Ryan Kubota - Molina Healthcare, Inc. Joseph M. Zubretsky - Molina Healthcare, Inc. Thomas L. Tran - Molina Healthcare, Inc..

Justin Lake - Wolfe Research LLC Joshua Raskin - Nephron Research LLC Ana Gupte - Leerink Partners LLC Sarah E. James - Piper Jaffray & Co. Stephen Tanal - Goldman Sachs & Co. LLC David Howard Windley - Jefferies LLC Steven Valiquette - Barclays Investment Bank Kevin Mark Fischbeck - Bank of America Merrill Lynch Gary P.

Taylor - JPMorgan Securities LLC Zachary Sopcak - Morgan Stanley & Co. LLC Michael Newshel - Evercore Group LLC.

Good day, and welcome to the Molina Healthcare Third Quarter 2018 Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Ryan Kubota, AVP of Investor Relations.

Please, go ahead..

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 third quarter ended September 30, 2018.

The company issued its earnings release reporting third quarter 2018 results last night after the market closed, and this release is now posted for viewing on the 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'll open the call to take your questions. If you have multiple questions, we ask that you get back into the queue so that others can have the opportunity to ask their questions.

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

A description of such risk factors can be found in our earnings release and in our reports filed with the Securities and Exchange Commission, including our Form 10-K Annual Report, our Form 10-Q Quarterly Reports, and our Form 8-K Current Reports.

These reports can be accessed under the Investor Relations tab of our company website, or on the SEC's website. All forward-looking statements made during today's call represent our judgment as of November 1, 2018, 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..

First, we have managed our head count to align with activity and transaction volumes. Since the beginning of the year, we have reduced our head count by more than 600 positions, or over 5% of our workforce. Second, we have continued to streamline our management ranks and managed bands (07:43) of control.

Third, we have eliminated spending on certain IT projects that in our view were not creating value. Fourth, we continue to steadily reduce our excess real estate capacity. And fifth, we have negotiated lower unit costs in many of our labor and non-labor contracts. We will continue to scrutinize all aspects of our administrative cost structure.

However, we anticipate that administrative expense in the fourth quarter will increase due to the seasonality of some marketing programs and the commencement of many of our transformation initiatives that will produce benefits in 2019 and beyond.

We also made significant progress in the quarter related to our capital structure and free cash flow to the parent. In the quarter, we continued to deleverage and reduce the share count volatility associated with our convertible notes.

We closed on the sale of MMS, delivering approximately $230 million of cash to the parent, and we recently announced the sale of Pathways, a non-core asset for a nominal purchase price. The transaction closed in October, and we estimate that we will record a loss on the sale of approximately $0.60 per diluted share in the fourth quarter.

Our capital structure is stable, cash flows to the parent entity are strong, and our credit metrics are sound. This positions us well for beginning the conversation about a potential credit rating upgrade which could lower our future cost of debt. I turn now to the performance of our product lines.

Our Medicaid product performed well compared to the second quarter. On a pure performance basis, our Medicaid MCR was 89% compared to 89.8% in the second quarter. Our ABD and Expansion products drove the improvement, while we experienced slightly higher medical costs in our TANF product which still has much room for improvement.

Medicare generally performed in line with our expectations, but deteriorated sequentially with a combined medical care ratio of 87.3% compared to 85% in the second quarter. On a nine-month basis, the total medical care ratio is in line with our expectations at 85.7%.

The sequentially elevated MCR was in the integrated MMP plans, and largely attributable to certain revenue transfers between the Medicare and Medicaid lines of business, which had no impact on our consolidated result. Our DSNP product continues to perform very well and serving the dual-eligible population is a key area for our future growth.

Both our MMP and DSNP products benefited from our improved collection of risk score data and our ability to retain quality withholds. Our Marketplace business has continued to perform well, achieving a pure performance medical care ratio of 65.3% compared to 68.4% in the second quarter after removing the impact of the non-run rate items.

This 310 basis point improvement was driven by lower medical costs and higher revenue from better risk score performance and better-than-expected membership retention. We have not yet observed the seasonal in-year utilization increase we experienced in prior years.

Marketplace is now performing at an after-tax margin of approximately 9% to 10% for the full year, well ahead of our pricing expectation while only triggering the minimum MLR in one market. The pricing actions that we took in 2018 increased our average rates by nearly 60%.

Based on our performance year-to-date, we are pleased at how well our forecast of expected cost trends and membership mix aligned with the rate increases we delivered. I turn now to the performance of our local health plan.

The majority of our health plans have continued to perform well, as a result of our new operating model, which mandates local execution and decision-making with stringent enterprise oversight and performance management. Michigan, Texas and Washington continued to perform well across most lines of business.

Michigan saw improvement from slightly higher premium revenue and continued in-patient cost improvement, as the health plan is focused on reducing short-term in-patient stays. Texas with more than 50% of our Marketplace revenue, improved sequentially.

While much of the improvement was due to lower medical costs and improved revenue retention in Marketplace, the Medicaid and Medicare lines of business combined also performed slightly better than expected. We remain positive on our prospects with the reprocurement of the STAR and the STAR+PLUS contracts.

Washington has continued to reduce the in-patient cost pressures in the Medicaid product that were identified earlier in the year to a more intense utilization management approach.

Also, as you will recall, Washington carved out the Medicaid pharmacy benefit in the third quarter and our results now reflect the corresponding premium and medical cost declines associated with that carve-out. In the quarter, we also made significant progress on many future value-creating initiatives.

Most notably, our Mississippi Health Plan went live on October 1 as a new entrant into a market with two existing health plans. As a start-up plan, we will receive all of the auto assignment membership until our health plan reaches 20% of the total membership in the program.

We currently expect to end the year with approximately 20,000 members and the projection for 2019 could be as high as 90,000 members by the end of the year.

Our new island-wide contract in Puerto Rico is expected to go live with approximately 290,000 members, a slight decline from our prior two region membership roles, but with significant potential for additional membership. We remain confident that we will be able to earn and sustain a return in excess of our cost of capital.

And finally, the court has not yet issued a ruling on our protest in New Mexico. Pending the court's decision, we are managing the run-off of the New Mexico Medicaid plan and transitioning the membership. We will remain in the Marketplace and Medicare business in New Mexico in 2019. I turn now to our revised guidance.

Our revised GAAP guidance for the year is $8.80 to $9.00 earnings per diluted share, or an increase of $1.65 at the midpoint from our previous guidance. On a pure performance basis, our revised guidance is a $2.60 per share increase.

Our GAAP guidance and our pure performance guidance are expected to be nearly identical, as the non-run rate benefit for the first nine months will be offset by the loss on the sale of the Pathways business. Tom will elaborate on guidance in a few minutes.

Assuming the achievement of our full year guidance, we step back and look at our businesses for the full year 2018 through the lens of our margin recovery plan.

Our Medicaid business is a solid franchise, has a diversified footprint, great product depth and with an after-tax margin between 2% and 2.5% is now performing very well, although there is still significant room for improvement.

Our Medicare business with annual revenue of approximately $2 billion is favorably positioned in the duals market and is performing well having now achieved after-tax margins between 3% and 3.5%.

And our Marketplace business, after years of corrective pricing actions and instability, is not only stable, but is now producing after-tax margins of 9% to 10%. Measured off of any starting point we could choose, Marketplace is a significant part of this overall margin recovery story.

On a consolidated basis, we expect to achieve an after-tax margin of 3.2%, which, for the first year of this turnaround, is a result we are very pleased with. I will close with some preliminary thoughts on 2019 as we head into the fourth quarter.

While it is too early to provide detail on 2019 earnings, I can provide the following observations as we see them today. At the midpoint of $8.90 pure performance guidance EPS for 2018, we have a very solid earnings baseline, and within a range margins that are sustainable and have less potential for volatility.

In short, the quality of earnings in 2018 is high.

Against this backdrop of a solid 2018 earnings baseline, we are currently in the process of developing our 2019 financial plan and evaluating all of the factors that will impact our 2019 earnings trajectory, including the continuation of the positive momentum we have in managing medical cost trend, the continued adequacy of our Medicaid rates, the competitiveness of our Medicare and Marketplace rates once our competitors rates are known, how much of the significant profit improvement plans we previously communicated will manifest in 2019 earnings, and while we are effectively managing the total and partial runoff of the New Mexico and Florida Medicaid contracts, the potential for some level of stranded fixed cost still exists.

Over the long term, management is committed to increasing both operating earnings and earnings per diluted share above the levels of our 2018 full year guidance. We are currently developing our 2019 financial plan.

This plan will fully consider the solid 2018 earnings baseline and these other factors, all of which will determine the 2019 earnings trajectory. We look forward to reporting that outlook to you in February when we announce fourth quarter earnings. We are very pleased with our results to-date.

We remain committed to executing the fundamentals of managed care and ensuring that our operating and financial platforms can produce sustainable results. When this is done, we will turn our focus to positioning the company for the inherent growth in this very attractive government managed care sector.

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

First, the expected Marketplace seasonal decline in membership and increase in medical costs. Second, the catch-up benefit from the lower effective tax rate in the third quarter will not repeat in the fourth quarter. And third, an increase in our general and administrative expense ratio for the fourth quarter, which is projected to be at 8%.

This increase is due to seasonal spending, including sales and marketing initiatives related to the open enrollment period for Marketplace and Medicare, expenses related to certain IT projects that were delayed from the third quarter into the fourth, and expenses relate to certain transformation initiative that began in the third and fourth quarters which will contribute to 2019 earnings and beyond.

Finally, let me offer a few additional points of consideration relating to our revised guidance. Our guidance assumes no prior-period development, and our guidance was developed based on GAAP rather than adjusted earnings per diluted share, which would exclude the amortization of intangible asset. This concludes our prepared remarks.

Operator, we are now ready to take questions..

Thank you. Our first question comes from Justin Lake of Wolfe Research. Please go ahead..

Thanks. Good morning. Joe, thanks for the 2019 outlook. Maybe you can give us a little more color there in terms of just starting with the 2018 numbers.

Can you talk about what you think a reasonable jump-off point for 2018 is versus the $8.80 to $9.00? Are there areas where you don't think the margins are sustainable, like potentially the 9% to 10% in the individual business?.

the continued strength of our Medicaid rates; the competitive positioning of our Medicare and our Marketplace rates, can we continue to manage our medical cost baseline and trend as effectively as we have this year.

And then certainly, the $500 million of profit improvement initiatives we outlined for you at Investor Day certainly some of that has inured to the benefit of 2018, but most of that is still yet to be harvested. So, the 2018 baseline is a great jumping-off point.

I think we've outlined the puts and takes that are endemic to the industry and those specific to Molina. And over the long term, we are committed to growing earnings per share and our pre-tax earnings off of the 2018 solid baseline..

That's helpful. And then just a follow-up there, maybe another way to come out of this is just net income margins. Clearly, relative to peers, they're now towards the higher end of the range.

To grow off here with a shrinking – with a topline that – looks like it's going to be down next year given the membership losses before accelerating in 2020, where do you think the margins on a net income basis can kind of sustain relative to what you've kind of put out there at the Investor Day given you're already there?.

We've challenged the operating team to aspire to be the best margin producers in our space. We're going to produce Medicaid margins just under 2.5% this year after tax, Medicare margins at nearly 3.5%, and Marketplace at nearly 9%, averaging to the 3.2% after-tax margin in our guidance.

Clearly, the Marketplace has outperformed our expectation this year, without question. We managed it effectively. We've put 58 points of rate into the market last year. But this year, we only put low-single digit rate increases into the market because our rate actions no longer needed to be corrective.

And so I think the question on the Marketplace isn't whether we can sustain the margins, is can we continue to hold on to the membership at the margin we produced this year. But it's a solid product, it's performing well.

And we're just now learning how our prices are comparing to our competitors, and we'll have a better outlook for you when we report our fourth quarter..

Thanks..

Our next question comes from Josh Raskin of Nephron Research. Please go ahead..

Hi, thanks. I guess similar sort of line of questioning around margin sustainability. And I guess the first thing is, I think you mentioned, Joe, long term you guys want to keep I think 2018 levels of profitability, and so – or I'm sorry, levels of earnings.

And so should we think about on a lower top line this 2019 – does that mean 2019 steps back and then longer term we get back to the $9.00, or is that not what you were saying? And then the second question just in terms of the sustainability looking at the G&A side, you guys are running at about a 7% ratio.

And so, I'm just curious, is that a sustainable number in light of the fact that you're going to be trying to reinvigorate the growth engine? I look at things like $24 million of CapEx through the first nine months, and it just feels like that can't be sustainable if you're really trying to grow the business.

So, maybe just help with the couple of those questions. Thanks..

Sure. With respect to 2019 revenue, at our Investor Day, we laid out an outlook which suggested that the 2019 premium revenue will be about $15.6 billion. At that time, of course, we were accounting for the total loss of Florida and the total loss of the New Mexico Medicaid contracts. We've since recovered two regions in Florida $0.5 billion.

And the Mississippi implementation will be an incremental $300 million to 2019. There are other growth opportunities in our existing portfolio. Our Marketplace business should grow next year with rates now filed in Utah and Wisconsin.

As you know, we are very successful in our Washington reprocurement where we have fewer competitors and many other regions we won, and so our membership will grow. Ohio carved in the behavioral benefit halfway through this year, we'll get a full year of that next year.

And we picked up 70,000 members mid-year in Illinois, and we'll get a full year effect of that in 2019. So, all-in-all, I think the premium revenue picture, without giving you a specific forecast, is a lot better than what we outlined at Investor Day. Your second question was about G&A, there is more G&A to harvest here.

We've redeployed a lot of that G&A to the frontlines. Our net 600 head count reduction was net of resources we've put in the field to control medical cost. We will spend money on many of our transformational initiatives that will produce better baseline medical costs that will put a little pressure on it next year.

But we are very determined to control our fixed cost and to leverage our fixed cost, and we think there's upside to the G&A ratio as well..

Got you. And I'm sorry, so just to clarify, my question on 2019 was with the understanding that premiums probably go from about $17.5 billion this year to maybe just under $17 billion next year now, obviously, a lot better than what you guys were talking about previously. My question was around the earnings.

I think you'd made the comment that 2018 that long term you wanted to maintain that level of profits that you're seeing in 2018, that run rate $9.00 number.

So, I was just asking more on the combination, if you've got a little bit lower top line on a year-over-year basis, did it sound like earnings per share in your mind for 2019 just directionally would have to take that step back on lower revenues and then eventually get back to where you were, what was that now what you were implying?.

Again, without giving a specific forecast, even with the revenue declines next year, we are pretty committed to growing earnings per share and pre-tax earnings off of the 2018 base.

Too early to give you the specific 2019 trajectory, but we are committed even in the phase of the revenue decline on the two lost contracts, we're committed to that long-term objective..

Got you. Got you. That's perfect. Thanks..

Our next question comes from Ana Gupte of Leerink Partners. Please go ahead..

Yes, hey. Thanks. Good morning. Yeah.

So, again, following up on the margins with the 3-plus net margin that you have right now, do you expect there's still runway for expansion? And is that likely to come mostly from additional mix shifting to the exchanges which are really high margin? Or is there still core MLR improvement from claims editing, payment integrity, PBM, or anything else in Medicare/Medicaid? And then on G&A, are you still looking to drive more efficiency, or are we just looking at leverage at this point as you grow on the cost side anyways?.

With respect to our margins, you specifically, Ana, mentioned Medicaid, with an 89.9% year-to-date MCR, there's still room for improvement in our core Medicaid business, maybe 100 basis points or 200 basis points long term in the MCR. And we're committed to improving our Medicaid margins.

On the G&A side, yeah, there's more efficiency, there's fixed cost leverage as we grow, there is more efficiency, and we will redeploy some of that efficiency back to the frontline to make sure that we do not skimp on utilization control resources, which was part of the medical cost problem the company experienced.

We also are going to invest in some of these transformational initiatives. It will cost money if we outsource or co-source our IT operation. We are spending more money on payment integrity routines and frontline utilization control.

So, there will be a little bit of upward pressure on the G&A ratio as we improve our processes, but it should have a corresponding and exponential effect on our medical cost line..

And then on the rate side, just finally, you have like a mid-60s exchange loss ratio, and you said only one region had the MLR floor issue.

But are there any rate pressures that states may be bringing to your attention with such low loss ratios, you're probably not alone? And then on the tax reform side, might they start to put pressure on the rates in Medicaid, is that sustainable over the long run?.

On the second question, the Medicaid rates, it's a very rational rate environment right now as we accept the Medicaid rates that are being offered to us. For the most part, the rates are actuarially sound.

They always seem to come in a little bit lower than your absorbed medical cost trend, but they'd suspect you to find managed care savings, and we do that routinely. The tax reform conversation really isn't part of the rate dialogue with the states.

On the Marketplace side, we're just now learning how our rates are going to stack up against our competitors. Our average rate increase for the Marketplace that we filed in 2018 for 2019 was 4%.

These rate increases no longer need to be corrective, they just need to accurately reflect medical cost trend, the acuity of our population and the metallic benefit designs that we've put into the market.

So we're pretty comfortable that our strategy in the Marketplace which was to hold on to our membership ranks and maximize contribution margin dollars for 2019 will hold, and that will position us well to file rates in 2019 that will allow us to grow into 2020..

Thanks for the color. Appreciate it..

Our next question comes from Sarah James of Piper Jaffray. Please go ahead..

Thanks, and congratulations on the turnaround execution. You've previously talked about focusing on the turnaround before you turn back to top line growth acceleration.

Given the progress is running ahead of schedule, how are you thinking about when it's right to explore top line opportunities again thinking specifically of non-incumbent RFPs, M&A, but also anything like organic M&A or fixed (41:30) market expansions? Thanks..

Well, as we continue to focus on our margin recovery and sustainability efforts, as you suggested, there is still more to do. Some of those opportunities have yet to been harvested. And that is our primary focus here at the company. In the meantime, we also recognized that the sales cycle in this business is very long.

And if you don't start building the engine today to grow, then you won't grow in 2019, 2020 and 2021. So we are hard at work rebuilding our RFP response unit, we're hard at work rebuilding our new contract business development unit. In the meantime, there are plenty of opportunities in our existing footprint, in our existing product line, to grow.

If we can win more regions in Texas, when Texas finally announces the STAR+PLUS contract, if we won seven more regions and add our current market share, could be over $1 billion of incremental opportunity. Ohio strongly considering putting their ML – their long-term services and supports business into managed care.

So there are plenty of opportunities in Marketplace. We believe that business could be twice the size it is today, and we can hold onto our margin, and have it be a very good allocation of capital in the portfolio at a very attractive margin.

So before we go into new-new, I think there's plenty of opportunities in our existing footprint and our existing product line to grow. But in the meantime, we are rebuilding that greenfield business development operation so we can participate in RFPs in 2019, 2020 for the benefit of 2021..

That's very helpful. And one more, you've previously talked about $0.50 upside not in guidance from capital deployment related to debt and converts, can you update us on how much of that has been achieved, and if the remainder is on the table for 2019, or if we should be thinking further out? Thanks..

We originally – I gave you a $0.50 estimate, and if you recall, I think at the time, our share price was about $85, which meant that the cash that we've used to buy in the converts was purchasing a lot more of the converts than it is at $125, $130. So, that estimate for the full year is now $0.30, but we've bought in a lot of those convertible notes.

We've reduced our share count and the potential volatility in EPS as a result of it. But I think Tom said in his prepared remarks that the estimate for the year on our capital actions is about a $0.30 benefit for the entire year..

Thank you..

Our next question comes from Steve Tanal of Goldman Sachs. Please go ahead..

Good morning, guys. Thanks for the question. So, it seems like you're implying further improvement in the Medicaid loss ratio next year will offset likely lower margins in the Marketplace.

And I guess if I think about that, is that now about the TANF population with where the Medicaid sort of loss ratio is running there? And does that become inevitably more dependent on rate updates to the extent that's sort of a lower acuity, lower utilizing population where there's maybe I guess in theory less you can do?.

Well, we definitely think there's upside to our core Medicaid performance. Citing some facts here, TANF is still running over 89% year-to-date. ABD is running at 92% – just under 92%, which is respectable.

But we actually think that we can more effectively manage the long-term support and services benefit that's embedded in the ABD product more effectively and we can improve on that 92% performance. And Expansion is doing well at 87%. We're still getting very, very effective rates. So, the business is performing well.

I think that there is upside in our ABD line and upside in our TANF line. Just being more effective on the frontlines and the utilization controls, the rate environment if it continues to be stable and we can continue to effectively manage our medical cost baseline and trend, we all believe that there's upside to those performance statistics..

Okay, that's really helpful.

And just sort of separately on the Marketplace business, kind of given the way minimum MLR rebates are assessed on a rolling three-year basis, is there anything you can tell us about the impact of I guess what would effectively be swapping 2018, obviously really strong year with 2015 less strong on sort of the outlook for earnings or margin next year?.

Good observation. The old, poorly-performing years are rolling off, but we still have room. As you suggested, it's a three-year rolling average. We only triggered the minimum MLR in one state, that being New Mexico. And we fully considered our position as we filed our 2019 rates.

So, no, we don't expect – the rates that we filed still do not imply a triggering of the minimum MLR in any of our other states. And if we did, we certainly would include it in any forecast we give you for 2019..

Awesome. Really helpful.

Just lastly for me, just on Marketplace enrollment, the expectations for increased enrollment there, can you talk about any new markets or geographies you're entering, or should we think about that as more of a same-store end-market growth rate?.

We're in seven. We re-filed – if you remember, we were in Utah and Wisconsin a year ago. We came out in 2018. We're going back in for 2019. We expect that Wisconsin and the positioning of our pricing and our product will provide some meaningful membership growth in Wisconsin. Utah, probably less so. But those are the two states.

So, we'll be in nine states in 2019 and we're going to consider expanding our Marketplace footprint to be everywhere we're in Medicaid in 2020, which would be I think South Carolina, Illinois and New York..

Awesome. Very helpful. Thanks a lot, Joe..

Our next question comes from Dave Windley of Jefferies. Please go ahead..

Hi, good morning. Thanks for taking my questions. So, Joe, thinking about your $500 million plan, just a few sub-part questions here. One, has this year benefited from anything that would have been, say, outside of that plan? Two, you mentioned that you've harvested some of that plan, but still a lot of it to go.

Would you care to put numbers on or maybe a proportion of the $500 million that you think you're already seeing flow through the P&L? And then, as you I guess in the extreme, and it's been asked a little bit already this morning, but in the full harvesting of the $500 million, Molina would seem to get to margin levels that would be very high relative to peers.

And I guess I'd be curious your view on the difficulty or the reasonableness of pushing margins at Molina kind of to that spread against similar books of business..

Well, thanks for the question. And as a reminder, I always remind folks when we talk about these profit improvement plans that one, it first goes to fund any deficit you get in rates. Rates always seem to lag medical cost trend by 1 basis point here or there, and it first goes to fund that.

If you remember the charts we showed you at Investor Day, we had this sort of contingency reserve sitting out there suggesting that somewhere you'll get a bad rate, somewhere the rate might be actuarially unsound. And you're always using your profit improvement issues to first offset that deficit before anything drops through.

And as you suggest, you're absolutely correct; we would then look at our profit improvement plans and the margins that we're creating as a result of it to reinvest in growth. We would not push margins up as high as you suggest and sacrifice growth when the time comes. So, the $500 million could drop through to margins.

And if we aspire to be the best margin producer in the industry, maybe we get there or maybe we'll reinvest it in top line growth. Your original question was about how much of the $500 million has fallen through to 2018. And without parsing it item by item, we definitely benefited this year by more effective utilization management.

We definitely benefited this year by working the network harder, claim payment integrity certainly added some benefit this year to our medical cost line. And as we suggested, we continue to be more effective at SG&A control.

I would say that the more technically challenging, the more operationally complex items that you saw on our chart at Investor Day still have yet to be harvested. So, bottom line, I would say a significant amount of the $500 million has yet to have been harvested and manifest in earnings.

You'll be seeing over the next two to three months announcements from us on partnerships that we are creating with world-class vendors to partner up and take advantage of high acuity care management, maybe a re-contracting of our pharmacy.

Clearly, we are anticipating co-sourcing or outsourcing our IT operation, you'll see some announcements for us on that front over the next two to three months..

Helpful. Thank you..

Our next question comes from Steven Valiquette of Barclays. Please go ahead..

Yeah, thanks, and good morning. I think most of the good questions have been addressed already. Just talk a little bit on that last one. Looking at your citing and throughout this year that some lower in-patient cost has also been part of the upside.

So, I was curious kind of where you stand just because (51:44) a little bit deeper on that last question just on the contract renegotiations on the in-patient side, whether that's something that has played a role this year or that's something that's also still kind of ahead of you, just thinking about that category in particular? Thanks..

A, stable and performing well; and secondly, we've been managing it better than we had in the past..

Yeah, okay. All right. Great, thanks..

Our next question comes from Kevin Fischbeck of Bank of America Merrill Lynch. Please go ahead..

Great. Thanks. I just wanted to circle back with the G&A commentary because it seems like you're talking, on the one hand, about significant savings, but then also kind of making some investments that might push up G&A with the MLR benefit.

And then I guess separately, I guess you're talking about maybe investing for growth in RFPs in the future, I wasn't sure if that was going to put upward pressure on G&A.

I guess when you put that altogether, are you looking for G&A as a percentage of revenue to continue to trend down, or this is more about, hey, there's savings that we can reinvest elsewhere to drive improvement elsewhere, either top line or MLR?.

Kevin, we're not prepared to give sort of a pinpoint forecast on our G&A ratio beyond 2018. But those are the headwinds and tailwinds to our G&A ratio. And I view the upward pressure – if we continue to invest in things that improve our medical cost baseline; I consider that to be -have an excellent return, and we would make that trade all day long.

So, yes, there are going to be some upward pressures as we invest in some of these processes that will produce significant benefits to the company. Certainly, when you're chasing top line revenue, it costs money. But there is more fixed cost leverage and there's more efficiency to be gained in our operation.

Those are the ups and downs, but we're just not prepared yet to give you a pinpoint SG&A ratio forecast beyond 2018. But it's there, we're managing it very effectively, and we definitely think there's a more effective way to deploy our SG&A dollars..

Okay. And then, I guess, when we think about getting back to the growth side of the equation, Molina has been historically much better at protecting and expanding in markets where you already are located.

I mean, what do you have to add capability-wise to be successful in entering new markets?.

Well, we are currently sketching out the rebuilding of our business development engine. You need to have a ground game, you need to be in the states developing network relationships and governmental relationships before the procurement drops.

And in the past two years, this company has not really invested in any of that given the issues it was going through. So, we're rebuilding all that under Pam Sedmak's leadership. We will develop a new business development engine that we think can compete with our rivals, and we can win our fair share.

It's really not about the money, it's about really establishing yourself locally building the relationships with the Department of Health Services and the regulators and making sure you have great network relationships, so when the RFP drops, you're prepared to go..

Okay.. Thanks..

Our next question comes from Gary Taylor of JPMorgan. Please go ahead..

Hi, good morning. Really amazing performance this year. So you've done a great job. Two questions about that performance.

The first one, just going back to exchanges a little bit, can you help us bridge this comment that you're looking – you're either running or anticipating for the year 9% to 10% after-tax margins in the exchange business with the 58% year-to-date MLR.

And I guess presuming some seasonal uptick in the 4Q, maybe you end the year closer to 70%, but still implies somewhere between a 20% and 30% G&A load to only get to a 9% to 10% after-tax margin, can you bridge that for us?.

Go ahead, Tom (56:54)..

Yeah. Your numbers are directionally in the right zone there. So in this business, the G&A tend to be high. You have commission, you have sales, marketing. So certainly, it's really in the upper-teen to as much as 20%. And our fourth quarter, you're right, the medical care ratio is going to be higher than what we experienced so far year-to-date.

In the last earnings call, we talk a little bit about that, that they tend to be somewhat in the 80s, but we believe that given the trajectory that we are in today, it will be much less than that, more likely start with a seven as opposed to an eight in front..

So, if we think about ultimately minimum MLRs at 80% in this business and G&A in upper-teens to 20%, I mean that would imply a longer-term after-tax margin significantly lower than the 9% to 10%.

Is that how we should be thinking about this? Or do you think you bring G&A down over time to seeing something mid-single digit or better?.

Our G&A loads in our product lines that aren't fully scaled are too high, and they can be scaled. If we double the size of the business, our SG&A would not double. There's fixed cost leverage there very, very clearly.

The other thing, as a reminder, in the minimum MLR, there's all the add-backs, right? The number we produce for GAAP, there's all kinds of additions and subtractions to get to the number. So, if we're operating in the mid to high-60s with our G&A load of 15% to 20%, we're still floating below the minimum MLR in many of our placements (58:49).

But your point is well taken. There is a practical cap in the margins you can achieve because of the minimum MLR, and if we ever get there, it's a high-class problem to have and we'll fully consider it in the rates we file and we'll grow more..

One other question for you, Joe. Just thinking about your comment that there's still significant amount of the $500 million opportunity you identified that could flow through to earnings.

When that takes place, if that does take place, it really seems that you're completely redefining the margin profile with still primarily Medicaid business and redefining that margin profile versus your peers and versus history.

And we've always heard companies in this business talk about over caps at the state level, politics and visibility of margins, et cetera. So, in just six months here, you've redefined the profile to some degree and you suggest there's still further to go.

How do we think about this historic concept that there were – these are pre-tax caps at the state level....

Sure..

...and just sort of the visibility of the margins politically?.

Oh, it's a very fair comment. And that's why every time I show a forecast or a projection, I always have what I call the rate yield decrement in the analysis because you're never sure that you're going to get fully paid for your medical cost trend. And I always say that over time profit improvement always ends up in rates somehow and somewhere.

So, you're right. Over time just through the – the process of negotiating and accepting rates from states, profit improvement will end up in rates over time. That in itself puts a practical (01:00:43) cap in what you can achieve. But again, our goal is to be low cost.

We want to be very effective on the frontlines, service our members and our provider partners well, but be low cost. And if we can continue to do that, we can either drop it through or we can reinvest it in top line growth. And that's our aspiration and that's what we're trying to achieve here..

Great. Thank you..

Our next question comes from Zack Sopcak of Morgan Stanley. Please go ahead..

Hey, thank you for the call, and congrats on the quarter. I wanted to ask first about exiting the Pathways business.

If you forget about the – I guess the loss you're taking on the sale of the business, was it a negative or positive earnings contributor in 2018? And should we think about that exit as a tailwind or a headwind going into 2019?.

The exit is clearly a tailwind. It was running an EBITDA loss for the year. If you recall, the goodwill associated with that purchase was written off in the third quarter of 2017, which left a little bit of working capital and fixed assets in the business, and selling it for a nominal purchase price still produced a loss.

Negative EBITDA contributor, and it would have required us a lot of future investment in order to fix the business, and there's always a private equity firm around who sees value in that, wants to put the hard work in, but it's just not core and was not a financial contributor..

Got it.

And just on that non-core comment, now that you've exited MMS and Pathways, is there anything else in your portfolio that you would consider non-core that you're still working on, or do you think it's where you wanted to be?.

No, we like the portfolio, we like the geographic diversity, we like the product line depth and breadth. The portfolio right now is fine, and we're focused on managed care and that's what our focus is on..

Okay, perfect. Thank you for the question..

Our next question comes from Michael Newshel of Evercore ISI. Please go ahead..

Thanks.

Do you have a timeline in mind for retiring the remaining convertible debt and warrants? And also do you expect to have more deployable capital from subsidiary dividends next year than you talked about at the Investor Day just given the earnings outperformance this year?.

I'll kick it to Tom in a minute, but bear in mind that the 2020s are due in January 2020. So, whether we buy them in the open market or they're presented to us by January of 2020, they will be totally out of our capital structure. Tom, do you want to (01:03:24)..

That's right, Joe. There's a balance remaining of approximately $315 million. So, between now and January 2020, we will retire those convertible..

All right.

And then to retire the associated warrants as well, it's like a total of like $1 billion close to?.

Exactly. And we're sitting now with close to $400 million in parent company cash. Obviously, with the outlook for next year, I have – we'll harvest more cash flow to the parent. We have the $500 million revolver. So, we have plenty of capacity.

As those notes are presented to us or as we go into the market, we have the free cash flow at the parent to buy them..

Do you have to (01:04:10) be able to do that all next – over the course of next year?.

Absolutely..

All right. Thank you..

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