Molina Healthcare, Inc. (MOH) Earnings Call Transcript & Summary

Good day, and welcome to the Molina Healthcare Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Joe Krocheski, Senior Vice President of Investor Relations. Please go ahead.

Good morning, and welcome to Molina Healthcare's call to discuss updates to our California Medi-Cal Contract Awards. Joining me today are Molina's President and CEO, Joe Zubretsky; and our CFO, Mark Keim. During our call, we will be making certain forward-looking statements, including, but not limited to, statements regarding our California Medi-Cal Awards, our projected revenue and earnings growth associated with these awards, as now modified, and our overall financial outlook with regard to both fiscal year 2023 and 2024. Listeners are cautioned that all of our forward-looking statements are subject to certain risks and uncertainties that can cause our actual results to differ materially from our current expectations. We advise listeners to review the risk factors discussed in our Form 10-K annual report filed with the SEC as well as the risk factors listed in our Form 10-Q and Form 8-K filings with the SEC. After the completion of our prepared remarks, we will open the call for a brief Q&A session. As we are currently in our quarterly blackout period, we will be taking questions only related to our California Medi-Cal Contract Awards. I will now turn the call over to our Chief Executive Officer, Joe Zubretsky. Joe?

Thank you, Joe, and good morning. First, some context for what brings us here this morning. By now, you have seen the State of California's announcement with respect to the county-by-county Medi-Cal awards. The timing of the announcement at the start of a long holiday weekend was not ideal, but we were not in control of that timing. With our fourth quarter earnings announcement still 5 weeks away, we believe that sharing our perspective on this matter in the meantime is important. So thanks for joining us this morning. Now I want to spend a few minutes discussing just what the changes are that pertain to us and the impact of those changes on our company's outlook. Regarding the changes that have been made to the RFP awards that were announced in August, I want to note a few important background points. Our winning RFP proposal has not been rescored or changed in any way. Our five-county win remains a five-county win. The earlier RFP award process, followed by a series of administrative-level protests filed by various plans, has effectively been superseded in its entirety by this new process pursued by the state. The state decided to award Medicaid contracts incepting on January 1, 2024, using an approach based on multiparty negotiations with the health plans in the state. Molina's geographic footprint remains unchanged, but other managed care plans, which were not included in the original award, are now allowed to participate in the program. This new approach and the resulting awards will have the effect of partially reducing our expected 2024 membership award from the levels announced by the state in August, but will still represent a doubling of our California membership and revenue profile versus the status quo of today. In summary, this new negotiated approach to the awards has resulted in the following: First, as noted above, we have been awarded contracts in every county originally awarded to us and in every county in which we bid. Our new geographic footprint remains intact. In Los Angeles County, we have been awarded 50% of the commercial membership, in effect sharing the commercial membership equally with the current incumbent. This membership will be served by us pursuant to a new form of subcontract with the incumbent. We also now have the state's commitment to issue us a contract to offer a D-SNP product in Los Angeles County, which we project to be a significant revenue contributor. In Sacramento, we maintain our winning presence. The state has awarded 1 additional contract, so we will now be 1 of 3 commercial plans rather than 1 of 2. In San Diego County, we also maintain our winning presence. Again, the state awarded 1 additional contract, so we will now be 1 of 3 commercial plans rather than 1 of 2. In the Inland Empire, which consists of Riverside and San Bernardino counties, our profile is unchanged. We will remain as the single commercial plan in a 2-plan model. With respect to the impact on our previously disclosed outlook for 2024 revenue, we make the following points. We currently have approximately 600,000 Medicaid members in California and approximately $1.9 billion in Medicaid premium revenue. In the original award this past August, the state published its intention for us to have approximately 1.8 million members, which we translated to $5.5 billion in Medicaid premium revenue. Under this new negotiated approach, we now project to have in 2024 approximately 1.2 million Medicaid members and $3.9 billion in Medicaid premium revenue. When also including the full run rate impact of the valuable D-SNP contract, this projected Medicaid full contract value would increase to approximately $4.4 billion in premium revenue. Under the new awards, therefore, compared to the status quo, our California Medicaid revenue more than doubles and will be increasing by approximately $2 billion and $2.5 billion when including the new projected D-SNP revenue. Before I turn it over to Mark for some more detail on our financial outlook, I make one final point as to the growth profile of our entire enterprise. The revision to our California awards does not change the trajectory we have created for significant top line growth, while maintaining best-in-class margins. To that point, we previously announced our new contract wins would produce $5.8 billion in incremental revenue. With this change in California, our new contract wins are now reprojected to produce $4.2 billion in incremental revenue. In addition, our outlook for 2024 revenue is now $35.5 billion rather than the previously projected $37 billion. With our continuing work on new strategic initiatives, we believe we are still squarely on track to meet our Investor Day commitment of $42 billion of premium revenue in 2025. As importantly, we also previously announced that the future accretion from all of our new contract wins was $3 per share, which we naturally include in our embedded earnings outlook. Although our California membership growth will now be lower than the state had previously intended, our earnings per share contribution from all 3 new contract wins is now projected to be at least $3.50 per share. Given that we were in the very early stages of all of our new contract wins, in our earlier remarks, we were purposely conservative in our earnings accretion estimates for our new contracts. We now have more confidence in projecting margins at our portfolio target, which we have been successful in achieving historically, while also recognizing modest operating leverage. With that, I will turn it over to Mark for more color on our financial outlook. Mark?

Thank you, Joe, and good morning, everyone. Starting with membership. Based on the state's revised award announcement, a conservative estimate of the impact of redeterminations and an estimate of the announced newly carved in populations for 2024, we project our California Medicaid membership will increase from approximately 600,000 members currently to approximately 1.2 million members in 2024. This compares to our previous projection of approximately 1.7 million members. Our updated membership projection now yields 2024 premium revenue of approximately $3.9 billion compared to our previous projection of $5.5 billion. The L.A. D-SNP opportunity represents an additional $500 million of upside at projected full run rate. Our total projected 2024 premium revenue growth from recently announced RFP wins in California, Iowa and Nebraska is now $4.2 billion compared to our previous projection of $5.8 billion, reflecting portfolio target after-tax margins at the midpoint of 3% to 3.75% long-term guidance and modest operating leverage. We now expect these 3 new contract wins to add at least $3.50 per share in incremental earnings at full run rate. Recall, our cost structure is evenly split between fixed and variable costs. So the portfolio impact of this meaningful revenue growth provides significant operating cost leverage. Finally, with our updated membership in 2024, we now expect the onetime nonrecurring implementation costs in 2023 to be lower than the previously projected $0.75 per share, providing modest upside to our 2023 outlook. We intend to provide a full update on our fourth quarter earnings call when we provide detailed 2023 guidance. I'll now turn the call back over to Joe for some concluding remarks. Joe?

Thanks, Mark. With this change to our successful California awards, we still have a substantially increased presence in California, with little change to our growth trajectory. Had this new result been the one originally awarded in the August award announcement, I can honestly say we would have been nearly as thrilled in that outcome as we were with the original outcome. Our confidence in continuing to win RFPs to create franchise value is unchanged. We have deep and broad capabilities in the Medicaid space, industry-wide referenceability and leading-edge technological and clinical innovation. We also have a local ground game that is unparalleled in its effectiveness. That has not changed, nor will it. In summary, the overall situation with respect to the California Medicaid awards can be summarized as taking 3 steps forward, taking 1 step back and ending up being 2 steps ahead. With that, we will now take your questions. Operator?

[Operator Instructions] Our first question today will come from Josh Raskin of Nephron Research.

Two questions here. The first one, just on the earnings power being $0.50 higher for the combined contracts. I'm curious if you could just give us a little color on sort of the bottoms-up analysis and what was conservative, which is now more confirmed? And I think you said you're now including some overall -- or modest G&A leverage to the overall company, whereas I don't think you had been previously including that. So kind of why the change? And then second question was, as part of this negotiation, was there ever a discussion at the state level around a complete rebid of the contract? Or was that never contemplated?

Josh, this is Joe. I'll answer your first question and then kick it to Mark for more detail. But obviously, in the early stages of RFP wins, you are purposely conservative in the earnings accretion that you predict. We actually, in doing so the first time, haircut our portfolio margins. And so the $3 per share was actually at a portfolio margin less than we've historically achieved. Now we have merely moved it up at what we've been achieving historically. And yes, we did feel at this stage because now we have a very good view of the membership flows that we introduced a modest amount of fixed cost leverage. Also bearing in mind that the California margins historically have operated just north of the portfolio average. Mark, anything to add?

Josh, it's Mark. Yes, if you look at the $4.2 billion of revenue incremental across the 3 states at $3.50, which is where we believe this pencils out at the low end, that implies a little bit less than a 5% after-tax margin. And here's the way I'm thinking about that. The midpoint of our long-term guidance after-tax margin is 3% to 3.75%. Call it, 3.5% in the midpoint. So if this pencils at a little less than 5%, that's 1.5% after-tax margin on the leverage benefit. Well, before tax, that's 2%. Here's the way I think about that to put that in context. Our G&A ratio is roughly 7%. What that would say is on these incremental $4.2 billion of revenue, the G&A ratio would be more like a 5%. That's well short of the 50-50 fixed/variable leverage that we talked about. So I'm pretty comfortable in that earnings power at the low end of $3.50 on these incremental revenues.

Josh, it's Joe again. To your second question, we believe, and based on historical experience nationwide, states, Medicaid departments and healthcare agencies have broad discretionary authority to conduct procurement and reprocurements under -- the way they see fit. And certainly, certainly, starting over, withdrawing the reprocurement and perhaps rebidding it or not rebidding it was certainly a possibility. So with that as the understanding, we thought it best for the company, for our membership and for our investors to participate in the negotiation. But certainly, states have broad authority on how to conduct their procurements, which means they could have withdrawn the current process and perhaps started it over, perhaps not starting it over for a while. So measured against the status quo, 1.2 million members is certainly a big step forward for us.

Our next question today will come from Kevin Fischbeck of Bank of America.

I just want to maybe ask 2 questions around timing. The first one, since you have a, I guess, a higher margin expectation, should we be thinking about a longer time to get to that higher margin? Is it like -- is this something that would have been done in 2 years, and now it's 3 years, or was in 3 years, now should be 4? And then I guess, the second one, you talked about the D-SNP as being a $500 million opportunity. How should we think about the timing of that opportunity?

Kevin, the D-SNP opportunity will likely be a revenue opportunity for calendar year 2025 as we implement Medicaid for 2024. That was your first question. And Mark, do you want to take the first question?

Kevin, what was the first question, can you just remind me?

Yes, it's just about the timing. We now have a -- you're now having a higher kind of margin target for this. And I guess, is this something that we should be thinking about happening later to get to that margin target? Or is it still achievable within a 2- or 3-year period?

No, both on M&A and new procurements, we've been very successful so far achieving our target margins by the end of the second year. This one is no different because the [ MLR ] behavior will be as a normal one. And on the operating leverage, that's something we have very clear visibility to. So getting there by the end of the second year, we feel really good about that.

The next question will come from Nathan Rich of Goldman Sachs.

I guess, first, could you maybe talk about why the state chose to use a subcontract relationship in L.A. County? And are there any effective differences between being a subcontractor in the initial award either operationally or from a margin standpoint? And then a quick follow-up. Could you maybe just comment on the margin profile of D-SNP membership relative to your kind of portfolio targets as we think about the earnings opportunity from that $500 million D-SNP revenue?

Well, first, on the L.A. County relationship, we can only presume that the reason for this model is because L.A. is a 2-plan model. So there can only be one commercial health plan and that would be the current incumbent. And that will be a subcontractor for a commitment for 50% of the commercial membership. We also have it committed by agreement that the relationship will be in form a subcontract, but in substance, be every bit as good as a primary contract with respect to operational content and financial profile. So even though structurally, this will be a subcontract to the current incumbent, it will have full force and effect and the profile of a primary contract. And yes, all the rules that pertain to primary contract holders, we have presumed in projecting our margins, will apply to us as a subcontractor. With respect to your comment on D-SNP, look, our Medicare business is operating at a pretax level portfolio-wide at just north of 6%. And we have every reason to believe that we can maintain that profile wherever we launch D-SNP. And now that we will have a very robust network, more robust than we have today with a very limited presence in L.A., we believe that it is a really, really fertile territory to grow our D-SNP product in L.A. County.

The next question today will come from A.J. Rice of Credit Suisse.