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Edited Transcript of MOH earnings conference call or presentation 12-Feb-19 1:30pm GMT

Q4 2018 Molina Healthcare Inc Earnings Call

LONG BEACH Feb 14, 2019 (Thomson StreetEvents) -- Edited Transcript of Molina Healthcare Inc earnings conference call or presentation Tuesday, February 12, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Joseph Michael Zubretsky

Molina Healthcare, Inc. - President, CEO & Director

* Ryan Kubota

Molina Healthcare, Inc. - Director, IR

* Thomas Lacy Tran

Molina Healthcare, Inc. - CFO & Treasurer

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Conference Call Participants

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* Anagha A. Gupte

SVB Leerink LLC, Research Division - MD of Healthcare Services & Senior Research Analyst

* David Howard Windley

Jefferies LLC, Research Division - Equity Analyst

* Gary Paul Taylor

JP Morgan Chase & Co, Research Division - Analyst

* Joshua Richard Raskin

Nephron Research LLC - Research Analyst

* Justin Lake

Wolfe Research, LLC - MD & Senior Healthcare Services Analyst

* Kevin Mark Fischbeck

BofA Merrill Lynch, Research Division - MD in Equity Research

* Matthew Richard Borsch

BMO Capital Markets Equity Research - Managed Care and Providers Analyst

* Michael Anthony Newshel

Evercore ISI Institutional Equities, Research Division - Associate

* Peter Heinz Costa

Wells Fargo Securities, LLC, Research Division - MD and Senior Analyst

* Sarah Elizabeth James

Piper Jaffray Companies, Research Division - Senior Research Analyst

* Scott J. Fidel

Stephens Inc., Research Division - MD & Analyst

* Stephen Vartan Tanal

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Steven J. James Valiquette

Barclays Bank PLC, Research Division - Research Analyst

* Zachary William Sopcak

Morgan Stanley, Research Division - VP on the Healthcare Services and Distribution Team

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Presentation

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Operator [1]

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Good morning, and welcome to the Molina Healthcare Fourth Quarter 2018 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Ryan Kubota, Vice President of Investor Relations. Mr. Kubota, please go ahead.

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Ryan Kubota, Molina Healthcare, Inc. - Director, IR [2]

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Thank you, operator. Hello, everyone, and thank you for joining us.

The purpose of this call is to discuss Molina Healthcare's financial results for the fourth quarter ended December 31, 2018. The company issued an earnings release reporting fourth quarter 2018 results last night after the market closed, and this release is now posted for viewing on our company website.

On the call with me today are Joe Zubretsky, our President and Chief Executive Officer; and Tom Tran, our Chief Financial Officer. After the completion of our prepared remarks, we will open the call to take your questions. (Operator Instructions)

Our comments today will contain forward-looking statements under the safe harbor provisions of the Private Securities Litigation Reform Act. All of our forward-looking statements are based on our current expectations and assumptions, which are subject to numerous risk factors that could cause our actual results to differ materially. A description of such risk factors can be found in our earnings release and our reports filed with the Securities and Exchange Commission, including our Form 10-K annual report, our Form 10-Q quarterly reports and our Form 8-K current reports.

These reports can be accessed under the Investor Relations tab of the company's website or on the SEC's website. All forward-looking statements made during today's call represent our judgment as of February 12, 2019, and we disclaim any obligation to update such statements, except as required by the securities laws. This call is being recorded, and a 30-day replay of the conference call will be available at our company's website, molinahealthcare.com.

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

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Joseph Michael Zubretsky, Molina Healthcare, Inc. - President, CEO & Director [3]

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Thank you, Ryan, and thank you all for joining us this morning.

Last night, we reported earnings per diluted share for the fourth quarter of $3.01 and $10.61 for the full year ending December 31, 2018. For the full year 2018, we produced pretax earnings of $999 million and after-tax earnings of $707 million, resulting in pretax and after-tax margins of 5.3% and 3.7%, respectively, on a reported basis.

As these results indicate, we have accomplished much over the last year as we executed the first phase of our margin recovery and sustainability plan. The rapid improvement in our operating margin profile has allowed us to shift our focus to driving our profit improvement initiatives for continued margin expansion while we are quickly pivoting to achieving top line revenue growth.

The quarter itself was very strong, with pure performance earnings per share of $3.82 and an after-tax margin of 5.4%, continuing the momentum we established early in the year. All in all, we are very pleased with the results for the quarter.

The scope of our prepared remarks today will focus primarily on the margin expansion success we have already achieved and our confidence in sustaining it. However, to be clear, we are equally focused on, and have already invested in, top line revenue growth in our very attractive lines of business: Medicaid, Medicare and Marketplace as well as our existing and potential new geographies. We plan to showcase this growth plan at our Investor Day in May.

Now returning to our financial results. In order to provide the context for our 2019 guidance, it is best to focus much of our commentary on recapping the full year of 2018, a year in which we produced pure performance earnings per share of $10.83, far surpassing our initial and revised guidance. This result includes, on a consolidated basis, a pure performance MCR of 86.3% and a G&A ratio of 7.1%, both of which enabled a pure performance after-tax margin of 3.8%.

Now commenting on 2018 by line of business. The Medicaid business, with $13.7 billion in pure performance premium revenue, ended the year with an 89.4% pure performance medical care ratio and a pure performance after-tax margin of 2.8%, which is within our revised long-term target margin range.

Several factors contributed to this result. We were able to skillfully manage medical costs, all against a backdrop of a reasonable and rational rate environment. And we were successful in executing on a variety of profit improvement initiatives, including network contracting, frontline utilization control and retaining increased levels of revenue at risk for quality scores.

Our $2.1 billion Medicare business, comprising our D-SNP and MMP products, also delivered favorable results in 2018. Managing to a medical care ratio of 84.5%, we produced an after-tax margin of 4.8%. Specifically on Medicare, we have proven we are adept at managing high-acuity members who have complex medical conditions and co-morbidities. We have also proven to be proficient at managing approximately $2 billion of long-term services and supports benefits, an important and fast-growing benefit across all of our products. And the risk scores of our members continued to improve, resulting in increased revenue that is more commensurate with the acuity of our population.

Finally, our Marketplace business was a significant contributor to this year's favorable results, with $1.9 billion in 2018 pure performance premium revenue and exceptional margins. If you recall, in 2017 and prior, this business was severely challenged. And at that time, we set a corrective 2018 pricing action of nearly 60% was warranted.

With that as the backdrop, the business produced performance MCR of 65% and an after-tax margin of 11.4% in 2018. Several factors contributed to this result. Our prices in the market, although they increased significantly over 2017, were still very competitive. And thus, we were able to retain a membership profile that could be adequately scaled.

Many of the core and routine-managed care fundamentals applicable to our other businesses also helped to produce favorable results in the Marketplace business. Our ability to capture and forecast adequate risk scores has improved dramatically. And our differentiated strategy of serving the highly subsidized working core produced the right acuity mix and the right metallic tier mix, all of which worked well within our pricing parameters.

Now commenting on 2018 through the lens of our locally operated health plans. We vastly improved the performance and balance of our health plan portfolio during 2018. Our largest health plans, Ohio, Texas, California, Washington and Michigan, continued to perform well and established themselves as worthy of winning re-procurements.

The underperforming aspects of our portfolio, which we described at the beginning of the year, were much improved in 2018. 1 year ago, we said that 25% of our revenue was in plans that were not profitable. In 2018, all of those plans were profitable. Florida and New Mexico were challenges for obvious reasons but performed admirably as they faced the runoff of large proportions of business. And Washington staged their recovery midway through the year. It is now well positioned to return to target margins on its expanded revenue base. In summary, the health plan portfolio is in excellent shape.

Now to recap the full year of 2018 from the perspective of the operational improvements we implemented and the operating efficiencies we gained. From a pure efficiency perspective, we continued to improve our G&A profile, managing to a ratio of 7.1% for the full year of 2018. We reduced our headcount by more than 800 FTEs or nearly 7% from the beginning of the year.

More importantly, we continued to invest in the business. We improved the performance of our core processes: claims, payment integrity, member and provider services and a host of others, all of which create lasting effect. And finally, in 2018, we set the stage for ongoing improvement by making significant progress on a variety of outsourcing initiatives, some recently announced, which benefit 2019 and beyond.

Turning now to addressing the 2018 improvements to our balance sheet and capital structure. Our improved operating performance allowed us to dividend approximately $300 million to the parent company. This augurs well for producing excess cash flow in the future. And we deployed approximately $1.2 billion to retire highly volatile and expensive convertible debt and repay the outstanding amount drawn on our revolving line of credit. This reduced earnings per share volatility and lowered our debt-to-cap ratio to approximately 47%.

In summary, for 2018, across all of our product lines, health plans, operating metrics and with respect to capital management, we are very pleased with our 2018 performance.

Now I will address our 2019 earnings guidance. We are establishing our initial earnings per share guidance for 2019 in the range of $9.25 to $9.75. As Tom will describe later, this is on the basis of GAAP reporting. The headline for 2019 is continued margin strength and sustainability despite the previously announced revenue decline, all without the benefit of anticipating any prior year reserve development.

On 2019 revenues. Overall, we expect premium revenue to come in at approximately $15.8 billion in 2019, a decrease of approximately 10% due to the contract losses in Florida and New Mexico and the membership attrition as a result of the conservative approach we have taken to Marketplace pricing. Despite these revenue challenges, we are encouraged by multiple new revenue foundations we laid in 2018 that will carry into 2019.

Specifically, within Medicaid, we invested heavily in new business development, winning 3 RFPs, the largest being Washington, but also Puerto Rico and Mississippi CHIP. We also submitted what we believe to be a winning proposal in the Texas STAR+ program. The Washington re-procurement award expanded membership in regions where we bested the competition in the consolidation of health plans and also enabled us to participate in the carve-in of behavioral health services.

In Florida, we were able to recapture 1/3 of our Medicaid contract and retain approximately $500 million of revenue, positioning us well for Medicare and Marketplace expansion.

In Illinois and Mississippi, we will benefit from membership gains in 2018, which will achieve full year run rate revenue in 2019. And for the 2020 Marketplace price filing in early 2019, we will equally focus on growing membership while maintaining profitability.

We are forecasting the continued strength and sustainability of margins in 2019. The following points are relevant to that forecast. First, given the significant operating leverage in the managed care business, a 10% decline in the premium revenue base is difficult to overcome from a margin expansion perspective, but we are forecasting being successful in doing so.

Second, we have taken a cautious view in forecasting the impact of our profit improvement initiatives in our 2019 guidance, although we maintained a high degree of confidence that we will capture them.

And third, while the 2018 results included significant prior year reserve development, as a matter of policy, we do not forecast any prior year reserve development in our guidance, although we maintained a consistent reserving policy throughout the year.

Taking these points into account, the after-tax margins in each of our lines of business will remain strong in 2019. Medicaid margins remain flat at approximately 2.8%, Medicare margins are up approximately 20 basis points to 5% and Marketplace margins are down slightly but still in double digits at 10.8%. Taken together, we expect a consolidated medical cost ratio between 86.7% and 87%, a consolidated after-tax margin in the range of 3.7% to 3.9% and net income in the range of $600 million to $630 million.

The margin improvement trajectory we've experienced is consistent with both our prior disclosures and the discussion of the profit improvement opportunities we have identified. Recall, in 2018, of the original $500 million projection, we harvested $200 million, which is now embedded in our run rate earnings. Earlier this year, we increased our projection of opportunities by $250 million to a total future improvement opportunity of $550 million.

Our 2019 guidance includes harvesting over $200 million of the revised profit improvement opportunity, which is more than offsetting the slightly negative spread between trend and yield of approximately $80 million. These ongoing profit improvement initiatives help create nearly $2 of earnings per share benefit in our 2019 guidance.

Overall, our margin recovery efforts have been successful to date, and our margin sustainability plan is well established. While we will remain focused on further margin improvement throughout 2019, we have simultaneously pivoted to growth. We are carefully evaluating new geographic opportunities as well as the adjacent product and benefit carve-in opportunities in our existing geographies.

With such a successful year now behind us, I would like to take a few moments to acknowledge the people who have made all of this happen. The executive leadership team we have assembled have proven their ability to successfully execute on the first phase of our turnaround plan, instilling confidence that they will likewise be able to execute on the next phase. And a special note of gratitude to the 11,000-plus associates on the front line every day, caring for our members and delivering high-quality service.

In conclusion, we are very pleased with our 2018 results and the strong foundation we have built. There is still significant opportunity for creating value, and we are excited for the future and what awaits us in 2019 and beyond. I look forward to sharing more about our future growth plans and longer-term strategy at our next Investor Day on May 30 in New York City.

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

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Thomas Lacy Tran, Molina Healthcare, Inc. - CFO & Treasurer [4]

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Thank you, Joe, and good morning.

As described in our earnings release, we report fourth quarter earnings per diluted share of $3.01 and adjusted earnings per diluted share of $3.07, excluding the amortization of intangible assets. We reported full year 2018 earnings per diluted share of $10.61 and full year 2018 adjusted earnings per diluted share of $10.86, excluding the amortization of intangible assets.

First, I will highlight the nonrecurring items that occurred in the quarter, resulting in fourth quarter pure performance earnings per diluted share of $3.82. It is important to note that these items are included in the fourth quarter GAAP reported numbers that we cited in the earnings release.

Specifically, we recorded a $52 million pretax loss on the sale of our Pathways subsidiary; $8 million of restructuring expenses, primarily related to cost associated with our ongoing IT restructuring plan; a $3 million gain as part of the repurchase of the 2020 convertible notes and related embedded call option termination; and a $24 million pretax expense for a retroactive risk corridor adjustment for the California expansion business, primarily related to the state fiscal year ended June 30, 2018.

Next, I would like to make some comments on the fourth quarter earnings beat of over $130 million pretax or approximately $1.90 per diluted share on a pure performance basis. Relative to the top end of our pure performance guidance range, the beat can be attributed primarily to the following 4 items: first, we had prior period development of approximately $90 million in the quarter, most of which is intra-year development and, therefore, is accounted for in our pure performance result for the full year.

Second, our Marketplace product continued to perform exceptionally well. The seasonal increase in medical cost we have historically seen did not materialize in the fourth quarter. And member retention was better than expected.

Third, administrative costs were lower than expected despite increased sales and marketing cost associated with open enrollment in Medicare and the Marketplace. Lower labor cost was a primary driver of this favorable G&A ratio.

And fourth, as a result of our improved fourth quarter performance and tax benefits on the loss related to the sale of Pathways, the effective tax rate for full year 2018, at 29.2%, was lower than we expected, which results in a fourth quarter benefit of approximately $20 million.

Turning to our balance sheet, cash flow and cash position for the quarter and the full year. Our reserve approach is consistent with prior quarters, and our position remains strong. We continue to have favorable intra-year reserve development. And as we have stated in the past, we intend to include that same level of conservatism in the quarter-end reserve balances.

Days and claims payables remained flat sequentially at 53 days. While operating cash flow was strong throughout the year, it was negative in the quarter, primarily due to our payment of the health insurer fee on October 1.

As of December 31, 2018, the company had unrestricted cash and investments of approximately $170 million at the parent company. The reduction to parent cash from the end of the third quarter of 2018 primarily relates to the purchase of the 2020 convertible debt. As of December 31, 2018, our health plans had aggregated statutory capital and surplus of approximately $2.4 billion, which represent approximately 400% of risk-based capital.

I will now quickly discuss capital actions. We have continued to look for opportunities to de-lever the balance sheet. Our actions in the quarter reduced average diluted shares outstanding to 66.6 million at year-end from 67.9 million at the end of the third quarter.

Finally, while not related to 2018, we recently completed a new $600 million term loan to finance the repurchased conversion and redemptions of our 2020 convertible notes that are currently in the money and eligible for early conversion. This is a temporary facility, which allow us to keep our $500 million revolver capacity undrawn.

Shifting to 2019 guidance. I will add some detail to bridge our 2018 performance to our 2019 pure performance guidance of $9.50 per diluted share at the midpoint. First, converting 2018 full year reported result to pure performance, the significant items that we called out in our earnings release added $0.22 to our 2018 reported earnings per diluted share of $10.61 for pure performance earnings per share of $10.83 for the full year 2018.

Second, prior year development, which we do not include in our 2019 guidance, positively impacted 2018 earnings per share by approximately $1.55 per diluted share.

Third, we believe that a stranded overhead and resulting negative operating leverage related to the loss contracts in New Mexico and Florida negatively impacts the earnings trajectory by approximately $0.75 per diluted share.

Fourth, the negative spread between trend and yield in Medicaid is projected to impact 2019 by approximately $0.90 per diluted share.

And fifth, our projected net profit improvement is forecast to increase full year earnings per diluted share by $1.87. Combined, we arrive at our guidance midpoint of $9.50.

The following points are also important relative to our 2019 guidance. First, 2019 guidance assumes consolidated net margins will remain flat at the midpoint. Specifically, we expect Medicaid to remain flat, Medicare to improve approximately 20 basis points and Marketplace to decline slightly but remain in the double digits of our 2018 pure performance base, which include prior year development.

Second, our G&A ratio increase 50 basis points to 7.6% in our 2019 guidance. This increase is primarily driven by the incremental G&A costs incurred to realize the profit improvement initiatives that will benefit our medical care ratio and result in an overall net profit improvement and a stranded overhead cost due to the revenue loss in New Mexico and Florida.

And third, 2019 guidance does not assume any impact from prior year development, positive or negative. All things being equal, if we have favorable development as we did in 2018, our forecasted result will be higher. And conversely, if development is unfavorable, our forecasted result would be lower. You should note that our reserve methodology has been consistently applied.

Finally, in conjunction with our earnings release last night, we include a supplemental presentation with additional detail on our financial result and 2019 guidance. Going forward, we plan to provide this additional detail alongside future earnings release as a way of providing further insight into the business.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question today comes from Josh Raskin with Nephron Research.

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Joshua Richard Raskin, Nephron Research LLC - Research Analyst [2]

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I wanted to ask a little bit more about the revenue bridge and sort of backing up to the Investor Day, where you guys started with a $15.6 billion of premiums. And I know you got $500 million back in Florida. You talked about, I think, Mississippi being about $300 million, and then Illinois, Ohio some other growth, et cetera. I guess, what are the offsets? It looks like only $200 million higher. So it sounds like some stuff has ebbed, I don't know how much of that is asset sales versus exchanges. And then I think, last quarter, you guys were a little bit more optimistic about potential growth in the Marketplace. And so I just wanted to hear a little bit, I guess, within that answer, what changed there?

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Joseph Michael Zubretsky, Molina Healthcare, Inc. - President, CEO & Director [3]

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Well, Josh, on the revenue bridge, very clearly, Florida and New Mexico was the major component of the decline at $2.2 billion. We also note that if you're looking at total revenue, you always have to adjust for the half of $400 million. And yes, the service businesses that we divested in 2018, MMS and Pathways, had $400 million in revenue, which effectively disappears in 2019 guidance. But we did pick up $900 million of organic growth. And you cited all the reasons: Mississippi; Illinois; full year run rate of increased membership; clawing back to $500 million in Florida certainly helped; Washington; as we bested certain competitors in various of the regions, we all have increased Medicaid membership; and the behavioral carve-in. So all in all, $900 million of organic growth embedded in what was a disappointing year of contract losses. It certainly bodes well for our revenue pickup in the future.

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Joshua Richard Raskin, Nephron Research LLC - Research Analyst [4]

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Got it, got it. And then just a quick question on the outsourcing you guys announced recently. Could you just walk through a little bit more of the specific functions that were outsourced? And maybe how much of that savings is in guidance?

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Joseph Michael Zubretsky, Molina Healthcare, Inc. - President, CEO & Director [5]

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The contract, we just signed the outsourcing arrangement with Infosys related to our IT infrastructure. Data centers, user services, et cetera. Sort of the hardware, think of it as the hardware. It will result in re-badging certain employees to Infosys. It will result in a certain number of position eliminations. But we also have increased the effectiveness of the operation: better uptimes, better response times and just more effective operations. That agreement has already incepted. There is a 90- to 120-day transition period. So the outsourcing won't actually occur to about -- until about the middle of the year. And so the savings in 2019 guidance is modest but will ramp to full run rate in 2020.

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Operator [6]

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The next question comes from Matthew Borsch with BMO Capital Markets.

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Matthew Richard Borsch, BMO Capital Markets Equity Research - Managed Care and Providers Analyst [7]

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So can you just help us think about where you would like to get to in terms of a run rate on the operating cost ratio? If that's even the right way to think about it. I mean, I know that there are structural differences depending on how much you grow the various parts of the business. But I'm just trying to look at your mid-7s guidance for 2019 relative to the low-7s that you achieved in 2018. And then the stranded overhead in the G&A that you're spending to achieve savings?

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Joseph Michael Zubretsky, Molina Healthcare, Inc. - President, CEO & Director [8]

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Sure. Matt, while we're not giving you a forecast for 2020 and beyond, we certainly believe there is more upside to our G&A ratio than downside risk. So you're right about the puts and takes in 2019, a painful reminder of how the operating leverage works in this business. The stranded fixed cost of the loss contribution margin from New Mexico and Florida put 30 to 40 basis points of pressure on that ratio. But more importantly, we're investing $90 million to $100 million in raw G&A to invest in medical cost improvements and other improvements to our core business. I believe, in the future, we will, as we grow, we'll get positive operating leverage. We'll continue to invest in the business. And of course, you cited the mix effects that you're likely to get depending on how big the Marketplace business in the future. So we believe that the G&A ratio has room for improvement going forward. While we're not giving a forecast, more room for upside than downside.

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Operator [9]

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The next question comes from Justin Lake with Wolfe Research.

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Justin Lake, Wolfe Research, LLC - MD & Senior Healthcare Services Analyst [10]

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So the focus shifts to top line growth. I was hoping you could walk us through any kind of early view of your exchange strategy for 2020 as well as any key RFPs or opportunities for state membership transitions that could fuel revenue growth into next year?

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Joseph Michael Zubretsky, Molina Healthcare, Inc. - President, CEO & Director [11]

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Sure, Justin. On the exchanges, as we said in a public forum just about 1 month ago, we plan to grow this business. We actually think we can double its size and still have a proportional relationship between our exchange business and our Medicaid business in the states in which we do business. Obviously, that won't all come in 1 year. And the interesting thing about this business is you know where your prices are in relation to the competitors. So we've done a very exhaustive price elasticity study. We know where our prices are too rich against the competition. We plan, for 2020, to ease up on price. We certainly are going to price to 15% pretax margins and 10% after-tax margins. But we believe we can grow the business, have the MCR move up from the mid-60s to 70%, maybe even into the low-70s, maintain a high single-digit margin without ever tripping the minimum MLR. So we're feeling really good about the growth prospects of this business and the ability to grow it, produce a high single-digit margin and have the pool of profits grow over time.

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Justin Lake, Wolfe Research, LLC - MD & Senior Healthcare Services Analyst [12]

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Any Medicaid opportunities?

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Joseph Michael Zubretsky, Molina Healthcare, Inc. - President, CEO & Director [13]

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Yes. Right now, the early read I can give you on growth for 2020 and beyond would be in Medicaid and Medicare. In D-SNP, we plan to file a notice of intent to play in 170 additional counties in D-SNP alone, 2 states of which would be brand new: Ohio and South Carolina. With respect to Medicaid, there are $30 billion of opportunities coming into the market, in our estimation, over the next 3 years. Wave 1: Louisiana, Minnesota, Hawaii, Kentucky and possibly, Pennsylvania; wave 2, Tennessee, West Virginia and Indiana. We have a newly developed business development team, a revamped RFP team. We're on the ground in many of these geographies doing a feasibility study: the regulatory environment, strength of the competitors, our ability to build networks. So we're actively at work, working on the growth phase of this turnaround.

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Operator [14]

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The next question comes from Ana Gupte with SVB Leerink.

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Anagha A. Gupte, SVB Leerink LLC, Research Division - MD of Healthcare Services & Senior Research Analyst [15]

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I just wanted to question about what you put out in January, which I thought was a very nice, logical presentation on your opportunities for growth. But when you kind of look at the Medicaid, if you start with Medicaid benchmarking again, the commentary and performance we're seeing from the key national competitors doesn't look like it's that easy to expand margins. And neither United or Wellcare or Centene has -- have shown great performance on margin expansion there. And trend yield spread, as you say, has brought some pressure. And while I can look at all of your margin expansion drivers, and they all make sense, I mean, is there any read across? Why does it look like you can do so much better than yourself and others, I guess, on the trajectory?

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Joseph Michael Zubretsky, Molina Healthcare, Inc. - President, CEO & Director [16]

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Well, I think, Ana -- I think, the first thing I'd like to remind folks is that the cost structure that is built into the rating structures is the entire market. And so that, if you can create a cost structure, both your G&A profile and your medical cost profile, that is better than your competitors, you get the lift in rates from the market cost structure. And then you can operate at a more efficient structure and produce best-in-class margins. Now whether it's sustainable or not, we have to prove that. But to your point about Medicaid, we broke through the 90% barrier on pure performance Medicaid for the year at 89.4%. But I would remind everybody that ABD is still at 91%. That's $5.5 billion of premium in 2018 alone. So I do believe there still is room for modest improvement in our Medicaid line, which, obviously, is a $13 billion line of business for us.

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Anagha A. Gupte, SVB Leerink LLC, Research Division - MD of Healthcare Services & Senior Research Analyst [17]

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Okay. All right. And then just following up on the earlier question related to Marketplace within margins and growth. If it's going to go from low double to very high single, and this year, you're not growing into '19 and margins look like they're a bit under pressure, the overall exchange book is down a bit year-over-year. And their policy changes and competitive also is at play. Do you think that would remain a big growth driver? I mean, looking at '19, it seems challenging to me to see that happening.

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Joseph Michael Zubretsky, Molina Healthcare, Inc. - President, CEO & Director [18]

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Well, I think, our market niche is very differentiated. We are servicing, as I mentioned in my prepared remarks, the working poor. 20% of our membership were fully subsidized, another 70% are partially subsidized. We get to leverage our Medicaid network, not only the network itself, but the cost structure in the network to give us a very, very competitive cost structure. So look, for 2019, at this time last year, we were compelled nearly to put trend into the market on top of our 2018 rates. We didn't know at this time last year that 2018 would have turned into a 15% pretax year. So we put trend into the market on top of what were already very rich rates. And we're paying for it on the membership line coming into '19. That is not going to be the phenomenon in '19 for '20. We now know exactly where we sit with our membership. We know their acuity. The churn of members is very low. So 80% of these members we have in the prior years. So we're feeling really good about the stability of our book of business, our ability to now put a more reasonable price point in the market to begin growing again.

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Operator [19]

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The next question comes from Scott Fidel with Stephens Inc.

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Scott J. Fidel, Stephens Inc., Research Division - MD & Analyst [20]

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Just a first question, I just wanted to get a little more detail on the negative spread that you discussed that you're building in for 2019 into Medicaid. And maybe just can you call out which markets in particular where you're seeing rate of cost spread upside down? Is it just a few markets? Or are you seeing that more widespread?

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Joseph Michael Zubretsky, Molina Healthcare, Inc. - President, CEO & Director [21]

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Well, Scott, we don't really like to talk about rates and the strength of rates in individual markets. But I would tell you that it's marginal across all markets. 20 basis points here, 50 basis points there. You're always having debates about trend components. How is pharmacy trending? Sometimes, when benefits are carved in and carved out, how much premium is a state taking away on a carved-out benefit? And how much premium are they putting in on a carved-in benefit? So I'm just saying, all in all, these are the normal puts and takes of the rating environment. And right now, at about 100 basis points of negative spread this year, it's very stable and very rational. And we'll always have profit improvement initiatives, always have an inventory of profit improvement initiatives of 150 to 200 basis points of premium. That is the way you need to run this business to make sure that in a year where we're presented with a negative spread, we can offset it and keep our margins whole.

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Scott J. Fidel, Stephens Inc., Research Division - MD & Analyst [22]

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Okay. And then just had a just one follow-up. Just interested in, in what you can update us at this point just around some of the recent headlines coming out of Ohio on them discussing potentially rebidding the Medicaid contract and just given some of the even sort of above-average scrutiny of the PBM servicing the Medicaid plans in that market?

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Joseph Michael Zubretsky, Molina Healthcare, Inc. - President, CEO & Director [23]

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Sure. We were fully expecting Ohio to reprocure -- to drop an RFP perhaps late in '19 for an effective date in '20. So we're fully prepared for that. The new administration, always when there is a change in administration, you never know what the new plan would be. The new administration in Ohio does seem to be prepared for reprocuring the Medicaid program. So we're fully prepared to deal with that. And given the scope of our business, our market share and the way we perform, we're extremely confident of prevailing and perhaps even growing in that reprocurement. With respect to PBM and pharmacy, yes, Ohio has been particularly scrutinizing the pharmacy industry. Look, the pharmacy trends are what they are. They're putting pressure on costs, and everybody knows that. I would say this. We have enough flexibility in our contract with CVS Caremark that if -- whatever Ohio decides they want for a pharmacy benefit, carved in, carved out, separate PBM, carved-in PBM, we would be able to deal with it and put a proposal that would satisfy their requirements both for medical and for PBM.

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Operator [24]

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The next question comes from Dave Windley with Jefferies.

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David Howard Windley, Jefferies LLC, Research Division - Equity Analyst [25]

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Joe, you mentioned that the Infosys contract, it sounds like, will ramp through the balance of the first half of this year and not generate a lot of savings for '19. I wondered if you could put a ballpark number on what you expect the total savings to be over time. And is that part of the remaining kind of overall cost-savings bogey that you've laid out recently? Or is that somehow separate from that?

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Thomas Lacy Tran, Molina Healthcare, Inc. - CFO & Treasurer [26]

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David, this is Tom. Yes, we're not going to disclose specific cost saving with the Infosys contract. But it would be fair to say that it is quite significant compared to our current base of operating -- our current base of expenses. And that it's really a multiyear contract, so you should expect to see that to be lasting over a number of years. And it is embedded in the $550 million of savings that we had put out at the last JPM conference.

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Operator [27]

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The next question comes from Steve Tanal with Goldman Sachs.

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Stephen Vartan Tanal, Goldman Sachs Group Inc., Research Division - Equity Analyst [28]

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Just 2 questions from me. I think, on the first one, just thinking about some of the thought processes around tax reform and Medicaid rates last year, I think you had all suggested that the tax reform benefits would find their way back into Medicaid rates. But I just want to get your updated thoughts on that. Are you seeing any actions from the states on that front that may be partly related to the trend discussion? Or how are you all thinking about that now?

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Joseph Michael Zubretsky, Molina Healthcare, Inc. - President, CEO & Director [29]

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No. The discussions about the tax regime rarely enters into rate discussions. As I said, most of the discussions are around debates about different cost components, how they're trending and the rate take up or take out for benefit carve-in and carve-outs. But very rarely, if ever, is there a discussion specifically about taxes.

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Stephen Vartan Tanal, Goldman Sachs Group Inc., Research Division - Equity Analyst [30]

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Great. Okay. So probably more sustainable now. And I guess just the other one that I had was I'm wondering if you could give us a little more specificity on sort of the savings that are baked into '19 versus '20. So in the slides for the call, it looks like you're stating there's a portion of the $550 million of remaining profit improvement opportunity. If you can maybe size what you expect to sort of book in '19 in the context of the guide? And maybe give us some clarity on what do you expect to drive your sort of annual G&A run rate down by about that amount sort of exiting '19 and into '20?

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Joseph Michael Zubretsky, Molina Healthcare, Inc. - President, CEO & Director [31]

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Sure. If you look at the $1.87 of earnings per share we put in the guidance bridge, just to pull that apart, it's about $150 million pretax. That number is $250 million of gross profit improvement, offset by $90 million to $100 million of higher G&A cost to produce them. And the first thing I would say is we were very exact by including all of the costs to produce those benefits but very cautious in forecasting the benefits that will actually emerge in the P&L. So that $150 million of net profit improvement is $250 million of gross profit improvement, offset by $100 million of the higher cost to produce them. We still consider that conservative. And that will build into the run rate that we will project forward into 2020.

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Operator [32]

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The next question comes from Sarah James with Piper Jaffray.

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Sarah Elizabeth James, Piper Jaffray Companies, Research Division - Senior Research Analyst [33]

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So great guidance for 2019. Obviously, a very impressive margin profile. Can you help us understand or break out parts of that, that may be unsustainable, help us understand what part of that is in different products or various lines?

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Joseph Michael Zubretsky, Molina Healthcare, Inc. - President, CEO & Director [34]

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All right. As we look at -- Sarah, as we look at the margin guidance, let's -- to keep it simple, after-tax margin is probably the easiest metric to look at. So we're not adjusting for all the puts and takes of HIFs and things like that. We are maintaining a 3.8% after-tax margin consolidated in an environment where revenues are declining by 10% and an environment where the 2018 margins included $137 million pretax or $1.55 of favorable development. So the question of sustainability is an interesting one. But to maintain that level of margin in that environment, particularly compared to 2018, we think, is a really good, solid forecast to project forward. 2.8% in Medicaid, 5% in Medicare and still double-digit in Marketplace is a very attractive margin profile. And really, in this environment, we think that's a very good start to the year.

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Sarah Elizabeth James, Piper Jaffray Companies, Research Division - Senior Research Analyst [35]

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Okay. And just to clarify there, so if we take those segment margin profiles that you talked about and the 3.8% in 2019, are you saying that this is a sustainable net margin profile for the company? So I'm thinking back to I Day, there was the 2.3% to 2.7% laid out for 2020. That as you move through some of the cost-saving initiatives, is this where the company looks like it's going to be going forward?

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Joseph Michael Zubretsky, Molina Healthcare, Inc. - President, CEO & Director [36]

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We think high 2s for Medicaid is certainly sustainable. We think that mid-single digits for Medicare is certainly sustainable. And as we've described previously, we believe that as we grow our Marketplace business, the margin will drop from low double digit to high single digit, a conscious effort to move the MCR up from the mid-60s to 70 or even low-70s, not trip the minimum MLR and grow the profit pool rather than focusing just on the percentage margin.

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Operator [37]

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The next question comes from Kevin Fischbeck with Bank of America.

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Kevin Mark Fischbeck, BofA Merrill Lynch, Research Division - MD in Equity Research [38]

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Great. So related to that exchange comment, is that transition to that new margin profile expected to happen in 2020? Or is this like a multiyear move for you?

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Joseph Michael Zubretsky, Molina Healthcare, Inc. - President, CEO & Director [39]

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It's an analysis of the elasticity, the pricing elasticity of the product and how much growth you think you can put on the books for the level of margin that you're willing to give up to do it. And it's market-by-market, geography-by-geography. We know where our competitors sit. We certainly know their strategy for the metallic tiers. They know ours as well. But with our new Marketplace management team, and now that we have a book of business that is 80% repeating, we think we have a very, very good visibility on our Marketplace business to grow it at high single-digit rates and never trip the minimum MLR. So it's all a question of how fast we want to grow. It is a multiyear effort. You'd never like to grow any book of business too quickly. So it's probably a multiyear effort.

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Kevin Mark Fischbeck, BofA Merrill Lynch, Research Division - MD in Equity Research [40]

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Okay. And then you mentioned that, I guess, you still have $350 million of cost savings out of the $550 million beyond 2019. How should we think about the ramp and the progression of those savings over the next few years?

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Joseph Michael Zubretsky, Molina Healthcare, Inc. - President, CEO & Director [41]

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Well, we're just now getting by the point where we plan for 2019. We'll probably give the market a view of that at our Investor Day in May, which will also give a glimpse of the 2020 growth rate as well. So if we can wait another month or so -- a couple of months until May, we'll try to give you a forward look of how the profit improvement will emerge over the next couple of years and also how the top line will grow over the next couple of years. But it's there. We've certainly -- we've put it out there for public disclosures. So we certainly understand it. We have models that I won't say prove it, but are strongly suggestive that it's real and tangible and actionable. And it can offset a lot of rate erosion in the marketplace and also help sustain our margins.

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Kevin Mark Fischbeck, BofA Merrill Lynch, Research Division - MD in Equity Research [42]

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And I guess, you probably -- I think just basically said it, you will answer this question in May as well. But you mentioned kind of 2 waves of Medicaid RFPs over the next few years. You've already talked a little bit -- just about exchange membership and then expanding Medicare into next year. Do you think that you're going to actually grow better in 2020 than -- top line than you did in 2019, excluding the contract losses? We're just going to put those aside. Is '20 FY going to be a year of showing that growth? Or is 2020 still you've got so many things investing that it's really 2021 before we see the top line grow?

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Joseph Michael Zubretsky, Molina Healthcare, Inc. - President, CEO & Director [43]

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Well, I think -- just to give us the next few months, we're in the middle of our 3-year strategic planning process, which is culminating in mid-April, share it with our board in May and showing to the Marketplace in late May. So if you could just indulge us and wait to that point in time, we'll give you a good view of 2020 at that time.

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Operator [44]

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The next question comes from Zach Sopcak with Morgan Stanley.

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Zachary William Sopcak, Morgan Stanley, Research Division - VP on the Healthcare Services and Distribution Team [45]

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I wanted to ask about the $1.55 prior year development. Just so I'm clear, it sounds like your reserving methodology is similar for 2019. Is there anything in that $1.55 we should think about as unusual as we think about how 2019 might progress?

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Thomas Lacy Tran, Molina Healthcare, Inc. - CFO & Treasurer [46]

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I wouldn't say there is anything unusual from the sense that our reserve methodology has been very consistently applied quarters-over-quarters. And so we saw that development coming out. And we have the same approach going through 2019. So we're not predicting any favorable and unfavorable development. But certainly, if you follow that methodology, then you can draw your own conclusion. What we also see in our first quarter so far is that flu effect has been somewhat tame, low compared to prior year. So that certainly can be a positive sign for potentially a mild seasonal effect of a seasonal high medical cost that you see in the winter.

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Zachary William Sopcak, Morgan Stanley, Research Division - VP on the Healthcare Services and Distribution Team [47]

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Okay. That's helpful. And that bears into my second question on seasonality. So you seem, in 2018, kind of bunked traditional seasonality, probably given you have a lot of different things going on with the profit improvement opportunities. Is there any way you can help us think about seasonality for 2019 given you'll also be harvesting additional opportunities? Or any other way to think about kind of the progressions throughout the year?

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Joseph Michael Zubretsky, Molina Healthcare, Inc. - President, CEO & Director [48]

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Medicare and Medicaid books are pretty evenly distributed from a seasonality perspective. Marketplace is generally back-end loaded as to medical costs. But last year, in 2018, it wasn't. We think we had more chronic members. That doesn't mean they were necessarily bad members, but they were just chronic members that were utilizing services throughout the year. So I think, this year, you'll see a pretty even seasonality pattern. Marketplace could be a little bit backloaded, but Medicare and Medicaid should be pretty evenly distributed.

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Operator [49]

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The next question comes from Gary Taylor with JPMorgan.

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Gary Paul Taylor, JP Morgan Chase & Co, Research Division - Analyst [50]

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Two-part question. One, you provided GAAP guidance without amortization of intangibles, which I think was roughly $0.30 last year. I know a little bit of that goes away with the Pathways deal. So if you have an updated estimate for 2019?

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Thomas Lacy Tran, Molina Healthcare, Inc. - CFO & Treasurer [51]

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We disclosed in a table in our earnings release the amortization of intangibles for '18. For '19, you're right. It's going to be lower. And we estimate that to be in the neighborhood of about $0.20 EPS.

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Gary Paul Taylor, JP Morgan Chase & Co, Research Division - Analyst [52]

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And the second part of my question, can you help us understand a little bit? So the exchange enrollment, down for 2019. You talked a bit about that, the effect of your pricing essentially. Can we talk about Florida a little bit? And what is the impact on your cost structure in Florida, your bid strategy in Florida? And maybe we could just talk about enrollment exchanges in Florida, but just -- did the impact of having to withdraw from a portion of the state from the Medicaid perspective have an impact on the Florida exchange enrollment?

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Thomas Lacy Tran, Molina Healthcare, Inc. - CFO & Treasurer [53]

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Yes. So Florida for the, obviously, the Medicaid contract that we had lost in certain regions. The state started to transition in the fourth quarter -- late fourth quarter. So when you look at membership that we disclosed in the table in the earnings release, you would see that TANF membership declined quarter-over-quarter. And the big chunk of that is really are from the Florida market decline as membership transitioned to the region that we will exit. From a viewpoint of impacting on exchange, the 2 really doesn't have that much effect. It's not really related. In fact, we do see membership growth for the fixed membership in the state of Florida.

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Gary Paul Taylor, JP Morgan Chase & Co, Research Division - Analyst [54]

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Okay. So which states would have been the largest exchange decline for 2019?

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Thomas Lacy Tran, Molina Healthcare, Inc. - CFO & Treasurer [55]

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The largest membership we have in the exchange is really in the state of Texas. So we do see decline in the state of Texas from '18 into '19. So there are fluctuations in many different states. Some gain, some loss. But certainly, Texas has a major impact on the decline from '18 into '19.

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Operator [56]

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The next question comes from Steve Valiquette with Barclays.

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Steven J. James Valiquette, Barclays Bank PLC, Research Division - Research Analyst [57]

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So Joe, I don't want to beat the exchange topic to death here. But just coming back to your Investor Presentation from last month, and again, that slide that showed Molina Marketplace growth scenarios, where you talked about the Marketplace revs for Molina growing to either $2.6 billion or $3.6 billion. You touched on the margin point on that slide already. But again, just for the revenue side, I just want to clarify whether those revenue numbers were intended to be actual targets for Molina? And what the time frame is, if there is one? Or again, was the revenue portion of that slide more just for illustrative purposes?

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Joseph Michael Zubretsky, Molina Healthcare, Inc. - President, CEO & Director [58]

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It was for illustrative purposes. And to be very clear, we are not giving a specific outlook or forecast until our Investor Day in May. But it was really to make the point that if we were to return the business to its original size, which was $4 billion, knowing what we know about our pricing competitiveness and knowing what we know about administrative cost leverage, can we produce high single-digit margins and grow the business back to its original state? So it was illustrative. We do believe it's doable over some period of time. And how that manifests itself in our ongoing forecasts will be showcased at our Investor Day in May.

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Operator [59]

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The next question comes from Michael Newshel with Evercore ISI.

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Michael Anthony Newshel, Evercore ISI Institutional Equities, Research Division - Associate [60]

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I know you touched on some specific states, but can you just break down the exchange enrollment results for the year between same-market declines versus gains you saw on new markets?

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Thomas Lacy Tran, Molina Healthcare, Inc. - CFO & Treasurer [61]

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We're not going to go into specifics state-by-state here. But Michael, I mentioned before is that Texas, which were roughly about 55%, 60% of our membership in 2018, we did see a decline there. So that's where really the main driver of the membership decline from '18 into '19. As you know, we have reentered into some new states. The former states that we exit, Utah and Wisconsin, we did see some level of membership there, nothing significant. But the remaining market, there are fluctuations up and down. Some we gained, some we lost. I mentioned before in Florida, we gained some membership. Some markets were fairly stable. For example, the state of California is fairly stable. So overall, there is a decline definitely, from 3 60 at the end of '18 into January. Right now, we are somewhere around 3 25 to 3 30.

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Michael Anthony Newshel, Evercore ISI Institutional Equities, Research Division - Associate [62]

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Okay. How about -- can you size the impact of the divestments there in the bridge from '18 to '19? I think you said Pathways removes the loss, but MMS may have been a slight contributor. Is the net impact material at all there?

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Thomas Lacy Tran, Molina Healthcare, Inc. - CFO & Treasurer [63]

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[Carryover], I would say that's about $0.10.

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Michael Anthony Newshel, Evercore ISI Institutional Equities, Research Division - Associate [64]

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I'm sorry. Was that -- it's about a $0.10 headwind, the divestments, net?

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Thomas Lacy Tran, Molina Healthcare, Inc. - CFO & Treasurer [65]

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2018.

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Operator [66]

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The next question comes from Peter Costa with Wells Fargo.

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Peter Heinz Costa, Wells Fargo Securities, LLC, Research Division - MD and Senior Analyst [67]

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I really want to talk to a bigger picture about what's going on with RFPs in Medicaid in general. You saw the North Carolina quality scores that came out. And you've seen other recent scores that have come out. Have you seen anything that is giving you more positive or less positive views on your Texas bid? And in particular, beyond that, do you think there's something that you guys are missing or that you need to acquire to look better for some of these RFPs opportunity favoring more population health and things like that?

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Joseph Michael Zubretsky, Molina Healthcare, Inc. - President, CEO & Director [68]

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Peter, we're still very optimistic based on everything we know about our RFP bid on STAR+ in Texas. No news has emerged that makes us any more or less confident. We've always been very, very confident in the outcome. We think our strategy on building capabilities internally and our rent-to-own strategy is the right balance. We really don't believe you need to acquire the equity of a company in order to import and integrate its capability. And you've seen us announce the major partnerships with some world-class partners. And you'll see more of that on esoteric and niche capabilities that we think could possibly be scaled adequately or capably in order to deliver into our operating platforms for delivery into a service model. So we're building capabilities internally on core capabilities. We're looking for co-sourcing partners on a rent-to-own strategy for esoteric capabilities. And as long as they're fully integrated, we believe our products can win in the marketplace and continue to win RFPs. We have no reason to believe that they can't.

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Peter Heinz Costa, Wells Fargo Securities, LLC, Research Division - MD and Senior Analyst [69]

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Okay. So not -- so we shouldn't expect any further acquisitions regarding specialty capabilities or anything like that?

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Joseph Michael Zubretsky, Molina Healthcare, Inc. - President, CEO & Director [70]

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Capability front, I always welcome an opportunity to look for a bolt-on membership opportunity in our current state where we can get some good operating leverage. But no, not spending capital on EBITDA multiples for capability plays.

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Operator [71]

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The last question today is a follow-up from Justin Lake with Wolfe Research.

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Justin Lake, Wolfe Research, LLC - MD & Senior Healthcare Services Analyst [72]

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I just wanted to ask the numbers question on investment income. It looked like you are guiding to about $195 million. I think there might be other stuff in there besides investment income, but a big step up in that number. So I just wanted to get some clarity on that.

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Thomas Lacy Tran, Molina Healthcare, Inc. - CFO & Treasurer [73]

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Justin, the $70 million increase in investment and other revenue is due to 2 things. One is the higher investment income. I would say that's roughly about 40% of that change. And the rest is really the full year effect of the [ASO] fee for the pharmacy benefit that were carved out in the State of Washington, whereby we'll pay an ASO fee to manage that program for the state. So last year, it was only a half year, and 2019 is really a full year. So I hope that clarified the change there.

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Operator [74]

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This concludes our question-and-answer session and also concludes our conference. Thank you for attending today's presentation. You may now disconnect.