change in Level 3 Instruments
 
Auction Rate Securities
 
Derivatives, Net
 
Contingent Consideration Liabilities
 
(In thousands)
Balance at December 31, 2013
$
10,898

 
$
112

 
$
(57,548
)
Total gains for the period recognized in:
 
 


 
 
General and administrative expenses

 

 
4,199

Other expenses, net

 
10

 

Other comprehensive income
127

 

 

 
 
 
 
 
 
Settlements

 

 
50,349

Balance at June 30, 2014
$
11,025

 
$
122

 
$
(3,000
)
Fair Value Measurements – Disclosure Only

13


The carrying amounts and estimated fair values of our convertible senior notes, which are classified as Level 2 financial instruments, are indicated in the following table. 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.
 
June 30, 2014
 
Carrying
Value
 
Total
Fair Value
 
Level 1
 
Level 2
 
Level 3
 
(In thousands)
1.125% Notes
$
425,709

 
$
687,819

 
$

 
$
687,819

 
$

3.75% Notes
185,258

 
269,905

 

 
269,905

 

 
$
610,967

 
$
957,724

 
$

 
$
957,724

 
$

 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
 
Carrying
Value
 
Total
Fair Value
 
Level 1
 
Level 2
 
Level 3
 
(In thousands)
1.125% Notes
$
416,368

 
$
572,627

 
$

 
$
572,627

 
$

3.75% Notes
181,872

 
219,491

 

 
219,491

 

 
$
598,240

 
$
792,118

 
$

 
$
792,118

 
$

7. Investments
The following tables summarize our investments as of the dates indicated:
 
June 30, 2014
 
Amortized
 
Gross
Unrealized
 
Estimated
Fair
 
Cost
 
Gains
 
Losses
 
Value
 
(In thousands)
Corporate debt securities
$
484,130

 
$
563

 
$
256

 
$
484,437

Municipal securities
96,763

 
278

 
143

 
96,898

GSEs
71,522

 
25

 
48

 
71,499

U.S. treasury notes
36,992

 
51

 
17

 
37,026

Certificates of deposit
51,027

 
2

 
15

 
51,014

Subtotal - current investments
740,434

 
919

 
479

 
740,874

Auction rate securities
11,400

 

 
375

 
11,025

 
$
751,834

 
$
919

 
$
854

 
$
751,899


 
December 31, 2013
 
Amortized
 
Gross
Unrealized
 
Estimated
Fair
 
Cost
 
Gains
 
Losses
 
Value
 
(In thousands)
Corporate debt securities
$
450,162

 
$
442

 
$
832

 
$
449,772

Municipal securities
114,126

 
119

 
915

 
113,330

GSEs
68,898

 
6

 
87

 
68,817

U.S. treasury notes
37,360

 
44

 
28

 
37,376

Certificates of deposit
33,756

 
2

 
1

 
33,757

Subtotal - current investments
704,302

 
613

 
1,863

 
703,052

Auction rate securities
11,400

 

 
502

 
10,898

 
$
715,702

 
$
613

 
$
2,365

 
$
713,950



14


The contractual maturities of our investments as of June 30, 2014 are summarized below:
 
Amortized Cost
 
Estimated
Fair Value
 
(In thousands)
Due in one year or less
$
328,339

 
$
328,437

Due one year through five years
412,095

 
412,437

Due after ten years
11,400

 
11,025

 
$
751,834

 
$
751,899


Gross realized gains and losses from sales of available-for-sale securities are calculated under the specific identification method and are included in investment income. Net realized investment gains for the three and six months ended June 30, 2014 and 2013 were insignificant.
We monitor our investments for other-than-temporary impairment. For investments other than our auction rate securities, discussed below, we have determined that unrealized gains and losses at June 30, 2014 and December 31, 2013, 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.
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 continuous loss position for 12 months or more as of June 30, 2014:
 
In a Continuous Loss Position
for Less than 12 Months
 
In a Continuous Loss Position
for 12 Months or More
 
Estimated
Fair
Value
 
Unrealized
Losses
 
Total
Number of
Securities
 
Estimated
Fair
Value
 
Unrealized
Losses
 
Total
Number of
Securities
 
(Dollars in thousands)
Corporate debt securities
$
139,464

 
$
155

 
74

 
$
22,928

 
$
101

 
7

Municipal securities
25,715

 
49

 
18

 
13,877

 
94

 
15

GSEs
27,136

 
24

 
9

 
6,009

 
24

 
6

U.S. treasury notes
6,971

 
14

 
5

 
4,276

 
3

 
2

Certificates of deposit
14,977

 
15

 
55

 

 

 

Auction rate securities

 

 

 
11,025

 
375

 
15

 
$
214,263

 
$
257

 
161

 
$
58,115

 
$
597

 
45


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 continuous loss position for 12 months or more as of December 31, 2013:
 
In a Continuous Loss Position
for Less than 12 Months
 
In a Continuous Loss Position
for 12 Months or More
 
Estimated
Fair
Value
 
Unrealized
Losses
 
Total
Number of
Securities
 
Estimated
Fair
Value
 
Unrealized
Losses
 
Total
Number of
Securities
 
(Dollars in thousands)
Corporate debt securities
$
210,057

 
$
802

 
91

 
$
2,540

 
$
30

 
3

Municipal securities
30,715

 
398

 
49

 
31,091

 
517

 
39

GSEs
53,308

 
87

 
21

 

 

 

U.S. treasury notes
12,037

 
28

 
11

 

 

 

Certificates of deposit
414

 
1

 
2

 

 

 

Auction rate securities

 

 

 
10,898

 
502

 
15

 
$
306,531

 
$
1,316

 
174

 
$
44,529

 
$
1,049

 
57


Auction Rate Securities. Due to events in the credit markets, the auction rate securities held by us experienced failed auctions beginning in the first quarter of 2008, and such auctions have not resumed. Therefore, quoted prices in active markets have not

15


been available since early 2008. Our investments in auction rate securities are collateralized by student loan portfolios guaranteed by the U.S. government, and the range of maturities for such securities is from 17 years to 32 years. Considering the relative insignificance of these securities when compared with our liquid assets and other sources of liquidity, we have no current intention of selling these securities nor do we expect to be required to sell these securities before a recovery in their cost basis. For this reason, and because the decline in the fair value of the auction rate securities was not due to the credit quality of the issuers, we do not consider the auction rate securities to be other-than-temporarily impaired at June 30, 2014. At the time of the first failed auctions during first quarter 2008, we held a total of $82.1 million in auction rate securities at par value; since that time, we have settled $70.7 million of these instruments at par value.
For the six months ended June 30, 2014 and 2013, we recorded pretax unrealized gains of $0.1 million and $0.4 million, respectively, to accumulated other comprehensive income for the changes in their fair value. 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. If we determine that any future impairment is other-than-temporary, we will record a charge to earnings as appropriate.
8. Receivables
Receivables consist primarily of amounts due from the various states in which we operate, which may be subject to potential retroactive adjustments. Because all of our receivable amounts are readily determinable and substantially all of our creditors are state governments, our allowance for doubtful accounts is immaterial.  
 
June 30,
2014
 
December 31,
2013
 
(In thousands)
California
$
221,336

 
$
148,654

Florida
4,562

 
2,901

Illinois
130

 
5,773

Michigan
31,017

 
15,253

New Mexico
56,143

 
17,056

Ohio
50,548

 
43,969

South Carolina
1,999

 

Texas
13,240

 
9,736

Utah
13,337

 
10,953

Washington
38,740

 
13,455

Wisconsin
12,654

 
8,087

Direct delivery and other
8,199

 
2,463

Total Health Plans segment
451,905

 
278,300

Molina Medicaid Solutions segment
21,609

 
20,635

 
$
473,514

 
$
298,935

9. Restricted Investments
Pursuant to the regulations governing our Health Plans segment subsidiaries, we maintain statutory deposits and deposits required by state authorities in certificates of deposit and U.S. treasury securities. We also maintain restricted investments as protection against the insolvency of certain capitated providers. Additionally, in connection with the Molina Medicaid Solutions contract with the state of Maine, we maintain restricted investments as collateral for a letter of credit. The following table

16


presents the balances of restricted investments:
 
June 30,
2014
 
December 31,
2013
 
(In thousands)
California
$
373

 
$
373

Florida
23,620

 
9,242

Illinois
310

 
310

Michigan
1,014

 
1,014

New Mexico
26,628

 
24,622

Ohio
12,718

 
9,080

South Carolina
6,037

 
310

Texas
3,500

 
3,500

Utah
3,601

 
3,301

Washington
151

 
151

Other
1,487

 
886

Total Health Plans segment
79,439

 
52,789

Molina Medicaid Solutions segment
5,001

 
10,304

 
$
84,440

 
$
63,093


The contractual maturities of our held-to-maturity restricted investments as of June 30, 2014 are summarized below:
 
Amortized
Cost
 
Estimated
Fair Value
 
(In thousands)
Due in one year or less
$
83,840

 
$
83,851

Due one year through five years
600

 
601

 
$
84,440

 
$
84,452

10. Medical Claims and Benefits Payable
The following table provides the details of our medical claims and benefits payable as of the dates indicated:
 
June 30,
2014
 
December 31,
2013
 
(In thousands)
Fee-for-service claims incurred but not paid (IBNP)
$
697,038

 
$
424,173

Pharmacy payable
54,935

 
45,037

Capitation payable
29,560

 
20,267

Other
142,649

 
180,310

 
$
924,182

 
$
669,787

"Other" medical claims and benefits payable include amounts payable to certain providers for which we act as an intermediary on behalf of various state agencies without assuming financial risk. Such receipts and payments do not impact our consolidated statements of income. Non-risk provider payables amounted to $68.3 million and $151.3 million as of June 30, 2014 and December 31, 2013, respectively.
The following table presents the components of the change in our medical claims and benefits payable from continuing and discontinued operations combined for the periods indicated. The amounts displayed for “Components of medical care costs related to: Prior periods” represent the amount by which our original estimate of medical claims and benefits payable at the beginning of the period were more than the actual amount of the liability based on information (principally the payment of claims) developed since that liability was first reported.

17


 
Six Months Ended
 
Year Ended
 
June 30, 2014
 
December 31, 2013
 
(Dollars in thousands)
Balances at beginning of period
$
669,787

 
$
494,530

Components of medical care costs related to:
 
 
 
Current period
3,693,730

 
5,434,443

Prior period
(37,131
)
 
(52,779
)
Total medical care costs
3,656,599

 
5,381,664

 
 
 
 
Change in non-risk provider payables
(83,044
)
 
111,267

 
 
 
 
Payments for medical care costs related to:
 
 
 
Current period
2,891,174

 
4,932,195

Prior period
427,986

 
385,479

Total paid
3,319,160

 
5,317,674

Balances at end of period
$
924,182

 
$
669,787

 
 
 
 
Benefit from prior period as a percentage of:
 
 
 
Balance at beginning of period
5.5
%
 
10.7
%
Premium revenue, trailing twelve months
0.5
%
 
0.9
%
Medical care costs, trailing twelve months
0.6
%
 
1.0
%
Assuming that our initial estimate of IBNP is accurate, we believe that amounts ultimately paid out would 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. Because the amount of our initial liability is merely an estimate (and therefore not perfectly accurate), we will always experience variability in that estimate as new information becomes available with the passage of time. Therefore, there can be no assurance that amounts ultimately paid out will fall within the range of 8% to 10% lower than the liability that was initially recorded. Furthermore, because our initial estimate of IBNP is derived from many factors, some of which are qualitative in nature rather than quantitative, we are seldom able to assign specific values to the reasons for a change in estimate – we only know when the circumstances for any one or more factors are out of the ordinary.
As indicated above, the amounts ultimately paid out on our liabilities in fiscal years 2014 and 2013 were less than what we had expected when we had established our reserves. For example, for the year ended December 31, 2013, the amounts ultimately paid out were less than the amount of the reserves we had established as of December 31, 2012 by 10.7%. While many related factors working in conjunction with one another determine the accuracy of our estimates, we are seldom able to quantify the impact that any single factor has on a change in estimate. In addition, given the variability inherent in the reserving process, we will only be able to identify specific factors if they represent a significant departure from expectations. As a result, we do not expect to be able to fully quantify the impact of individual factors on changes in estimates.
While prior period development of our estimate as of December 31, 2013 through June 30, 2014 has been favorable by $37.1 million, that amount is substantially less than the favorable prior period development of $52.8 million that we recognized in all of 2013. Furthermore, favorable development through June 30, 2014 was less than the 8% to 10% we typically expect.
In estimating our claims liability at June 30, 2014, we adjusted our base calculation to take account of the numerous factors that we believe will likely change our final claims liability amount. We believe the most significant among those factors are:
Since January 1, 2014, we have added approximately 232,300 members under Medicaid expansion. Because these members have different demographics than our current members and are transitioning into managed are, we have little insight into their utilization of medical services. Additionally, as of June 30, 2014, we have relatively little medical claims payment history related to these members. Accordingly, our estimates of our liability are subject to a high degree of uncertainty.
Since January 1, 2014, we have added approximately 119,000 new members at our South Carolina health plan. Because we have only six months of claims payment history, the reserves are more subject to change than usual.

18


At our Texas health plan, we have recorded reserves to cover estimated liabilities for potential payment of additional claims where the initial claim payments were disputed by the providers. The actual additional payments may differ from the amount we have reserved.
At our New Mexico health plan, the state has been adding 10,000 to 15,000 members per month on a retroactive basis since March, 2014. Because we have no claims payment history for these members, our estimates of our liability are subject to a high degree of uncertainty.
The use of a consistent methodology in estimating our liability for medical claims and 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. In particular, the use of a consistent methodology should result in the replenishment of reserves during any given period in a manner that generally offsets the benefit of favorable prior period development in that period. 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 2013, and for the six months ended June 30, 2014, the absence of adverse development of the liability for medical claims and benefits payable at the close of the previous period resulted in the recognition of substantial favorable prior period development. In both periods, 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 replenishment of reserves in the respective periods generally offset the benefit from the prior period.
11. Long-Term Debt
As of June 30, 2014, maturities of long-term debt for the years ending December 31 are as follows (in thousands):
 
Total
 
2014
 
2015
 
2016
 
2017
 
2018
 
Thereafter
1.125% Notes
$
550,000

 
$

 
$

 
$

 
$

 
$

 
$
550,000

3.75% Notes
187,000

 
187,000

 

 

 

 

 

 
$
737,000

 
$
187,000

 
$

 
$

 
$

 
$

 
$
550,000

1.125% Cash Convertible Senior Notes due 2020. In February 2013, we issued $550.0 million aggregate principal amount of 1.125% Cash Convertible Senior Notes due 2020 (the 1.125% Notes), which were outstanding as of June 30, 2014 and December 31, 2013. Interest on the 1.125% Notes is payable semiannually in arrears on January 15 and July 15 of each year, at a rate of 1.125% per annum, and commenced on July 15, 2013. The 1.125% Notes will mature on January 15, 2020 unless repurchased or converted in accordance with their terms prior to such date. The 1.125% Notes are convertible only into cash, and not into shares of our common stock or any other securities.
The initial conversion rate for the 1.125% Notes is 24.5277 shares of our common stock per $1,000 principal amount of 1.125% Notes (equivalent to an initial conversion price of approximately $40.77 per share of common stock). The conversion rate is subject to adjustment in some events but will not be adjusted for any accrued and unpaid interest.
The 1.125% Notes contain an embedded cash conversion option, which was separated from the 1.125% Notes and accounted for separately as a derivative liability, with changes in fair value reported in our consolidated statements of income until the embedded cash conversion option transaction settles or expires. The initial fair value liability of the embedded cash conversion option simultaneously reduced the carrying value of the 1.125% Notes (effectively an original issuance discount). This discount is amortized to the 1.125% Notes' principal amount through the recognition of non-cash interest expense over the expected life of the debt. This has resulted in our recognition of interest expense on the 1.125% Notes at an effective rate approximating what we would have incurred had nonconvertible debt with otherwise similar terms been issued, or approximately 5.9%. As of June 30, 2014, we expect the 1.125% Notes to be outstanding until their January 15, 2020 maturity date, for a remaining amortization period of 5.5 years. The 1.125% Notes' if-converted value did not exceed their principal amount as of June 30, 2014 and December 31, 2013.
3.75% Convertible Senior Notes due 2014. We had $187.0 million of 3.75% Convertible Senior Notes due 2014 (the 3.75% Notes) outstanding as of June 30, 2014 and December 31, 2013. The 3.75% 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 3.75% Notes. This represents an initial conversion price of approximately $31.29 per share of our common stock.
Because the 3.75% Notes have cash settlement features, we have allocated the proceeds from their issuance between a liability component and an equity component. The reduced carrying value on the 3.75% Notes resulted in a debt discount that is amortized back to the 3.75% Notes' principal amount through the recognition of non-cash interest expense over the expected

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life of the debt. This has resulted in our recognition of interest expense on the 3.75% Notes at an effective rate approximating what we would have incurred had nonconvertible debt with otherwise similar terms been issued. The effective interest rate of the 3.75% 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. While the 3.75% Notes may be converted beginning July 1, 2014, we expect the 3.75% Notes to be outstanding until their October 1, 2014 maturity date, for a remaining amortization period of 3 months. The 3.75% Notes’ if-converted value exceeded their principal amount by approximately $79 million and $11 million as of June 30, 2014, and December 31, 2013, respectively. At June 30, 2014, the equity component of the 3.75% Notes, net of the impact of deferred taxes, was $24.0 million.
The principal amounts, unamortized discount and net carrying amounts of the convertible senior notes were as follows:
 
Principal Balance
 
Unamortized Discount
 
Net Carrying Amount
 
(In thousands)
June 30, 2014:
 
 
 
 
 
1.125% Notes
$
550,000

 
$
124,291

 
$
425,709

3.75% Notes
187,000

 
1,742

 
185,258

 
$
737,000

 
$
126,033

 
$
610,967

December 31, 2013:
 
 
 
 
 
1.125% Notes
$
550,000

 
$
133,632

 
$
416,368

3.75% Notes
187,000

 
5,128

 
181,872

 
$
737,000

 
$
138,760

 
$
598,240

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Interest cost recognized for the period relating to the:
 
 
 
 
 
 
 
Contractual interest coupon rate
$
3,300

 
$
3,300

 
$
6,600

 
$
5,827

Amortization of the discount
6,414

 
5,965

 
12,728

 
9,688

Total interest cost recognized
$
9,714

 
$
9,265

 
$
19,328

 
$
15,515

Lease Financing Obligations. In 2013 we entered into a sale-leaseback transaction for the sale and contemporaneous leaseback of two properties, including the Molina Center located in Long Beach, California, and our Ohio health plan office building in Columbus, Ohio. Due to our continuing involvement with these leased properties, the sale did not qualify for sale-leaseback accounting treatment and we remain the "accounting owner" of the properties. These assets continue to be included in our consolidated balance sheets, and also continue to be depreciated and amortized over their remaining useful lives. The lease financing obligation is amortized over the 25-year lease term such that there will be no gain or loss recorded if the lease is not extended at the end of its term. Payments under the lease adjust the lease financing obligation, and the imputed interest is recorded to interest expense in our consolidated statements of income.
As described and defined in further detail in Note 16, "Related Party Transactions," we entered into a lease for office space in February 2013 consisting of two office buildings then under construction. We have concluded that we are the accounting owner of the properties due to of our continuing involvement with the properties. We have recorded $38.5 million to property, equipment and capitalized software, net, in the accompanying consolidated balance sheet as of June 30, 2014, which represents the total cost, including imputed interest, incurred by the Landlord thus far for the construction of the buildings. As of June 30, 2014, the aggregate amount recorded to lease financing obligations amounted to $39.4 million. Payments under the lease adjust the lease financing obligation, and the imputed interest is recorded to interest expense in our consolidated statements of income. Such interest expense was $1.1 million for the six months ended June 30, 2014. In addition to the capitalization of the costs incurred by the Landlord, we impute and record rent expense relating to the ground leases for the property sites. Such rent expense is computed based on the fair value of the land and our incremental borrowing rate, and was $0.4 million for the six months ended June 30, 2014.

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12. Derivative Financial Instruments
The following table summarizes the fair values and the presentation of our derivative financial instruments (defined and discussed individually below) in the consolidated balance sheets:
 
Balance Sheet Location
 
June 30, 2014
 
December 31, 2013
 
 
 
(In thousands)
Derivative asset:
 
 
 
 
 
1.125% Call Option
Non-current assets: Derivative asset
 
$
250,160

 
$
186,351

 

 


 
 
Derivative liability:
 
 
 
 
 
Embedded cash conversion option
Non-current liabilities: Derivative liability
 
$
250,038

 
$
186,239

Our derivative financial instruments do not qualify for hedge treatment, therefore the change in fair value of these instruments is recognized immediately in our consolidated statements of income, and reported in other expenses, net. Gains and losses for our derivative financial instruments are presented individually in the consolidated statements of cash flows, supplemental cash flow information.
1.125% Notes Call Spread Overlay. Concurrent with the issuance of the 1.125% Notes in 2013 as described in Note 11, "Long-Term Debt," we entered into privately negotiated hedge transactions (collectively, the 1.125% Call Option) and warrant transactions (collectively, the 1.125% Warrants), with certain of the initial purchasers of the 1.125% Notes (the Counterparties). We refer to these transactions collectively as the Call Spread Overlay. Under the Call Spread Overlay, the cost of the 1.125% Call Option we purchased to cover the cash outlay upon conversion of the 1.125% Notes was reduced by proceeds from the sale of the 1.125% Warrants. Assuming full performance by the Counterparties (and 1.125% Warrants strike prices in excess of the conversion price of the 1.125% Notes), these transactions are intended to offset cash payments due upon any conversion of the 1.125% Notes.
1.125% Call Option. The 1.125% Call Option, which is indexed to our common stock, is a derivative asset that requires mark-to-market accounting treatment due to cash settlement features until the 1.125% Call Option settles or expires. For further discussion of the inputs used to determine the fair value of the 1.125% Call Option, refer to Note 6, "Fair Value Measurements."
Embedded Cash Conversion Option. The embedded cash conversion option within the 1.125% Notes is accounted for separately as a derivative liability, with changes in fair value reported in our consolidated statements of income until the cash conversion option settles or expires. For further discussion of the inputs used to determine the fair value of the embedded cash conversion option, refer to Note 6, "Fair Value Measurements."
13. Stockholders' Equity
Stockholders' equity increased $24.1 million during the six months ended June 30, 2014 compared with stockholders' equity at December 31, 2013. The increase was due to net income of $12.3 million, $1.1 million related to other comprehensive income and $10.7 million related to employee stock transactions.
1.125% Warrants. If the market value per share of our common stock exceeds the strike price of the 1.125% Warrants on any trading day during the 160 trading day measurement period under the 1.125% Warrants, we will be obligated to issue to the Counterparties a number of shares equal in value to the product of the amount by which such market value exceeds such strike price and 1/160th of the aggregate number of shares of our common stock underlying the 1.125% Warrants, subject to a share delivery cap. We will not receive any additional proceeds if the 1.125% Warrants are exercised. Pursuant to the 1.125% Warrants, we issued 13,490,236 warrants with a strike price of $53.8475 per share. The number of warrants and the strike price are subject to adjustment under certain circumstances. The 1.125% Warrants could separately have a dilutive effect to the extent that the market value per share of our common stock (as measured under the terms of the warrant transactions) exceeds the applicable strike price of the 1.125% Warrants.
Securities Repurchases and Repurchase Program. Effective September 30, 2013, our board of directors authorized the repurchase of up to $50.0 million in aggregate of our common stock through December 31, 2014. Stock repurchases under this program may be made through open-market and/or privately negotiated transactions at times and in such amounts as management deems appropriate. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements and other market conditions. As of June 30, 2014, the remaining balance available to repurchase our stock under this program was $47.3 million.

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Shelf Registration Statement. In May 2012, we filed an automatic shelf registration statement on Form S-3 with the SEC covering the issuance of an indeterminate number of our securities, including common stock, warrants, or debt securities. We may publicly offer securities from time to time at prices and terms to be determined at the time of the offering.
Stock Plans. In connection with our equity incentive plans, we issued approximately 623,000 shares of common stock, net of shares used to settle employees’ income tax obligations, for the six months ended June 30, 2014.
14. Segment Information
We report our financial performance based on two reportable segments: the Health Plans segment and the Molina Medicaid Solutions segment. Our reportable segments are consistent with how we manage the business and view the markets we serve. Our Health Plans segment consists of our state health plans and our direct delivery business. Our state health plans represent operating segments that have been aggregated for reporting purposes as they share similar economic characteristics.
Our Molina Medicaid Solutions segment provides MMIS design, development, implementation; business process outsourcing solutions; hosting services; and information technology support services to state Medicaid agencies.
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 segment is charged to the Health Plans segment.
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
 
(In thousands)
Revenue from continuing operations:
 
 
 
 
 
 
 
Health Plans segment:
 
 
 
 
 
 
 
Premium revenue
$
2,167,142

 
$
1,501,729

 
$
4,107,479

 
$
2,999,162

Premium tax revenue
70,120

 
46,883

 
121,813

 
83,883

Health insurer fee revenue
19,662

 

 
38,358

 

Investment income
1,945

 
1,628

 
3,574

 
3,144

Other revenue
2,938

 
5,922

 
6,196

 
10,616

Molina Medicaid Solutions segment:
 
 
 
 
 
 
 
Service revenue
50,232

 
49,672

 
103,862

 
99,428

Total revenue
$
2,312,039

 
$
1,605,834

 
$
4,381,282

 
$
3,196,233

 
 
 
 
 
 
 
 
Operating income from continuing operations:
 
 
 
 
 
 
 
Health Plans segment
$
21,986

 
$
40,151

 
$
36,005

 
$
101,671

Molina Medicaid Solutions segment
10,441

 
6,295

 
20,689

 
12,648

Total operating income from continuing operations
32,427

 
46,446

 
56,694

 
114,319

Other expenses, net
13,984

 
15,169

 
27,762

 
28,075

Income from continuing operations before income tax expense
$
18,443

 
$
31,277

 
$
28,932

 
$
86,244

15. Commitments and Contingencies
California Health Plan Rate Settlement Agreement. In the fourth quarter of 2013, our California health plan entered into a settlement agreement with the California Department of Health Care Services (DHCS). The agreement settled rate disputes initiated by our California health plan dating back to 2003 with respect to its participation in Medi-Cal (California’s Medicaid program). Under the terms of the agreement, a settlement account (the Account) applicable to the California health plan’s managed care contracts has been established.
Effective January 1, 2014, the Account was established with an initial balance of zero, and will be settled after December 31, 2017. DHCS will make an interim partial settlement payment to us if it terminates early, without replacement, any of our managed care contracts. The Account will be adjusted annually to reflect a calendar year deficit or surplus, which is determined by comparing the California health plan’s pre-tax margin and a target margin established in the settlement agreement. Upon expiration of the settlement agreement, if the Account is in a deficit position, then DHCS will pay the amount of the deficit to us, subject to an alternative minimum payment amount. If the Account is in a surplus position, then no amount is owed to either party. The maximum amount that DHCS would pay to us under the terms of the settlement agreement is $40.0 million.

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We estimate and recognize the retrospective adjustments to premium revenue based on our experience to date under the California health plan's managed care contracts. As of June 30, 2014, we recorded a deficit, or receivable, of $9.5 million, net of a valuation discount of $0.5 million, reflecting our estimated retrospective premium adjustment to the Account based on the California health plan's actual pretax margin for the six months ended June 30, 2014.
Legal Proceedings. The health care and business process outsourcing industries are 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 and penalties, exclusion from participating in publicly funded programs, and the repayment of previously billed and collected revenues.
We are involved in legal actions in the ordinary course of business, some of which seek monetary damages, including claims for punitive damages, which are not covered by insurance. We have accrued liabilities for certain matters for which we deem the loss to be both probable and estimable. Although we believe that our estimates of such losses are reasonable, these estimates could change as a result of further developments of these matters. The outcome of legal actions is inherently uncertain and such pending matters for which accruals have not been established have not progressed sufficiently through discovery and/or development of important factual information and legal issues to enable us to estimate a range of possible loss, if any. While it is not possible to accurately predict or determine the eventual outcomes of these items, an adverse determination in one or more of these pending matters could have a material adverse effect on our consolidated financial position, results of operations, or cash flows.
Washington Health Plan. The Washington Health Care Authority (HCA) has communicated that it believes it has overpaid our Washington health plan with regard to certain claims. The alleged overpayments purportedly involve an undifferentiated incremental component of the capitation rates paid to our Washington health plan from and after July 1, 2012, the start date of the contract at issue. On March 25, 2014, HCA alleged that the total "overpayments" related to HCA’s delayed enrollment of so-called Washington Community Options Program Entry System (COPES) members were $14.4 million, and demanded payment in that amount. On April 7, 2014, HCA alleged that the total "overpayments" related to certain psychotropic drug claims that had been included in the Request for Proposal (RFP) rate book were $5.8 million, and demanded payment in that amount. HCA has provided us with minimal data by which we might independently validate HCA’s allegations. Furthermore, both alleged errors, if they in fact occurred, were unilateral errors committed and caused by HCA for which our Washington health plan had no contemporaneous knowledge and had assumed and bore no contractual risk. We have responded to HCA’s demands for payment, noting, among other things, that the demands are improper as a matter of law because under the Washington statue cited regarding the definition of an "overpayment," there were in fact no "overpayments" since payment was made consistent with the express terms of the parties’ contract. We believe that any actual liability for the alleged overpayment claims is not currently probable or reasonably estimable.
State of Louisiana. On June 26, 2014, the State of Louisiana filed a Petition for Damages against Molina Medicaid Solutions, Molina Healthcare, Inc., Unisys Corporation, and Paramax Systems Corporation, a subsidiary of Unisys, in the Parish of Baton Rouge, 19th Judicial District. The Petition alleges that between 1989 and 2012, the defendants utilized an incorrect reimbursement formula for the payment of pharmaceutical claims. We believe we have several meritorious defenses to the claims of the state, and any liability for the alleged claims is not currently probable or reasonably estimable.
USA and State of Florida ex rel. Charles Wilhelm. On July 24, 2014, Molina Healthcare, Inc. and Molina Healthcare of Florida, Inc. were served with a Complaint filed under seal on December 5, 2012 in District Court for the Southern District of Florida by relator, Charles C. Wilhelm, M.D., Case No. 12-24298. The Complaint alleges that, in late 2008 and early 2009, in connection with the acquisition of Florida NetPass by which Molina Healthcare entered into the state of Florida, the defendants failed to adequately staff the plan and provide other services, resulting in a disproportionate number of sicker beneficiaries of Florida NetPass moving back into the Florida fee-for-service Medicaid program. This alleged conduct purportedly resulted in a violation of the federal False Claims Act. Both the United States of America and the State of Florida have reviewed the allegations made in the Complaint, and have declined to intervene. We believe we have several meritorious defenses to the claims of the relator, and any liability for the alleged claims is not currently probable or reasonably estimable.
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.

23


Regulatory Capital and Dividend Restrictions. Our health plans, which are operated by our respective wholly owned subsidiaries in those states, 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. Regulators in some states may also attempt to enforce capital requirements upon us that require the retention of net worth in excess of amounts formally required by statute or regulation. Such statues, regulations and informal capital requirements also restrict the timing, payment, and amount of dividends and other distributions that may be paid to us as the sole stockholder. To the extent our subsidiaries must comply with these regulations, they may not have the financial flexibility to transfer funds to us. Based upon current statutes and regulations, 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 approximately $663 million at June 30, 2014, and $608 million at December 31, 2013. Because of the statutory restrictions that inhibit the ability of our health plans to transfer net assets to us, the amount of retained earnings readily available to pay dividends to our stockholders is generally limited to cash, cash equivalents and investments held by the parent company – Molina Healthcare, Inc. Such cash, cash equivalents and investments amounted to $299.8 million and $365.2 million as of June 30, 2014 and December 31, 2013, respectively.
The National Association of Insurance Commissioners (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. Illinois, Michigan, New Mexico, Ohio, South Carolina, Texas, Utah, Washington, and Wisconsin have adopted these rules, which may vary from state to state. California and Florida have not 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 June 30, 2014, our health plans had aggregate statutory capital and surplus of approximately $728 million compared with the required minimum aggregate statutory capital and surplus of approximately $418 million. All of our health plans were in compliance with the minimum capital requirements at June 30, 2014. 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.
16. Related Party Transactions
In February 2013, we entered into a lease with 6th & Pine Development, LLC (the Landlord) for office space located in Long Beach, California. The lease consists of two office buildings, referred to as Building A and Building B.
The principal members of the Landlord are John C. Molina, our chief financial officer and a director of the Company, and his wife. In addition, in connection with the development of the buildings being leased, the Landlord has pledged shares of common stock in the Company the Landlord holds as trustee. Dr. J. Mario Molina, our chief executive officer, president, and chairman of the board of directors, holds a partial interest in such shares as trust beneficiary.
The lease term for Building A commenced in June 2013, and the lease term for Building B commenced in July 2014. The initial lease term for both buildings expires on December 31, 2024, subject to two five-year renewal options. Annual rent for Building A is approximately $3 million, and initial annual rent for Building B is approximately $4 million. Rent increases 3.75% per year during the initial term. Rent during the extension terms will be the greater of then-current rent or fair market rent.
Refer to Note 17, "Variable Interest Entities," for a discussion of the Joseph M. Molina, M.D. Professional Corporations.
17Variable Interest Entities
Joseph M. Molina M.D., Professional Corporations. The Joseph M. Molina, M.D. Professional Corporations (JMMPC) were created in 2012 to further advance our direct delivery business. JMMPC's sole shareholder is Dr. J. Mario Molina, our chief executive officer, president, and chairman of the board of directors. Dr. Molina is paid no salary and receives no dividends in connection with his work for, or ownership of, JMMPC. JMMPC provides professional medical services to the general public for routine non-life threatening, outpatient health care needs. Substantially all of the individuals served by JMMPC are members of our health plans. JMMPC does not have agreements to provide professional medical services with any other entities.
Our wholly owned subsidiary, American Family Care, Inc. (AFC), has entered into services agreements with JMMPC to provide clinic facilities, clinic administrative support staff, patient scheduling services and medical supplies to JMMPC. The services agreements were designed such that JMMPC will operate at break even, ensuring the availability of quality care and access for our health plan members. The services agreements provide that the administrative fees charged to JMMPC by AFC are reviewed annually to assure the achievement of this goal.
Separately, our California, Florida, New Mexico, Utah and Washington health plans have entered into primary care services agreements with JMMPC. These agreements direct our health plans to perform a monthly reconciliation, to either fund JMMPC's operating deficits, or receive JMMPC's operating surpluses, such that JMMPC will derive no profit or loss. Because

24


the AFC services agreements described above mitigate the likelihood of significant operating deficits or surpluses, such monthly reconciliation amounts are generally insignificant.
We have determined that JMMPC is a variable interest entity (VIE), and that we are its primary beneficiary. We have reached this conclusion under the power and benefits criterion model according to GAAP. Specifically, we have the power to direct the activities that most significantly affect JMMPC's economic performance, and the obligation to absorb losses or right to receive benefits that are potentially significant to the VIE, under the agreements described above. Because we are its primary beneficiary, we have consolidated JMMPC. JMMPC's assets may be used to settle only JMMPC's obligations, and JMMPC's creditors have no recourse to the general credit of Molina Healthcare, Inc. As of June 30, 2014, JMMPC had total assets of $10.4 million, and total liabilities of $10.1 million. As of December 31, 2013, JMMPC had total assets of $6.9 million and total liabilities of $6.6 million.
Our maximum exposure to loss as a result of our involvement with JMMPC is generally limited to the amounts needed to fund JMMPC's ongoing payroll and employee benefits. We believe that such loss exposure will be immaterial to our consolidated operating results and cash flows for the foreseeable future.


25


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 harbor 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 harbor 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. Those known risks and uncertainties include, but are not limited to, the following:
uncertainties associated with the implementation of the Affordable Care Act, including the full grossed up reimbursement by states of the non-deductible health insurer fee, the expansion of Medicaid eligibility in the states that participate to previously uninsured populations unfamiliar with managed care, the implementation of state insurance marketplaces, the effect of various implementing regulations, and uncertainties regarding the impact of other federal or state health care and insurance reform measures, including the dual eligibles demonstration programs in California, Illinois, Michigan, Ohio, and South Carolina;
newly FDA-approved drugs such as Sovaldi, Olysio, and other drugs for hepatitis C or other medical conditions that are exorbitantly priced but not factored into the calculation of our capitated rates for 2014;
significant budget pressures on state governments and their potential inability to maintain current rates, to implement expected rate increases, or to maintain existing benefit packages or membership eligibility thresholds or criteria;
management of our medical costs, including seasonal flu patterns and rates of utilization that are consistent with our expectations, and our ability to reduce over time the high medical costs commonly associated with new patient populations;
the accurate estimation of incurred but not paid medical costs across our health plans;
retroactive adjustments to premium revenue or accounting estimates which require adjustment based upon subsequent developments, including Medicaid pharmaceutical rebates or retroactive premium rate increases;
efforts by states to recoup previously paid amounts, including claims by the Washington Health Care Authority (HCA) that it overpaid our Washington health plan for certain claims related to psychotropic drugs and the Washington Community Options Program Entry System (COPES);
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 the success of the proposal of Molina Medicaid Solutions in New Jersey;
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, including the extension of the Louisiana contract of Molina Medicaid Solutions through 2015;
government audits and reviews, and any fine, enrollment freeze, or monitoring program that may result therefrom;
changes with respect to our provider contracts and the loss of providers;
federal or state medical cost expenditure floors, 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, including 2014 at-risk premium rules in the state of Texas;
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 or unfavorable resolution of litigation, arbitration, or administrative proceedings, including the litigation commenced against us by the state of Louisiana alleging that Molina Medicaid Solutions and its predecessors used an incorrect reimbursement formula for the payment of pharmaceutical claims;
the relatively small number of states in which we operate health plans;
our management of a portion of College Health Enterprises’ hospital in Long Beach, California;

26


the availability of adequate financing on acceptable terms to fund and capitalize our expansion and growth, repay our outstanding indebtedness at maturity and meet our liquidity needs, including the interest expense and other costs associated with such financing;
the failure of a state in which we operate to renew its federal Medicaid waiver;
an inadvertent unauthorized disclosure of protected health information;
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; and
increasing consolidation in the Medicaid industry.
Investors should refer to Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2013, 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, 2013.







27


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. We report our financial performance based on two reportable segments: the Health Plans segment and the Molina Medicaid Solutions segment.
Our Health Plans segment consists of health plans in 11 states, and includes our direct delivery business. As of June 30, 2014, these health plans served approximately 2.3 million members eligible for Medicaid, Medicare, and other government-sponsored health care programs for low-income families and individuals. Additionally, we serve a small number of Health Insurance Marketplaces (Marketplaces) members, many of whom are eligible for government premium subsidies. The health plans are operated by our respective wholly owned subsidiaries in those states, each of which is licensed as a health maintenance organization (HMO). Our direct delivery business consists primarily of the operation of primary care clinics in California.
Our Molina Medicaid Solutions segment provides business processing and information technology development and administrative services to Medicaid agencies in Idaho, Louisiana, Maine, New Jersey, West Virginia, and the U.S. Virgin Islands, and drug rebate administration services in Florida.
We previously reported that our Medicaid managed care contract with the state of Missouri expired without renewal in 2012, and effective June 2013 the transition obligations associated with that contract terminated. Therefore, beginning in the second quarter of 2013, we classified the operations for our Missouri health plan as discontinued operations for all periods presented in our consolidated financial statements. The following discussion and analysis, with the exception of cash flow information, is presented in the context of continuing operations unless otherwise identified.
Health Care Reform
We believe that the Affordable Care Act (defined below) will continue to provide us with significant opportunities for membership growth in our existing markets and, potentially, in new markets in the future as follows:
Medicaid Expansion. In the states that have elected to participate, the Affordable Care Act provides for the expansion of the Medicaid program to provide eligibility to nearly all low-income people under age 65 with incomes at or below 138 percent of the federal poverty line. Medicaid expansion membership phased in beginning January 1, 2014. Since that date, our health plans in California, Illinois, Michigan, New Mexico, Ohio, and Washington have begun participating in Medicaid expansion. In the six months ended June 30, 2014, we added approximately 232,300 Medicaid expansion members, or 10% of total membership.
Health Insurance Marketplaces. On October 1, 2013, Marketplaces became available for consumers to access and begin the enrollment process for coverage beginning January 1, 2014. Marketplaces allow individuals and small groups to purchase health insurance that is federally subsidized. We participate in Marketplaces in all of the states in which we operate, except Illinois and South Carolina. At June 30, 2014, we had fewer than 20,000 Marketplaces members.
Dual Eligibles. Policymakers at the federal and state levels are increasingly developing initiatives, and the Centers for Medicare and Medicaid Services (CMS) has implemented several demonstrations, designed to improve the coordination of care for dual eligibles and reduce spending under Medicare and Medicaid. These demonstrations include issuing contracts to 15 states to design a program to integrate Medicare and Medicaid services for dual eligibles in the state. We refer to such demonstrations as our Medicare-Medicaid Plan (MMP) implementations. Our MMP implementations in California, Illinois, and Ohio offered coverage beginning in the second quarter of 2014.
Health Insurer Fee. In the first quarter of 2014, we adopted the guidance of the Financial Accounting Standards Board (FASB) related to accounting for the fees to be paid by health insurers to the federal government under the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 (collectively, the Affordable Care Act, or ACA). The ACA imposes an annual fee, or excise tax, on health insurers for each calendar year beginning on or after January 1, 2014. The health insurer fee (HIF) is imposed beginning in 2014 based on a company's share of the industry's net premiums written during the preceding calendar year, and is payable on September 30 of each year.
As of June 30, 2014, we expect the liability to amount to $88.3 million. We are recognizing this expense on a straight-line basis in 2014, and recorded $21.9 million and $44.1 million to health insurer fee expenses in the three months and six months ended June 30, 2014, respectively. As enacted, this federal premium-based assessment is non-deductible for income tax purposes.
For further discussion of the risks and uncertainties relating to the HIF, refer to the subheading below, "Liquidity and Capital Resources—Financial Condition."

28


Market Updates - Health Plans Segment
Florida. Enrollment at the Florida health plan declined between the first and second quarters of 2014 due to a reassignment of membership as part of the implementation of Florida’s Managed Medical Assistance program. We believe that enrollment at the Florida health plan will grow later in the year.
On March 12, 2014, our Florida health plan entered into an agreement with Healthy Palm Beaches, Inc. (HPB) to acquire certain assets relating to HPB’s Medicaid business for $7.5 million. Our Florida health plan expects to close on this transaction in the third quarter of 2014.
South Carolina. Our South Carolina health plan began serving members under the state of South Carolina’s new full-risk Medicaid managed care program effective January 1, 2014. For further information on this transaction, refer to Item 1 of this Form 10-Q, Notes to Consolidated Financial Statements, in Note 4, "Business Combinations." 
Composition of Revenue and Membership
Health Plans Segment
Our health plans' state Medicaid contracts generally have terms of three to four years with annual adjustments to premium rates. These contracts typically contain renewal options exercisable by the state Medicaid agency, and allow either the state or the health plan to terminate the contract with or without cause. Our health plan subsidiaries have generally been successful in retaining their contracts, but such contracts are subject to risk of loss when a state issues a new RFP open to competitive bidding by other health plans. If one of our health plans is not a successful responsive bidder to a state RFP, its contract may be subject to non-renewal.
In addition to contract renewal, our state Medicaid contracts may be periodically amended to include or exclude certain health benefits (such as pharmacy services, behavioral health services, or long-term care services); populations such as the aged, blind or disabled; and regions or service areas.
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 Item 1 of this Form 10-Q, Notes to Consolidated Financial Statements, in Note 2, "Significant Accounting Policies," is not generally subject to significant accounting estimates. For the six months ended June 30, 2014, we received approximately 97% of our premium revenue as a fixed amount per member per month (PMPM), pursuant to our Medicaid contracts with state agencies, Medicare and other managed care organizations for which we operate as 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 six months ended June 30, 2014, we recognized approximately 3% 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 Illinois and 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. The following table sets forth the ranges of premiums paid to our state health plans in the six months ended June 30, 2014, by program:
 
Ending
 
PMPM Premiums
 
Membership
 
Low
 
High
 
Consolidated
Temporary Assistance for Needy Families (TANF)
1,564,500

 
$
100.00

 
$
260.00

 
$
160.00

Aged, Blind or Disabled (ABD)
305,300

 
370.00

 
1,260.00

 
770.00

Medicaid Expansion
232,300

 
370.00

 
550.00

 
500.00

Children's Health Insurance Program (CHIP)
77,000

 
90.00

 
130.00

 
120.00

Medicare Special Needs Plans (Medicare)
44,000

 
530.00

 
1,280.00

 
1,190.00

Marketplaces
18,300

 
170.00

 
640.00

 
300.00

MMP–Integrated (1)
5,200

 
1,230.00

 
3,240.00

 
1,910.00

MMP–Medicare Opt Out (1)
8,400

 
1,370.00

 
1,420.00

 
1,390.00

(1)
MMPs serve members who are dually eligible for Medicare and Medicaid.
(2)
MMP members who have elected to "opt out" of Medicare coverage and receive Medicaid coverage only.

29



The following tables set forth our Health Plans segment membership as of the dates indicated:
 
June 30,
2014
 
March 31,
2014
 
December 31,
2013
 
June 30,
2013
Ending Membership by Health Plan:
 
 
 
 
 
 
 
California
455,000

 
418,000

 
368,000

 
355,000

Florida (1)
58,000

 
91,000

 
89,000

 
81,000

Illinois
6,000

 
5,000

 
4,000

 

Michigan
244,000

 
218,000

 
213,000

 
215,000

New Mexico
195,000

 
183,000

 
168,000

 
92,000

Ohio
302,000

 
260,000

 
255,000

 
240,000

South Carolina (2)
119,000

 
126,000

 

 

Texas
247,000

 
246,000

 
252,000

 
266,000

Utah
83,000

 
80,000

 
86,000

 
87,000

Washington
461,000

 
434,000

 
403,000

 
413,000

Wisconsin
85,000

 
90,000

 
93,000

 
98,000

 
2,255,000

 
2,151,000

 
1,931,000

 
1,847,000

 
 
 
 
 
 
 
 
Ending Membership by Program:
 
 
 
 
 
 
 
TANF
1,564,500

 
1,575,300

 
1,503,800

 
1,435,400

ABD
305,300

 
309,900

 
288,600

 
270,300

Medicaid Expansion (3)
232,300

 
133,000

 

 

CHIP
77,000

 
83,700

 
99,200

 
105,000

Medicare
44,000

 
41,400

 
39,400

 
36,300

Marketplaces (3)
18,300

 
7,700

 

 

MMP–Integrated
5,200

 

 

 

MMP–Medicare Opt Out
8,400

 

 

 

 
2,255,000

 
2,151,000

 
1,931,000

 
1,847,000

_________________________
(1)
Enrollment at our Florida health plan declined between the first and second quarters of 2014 due to a reassignment of membership as part of the implementation of Florida's Managed Medical Assistance program. We believe enrollment at our Florida health plan will grow later in the year.
(2)
Our South Carolina health plan began serving members under the state of South Carolina’s new full-risk Medicaid managed care program effective January 1, 2014.
(3)
Medicaid expansion membership phased in, and Health Insurance Marketplaces became available for consumers to access coverage, beginning January 1, 2014.
Molina Medicaid Solutions Segment
The payments received by our Molina Medicaid Solutions segment under its state contracts are based on the performance of multiple services. The first of these is the design, development and implementation (DDI) of a Medicaid management information system (MMIS). An additional service, following completion of DDI, is the operation of the MMIS under a business process outsourcing (BPO) arrangement. When providing BPO services (which include claims payment and eligibility processing) we also provide the state with other services including both hosting and support, and maintenance. Because we have determined the services provided under our Molina Medicaid Solutions contracts represent a single unit of accounting, we generally recognize revenue associated with such contracts on a straight-line basis over the original contract term during which BPO, hosting, and support and maintenance services are delivered. There may be certain contractual provisions containing contingencies, however that require us to delay recognition of all or part of our service revenue until such contingencies have been removed.

30


Composition of Expenses
Health Plans Segment
Operating expenses for the Health Plans segment include expenses related to the provision of medical care services, general and administrative 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 categories:
Fee-for-service expenses: Under fee-for-service arrangements, we retain the financial responsibility for medical care provided and incur costs based on actual utilization of services. Such expenses are recorded in the period in which the related services are dispensed. Nearly all hospital services and the majority of our primary care and physician specialist services are paid on a fee-for-service basis.
Pharmacy expenses: All drug, injectables, and immunization costs paid through our pharmacy benefit manager are classified as pharmacy expenses.
Capitation expenses: Under capitation arrangements, we pay a fixed amount PMPM to the provider without regard to the frequency, extent, or nature of the medical services actually furnished.
Direct delivery expenses: All costs associated with our operation of primary care clinics are classified as direct delivery expenses.
Other medical expenses: All medically related administrative costs, certain provider incentive costs, reinsurance costs and other health care expenses are classified as 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 Item 1 of this Form 10-Q, Notes to Consolidated Financial Statements in Note 10, "Medical Claims and Benefits Payable," for further information on how we estimate such liabilities.
Molina Medicaid Solutions Segment
Cost of service revenue consists primarily of the costs incurred to provide BPO and technology outsourcing services under our MMIS contracts. 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.

31


Second Quarter Financial Performance Summary, Continuing Operations
The following table and narrative briefly summarize our financial and operating performance from continuing operations for the three and six months ended June 30, 2014 and 2013. All ratios, with the exception of the medical care ratio and the premium tax ratio, are computed as a percentage of total revenue. The medical care ratio is computed as a percentage of premium revenue, the premium tax ratio is computed as a percentage of premium revenue plus premium tax revenue because direct relationships exist between premium revenue earned, and the cost of health care and premium taxes.
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
 
(Dollar amounts in thousands, except per share data)
Net income per diluted share
$
0.16

 
$
0.34

 
$
0.26

 
$
1.00

Premium revenue
$
2,167,142

 
$
1,501,729

 
$
4,107,479

 
$
2,999,162

Service revenue
$
50,232

 
$
49,672

 
$
103,862

 
$
99,428

Operating income
$
32,427

 
$
46,446

 
$
56,694

 
$
114,319

Net income
$
7,741

 
$
15,796

 
$
12,575

 
$
46,318

 
 
 
 
 
 
 
 
Total ending membership
2,255,000

 
1,847,000

 
2,255,000

 
1,847,000

 
 
 
 
 
 
 
 
Premium revenue
93.7
%
 
93.5
%
 
93.7
%
 
93.9
%
Service revenue
2.2

 
3.1

 
2.4

 
3.1

Premium tax revenue
3.0

 
2.9

 
2.8

 
2.6

Health insurer fee revenue
0.9

 

 
0.9

 

Investment income
0.1

 
0.1

 
0.1

 
0.1

Other revenue
0.1

 
0.4

 
0.1

 
0.3

Total revenue
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
 
 
 
 
 
 
 
 
Operating Statistics:
 
 
 
 
 
 
 
Medical care ratio
89.3
%
 
86.2
%
 
89.0
%
 
86.1
%
Service revenue ratio
73.9
%
 
79.1
%
 
74.9
%
 
79.5
%
General and administrative expense ratio
8.4
%
 
10.1
%
 
8.7
%
 
9.5
%
Premium tax ratio
3.1
%
 
3.0
%
 
2.9
%
 
2.7
%
Operating income
1.4
%
 
2.9
%
 
1.3
%
 
3.6
%
Net income
0.3
%
 
1.0
%
 
0.3
%
 
1.4
%
Effective tax rate
58.0
%
 
49.5
%
 
56.5
%
 
46.3
%
 
 
 
 
 
 
 
 
Medical Claims Data:
 
 
 
 
 
 
 
Days in claims payable, fee for service
46

 
38

 
46

 
38

Number of claims in inventory at end of period
180,600

 
109,900

 
180,600

 
109,900

Billed charges of claims in inventory at end of period
$
400,000

 
$
200,400

 
$
400,000

 
$
200,400

Claims in inventory per member at end of period
0.08

 
0.06

 
0.08

 
0.06

Billed charges of claims in inventory per member at end of period
$
177.38

 
$
108.50

 
$
177.38

 
$
108.50

Number of claims received during the period
6,655,300

 
5,253,500

 
12,641,300

 
10,524,500

Billed charges of claims received during the period
$
7,255,000

 
$
5,307,200

 
$
13,609,000

 
$
10,477,900


Non-GAAP Financial Measures
We use the following non-GAAP financial measures as supplemental metrics in evaluating our financial performance, making financing and business decisions, and forecasting and planning for future periods. For these reasons, management believes such measures are useful supplemental measures to investors in comparing our performance and the performance of other companies in the health care industry. These non-GAAP financial measures should be considered as supplements to, and not substitutes for or superior to, GAAP measures (GAAP stands for U.S. generally accepted accounting principles).
The first of these non-GAAP measures is earnings before interest, taxes, depreciation and amortization, or EBITDA. The following table reconciles net income, which we believe to be the most comparable GAAP measure, to EBITDA.


32


 
Three Months Ended June 30,
 
Six Months Ended June 30,
2014
 
2013
 
2014
 
2013
 
(In thousands)
Net income
$
7,811

 
$
24,571

 
$
12,309

 
$
54,486

Adjustments:
 
 
 
 
 
 
 
Depreciation, and amortization of intangible assets and capitalized software
28,292

 
22,108

 
54,206

 
43,907

Interest expense
13,993

 
11,667

 
27,815

 
24,704

Income tax expense
10,760

 
5,513

 
15,997

 
29,783

EBITDA
$
60,856

 
$
63,859

 
$
110,327

 
$
152,880

The second of these non-GAAP measures is adjusted net income, continuing operations. The following table reconciles net income from continuing operations, which we believe to be the most comparable GAAP measure, to adjusted net income, continuing operations.
 
Three Months Ended June 30,
2014
 
2013
 
(In thousands, except diluted per-share amounts)
Net income, continuing operations
$
7,741

 
$
0.16

 
$
15,796

 
$
0.34

Adjustments, net of tax:
 
 
 
 
 
 
 
Depreciation, and amortization of capitalized software
14,614

 
0.30

 
10,875

 
0.23

Stock-based compensation
4,322

 
0.09

 
5,890

 
0.13

Amortization of convertible senior notes and lease financing obligations
4,272

 
0.09

 
3,758

 
0.08

Amortization of intangible assets
3,209

 
0.07

 
3,053

 
0.07

Change in fair value of derivatives, net
(5
)
 

 
3,658

 
0.08

Adjusted net income, continuing operations
$
34,153

 
$
0.71

 
$
43,030

 
$
0.93


 
Six Months Ended June 30,
2014
 
2013
 
(In thousands, except diluted per-share amounts)
Net income, continuing operations
$
12,575

 
$
0.26

 
$
46,318

 
$
1.00

Adjustments, net of tax:
 
 
 
 
 
 
 
Depreciation, and amortization of capitalized software
27,612

 
0.58

 
21,554

 
0.46

Stock-based compensation
9,221

 
0.19

 
9,490

 
0.20

Amortization of convertible senior notes and lease financing obligations
8,477

 
0.18

 
6,103

 
0.13

Amortization of intangible assets
6,538

 
0.14

 
6,107

 
0.13

Change in fair value of derivatives, net
(6
)
 

 
3,583

 
0.08

Adjusted net income, continuing operations
$
64,417

 
$
1.35

 
$
93,155

 
$
2.00


Analysis of Second Quarter 2014 Financial Results - Trends and Developments
We previously reported that our first quarter of 2014 results were adversely affected by delays in securing agreements for the reimbursement (including reimbursement for tax effect) of the HIF, and delays in the recognition of quality related revenue. Those circumstances continued through the end of the second quarter of 2014. Net income reported for the second quarter and six months ended June 30, 2014 would have been higher except for:

HIF not reimbursed by our state partners reduced earnings approximately $16 million, or $0.14 per diluted share for the second quarter of 2014, and $32 million, or $0.29 per diluted share for the six months ended June 30, 2014 (per-share amounts for both periods on a GAAP and adjusted basis). We remain guardedly optimistic that we will secure reimbursement agreements with all of our state partners prior to the close of 2014.
Our non-recognition of a portion of the Texas health plan's quality incentive program reduced earnings approximately $7 million, or $0.06 per diluted share for the second quarter of 2014, and $13 million, or $0.12 per diluted share, for the six months ended June 30, 2014 (per-share amounts for both periods on a GAAP and adjusted basis). We remain guardedly optimistic that we will be able to recognize most of our quality revenue in Texas prior to the close of 2014.

33


Results of Operations, Continuing Operations
Health Plans Segment
Premium Revenue
Premium revenue for the second quarter of 2014 increased 44% over the second quarter of 2013, due to a 21% increase in member months, and a 19% increase in revenue per member per month (PMPM). The increase in member months was due to the addition of Medicaid expansion membership primarily at our health plans in California, New Mexico, Ohio and Washington, and the addition of Medicaid members at our South Carolina health plan, all effective January 1, 2014.
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 June 30,
 
2014
 
2013
 
Amount
 
PMPM
 
% of
Total
 
Amount
 
PMPM
 
% of
Total
Fee for service
$
1,378,037

 
$
205.08

 
71.2
%
 
$
879,865

 
$
158.96

 
68.0
%
Pharmacy
295,596

 
43.99

 
15.3

 
222,992

 
40.29

 
17.2

Capitation
176,817

 
26.31

 
9.1

 
138,409

 
25.00

 
10.7

Direct delivery
23,063

 
3.43

 
1.2

 
9,443

 
1.71

 
0.7

Other
60,786

 
9.06

 
3.2

 
43,997

 
7.95

 
3.4

Total
$
1,934,299

 
$
287.87

 
100.0
%
 
$
1,294,706

 
$
233.91

 
100.0
%

Our consolidated medical care ratio increased to 89.3% in the second quarter of 2014, from 86.2% in the second quarter of 2013. We recognized approximately $15 million of revenue related to 2013 in the second quarter of 2014. This out of period benefit was offset by unfavorable development of our consolidated medical claims and benefits payable liability at the end of the prior year; when compared with the second quarter of 2013.
Individual Health Plan Analysis
California. Medical margin improved $63.0 million at the California health plan, when compared with the second quarter of 2013. This improvement was the result of the following:
Higher enrollment and PMPM premiums, particularly as a result of 66,000 members added due to Medicaid expansion;
Approximately $25 million benefit from recognition in the second quarter of 2014 of certain premium revenues of which $15 million related to the year ended December 31, 2013, and $5 million related to the first quarter of 2014; and
A $4.5 million benefit from the rate settlement agreement with the DHCS.
Florida. Despite an increase in revenue of over 60%, medical margin fell at the Florida health plan by $1.4 million in the second quarter of 2014 when compared with the second quarter of 2013. Although we earn a comparatively large premium for long-term care members, the medical care ratio associated with these services is very high compared to the benefits traditionally offered by us. Accordingly, the medical care ratio of the Florida health plan increased to 91.6% in the second quarter of 2014 from 84.0% in the second quarter of 2013.
Illinois. The medical care ratio for the Illinois health plan was 106.3% in the second quarter of 2014. The Illinois health plan served its first member effective September 2013. The high medical care ratio at the Illinois health plan is the result of: 1) a small membership base transitioning into managed care; and 2) the need to incur relatively high medically related administrative costs in light of the enrollment increase anticipated at the health plan later in 2014.
Michigan. Financial performance at the Michigan health plan declined in the second quarter of 2014, when compared with the second quarter of 2013, primarily due to to comparatively higher medical care ratios for the Medicaid expansion (new in 2014) and Medicare programs. The medical care ratio of the Michigan health plan increased to 88.2% for the second quarter of 2014, from 84.7% for the second quarter of 2013. The Michigan health plan added its first Medicaid expansion members during the second quarter of 2014. Medicaid expansion enrollment as of June 30, 2014 was approximately 20,000.

34


New Mexico. Medical margin improved at the New Mexico health plan in the second quarter of 2014, when compared with the second quarter of 2013, primarily due to higher revenues that offset an increase in the medical care ratio to 89.6% in the second quarter of 2014, from 80.8% in the second quarter of 2013. The New Mexico health plan added approximately 42,000 Medicaid expansion members in the first half of 2014; as well as approximately 60,000 new members in a business combination effective August 1, 2013. The higher medical care ratio was primarily the result of the addition of Medicaid behavioral health and long-term care services effective January 1, 2014 (which are reimbursed at a higher medical care ratio than traditional medical benefits); and a return to more typical medical cost levels overall in 2014.
Ohio. The medical care ratio of the Ohio health plan increased to 84.2% for the second quarter of 2014, from 79.8% for the second quarter of 2013. Medical care costs increased to a more typical level in the second quarter of 2014. We do not believe that medical care ratios below 80% are sustainable over time. The Ohio health plan added its first meaningful number of Medicaid expansion members during the second quarter of 2014. Medicaid expansion enrollment as of June 30, 2014 was approximately 30,000.
South Carolina. The medical care ratio for the South Carolina health plan was 87.8% in the second quarter of 2014. The South Carolina health plan served its first members effective January 2014.
Texas. Financial performance worsened at the Texas health plan in the second quarter of 2014, when compared with the second quarter of 2013, due to a decrease in quality revenue as described above and an increase in amounts returned to the state under a profit-sharing agreement. The medical care ratio of the Texas health plan increased to 92.8% in the second quarter of 2014, from 86.5% in the second quarter of 2013. Removing quality revenue and profit-sharing adjustments for both quarters would have resulted in a medical care ratio at the Texas health plan of approximately 91% for the second quarter of 2014 and 92% for the second quarter of 2013.
Utah. Financial performance worsened at the Utah health plan in the second quarter of 2014, when compared with the second quarter of 2013, due to higher inpatient utilization and a general return of medical costs to a more typical level in the second quarter of 2014. The medical care ratio of the Utah health plan increased to 95.5% in the second quarter of 2014, from 79.6% in the second quarter of 2013. We do not believe that medical care ratios below 80% are sustainable over time.
Washington. Financial performance worsened at the Washington health plan in the second quarter of 2014, when compared with the second quarter of 2013, primarily due to lower premiums relative to the risk assumed for our members. The medical care ratio of the Washington health plan increased to 90.5% in the second quarter of 2014, from 88.0% in the second quarter of 2013. The Washington health plan added approximately 73,000 Medicaid expansion members in the first half of 2014.
Wisconsin. Financial performance worsened at the Wisconsin health plan in the second quarter of 2014, when compared with the second quarter of 2013. The medical care ratio of the Wisconsin health plan increased to 89.8% in the second quarter of 2014, from 82.6% in the second quarter of 2013.



35


Operating Data
The following table summarizes member months, premium revenue, medical care costs, medical care ratio, and medical margin 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 June 30, 2014
 
Member
Months (1)
 
Premium Revenue
 
Medical Care Costs
 
MCR (2)
 
Medical Margin
 
 
Total
 
PMPM
 
Total
 
PMPM
 
 
California
1,335

 
$
398,071

 
$
298.11

 
$
324,923

 
$
243.33

 
81.6
%
 
$
73,148

Florida
229

 
101,423

 
443.05

 
92,865

 
405.67

 
91.6

 
8,558

Illinois (3)
17

 
19,263

 
1,136.20

 
20,472

 
1,207.48

 
106.3

 
(1,209
)
Michigan
702

 
185,337

 
264.18

 
163,392

 
232.89

 
88.2

 
21,945

New Mexico
617

 
267,994

 
434.57

 
240,151

 
389.42

 
89.6

 
27,843

Ohio
849

 
328,630

 
386.79

 
276,716

 
325.69

 
84.2

 
51,914

South Carolina
360

 
96,453

 
268.38

 
84,686

 
235.64

 
87.8

 
11,767

Texas
742

 
320,966

 
432.46

 
297,899

 
401.38

 
92.8

 
23,067

Utah
249

 
76,574

 
307.47

 
73,094

 
293.49

 
95.5

 
3,480

Washington
1,364

 
336,959

 
247.03

 
305,098

 
223.67

 
90.5

 
31,861

Wisconsin
256

 
36,925

 
144.42

 
33,143

 
129.63

 
89.8

 
3,782

Other (4)

 
(1,453
)
 

 
21,860

 

 

 
(23,313
)
 
6,720

 
$
2,167,142

 
$
322.52

 
$
1,934,299

 
$
287.87

 
89.3
%
 
$
232,843

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended June 30, 2013
 
Member
Months (1)
 
Premium Revenue
 
Medical Care Costs
 
MCR (2)
 
Medical Margin
 
 
Total
 
PMPM
 
Total
 
PMPM
 
 
California
1,055

 
$
180,927

 
$
171.58

 
$
170,777

 
$
161.96

 
94.4
%
 
$
10,150

Florida
238

 
61,837

 
260.61

 
51,915

 
218.80

 
84.0

 
9,922

Illinois (3)

 

 

 

 

 

 

Michigan
648

 
167,485

 
258.40

 
141,859

 
218.86

 
84.7

 
25,626

New Mexico
275

 
84,449

 
307.20

 
68,253

 
248.28

 
80.8

 
16,196

Ohio
722

 
270,107

 
373.78

 
215,664

 
298.44

 
79.8

 
54,443

South Carolina

 

 

 

 

 

 

Texas
805

 
318,955

 
396.05

 
275,959

 
342.66

 
86.5

 
42,996

Utah
261

 
77,511

 
296.69

 
61,677

 
236.08

 
79.6

 
15,834

Washington
1,238

 
299,533

 
241.89

 
263,512

 
212.80

 
88.0

 
36,021

Wisconsin
293

 
37,740

 
128.79

 
31,185

 
106.43

 
82.6

 
6,555

Other (3)(4)

 
3,185

 

 
13,905

 

 

 
(10,720
)
 
5,535

 
$
1,501,729

 
$
271.30

 
$
1,294,706

 
$
233.91

 
86.2
%
 
$
207,023

 
                               
(1)
A member month is defined as the aggregate of each month’s ending membership for the period presented.
(2)
The MCR represents medical costs as a percentage of premium revenue.
(3)
The Illinois health plan's results prior to October 1, 2013, were insignificant and reported in "Other."
(4)
"Other" medical care costs include primarily medically related administrative costs at the parent company, and direct delivery costs.


36


Molina Medicaid Solutions Segment
Performance of the Molina Medicaid Solutions segment was as follows:
 
Three Months Ended June 30,
 
2014
 
2013
 
(In thousands)
Service revenue before amortization
$
50,960

 
$
50,400

Amortization recorded as reduction of service revenue
(728
)
 
(728
)
Service revenue
50,232

 
49,672

Cost of service revenue
37,107

 
39,305

General and administrative costs
1,891

 
2,790

Amortization of customer relationship intangibles recorded as amortization
793

 
1,282

Operating income
$
10,441

 
$
6,295


Operating income for our Molina Medicaid Solutions segment increased $4.1 million in the second quarter of 2014, compared with the second quarter of 2013, primarily due to reduced service costs associated with our West Virginia and Maine contracts, and lower general and administrative costs overall.
Results of Operations, Continuing Operations
Six Months Ended June 30, 2014 Compared with Six Months Ended June 30, 2013
Health Plans Segment
Premium Revenue
Premium revenue for the six months ended June 30, 2014 increased 37% over the six months ended June 30, 2013, due to a 20% increase in member months, and a 14% increase in revenue PMPM. The increase in member months was due to the addition of Medicaid expansion membership primarily at our health plans in California, New Mexico, Ohio and Washington, and the addition of Medicaid members at our South Carolina health plan, all effective January 1, 2014. Additionally, our New Mexico health plan added approximately 60,000 new members in a business combination effective August 1, 2013.
Medical Care Costs
The following table provides the details of consolidated medical care costs for the periods indicated (dollars in thousands except PMPM amounts):
 
Six Months Ended June 30,
 
2014
 
2013
 
Amount
 
PMPM
 
% of
Total
 
Amount
 
PMPM
 
% of
Total
Fee for service
$
2,559,098

 
$
194.38

 
70.0
%
 
$
1,746,620

 
$
159.48

 
67.6
%
Pharmacy
582,224

 
44.22

 
15.9

 
454,830

 
41.53

 
17.6

Capitation
346,256

 
26.30

 
9.5

 
278,733

 
25.45

 
10.8

Direct delivery
45,084

 
3.42

 
1.2

 
18,127

 
1.66

 
0.7

Other
123,295

 
9.37

 
3.4

 
84,311

 
7.69

 
3.3

Total
$
3,655,957

 
$
277.69

 
100.0
%
 
$
2,582,621

 
$
235.81

 
100.0
%

Our consolidated medical care ratio increased to 89.0% in the six months ended June 30, 2014, from 86.1% in the six months ended June 30, 2013.



37


Operating Data
The following table summarizes member months, premium revenue, medical care costs, medical care ratio, and medical margin by health plan for the periods indicated (PMPM amounts are in whole dollars; member months and other dollar amounts are in thousands):
 
Six Months Ended June 30, 2014
 
Member
Months (1)
 
Premium Revenue
 
Medical Care Costs
 
MCR (2)
 
Medical Margin
 
 
Total
 
PMPM
 
Total
 
PMPM
 
 
California
2,589

 
$
675,713

 
$
260.97

 
$
562,267

 
$
217.16

 
83.2
%
 
$
113,446

Florida
499

 
206,589

 
414.17

 
186,326

 
373.55

 
90.2

 
20,263

Illinois (3)
31

 
34,434

 
1,109.99

 
34,966

 
1,127.12

 
101.5

 
(532
)
Michigan
1,350

 
358,833

 
265.81

 
298,712

 
221.27

 
83.2

 
60,121

New Mexico
1,166

 
493,062

 
423.00

 
436,560

 
374.53

 
88.5

 
56,502

Ohio
1,621

 
606,925

 
374.33

 
514,044

 
317.04

 
84.7

 
92,881

South Carolina
754

 
192,473

 
255.31

 
174,948

 
232.07

 
90.9

 
17,525

Texas
1,491

 
641,062

 
429.85

 
590,857

 
396.19

 
92.2

 
50,205

Utah
495

 
155,228

 
313.67

 
140,294

 
283.49

 
90.4

 
14,934

Washington
2,640

 
660,420

 
250.15

 
603,205

 
228.48

 
91.3

 
57,215

Wisconsin
530

 
75,453

 
142.48

 
61,952

 
116.99

 
82.1

 
13,501

Other (4)

 
7,287

 

 
51,826

 

 

 
(44,539
)
 
13,166

 
$
4,107,479

 
$
311.98

 
$
3,655,957

 
$
277.69

 
89.0
%
 
$
451,522

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2013
 
Member
Months (1)
 
Premium Revenue
 
Medical Care Costs
 
MCR (2)
 
Medical Margin
 
 
Total
 
PMPM
 
Total
 
PMPM
 
 
California
2,056

 
$
368,715

 
$
179.36

 
$
330,540

 
$
160.79

 
89.6
%
 
$
38,175

Florida
461

 
120,001

 
260.38

 
101,319

 
219.84

 
84.4

 
18,682

Illinois (3)

 

 

 

 

 

 

Michigan
1,300

 
334,042

 
256.96

 
288,607

 
222.01

 
86.4

 
45,435

New Mexico
549

 
168,449

 
307.08

 
140,402

 
255.95

 
83.3

 
28,047

Ohio
1,448

 
538,915

 
372.10

 
443,118

 
305.96

 
82.2

 
95,797

South Carolina

 

 

 

 

 

 

Texas
1,637

 
648,406

 
396.01

 
542,408

 
331.27

 
83.7

 
105,998

Utah
520

 
152,467

 
293.16

 
126,706

 
243.63

 
83.1

 
25,761

Washington
2,488

 
597,819

 
240.29

 
524,909

 
210.98

 
87.8

 
72,910

Wisconsin
493

 
64,864

 
131.53

 
54,849

 
111.22

 
84.6

 
10,015

Other (3)(4)

 
5,484

 

 
29,763

 

 

 
(24,279
)
 
10,952

 
$
2,999,162

 
$
273.85

 
$
2,582,621

 
$
235.81

 
86.1
%
 
$
416,541

 
                               
(1)
A member month is defined as the aggregate of each month’s ending membership for the period presented.
(2)
The MCR represents medical costs as a percentage of premium revenue.
(3)
The Illinois health plan's results prior to October 1, 2013, were insignificant and reported in "Other."
(4)
"Other" medical care costs include primarily medically related administrative costs at the parent company, and direct delivery costs.

38


Molina Medicaid Solutions Segment
Performance of the Molina Medicaid Solutions segment was as follows:
 
Six Months Ended June 30,
 
2014
 
2013
 
(In thousands)
Service revenue before amortization
$
105,319

 
$
100,885

Amortization recorded as reduction of service revenue
(1,457
)
 
(1,457
)
Service revenue
103,862

 
99,428

Cost of service revenue
77,764

 
79,075

General and administrative costs
3,641

 
5,141

Amortization of customer relationship intangibles recorded as amortization
1,768

 
2,564

Operating income
$
20,689

 
$
12,648


Operating income for our Molina Medicaid Solutions segment increased $8.0 million in the six months ended June 30, 2014, compared with the six months ended June 30, 2013, primarily the result of increased revenues due to Medicaid expansion membership, reduced service costs associated with our West Virginia and Maine contracts, and lower general and administrative costs overall.
Consolidated Expenses
General and Administrative Expenses
General and administrative expenses decreased to 8.4% of total revenue for the second quarter of 2014, compared with 10.1% of total revenue for the second quarter of 2013. General and administrative expenses decreased to 8.7% of total revenue for the six months ended June 30, 2014, compared with 9.5% of total revenue for the six months ended June 30, 2013.
Premium Tax Expense
Premium tax expense was 3.1% of premium revenue plus premium tax revenue in the second quarter of 2014, compared with 3.0% in the second quarter of 2013 and 2.9% of premium revenue plus premium tax revenue in the six months ended June 30, 2014, compared with 2.7% in the six months ended June 30, 2013.
Health Insurer Fee Revenue and Expenses
Refer to "Liquidity and Capital Resources—Financial Condition" below, for a comprehensive discussion of the HIF.
Depreciation and Amortization
 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 service revenue, or as cost of service revenue.  
 
Three Months Ended June 30,
 
2014
 
2013
 
Amount
 
% of Total
Revenue
 
Amount
 
% of Total
Revenue
 
(Dollar amounts in thousands)
Depreciation, and amortization of capitalized software, continuing operations
$
18,536

 
0.8
%
 
$
12,896

 
0.8
%
Amortization of intangible assets, continuing operations
4,366

 
0.2

 
4,119

 
0.3

Depreciation and amortization, continuing operations
22,902

 
1.0

 
17,015

 
1.1

Amortization recorded as reduction of service revenue
728

 

 
728

 

Amortization recorded as cost of service revenue
9,030

 
0.4

 
4,365

 
0.3

Depreciation and amortization reported in the consolidated statements of cash flows
$
32,660

 
1.4
%
 
$
22,108

 
1.4
%


39


 
Six Months Ended June 30,
 
2014
 
2013
 
Amount
 
% of Total
Revenue
 
Amount
 
% of Total
Revenue
 
(Dollar amounts in thousands)
Depreciation, and amortization of capitalized software, continuing operations
$
34,672

 
0.8
%
 
$
25,341

 
0.8
%
Amortization of intangible assets, continuing operations
8,921

 
0.2

 
8,237

 
0.3

Depreciation and amortization, continuing operations
43,593

 
1.0

 
33,578

 
1.1

Depreciation and amortization, discontinued operations

 

 
2

 

Amortization recorded as reduction of service revenue
1,457

 

 
1,457

 

Amortization recorded as cost of service revenue
20,604

 
0.5

 
8,870

 
0.3

Depreciation and amortization reported in the consolidated statements of cash flows
$
65,654

 
1.5
%
 
$
43,907

 
1.4
%

Interest Expense
Interest expense increased to $14.0 million for the second quarter of 2014, from $11.7 million for the second quarter of 2013, and increased to $27.8 million for the six months ended June 30, 2014, from $24.7 million for the six months ended June 30, 2013 primarily due to lease financing transactions in the second quarter of 2013. Interest expense includes non-cash interest expense relating to the amortization of the discount on our long-term debt obligations, which amounted to $6.8 million and $6.0 million for the three months ended June 30, 2014, and 2013, respectively and $13.5 million and $9.7 million for the six months ended June 30, 2014 and 2013, respectively.
Income Taxes
The provision for income taxes in continuing operations is recorded at an effective rate of 58.0% for the second quarter of 2014, compared with 49.5% for the second quarter of 2013, and 56.5% for the six months ended June 30, 2014 compared with 46.3% for the six months ended June 30, 2013. The disparity between rates in 2014 and 2013 is primarily due to the nondeductible HIF in 2014.
Liquidity and Capital Resources
Introduction
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. 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, and 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 June 30, 2014, 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 restricted investments, and 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 was $3.6 million for the six months ended June 30, 2014, compared with $3.1 million for the six months ended June 30, 2013. Our annualized portfolio yield for the six months ended June 30, 2014 and 2013 was 0.4%.

40


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. 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.
Liquidity
A condensed schedule of cash flows to facilitate our discussion of liquidity follows:
 
Six Months Ended June 30,
 
2014
 
2013
 
Change
 
(In thousands)
Net cash provided by (used in) operating activities
$
235,460

 
$
(111,748
)
 
$
347,208

Net cash used in investing activities
(102,336
)
 
(431,812
)
 
329,476

Net cash (used in) provided by financing activities
(41,668
)
 
490,460

 
(532,128
)
Net increase (decrease) in cash and cash equivalents
$
91,456

 
$
(53,100
)
 
$
144,556

Operating Activities. Cash provided by operating activities increased $347.2 million, primarily due to the year-over-year change in medical claims and benefits payable, which increased $283.4 million in connection with our membership growth in the six months ended June 30, 2014, as described above in "Results of Operations."
Investing Activities. Cash used in investing activities decreased $329.5 million primarily due to significant purchases of investments, net of sales and maturities, amounting to $382.7 million in the second quarter of 2013. Such significant purchases of investments were a result of financing transactions described below in "Financing Activities," with no comparable activity in 2014.
Financing Activities. Cash used in financing activities for the six months ended June 30, 2014 related primarily to the settlement of $50.3 million of contingent consideration liabilities relating to our 2013 South Carolina health plan acquisition. Financing activities generated net cash of $490.5 million in the six months ended June 30, 2013, primarily due to proceeds from the issuance of the 1.125% Notes and related financing transactions, with no comparable activity in the six months ended June 30, 2014.
Financial Condition
On a consolidated basis, at June 30, 2014, we had working capital of $740.9 million compared with $745.7 million at December 31, 2013. At June 30, 2014, and December 31, 2013, we had cash and investments, including restricted investments, of $1,863.7 million, and $1,712.9 million, respectively. We believe that our cash resources and internally generated funds will be sufficient to support our operations, regulatory requirements, and capital expenditures for at least the next 12 months.
Health Insurer Fee. One notable provision of the ACA is an excise tax or annual fee that applies to most health plans, including commercial health plans and Medicaid managed care plans like Molina Healthcare. While characterized as a "fee" in the text of the ACA, the intent of Congress was to impose a broad-based health insurance industry excise tax, with the understanding that the tax could be passed on to consumers, most likely through higher commercial insurance premiums.
However, because Medicaid is a government–funded program, Medicaid health plans have no alternative but to look to their respective state partners for payment to offset the impact of this tax. We continue to work with our state partners to obtain reimbursement for the full economic impact of the excise tax. Currently, we project that the HIF payable by September 30, 2014 will be $88.3 million. Because this amount is not deductible for income tax purposes, our net income will be reduced by the full amount of the assessment.
When states reimburse us for the amount of the HIF, that reimbursement will itself be subject to income tax, the HIF, and applicable state premium taxes. If our estimate of the $88.3 million HIF liability in 2014 is correct, and if our estimate of the amount allocable to Medicaid of approximately $81 million is correct, states will need to pay us an incremental amount of approximately $132 million in revenue during 2014 to account for the HIF and the absence of its tax deductibility. As of June 30, 2014, we had received contract amendments for reimbursement representing approximately 50% of the Medicaid-related HIF. On a percentage basis, we anticipate that states will need to increase our Medicaid premium rates by approximately 1.5% to reimburse us for the HIF we will owe (based upon our estimated pro-rata share of total industry revenue in 2013). In addition, we estimate that states will need to increase our Medicaid premium rates by a further 0.9% to make us

41


whole for the lack of tax deductibility of the HIF, representing an estimated overall premium rate increase of approximately 2.4%.
As of July 30, 2014, we have contractual commitments from the states of Florida, Illinois, Ohio, Washington and Wisconsin to reimburse us by way of a lump sum payment for the full economic impact of the HIF in their respective states. While all of our remaining states have acknowledged the actuarial requirement that they reimburse us for the HIF, and its related income tax effects, no state other than those indicated above have contractually committed to do so.
Furthermore, states which have acknowledged the requirement to include the impact of the tax in our premium payments may argue that current premium rates will remain actuarially sound even if no adjustment is made to those rates. We continue to work with state officials to address the issue of fully grossed up reimbursement. If we are unable to obtain either premium increases or direct reimbursements to offset the impact of the tax on a fully grossed up basis, our business, financial condition, cash flows or results of operations could be materially adversely affected.
Regulatory Capital and Dividend Restrictions
For information on our regulatory capital requirements and dividend restrictions, refer to Item 1 of this Form 10-Q, Notes to Consolidated Financial Statements, in Note 15, "Commitments and Contingencies."
Future Sources and Uses of Liquidity
For information on our debt instruments, refer to Item 1 of this Form 10-Q, Notes to Consolidated Financial Statements, in Note 11, "Long-Term Debt."
For information on our shelf registration statement and our securities repurchase program, refer to Item 1 of this Form 10-Q, Notes to Consolidated Financial Statements, in Note 13, "Stockholders' Equity."
Contractual Obligations
A summary of future obligations under our various contractual obligations and commitments as of December 31, 2013, was disclosed in our 2013 Annual Report on Form 10-K. There were no material changes to this previously filed information outside the ordinary course of business during the six months ended June 30, 2014. For further discussion and maturities of our long-term debt, refer to Item 1 of this Form 10-Q, Notes to Consolidated Financial Statements, in Note 11, "Long-Term Debt."
Critical Accounting Estimates
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 critical accounting estimates relate to:
Health Plans segment medical claims and benefits payable. Refer to Item 1 of this Form 10-Q, Notes to Consolidated Financial Statements, in Note 10, "Medical Claims and Benefits Payable," for a table which presents the components of the change in medical claims and benefits payable, and for additional information regarding the factors used to determine our changes in estimates for all periods presented in the accompanying consolidated financial statements.
Health Plans segment contractual provisions that may adjust or limit revenue or profit. Refer to Item 1 of this Form 10-Q, Notes to Consolidated Financial Statements, in Note 2, "Significant Accounting Policies," for a discussion of amounts recorded in the second quarter of 2014 in connection with such contractual provisions.
Health Plans segment quality incentives. Refer to Item 1 of this Form 10-Q, Notes to Consolidated Financial Statements, in Note 2, "Significant Accounting Policies," for a discussion of amounts recorded in the second quarter of 2014 in connection with such quality incentives.
Molina Medicaid Solutions segment revenue and cost recognition.
There have been no significant changes during the six months ended June 30, 2014, to the items that we disclosed as our critical accounting estimates in our discussion and analysis of financial condition and results of operations in our Annual Report on Form 10-K for the year ended December 31, 2013.
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.

42


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.
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, 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, as amended (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: There has been no change in our internal control over financial reporting during the fiscal quarter ended June 30, 2014 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
Washington Health Plan. The Washington Health Care Authority (HCA) has communicated that it believes it has overpaid our Washington health plan with regard to certain claims. The alleged overpayments purportedly involve an undifferentiated incremental component of the capitation rates paid to our Washington health plan from and after July 1, 2012, the start date of the contract at issue. On March 25, 2014, HCA alleged that the total "overpayments" related to HCA’s delayed enrollment of so-called Washington Community Options Program Entry System (COPES) members were $14.4 million, and demanded payment in that amount. On April 7, 2014, HCA alleged that the total "overpayments" related to certain psychotropic drug claims that had been included in the Request for Proposal (RFP) rate book were $5.8 million, and demanded payment in that amount. HCA has provided us with minimal data by which we might independently validate HCA’s allegations. Furthermore, both alleged errors, if they in fact occurred, were unilateral errors committed and caused by HCA for which our Washington health plan had no contemporaneous knowledge and had assumed and bore no contractual risk. We have responded to HCA’s demands for payment, noting, among other things, that the demands are improper as a matter of law because under the Washington statue cited regarding the definition of an "overpayment," there were in fact no "overpayments" since payment was made consistent with the express terms of the parties’ contract. We believe that any actual liability for the alleged overpayment claims is not currently probable or reasonably estimable.
State of Louisiana. On June 26, 2014, the State of Louisiana filed a Petition for Damages against Molina Medicaid Solutions, Molina Healthcare, Inc., Unisys Corporation, and Paramax Systems Corporation, a subsidiary of Unisys, in the Parish of Baton Rouge, 19th Judicial District. The Petition alleges that between 1989 and 2012, the defendants utilized an incorrect reimbursement formula for the payment of pharmaceutical claims. We believe we have several meritorious defenses to the claims of the state, and any liability for the alleged claims is not currently probable or reasonably estimable.
USA and State of Florida ex rel. Charles Wilhelm. On July 24, 2014, Molina Healthcare, Inc. and Molina Healthcare of Florida, Inc. were served with a Complaint filed under seal on December 5, 2012 in District Court for the Southern District of Florida by relator, Charles C. Wilhelm, M.D., Case No. 12-24298. The Complaint alleges that, in late 2008 and early 2009, in connection with the acquisition of Florida NetPass by which Molina Healthcare entered into the state of Florida, the defendants failed to adequately staff the plan and provide other services, resulting in a disproportionate number of sicker beneficiaries of Florida NetPass moving back into the Florida fee-for-service Medicaid program. This alleged conduct purportedly resulted in a violation of the federal False Claims Act. Both the United States of America and the State of Florida have reviewed the allegations made in the Complaint, and have declined to intervene. We believe we have several meritorious defenses to the claims of the relator, and any liability for the alleged claims is not currently probable or reasonably estimable.
The health care and business process outsourcing industries are 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 and penalties, exclusion from participating in publicly funded programs, and the repayment of previously billed and collected revenues.
We are involved in legal actions in the ordinary course of business, some of which seek monetary damages, including claims for punitive damages, which are not covered by insurance. We have accrued liabilities for certain matters for which we deem the loss to be both probable and estimable. Although we believe that our estimates of such losses are reasonable, these estimates could change as a result of further developments of these matters. The outcome of legal actions is inherently uncertain and such pending matters for which accruals have not been established have not progressed sufficiently through discovery and/or development of important factual information and legal issues to enable us to estimate a range of possible loss, if any. While it is not possible to accurately predict or determine the eventual outcomes of these items, an adverse determination in one or more of these pending matters could have a material adverse effect on our consolidated financial position, results of operations, or cash flows.
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, you should carefully consider the risk factors discussed in Part I, Item 1A – Risk Factors, in our Annual Report on Form 10-K for the year ended December 31, 2013. The risk factors described herein and in our 2013 Annual Report on Form 10-K 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 also may materially adversely affect our business, financial condition, cash flows, or results of operations.
There have been no material changes to the risk factors disclosed in our 2013 Annual Report on Form 10-K.

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Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
Share repurchase activity during the three months ended June 30, 2014 was as follows:
 
Total  Number
of
Shares
Purchased (a)
 
Average Price Paid
per Share
 
Total Number of Shares
Purchased as Part of
Publicly Announced Plans
or Programs
 
Maximum Number (or
Approximate Dollar Value)
of Shares that May Yet Be
Purchased Under the Plans
or Programs (b)
April 1 - April 30
360

 
$
37.50

 

 
$
47,338,505

May 1 - May 31
1,490

 
$
37.82

 

 
$
47,338,505

June 1 - June 30
2,702

 
$
43.09

 

 
$
47,338,505

Total
4,552

 
$
40.92

 

 
 
(a)
During the three months ended June 30, 2014, we withheld 4,552 shares of common stock under our 2002 Equity Incentive Plan and 2011 Equity Incentive Plan to settle our employees' income tax obligations.
(b)
Effective as of September 30, 2013, our board of directors authorized the repurchase of up to $50.0 million in aggregate of our common stock. Stock repurchases under this program may be made through open-market and/or privately negotiated transactions at times and in such amounts as management deems appropriate. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements and market conditions. This repurchase program extends through December 31, 2014.
Item 3.    Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
None.
Item 5.    Other Information
None.
Item 6.    Exhibits
Reference is made to the accompanying Index to Exhibits.

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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:
July 30, 2014
 
/s/ JOSEPH M. MOLINA, M.D.
 
 
 
Joseph M. Molina, M.D.
 
 
 
Chairman of the Board,
 
 
 
Chief Executive Officer and President
 
 
 
(Principal Executive Officer)
 
 
 
Dated:
July 30, 2014
 
/s/ JOHN C. MOLINA, J.D.
 
 
 
John C. Molina, J.D.
 
 
 
Chief Financial Officer and Treasurer
 
 
 
(Principal Financial Officer)


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INDEX TO EXHIBITS
 
Exhibit No.
 
Title
 
 
3.1
 
Third Amended and Restated Bylaws.

 
 
 
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 
 
XBRL Taxonomy Instance Document.
 
 
101.SCH 
 
XBRL Taxonomy Extension Schema Document.
 
 
101.CAL 
 
XBRL Taxonomy Extension Calculation Linkbase Document.
 
 
101.DEF 
 
XBRL Taxonomy Extension Definition Linkbase Document.
 
 
101.LAB 
 
XBRL Taxonomy Extension Label Linkbase Document.
 
 
101.PRE 
 
XBRL Taxonomy Extension Presentation Linkbase Document.


47