UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2009

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Molina Healthcare, Inc.

Delaware		13-4204626
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
200 Oceangate, Suite 100
Long Beach, California		90802
(Address of principal executive offices)		(Zip Code)

(562) 435-3666
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

     Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o
				(Do not check if a smaller reporting company)

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

     The number of shares of the issuer’s Common Stock, par value $0.001 per share, outstanding as of October 30, 2009, was approximately 25,550,000.

 

 

MOLINA HEALTHCARE, INC.

Index

Part I — Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 2009 (unaudited) and December 31, 2008			3
Consolidated Statements of Income for the three month and nine month periods ended September 30, 2009 and 2008 (unaudited)			4
Consolidated Statements of Comprehensive Income for the three month and nine month periods ended September 30, 2009 and 2008 (unaudited)			5
Consolidated Statements of Cash Flows for the nine months ended September 30, 2009 and 2008 (unaudited)			6
Notes to Condensed Consolidated Financial Statements (unaudited)			8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			20
Item 3. Quantitative and Qualitative Disclosures About Market Risk			41
Item 4. Controls and Procedures			42
Part II — Other Information
Item 1. Legal Proceedings			43
Item 1A. Risk Factors			43
Item 5. Other Information			44
Item 6. Exhibits			44
Signatures			45
EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I — FINANCIAL INFORMATION

Item 1: Financial Statements.

MOLINA HEALTHCARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

		September 30,				December 31,
		2009				2008 (1)
		(Unaudited)
		(Amounts in thousands, except per-share data)
ASSETS
Current assets:
Cash and cash equivalents		$	449,469			$	387,162
Investments			170,194				189,870
Receivables			144,129				128,562
Refundable income taxes			—				4,019
Deferred income taxes (1)			7,261				9,071
Prepaid expenses and other current assets			14,312				14,766
Total current assets			785,365				733,450
Property and equipment, net			76,244				65,058
Goodwill and intangible assets, net			214,102				192,599
Investments			59,855				58,169
Restricted investments			42,400				38,202
Receivable for ceded life and annuity contracts			25,926				27,367
Other assets (1)			20,113				33,223
		$	1,224,005			$	1,148,068
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Medical claims and benefits payable		$	303,114			$	292,442
Accounts payable and accrued liabilities			72,093				66,247
Deferred revenue			90,919				29,538
Income taxes payable			1,937				—
Total current liabilities			468,063				388,227
Long-term debt (1)			157,681				164,873
Deferred income taxes (1)			13,423				12,911
Liability for ceded life and annuity contracts			25,926				27,367
Other long-term liabilities			14,140				22,928
Total liabilities			679,233				616,306
Stockholders’ equity:
Common stock, $0.001 par value; 80,000 shares authorized, outstanding: 25,549 shares at September 30, 2009 and 26,725 shares at December 31, 2008			26				27
Preferred stock, $0.001 par value; 20,000 shares authorized, no shares issued and outstanding			—				—
Additional paid-in capital (1)			127,317				170,681
Accumulated other comprehensive loss			(1,665	)			(2,310	)
Retained earnings (1)			419,094				383,754
Treasury stock, at cost; 1,201 shares at December 31, 2008			—				(20,390	)
Total stockholders’ equity			544,772				531,762
		$	1,224,005			$	1,148,068

See accompanying notes.

CONSOLIDATED STATEMENTS OF INCOME

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2009				2008 (1)				2009				2008 (1)
		(Amounts in thousands, except
		net income per share)
		(Unaudited)
Revenue:
Premium revenue		$	914,805			$	791,554			$	2,697,796			$	2,282,345
Investment income			1,707				4,775				7,336				17,517
Total revenue			916,512				796,329				2,705,132				2,299,862
Expenses:
Medical care costs			792,771				669,355				2,333,865				1,936,531
General and administrative expenses			97,635				88,030				283,216				253,196
Depreciation and amortization			9,832				8,515				28,468				24,997
Total expenses			900,238				765,900				2,645,549				2,214,724
Gain on retirement of convertible senior notes			—				—				1,532				—
Operating income			16,274				30,429				61,115				85,138
Interest expense (1)			(3,279	)			(3,120	)			(9,917	)			(9,913	)
Income before income taxes (1)			12,995				27,309				51,198				75,225
Provision for income taxes (1)			4,431				10,829				15,858				30,447
Net income (1)		$	8,564			$	16,480			$	35,340			$	44,778
Net income per share (1):
Basic		$	0.34			$	0.60			$	1.36			$	1.60
Diluted (2)		$	0.33			$	0.60			$	1.36			$	1.59
Weighted average shares outstanding:
Basic			25,539				27,449				25,944				27,971
Diluted (2)			25,630				27,582				26,058				28,087

See accompanying notes.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2009				2008(1)				2009				2008 (1)
		(Amounts in thousands)								(Amounts in thousands)
		(Unaudited)								(Unaudited)
Net income (1)		$	8,564			$	16,480			$	35,340			$	44,778
Other comprehensive income (loss), net of tax:
Unrealized gain (loss) on investments			37				(1,562	)			645				(4,809	)
Other comprehensive income (loss)			37				(1,562	)			645				(4,809	)
Comprehensive income (1)		$	8,601			$	14,918			$	35,985			$	39,969

See accompanying notes.

CONSOLIDATED STATEMENTS OF CASH FLOWS

		Nine Months Ended
		September 30,
		2009				2008 (1)
		(Amounts in thousands)
		(Unaudited)
Operating activities
Net income (1)		$	35,340			$	44,778
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			28,468				24,997
Unrealized gain on trading securities			(3,509	)			—
Loss on rights agreement			3,204				—
Gain on purchase and retirement of convertible senior notes			(1,532	)			—
Non-cash interest on convertible senior notes (1)			3,563				3,497
Amortization of deferred financing costs (1)			1,040				1,076
Deferred income taxes			2,322				(7,410	)
Tax deficiency from employee stock compensation recorded as additional paid-in capital			(704	)			(247	)
Stock-based compensation			5,730				5,769
Changes in operating assets and liabilities:
Receivables			(15,567	)			(58,223	)
Prepaid expenses and other current assets			454				(1,881	)
Medical claims and benefits payable			10,672				(12,819	)
Accounts payable and accrued liabilities			(6,140	)			(666	)
Deferred revenue			61,381				(20,951	)
Income taxes			5,561				1,809
Net cash provided by (used in) operating activities			130,283				(20,271	)
Investing activities
Purchases of equipment			(28,390	)			(28,314	)
Purchases of investments			(127,335	)			(181,377	)
Sales and maturities of investments			149,770				188,896
Increase in restricted investments			(4,198	)			(7,491	)
Cash paid in business purchase transaction			(10,900	)			(1,000	)
Increase in other assets			(1,877	)			(578	)
(Decrease) increase in other long-term liabilities			(8,788	)			4,211
Net cash used in investing activities			(31,718	)			(25,653	)
Financing activities
Treasury stock purchases			(27,712	)			(32,237	)
Purchase and retirement of convertible senior notes			(9,653	)			—
Excess tax benefits from employee stock compensation			26				43
Proceeds from exercise of stock options and employee stock purchases			1,081				1,490
Net cash used in financing activities			(36,258	)			(30,704	)
Net increase (decrease) in cash and cash equivalents			62,307				(76,628	)
Cash and cash equivalents at beginning of period			387,162				459,064
Cash and cash equivalents at end of period		$	449,469			$	382,436

See accompanying notes.

CONSOLIDATED STATEMENTS OF CASH FLOWS (cont’d)

		Nine Months Ended
		September 30,
		2009				2008
		(Amounts in thousands)
		(Unaudited)
Supplemental cash flow information
Cash paid during the period for:
Income taxes		$	19,954			$	36,127
Interest		$	4,254			$	3,945
Schedule of non-cash investing and financing activities:
Unrealized gain (loss) on investments		$	936			$	(7,833	)
Deferred taxes			(291	)			3,024
Net unrealized gain (loss) on investments		$	645			$	(4,809	)
Retirement of common stock used for stock-based compensation		$	920			$	512
Accrued purchases of equipment		$	366			$	541
Retirement of treasury stock		$	48,102			$	29,966
Details of business purchase transaction:
Fair value of assets acquired		$	10,900			$	2,262
Common stock issued to seller			—				(1,262	)
Net cash paid in business purchase transaction		$	10,900			$	1,000
Business purchase transactions adjustments:
Other assets		$	9,000			$	—
Accounts payable and accrued liabilities			16,100				1,265
Deferred taxes			—				65
Goodwill and intangible assets, net		$	25,100			$	1,330

MOLINA HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 2009

1. Basis of Presentation

Organization and Operations

     Molina Healthcare, Inc. is a multi-state managed care organization participating exclusively in government-sponsored health care programs for low-income persons, such as the Medicaid program and the Children’s Health Insurance Program, or CHIP. We also serve a small number of low-income Medicare members. We conduct our business primarily through 10 licensed health plans in the states of California, Florida, Michigan, Missouri, Nevada, New Mexico, Ohio, Texas, Utah, and Washington. The health plans are locally operated by our respective wholly owned subsidiaries in those 10 states, each of which is licensed as a health maintenance organization, or HMO. Effective December 31, 2009, we will no longer serve members in Nevada.

Consolidation and Interim Financial Information

     The condensed consolidated financial statements include the accounts of Molina Healthcare, Inc. and all majority-owned subsidiaries. In the opinion of management, all adjustments considered necessary for a fair presentation of the results as of the date and for the interim periods presented have been included. Except as described below, such adjustments consist of normal recurring adjustments. All significant intercompany balances and transactions have been eliminated in consolidation. The condensed consolidated results of operations for the current interim period are not necessarily indicative of the results for the entire year ending December 31, 2009. Financial information related to subsidiaries acquired during any year is included only for the period subsequent to their acquisition.

     The unaudited condensed consolidated interim financial statements have been prepared under the assumption that users of the interim financial data have either read or have access to our audited consolidated financial statements for the fiscal year ended December 31, 2008. Accordingly, certain disclosures that would substantially duplicate the disclosures contained in the December 31, 2008 audited consolidated financial statements have been omitted. These unaudited condensed consolidated interim financial statements should be read in conjunction with our December 31, 2008 audited financial statements.

     In preparing the accompanying unaudited condensed consolidated financial statements, we have evaluated subsequent events through November 5, 2009, the date of issuance of the financial statements.

     Effective January 1, 2009, we adopted FASB Accounting Standards Codification (ASC) Subtopic 470-20, Debt with Conversion and Other Options. This change in accounting treatment has been applied retrospectively to prior periods, and resulted in additional interest expense of $1.2 million ($0.03 per diluted share) for the three months ended September 30, 2008, and $3.5 million ($0.08 per diluted share) for the nine months ended September 30, 2008. The cumulative adjustments to reduce retained earnings were $3.4 million as of January 1, 2009, and $0.6 million as of January 1, 2008. For a comprehensive discussion of the application of ASC Subtopic 470-20, and its impact to the accompanying financial statements, see Note 11, “Convertible Senior Notes.”

2. Significant Accounting Policies

Investments

     Our investments are principally held in debt securities, which are grouped into three separate categories for accounting and reporting purposes: available-for-sale securities, held-to-maturity securities, and trading securities. Available-for-sale securities are recorded at fair value and unrealized gains and losses, if any, are recorded in stockholders’ equity as other comprehensive income, net of applicable income taxes. Held-to-maturity securities are recorded at amortized cost, which approximates fair value, and unrealized holding gains or losses are not generally recognized. Realized gains and losses and unrealized losses judged to be other than temporary with respect to available-for-sale and held-to-maturity securities are included in the determination of net income. Trading securities are recorded at fair value, and holding gains and losses are recognized in net income.

     Except for restricted investments and certain student loan portfolios (the “auction rate securities”), our debt securities are designated as available-for-sale and are carried at fair value. The cost of securities sold is determined using the specific-identification method, on an amortized cost basis. Fair values of securities are generally based on quoted prices in active markets.

     Our investment policy requires that all of our investments have final maturities of ten years or less (excluding auction rate and variable rate securities where interest rates may be periodically reset), and that the average maturity be four years or less. Investments and restricted investments are subject to interest rate risk and will decrease in value if market rates increase. Declines in interest rates over time will reduce our investment income.

     In general, our available-for-sale securities are classified as current assets without regard to the securities’ contractual maturity dates because they may be readily liquidated. During 2008, our auction rate securities were classified as non-current assets. During the fourth quarter of 2008, certain auction rate securities were designated as trading securities. For comprehensive discussions of the fair value and classification of our current and non-current investments, including auction rate securities, see Note 5, “Fair Value Measurements,” and Note 6, “Investments.”

Income Taxes

     We record accruals for uncertain tax positions by applying a two-step process. First, we determine whether it is more likely than not that a tax position will be sustained upon examination. In the second step, a tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements.

     Our accrual for unrecognized tax benefits decreased $10.7 million to $1.0 million as of September 30, 2009, from $11.7 million as of December 31, 2008. This accrual is included in “Other long-term liabilities” in the accompanying condensed consolidated balance sheets. Approximately $9.7 million of the decrease in our accrual for unrecognized tax benefits was recorded during the three months ended June 30, 2009, as (a) a gross discrete tax benefit of $3.8 million ($3.6 million net of tax), (b) a reduction in deferred tax assets of $5.2 million, and (c) an increase in taxes payable of $0.7 million. An additional $1.0 million decrease in our accrual for unrecognized tax benefits was recorded during the three months ended September 30, 2009. The aggregate $10.7 million decrease during the nine months ended September 30, 2009 was primarily related to settling certain tax examinations and voluntarily electing to change certain tax accounting methods. Approximately $0.8 million of the $1.0 million in unrecognized tax benefits at September 30, 2009 would affect our effective tax rate, if recognized. We anticipate a decrease of $0.4 million to our liability for unrecognized tax benefits within the next twelve-month period.

     Our continuing practice is to recognize interest and/or penalties related to unrecognized tax benefits in income tax expense. Our accrual for the payment of interest relating to unrecognized tax benefits decreased $1.3 million ($0.8 million net of tax) to $0.1 million as of September 30, 2009, from $1.4 million as of December 31, 2008. The accrual for interest on unrecognized tax benefits decreased as a result of the decrease in the accrual for unrecognized tax benefits as described above.

Recent Accounting Pronouncements

     In June 2009, the FASB issued ASC Topic 105, Generally Accepted Accounting Principles, which establishes the FASB Accounting Standards Codification as the source of authoritative accounting principles recognized by the FASB to be applied in the preparation of financial statements in conformity with generally accepted accounting principles. ASC Topic 105 explicitly recognizes rules and interpretive releases of the Securities and Exchange Commission (SEC) under federal securities laws as authoritative generally accepted accounting principles (GAAP) for SEC registrants. ASC Topic 105 became effective on September 15, 2009; we have updated and will update all existing GAAP references to the new codification references for all current and future filings.

     On August 28, 2009, the FASB issued Accounting Standards Update (ASU) No. 2009-05, “Measuring Liabilities at Fair Value” (ASU 2009-05). ASU 2009-05 provides additional guidance clarifying the measurement of liabilities at fair value. ASU 2009-05 is effective in fourth quarter 2009 for a calendar-year entity. We are currently evaluating the impact of ASU 2009-05 on our financial position, results of operations, cash flows, and disclosures.

     On September 23, 2009, the FASB ratified Emerging Issues Task Force Issue No. 08-1, “Revenue Arrangements with Multiple Deliverables” (EITF 08-1). EITF 08-1 updates the current guidance pertaining to multiple-element revenue arrangements included in ASC Subtopic 605-25, which originated primarily from EITF

00-21, also titled “Revenue Arrangements with Multiple Deliverables.” EITF 08-1 will be effective for annual reporting periods beginning January 1, 2011 for calendar-year entities. We are currently evaluating the impact of EITF 08-1 on our financial position, results of operations, cash flows, and disclosures.

     Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the AICPA, and the SEC did not, or are not believed by management to, have a material impact on our present or future consolidated financial statements.

3. Earnings per Share

     The denominators for the computation of basic and diluted earnings per share are calculated as follows:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2009				2008				2009				2008
						(In thousands)
Shares outstanding at the beginning of the period			25,529				27,453				26,725				28,444
Weighted average number of treasury shares purchased			—				(20	)			(865	)			(549	)
Weighted average number of shares issued under employee stock plans			10				16				84				76
Denominator for basic earnings per share			25,539				27,449				25,944				27,971
Dilutive effect of employee stock options and restricted stock (1)			91				133				114				116
Denominator for diluted earnings per share (2)			25,630				27,582				26,058				28,087

4. Stock-Based Compensation

     At September 30, 2009, we had employee equity incentives outstanding under two plans: (1) the 2002 Equity Incentive Plan; and (2) the 2000 Omnibus Stock and Incentive Plan (from which equity incentives are no longer awarded). Charged to general and administrative expenses, total stock-based compensation expense for the three and nine months ended September 30, 2009 and 2008 was as follows:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2009				2008				2009				2008
						(In thousands)
Restricted stock awards		$	1,787			$	1,480			$	4,661			$	3,687
Stock options (including shares issued under our employee stock purchase plan)			485				702				1,069				2,082
Total stock-based compensation expense		$	2,272			$	2,182			$	5,730			$	5,769

     As of September 30, 2009, there was $16.5 million of total unrecognized compensation expense related to non-vested restricted stock awards, which we expect to be recognized over a weighted-average period of 2.8 years. Also as of September 30, 2009, there was $1.1 million of unrecognized compensation expense related to non-vested stock options, which we expect to recognize over a weighted-average period of 1.5 years.

     Non-vested restricted stock and restricted stock unit activity for the nine months ended September 30, 2009 is summarized below:

						Weighted Average
						Grant Date
		Shares				Fair Value
Non-vested balance as of December 31, 2008			470,955			$	31.95
Granted			411,600				18.89
Vested			(150,450	)			30.86
Forfeited			(44,625	)			25.82
Non-vested balance as of September 30, 2009			687,480				24.77

     The aggregate fair value of restricted shares granted during the nine months ended September 30, 2009 and 2008 was $7.8 million and $11.9 million, respectively. The aggregate fair value of restricted shares vested during the nine months ended September 30, 2009 and 2008 was $3.0 million and $2.2 million, respectively.

     Stock option activity during the nine months ended September 30, 2009 is summarized below:

														Weighted
														Average
						Weighted				Aggregate				Remaining
						Average				Intrinsic				Contractual
						Exercise				Value (in				Term
		Shares				Price				Thousands)				(Years)
Stock options outstanding as of December 31, 2008			665,339			$	30.29
Forfeited			(12,850	)			31.98
Stock options outstanding as of Sept. 30, 2009			652,489			$	30.25			$	205				6.1
Stock options exercisable and expected to vest as of Sept. 30, 2009			638,921			$	30.21			$	205				6.0
Exercisable as of Sept. 30, 2009			542,155			$	29.89			$	205				5.8

5. Fair Value Measurements

     Our consolidated balance sheets include the following financial instruments: cash and cash equivalents, investments, receivables, trade accounts payable, medical claims and benefits payable, long-term debt and other liabilities. We consider the carrying amounts of cash and cash equivalents, receivables, other current assets and current liabilities to approximate their fair value because of the relatively short period of time between the origination of these instruments and their expected realization or payment. For a comprehensive discussion of fair value measurements with regard to our current and non-current investments, see below.

     Based on quoted market prices, the fair value of our convertible senior notes issued in October 2007 was $155.2 million as of September 30, 2009, and $115.5 million as of December 31, 2008. The carrying amount of the convertible senior notes was $157.7 million as of September 30, 2009.

     To prioritize the inputs we use in measuring fair value, we apply a three-tier fair value hierarchy. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

     As of September 30, 2009, we held certain assets that are required to be measured at fair value on a recurring basis. These included investments and restricted investments as follows:

Balance Sheet
Classification		Description
Current assets:
Investments		Investment grade debt securities; designated as available-for-sale; reported at fair value based on market prices that are readily available (Level 1). See Note 6, “Investments,” for further information regarding fair value measurements.
Non-current assets:
Investments		Auction rate securities; designated as available-for-sale; reported at fair value based on discounted cash flow analysis or other type of valuation model (Level 3).

Balance Sheet
Classification		Description
		Auction rate securities; designated as trading; reported at fair value based on discounted cash flow analysis or other type of valuation model (Level 3).
Other assets		Other assets include auction rate securities rights (the “Rights”); reported at fair value based on discounted cash flow analysis or other type of valuation model (Level 3).
Restricted investments		Interest-bearing deposits and U.S. treasury securities required by the respective states in which we operate, or required by contractual arrangement with a third party such as a provider group; designated as held-to-maturity; reported at amortized cost which approximates market value and based on market prices that are readily available (Level 1). See Note 9, “Restricted Investments,” for further information regarding fair value measurements.

     As of September 30, 2009, $68.1 million par value (fair value of $59.9 million) of our investments consisted of auction rate securities, all of which were collateralized by student loan portfolios guaranteed by the U.S. government. We continued to earn interest on substantially all of these auction rate securities as of September 30, 2009. Due to events in the credit markets, the auction rate securities held by us experienced failed auctions beginning in the first quarter of 2008. As such, quoted prices in active markets were not readily available during the majority of 2008, and continued to be unavailable as of September 30, 2009. To estimate the fair value of these securities, we used pricing models that included factors such as the collateral underlying the securities, the creditworthiness of the counterparty, the timing of expected future cash flows, and the expectation of the next time the security would have a successful auction. The estimated values of these securities were also compared, when possible, to valuation data with respect to similar securities held by other parties. We concluded that these estimates, given the lack of market available pricing, provided a reasonable basis for determining fair value of the auction rate securities as of September 30, 2009. For our investments in auction rate securities, we do not intend to sell, nor is it more likely than not that we will be required to sell, these investments before recovery of their cost.

     As of September 30, 2009, we held $41.1 million par value (fair value of $37.0 million) auction rate securities (designated as trading securities) with a certain investment securities firm. In the fourth quarter of 2008, we entered into a rights agreement with this firm that (1) allows us to exercise rights (the “Rights”) to sell the eligible auction rate securities at par value to this firm between June 30, 2010 and July 2, 2012, and (2) gives the investment securities firm the right to purchase the auction rate securities from us any time after the agreement date as long as we receive the par value.

     We have accounted for the Rights as a freestanding financial instrument, and have elected to record the value of the Rights at fair value, which totaled $3.7 million at September 30, 2009. To determine the fair value estimate of the Rights, we use a discounted cash-flow model based on the expectation that the auction rate securities will be put back to the investment securities firm at par on June 30, 2010, as permitted by the rights agreement.

     For the three months ended September 30, 2009, we recorded a nominal pretax loss on the auction rate securities underlying the Rights, which was offset by a nominal pretax gain on the Rights. For the nine months ended September 30, 2009, we recorded pretax gains of $3.5 million on the auction rate securities underlying the Rights. Pretax gains and losses are recorded to investment income. We expect that the future changes in the fair value of the Rights will continue to be substantially offset by the fair value movements in the underlying auction rate securities.

     As of September 30, 2009, the remainder of our auction rate securities (designated as available-for-sale securities) amounted to $27.0 million par value (fair value of $22.8 million). As a result of the increase in fair value of auction rate securities designated as available-for-sale, we recorded unrealized gains of $0.5 million ($0.3 million, net of tax) to accumulated other comprehensive loss for the nine months ended September 30, 2009. We recorded unrealized losses of $6.9 million ($4.3 million, net of tax) to other comprehensive loss for the nine months ended September 30, 2008. We have deemed these unrealized gains and losses to be temporary and attribute the decline in value to liquidity issues, as a result of the failed auction market, rather than to credit issues. Any future fluctuation in fair value related to these instruments that we deem to be temporary, including any recoveries of previous write-downs, would be recorded to accumulated other comprehensive loss. If we determine that any future valuation adjustment was other-than-temporary, we would record a charge to earnings as appropriate.

     Our assets measured at fair value on a recurring basis, at September 30, 2009, were as follows:

		Fair Value Measurements at Reporting Date Using
		Total				Level 1				Level 2				Level 3
		(In thousands)
Investments		$	170,194			$	170,194			$	—			$	—
Auction rate securities (available-for-sale)			22,811				—				—				22,811
Auction rate securities (trading)			37,044				—				—				37,044
Auction rate securities rights			3,704				—				—				3,704
Restricted investments			42,400				42,400				—				—
Total assets measured at fair value		$	276,153			$	212,594			$	—			$	63,559

     The following table presents our assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3):

		(Level 3)
		(In thousands)
Balance at December 31, 2008		$	65,076
Transfers to Level 3			—
Auction rate securities rights			(3,204	)
Total gains (unrealized):
Included in earnings			3,509
Included in other comprehensive income			528
Settlements			(2,350	)
Balance at September 30, 2009		$	63,559
The amount of total gains for the period included in other comprehensive income attributable to the change in unrealized gains relating to assets still held at September 30, 2009		$	528

6. Investments

     The following tables summarize our investments as of the dates indicated:

		September 30, 2009
		Cost or				Gross								Estimated
		Amortized				Unrealized								Fair
		Cost				Gains				Losses				Value
						(In thousands)
Municipal securities (including auction rate securities)		$	82,261			$	3,291			$	4,446			$	81,106
U.S. government agency securities			88,098				788				173				88,713
U.S. treasury securities			21,818				143				15				21,946
Certificates of deposit			2,885				—				—				2,885
Corporate debt securities			35,350				261				212				35,399
		$	230,412			$	4,483			$	4,846			$	230,049

		December 31, 2008
		Cost or				Gross								Estimated
		Amortized				Unrealized								Fair
		Cost				Gains				Losses				Value
						(In thousands)
Municipal securities (including auction rate securities)		$	85,973			$	23			$	5,313			$	80,683
U.S. government agency securities			93,994				1,309				79				95,224
U.S. treasury securities			8,604				295				—				8,899
Certificates of deposit			13,494				—				—				13,494
Corporate debt securities			50,315				155				731				49,739
		$	252,380			$	1,782			$	6,123			$	248,039

The contractual maturities of our investments as of September 30, 2009 are summarized below.

		Amortized				Estimated
		Cost				Fair Value
		(In thousands)
Due in one year or less		$	79,113			$	79,171
Due one year through five years			89,850				90,587
Due after five years through ten years			1,430				1,403
Due after ten years			60,019				58,888
		$	230,412			$	230,049

     Gross realized gains and gross realized losses from sales of available-for-sale securities are calculated under the specific identification method and are included in investment income. Total proceeds from sales of available-for-sale securities were $66.9 million and $50.9 million for the three month periods ended September 30, 2009, and 2008, respectively. Total proceeds from sales of available-for-sale securities were $148.8 million and $187.7 million for the nine month periods ended September 30, 2009, and 2008, respectively. Net realized investment gains for the three months ended September 30, 2009, and 2008 were $56,000 and $31,000 respectively. Net realized investment gains for the nine months ended September 30, 2009, and 2008 were $251,000, and $164,000 respectively.

     We monitor our investments for other-than-temporary impairment. For investments other than our municipal securities, we have determined that unrealized gains and losses at September 30, 2009, and December 31, 2008, are temporary in nature, because the change in market value for these securities has resulted from fluctuating interest rates, rather than a deterioration of the credit worthiness of the issuers. So long as we hold these securities to maturity, we are unlikely to experience gains or losses. In the event that we dispose of these securities before maturity, we expect that realized gains or losses, if any, will be immaterial.

     Our investment in municipal securities consists primarily of auction rate securities. As described in Note 5, “Fair Value Measurements,” the unrealized losses on these investments were caused primarily by the illiquidity in the auction markets. Because the decline in market value is not due to the credit quality of the issuers, and because we do not intend to sell, nor is it more likely than not that we will be required to sell, these investments before recovery of their cost, we do not consider the auction rate securities that are designated as available-for-sale to be other-than-temporarily impaired at September 30, 2009.

     The following table segregates those available-for-sale investments that have been in a continuous loss position for less than 12 months, and those that have been in a loss position for 12 months or more as of September 30, 2009.

		In a Continuous Loss								In a Continuous Loss
		Position								Position
		for Less than 12 Months								for 12 Months or More								Total
		Estimated								Estimated								Estimated
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Losses				Value				Losses				Value				Losses
										(In thousands)
Municipal securities		$	8,484			$	36			$	24,818			$	4,251			$	33,302			$	4,287
U.S. government agency securities			15,843				137				6,129				36				21,972				173
Corporate debt securities			9,653				65				3,783				147				13,436				212
U.S. treasury securities			4,064				11				552				3				4,616				14
		$	38,044			$	249			$	35,282			$	4,437			$	73,326			$	4,686

7. Receivables

     Receivables consist primarily of amounts due from the various states in which we operate. All receivables are subject to potential retroactive adjustment. Because the amounts of all receivables are readily determinable and our creditors are in almost all instances state governments, our allowance for doubtful accounts is immaterial. Any amounts determined to be uncollectible are charged to expense when such determination is made. Accounts receivable by health plan operating subsidiary were as follows:

		September 30,				December 31,
		2009				2008
		(In thousands)
California		$	30,309			$	20,740
Michigan			12,088				6,637
Missouri			22,552				24,024
New Mexico			10,810				5,712
Ohio			38,242				34,562
Utah			16,477				20,614
Washington			11,663				14,184
Others			1,988				2,089
Total receivables		$	144,129			$	128,562

     Ohio. As of September 30, 2009, the receivable due our Ohio health plan included two significant components. The first is approximately $6.6 million of accrued birth income, net, due from the state of Ohio. Birth income is a one-time payment for the birth of a child from the Medicaid program in Ohio.

     The second significant component of the Ohio receivable is approximately $25.0 million due from a capitated provider group. Although we have a capitation arrangement with this provider group, our agreement with them calls for us to pay for certain medical services incurred by the provider group’s members, and then to deduct the amount of such payments from future monthly capitation amounts owed to the provider group. Of the $25.0 million receivable, approximately $16.4 million represents medical services we have paid on behalf of the provider group, which we will deduct from capitation payments in the months of October and November of 2009. The other component of the Ohio receivable includes an estimate of our liability for claims incurred by members of this provider group, not covered by capitation, for which we have not yet made payment. This amount totaled $8.5 million as of September 30, 2009. The offsetting liability for the amount of this receivable established for claims incurred but not paid is included in “Medical claims and benefits payable” in our consolidated balance sheets. As part of the agreement with this provider group, our Ohio health plan has withheld approximately $8.2 million from capitation payments due the group, which funds are held in an escrow account. The Ohio health plan is entitled to the escrow amount if the provider group is unable to repay amounts owed to us for these incurred but not reported claims. The escrow account is included in “Restricted investments” in our consolidated balance sheets. During the nine months ended September 30, 2009, our average monthly capitation payment to this provider group was approximately $14 million.

     Utah. Prior to September 1, 2009, our Utah health plan’s agreement with the state of Utah called for the reimbursement of medical costs incurred in serving our members plus an administrative fee for a specified percentage of that medical cost amount (which was formerly 9% and most recently 6.5%), plus a portion of any cost savings realized as defined in the agreement. Our Utah health plan billed the state of Utah monthly for actual paid health care claims plus administrative fees. Prior to September 1, 2009, our receivable balance from the state of Utah included: (1) amounts billed to the state for actual paid health care claims plus administrative fees; and (2) amounts estimated for incurred but not reported claims, which, along with the related administrative fees, were not billable to the state of Utah until such claims are actually paid. Effective September 1, 2009, the Utah health plan’s agreement with the state of Utah became a prepaid capitation contract, under which the plan will be paid a fixed per member, per month amount, resulting in a decline of the receivable as of September 30, 2009.

8. Business Purchase Transactions

     Missouri subsidiary. Effective November 1, 2007, we acquired Mercy CarePlus, a licensed Medicaid managed care plan based in St. Louis, Missouri, to expand our market share within our core Medicaid managed care business. The $80.0 million purchase price was subject to certain post-closing adjustments. During the third quarter of 2009, we paid the sellers $2.5 million to settle all outstanding issues relating to the post-closing adjustments. This amount was recorded to “Goodwill and intangible assets, net” in the accompanying condensed consolidated balance sheets.

     Florida subsidiary. In August 2008, we announced our intention to acquire Florida NetPASS, LLC (“NetPASS”), a provider of care management and administrative services at that time to approximately 58,000 Florida MediPass members in south and central Florida. As of September 30, 2009, we had transitioned approximately 43,000 members to our Florida health plan. Year to date in 2009, we have recorded $25.1 million to “Goodwill and intangible assets, net,” for the assets acquired. Of this total, $5.4 million was a cash payment in the third quarter of 2009. We expect the transition of the NetPASS members and the final payments of the purchase price, if any, to be completed by the second quarter of 2010.

     Texas subsidiary. In late September 2009, the Texas health plan acquired certain CHIP contracts for $3 million. This amount is included in “Goodwill and intangible assets, net.”

9. Restricted Investments

     Restricted investments, which consist of certificates of deposit and treasury securities, are designated as held-to-maturity and are carried at amortized cost, which approximates market value. The use of these funds is limited to specific purposes as required by each state, or as protection against the insolvency of capitated providers. We have the ability to hold our restricted investments until maturity and, as a result, we would not expect the value of these

investments to decline significantly due to a sudden change in market interest rates. The following table presents the balances of restricted investments by health plan, and by our insurance company:

		Sept. 30,				December 31,
		2009				2008
		(In thousands)
California		$	368			$	367
Florida			10,569				9,828
Insurance Company			4,694				4,718
Michigan			1,000				1,000
Missouri			503				506
Nevada			790				787
New Mexico			13,119				9,670
Ohio			9,020				8,459
Texas			1,504				1,521
Utah			581				577
Washington			151				151
Other			101				618
Total		$	42,400			$	38,202

     The contractual maturities of our held-to-maturity restricted investments as of September 30, 2009 are summarized below.

		Amortized				Estimated
		Cost				Fair Value
		(In thousands)
Due in one year or less		$	41,754			$	41,803
Due one year through five years			503				505
Due after five years through ten years			143				158
Due after ten years			—				—
		$	42,400			$	42,466

10. Other Assets

     Other assets include deferred financing costs associated with long-term debt, certain investments held in connection with our employee deferred compensation program, and an investment in a vision services provider (see Note 14, “Related Party Transactions”). The deferred financing costs are being amortized on a straight-line basis over the seven-year term of the convertible senior notes maturing in 2014. Other assets declined in the nine months ended September 30, 2009, primarily due to the reclassification to goodwill and intangible assets of the $9.0 million initial payment for the acquisition of Florida NetPASS.

11. Convertible Senior Notes

     In October 2007, we completed our offering of $200.0 million aggregate principal amount of 3.75% Convertible Senior Notes due 2014 (the “Notes”). The sale of the Notes resulted in net proceeds totaling $193.4 million. The Notes rank equally in right of payment with our existing and future senior indebtedness.

     The Notes are convertible into cash and, under certain circumstances, shares of our common stock. The initial conversion rate is 21.3067 shares of our common stock per one thousand dollar principal amount of the Notes. This represents an initial conversion price of approximately $46.93 per share of our common stock. In addition, if certain corporate transactions that constitute a change of control occur prior to maturity, we will increase the conversion rate in certain circumstances. Prior to July 2014, holders may convert their Notes only under the following circumstances (none of which have occurred to date as of September 30, 2009):

	•		During any fiscal quarter after our fiscal quarter ended December 31, 2007, if the closing sale price per share of our common stock, for each of at least 20 trading days during the period of 30 consecutive trading days ending on the last trading day of the previous fiscal quarter, is greater than or equal to 120% of the conversion price per share of our common stock;
	•		During the five business day period immediately following any five consecutive trading day period in which the trading price per one thousand dollar principal amount of the Notes for each trading day of such period

			was less than 98% of the product of the closing price per share of our common stock on such day and the conversion rate in effect on such day; or
	•		Upon the occurrence of specified corporate transactions or other specified events.

     On or after July 1, 2014, holders may convert their Notes at any time prior to the close of business on the scheduled trading day immediately preceding the stated maturity date regardless of whether any of the foregoing conditions is satisfied.

     We will deliver cash and shares of our common stock, if any, upon conversion of each $1,000 principal amount of Notes, as follows:

	•		An amount in cash (the “principal return”) equal to the sum of, for each of the 20 Volume-Weighted Average Price (VWAP) trading days during the conversion period, the lesser of the daily conversion value for such VWAP trading day and fifty dollars (representing 1/20th of one thousand dollars); and
	•		A number of shares based upon, for each of the 20 VWAP trading days during the conversion period, any excess of the daily conversion value above fifty dollars.

     Adoption of ASC Subtopic 470-20. Effective January 1, 2009, we adopted ASC Subtopic 470-20. This standard has changed our accounting treatment of the Notes, resulting in an increase to non-cash interest expense beginning on January 1, 2009. We have also recast prior periods, beginning with the year ended December 31, 2007, the year in which the Notes were issued.

     ASC Subtopic 470-20 requires the proceeds from the issuance of the Notes to be allocated between a liability component and an equity component. We have determined that the effective interest rate is 7.5%, principally based on the seven-year U.S. treasury note rate as of the October 2007 issuance date, plus an appropriate credit spread. The resulting debt discount is being amortized over the period the Notes are expected to be outstanding, as additional non-cash interest expense. As of September 30, 2009, we expect the Notes to be outstanding until their October 1, 2014 maturity date, for a remaining amortization period of 60 months. The Notes’ if-converted value did not exceed their principal amount as of September 30, 2009. The following table provides the details of the amounts recorded under ASC Subtopic 470-20:

		As of				As of
		Sept. 30,				December 31,
		2009				2008
		(In thousands)
Details of the liability component:
Principal amount		$	187,000			$	200,000
Unamortized discount			(29,319	)			(35,127	)
Net carrying amount		$	157,681			$	164,873

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2009				2008				2009				2008
		(In thousands)
Interest cost recognized for the period relating to the:
Contractual interest coupon rate of 3.75%		$	1,753			$	1,875			$	5,323			$	5,625
Amortization of the discount on the liability component			1,197				1,187				3,563				3,497
Total interest cost recognized		$	2,950			$	3,062			$	8,886			$	9,122

     Securities Purchase Program. Under the $25 million securities purchase program announced in January 2009, we purchased and retired $13.0 million face amount of our convertible senior notes during the first quarter. We purchased the notes at an average price of $74.25 per $100 principal amount, for a total of $9.8 million, including accrued interest. The gain recognized during the quarter ended March 31, 2009 on the purchase of the notes was $1.5 million, or approximately $0.04 per diluted share.

     In March 2009, our board of directors authorized the purchase of up to an additional $25 million in aggregate of either our common stock or our convertible senior notes. The purchase program is funded with working capital, and purchases may be made from time to time on the open market or through privately negotiated transactions. The purchase program extends through December 31, 2009, but we reserve the right to suspend or discontinue the program at any time. See the details regarding the stock purchases at Note 12, “Stockholders’ Equity.”

12. Stockholders’ Equity

     Under the purchase programs described in Note 11, “Convertible Senior Notes,” we have purchased approximately 1.4 million shares of our common stock for $27.7 million (average cost of approximately $20.49 per share), year to date. These purchases have increased diluted earnings per share for the nine months ended September 30, 2009 by $0.04. Approximately $12.7 million of the $27.7 million treasury shares purchased year to date, and $20.4 million purchased in prior years, were retired in the third quarter of 2009 resulting in a reduction of additional paid-in capital as of September 30, 2009 compared with December 31, 2008.

     On March 1, 2009, we awarded 364,700 shares of restricted stock to our officers and employees, primarily in connection with our annual long-term incentive compensation program. These shares will vest in equal annual installments over the four-year period following the date of grant. During the nine months ended September 30, 2009, we issued approximately 103,000 shares (net of shares withheld to settle taxes) in connection with vested restricted stock awards. See Note 4, “Stock-Based Compensation,” for further information regarding share-based compensation.

13. Commitments and Contingencies

Legal

     The health care industry is subject to numerous laws and regulations of federal, state, and local governments. Compliance with these laws and regulations can be subject to government review and interpretation, as well as regulatory actions unknown and unasserted at this time. Penalties associated with violations of these laws and regulations include significant fines and penalties, exclusion from participating in publicly-funded programs, and the repayment of previously billed and collected revenues.

     We are involved in various legal actions in the normal course of business, some of which seek monetary damages, including claims for punitive damages, which are not covered by insurance. These actions, when finally concluded and determined, are not likely, in our opinion, to have a material adverse effect on our business, consolidated financial position, results of operations, or cash flows.

Provider Claims

     Many of our medical contracts are complex in nature and may be subject to differing interpretations regarding amounts due for the provision of various services. Such differing interpretations have led certain medical providers to pursue us for additional compensation. The claims made by providers in such circumstances often involve issues of contract compliance, interpretation, payment methodology, and intent. These claims often extend to services provided by the providers over a number of years.

     Various providers have contacted us seeking additional compensation for claims that we believe to have been settled. These matters, when finally concluded and determined, will not, in our opinion, have a material adverse effect on our business, consolidated financial position, results of operations, or cash flows.

Regulatory Capital and Dividend Restrictions

     Our principal operations are conducted through our health plans operating in California, Florida, Michigan, Missouri, Nevada, New Mexico, Ohio, Texas, Utah, and Washington. Our health plans are subject to state regulations that, among other things, require the maintenance of minimum levels of statutory capital, as defined by each state, and restrict the timing, payment, and amount of dividends and other distributions that may be paid to us as the sole stockholder. To the extent the health plans must comply with these regulations, they may not have the financial flexibility to transfer funds to us. The net assets in these health plans (after intercompany eliminations), which may not be transferable to us in the form of cash dividends, loans, or advances, were $352.1 million at September 30, 2009 and $355.0 million at December 31, 2008. The National Association of Insurance Commissioners, or NAIC, adopted model rules effective December 31, 1998, which, if implemented by a state, set minimum capitalization requirements for insurance companies, health plans, and other entities bearing risk for health care coverage. The requirements take the form of risk-based capital, or RBC, rules. Michigan, Nevada, New Mexico, Ohio, Texas, Utah, and Washington have adopted these rules, although the rules as adopted may vary somewhat from state to state. California, Florida, and Missouri have established their own minimum capitalization requirements for insurance companies.

     As of September 30, 2009, our health plans had aggregate statutory capital and surplus of approximately $363.4 million, compared with the required minimum aggregate statutory capital and surplus of approximately $213.3 million. All of our health plans were in compliance with the minimum capital requirements at September 30, 2009. We have the ability and commitment to provide additional capital to each of our health plans when necessary to ensure that they continue to meet statutory and regulatory capital requirements.

14. Related Party Transactions

     We have an equity investment in a medical service provider that provides certain vision services to our members. We account for this investment under the equity method of accounting because we have an ownership interest in the investee that provides us with significant influence over operating and financial policies of the investee. As of September 30, 2009 and December 31, 2008, our carrying amount for this investment totaled $3.8 million and $3.6 million, respectively. For the three months ended September 30, 2009 and 2008, we paid $4.5 million and $4.1 million, respectively, for medical service fees to this provider. For the nine months ended September 30, 2009 and 2008, we paid $15.0 million and $11.2 million, respectively, for medical service fees to this provider.

     We are a party to a fee-for-service agreement with Pacific Hospital of Long Beach (“Pacific Hospital”). Pacific Hospital is owned by Abrazos Healthcare, Inc., the shares of which are held as community property by the husband of Dr. Martha Bernadett, our Executive Vice President, Research and Development. Amounts paid under the terms of this fee-for-service agreement were $0.5 million and $0.1 million for the nine months ended September 30, 2009, and 2008, respectively. We also have a capitation arrangement with Pacific Hospital, where we pay a fixed monthly fee based on member type. We paid Pacific Hospital for capitation services totaling approximately $0.8 million and $3.2 million for the nine months ended September 30, 2009, and 2008, respectively. We believe that both arrangements with Pacific Hospital are based on prevailing market rates for similar services.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Forward Looking Statements

     This quarterly report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, or Securities Act, and Section 21E of the Securities Exchange Act of 1934, or Securities Exchange Act. All statements, other than statements of historical facts, that we include in this quarterly report may be deemed to be forward-looking statements for purposes of the Securities Act and the Securities Exchange Act. We use the words “anticipate(s),” “believe(s),” “estimate(s),” “expect(s),” “intend(s),” “may,” “plan(s),” “project(s),” “will,” “would” and similar expressions to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We cannot guarantee that we will actually achieve the plans, intentions, or expectations disclosed in our forward-looking statements and, accordingly, you should not place undue reliance on our forward-looking statements. There are a number of important factors that could cause actual results or events to differ materially from the forward-looking statements that we make. You should read these factors and the other cautionary statements as being applicable to all related forward-looking statements wherever they appear in this quarterly report. We caution you that we do not undertake any obligation to update forward-looking statements made by us. Forward-looking statements involve known and unknown risks and uncertainties that may cause our actual results in future periods to differ materially from those projected or contemplated as a result of, but not limited to, risk factors related to the following:

	•		both the 2009 H1N1 flu and the seasonal flu, including utilization rates that are materially elevated above historical seasonal patterns;
	•		budgetary pressures on the federal and state governments and their resulting inability to fully fund Medicaid, Medicare, or CHIP or to maintain current membership eligibility levels, thresholds, or criteria;
	•		the potential need to establish a premium deficiency reserve for the California health plan’s Los Angeles contract if future results establish a need for such a reserve;
	•		the successful management of our medical costs and the achievement of our projected medical care ratios in all our health plans;
	•		changes made in provider rates or in Medicaid benefits (including pharmacy benefits) that are not commensurate with the changes made in premium rates paid to our health plans;
	•		the success of our efforts to leverage our administrative costs to address the needs associated with increased enrollment;
	•		growth in our Medicaid and Medicare enrollment consistent with our expectations;
	•		uncertainties regarding the impact of federal and state health care reform efforts;
	•		our ability to accurately estimate incurred but not reported medical costs across all health plans;
	•		rate revisions and the maintenance of existing rate levels that are consistent with our expectations;
	•		our inability to pass on to our contracted providers any rate cuts under our governmental contracts, including the reduction in provider payment levels under the Washington Medicaid fee schedule that is commensurate with the reduced rates paid to our Washington health plan;
	•		the successful renewal and continuation of the government contracts of all of our health plans;
	•		the relatively small number of states in which we operate health plans and the impact on the consolidated entity of adverse developments in any single health plan;
	•		the transition from a non-risk to a risk-based capitation contract by our Utah health plan;
	•		our limited experience operating in Florida;
	•		the availability of financing to fund and capitalize our acquisitions and start-up activities and to meet our liquidity needs;
	•		the illiquidity of our auction rate securities;

	•		restrictions and covenants in our credit facility and adverse credit and equity market conditions;
	•		governmental audits and reviews;
	•		the successful and cost-effective integration of our acquisitions;
	•		our information and medical management systems, including the migration of our primary data center to our New Mexico IT facility;
	•		earnings seasonality that is contrary to our expectations;
	•		retroactive adjustments of premium revenue;
	•		interest rates on invested balances that are lower than expected;
	•		high profile qui tam matters and negative publicity regarding Medicaid managed care and Medicare Advantage;
	•		changes in funding under our contracts as a result of regulatory and programmatic adjustments and reforms;
	•		approval by state regulators of dividends and distributions by our subsidiaries;
	•		unexpected changes in member utilization patterns, healthcare practices, or healthcare technologies;
	•		high dollar claims related to catastrophic illness;
	•		a state’s failure to renew its federal Medicaid waiver;
	•		changes in federal or state laws or regulations or in their interpretation;
	•		the favorable resolution of litigation or arbitration matters;
	•		announcements by government officials or our competitors or peers relating to our business or industry;
	•		an unauthorized disclosure of confidential member information;
	•		changes generally affecting the managed care industry; and
	•		general economic conditions, including unemployment rates.

     Investors should refer to Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2008, and to Part II, Item 1A — Risk Factors, in our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2009, and June 30, 2009, and in this Quarterly Report, for a discussion of certain risk factors which could materially affect our business, financial condition, cash flows, or results of operations. Given these risks and uncertainties, we can give no assurances that any results or events projected or contemplated by our forward-looking statements will in fact occur and we caution investors not to place undue reliance on these statements.

     This document and the following discussion of our financial condition and results of operations should be read in conjunction with the accompanying consolidated financial statements and the notes to those statements appearing elsewhere in this report and the audited financial statements and Management’s Discussion and Analysis appearing in our Annual Report on Form 10-K for the year ended December 31, 2008.

Adoption of Convertible Debt Accounting

     Our 2008 consolidated financial statements have been recast to reflect the adoption of FASB Accounting Standards Codification (FASC) 470-20, Debt with Conversion and Other Options. This resulted in additional interest expense of $1.2 million ($0.03 per diluted share) for the three months ended September 30, 2008, and $3.5 million ($0.08 per diluted share) for the nine months ended September 30, 2008.

Overview

     Our financial performance for the three and nine months ended September 30, 2009 compared with the same prior year periods is briefly summarized as follows:

		Three Months Ended September 30,								Nine Months Ended September 30,
		2009				2008				2009				2008
		(Dollar amounts in thousands, except per-share data)
Earnings per diluted share		$	0.33			$	0.60			$	1.36			$	1.59
Premium revenue		$	914,805			$	791,554			$	2,697,796			$	2,282,345
Operating income		$	16,274			$	30,429			$	61,115			$	85,138
Net income		$	8,564			$	16,480			$	35,340			$	44,778
Medical care ratio			86.7	%			84.6	%			86.5	%			84.9	%
G&A expenses as a percentage of total revenue			10.7	%			11.1	%			10.5	%			11.0	%
Total ending membership			1,411,000				1,239,000				1,411,000				1,239,000

Health Plan Contracts

     Texas health plan. In late September 2009, our Texas health plan acquired certain CHIP contracts for $3 million. Effective October 1, 2009, we transitioned approximately 9,000 CHIP members from another health plan to the Texas health plan under these contracts.

     Utah health plan. Effective September 1, 2009, the Utah health plan’s contract with the state of Utah became a prepaid capitation contract, under which the plan will be paid a fixed per member per month, or PMPM, amount. Prior to September 1, 2009, our Utah health plan’s agreement with the state of Utah called for the reimbursement of medical costs incurred in serving our members plus an administrative fee for a specified percentage of that medical cost amount (which was formerly 9% and most recently 6.5%), plus a portion of any cost savings realized as defined in the agreement.

     Nevada health plan. Effective December 31, 2009, we will no longer serve members in Nevada.

Revenue

     Premium revenue is fixed in advance of the periods covered and, except as described below, is not generally subject to significant accounting estimates. For the nine months ended September 30, 2009, we received approximately 91% of our premium revenue as a fixed amount PMPM pursuant to our Medicaid contracts with state agencies, our Medicare contracts with the Centers for Medicare and Medicaid Services (CMS), and our contracts with other managed care organizations for which we operate as a subcontractor. These premium revenues are recognized in the month that members are entitled to receive health care services. The state Medicaid programs and the federal Medicare program periodically adjust premium rates.

     The amount of the premiums paid to us may vary substantially between states and among various government programs. PMPM premiums for members of the Children’s Health Insurance Program (CHIP) are generally among our lowest, with rates as low as approximately $75 PMPM in California. Premium revenues for Medicaid members are generally higher. Among the Temporary Aid for Needy Families (TANF) Medicaid population — the Medicaid group that includes most mothers and children — PMPM premiums range between approximately $100 in California to over $250 in Missouri and New Mexico. Among our Medicaid Aged, Blind or Disabled (ABD) membership, PMPM premiums range from approximately $425 in California to over $1,000 in Ohio. Medicare premiums are approximately $1,200 PMPM, with Medicare revenue totaling $95.9 million and $72.4 million, for the nine months ended September 30, 2009, and 2008, respectively.

     Approximately 4% of our premium revenue for the nine months ended September 30, 2009 was realized under a Medicaid cost-plus reimbursement agreement that our Utah health plan had with that state prior to September 1, 2009. For the nine months ended September 30, 2009, we also received approximately 5% of our premium revenue in the form of “birth income” — a one-time payment for the birth of a child — from the Medicaid programs in Michigan, Missouri, Ohio, Texas, and Washington. Such payments are recognized as revenue in the month the birth occurs.

     Certain components of premium revenue are subject to accounting estimates. Chief among these are (1) that portion of premium revenue paid to our New Mexico health plan by the state of New Mexico that may be refunded to the state if certain minimum amounts are not expended on defined medical care costs, or if administrative costs or profit (as defined) exceed certain amounts, (2) that portion of the revenue of our Ohio health plan that is at risk if

certain performance measures are not met, (3) the additional premium revenue our Utah health plan is entitled to receive from the state of Utah as an incentive payment for saving the state of Utah money in relation to fee-for-service Medicaid for services provided prior to September 1, 2009, (4) the profit-sharing agreement between our Texas health plan and the state of Texas, where we pay a rebate to the state of Texas if our Texas health plan generates pretax income above a certain specified percentage, according to a tiered rebate schedule, and (5) that portion of our Medicare revenue that is subject to retroactive adjustment for member risk adjustment and recoupment of pharmacy related revenue.

     Our contract with the state of New Mexico requires that we spend a minimum percentage of premium revenue on certain explicitly defined medical care costs (the medical cost floor). During the nine months ended September 30, 2008, we recorded adjustments totaling $12.9 million to increase premium revenue associated with this requirement. The revenue resulted from a reversal of previously recorded amounts due the state of New Mexico when we were below the minimum percentage.

     Effective July 1, 2008, our New Mexico health plan entered into a new three year contract that, in addition to retaining the medical cost floor, added certain limits on the amount our New Mexico health plan can: (1) expend on administrative costs; and (2) retain as profit. At September 30, 2009, there was no liability recorded under the terms of these contract provisions. Any changes to the terms of these provisions, including revisions to the definitions of premium revenue, medical care costs, administrative costs or profit, the period of time over which performance is measured or the manner of its measurement, or the percentages used in the calculations, may trigger a change in the amounts owed. If the state of New Mexico disagrees with our interpretation of the existing contract terms, an adjustment to the amounts owed may be required.

     The rates paid to our Michigan health plan were increased by approximately 2.6% effective as of October 1, 2009.

     Under our contract with the state of Ohio, up to 1% of our Ohio health plan’s revenue may be refundable to the state if certain performance measures are not met. At September 30, 2009, we had no recorded liability under the terms of this contract provision.

     In prior years, we estimated amounts we believed were recoverable under our savings sharing agreement with the state of Utah based on available information and our interpretation of our contract with the state. The state may not agree with our interpretation or our application of the contract language, and it may also not agree with the manner in which we have processed and analyzed our member claims and encounter records. Thus, the ultimate amount of savings sharing revenue that we realize from prior years, if any, may be subject to negotiation with the state. Our Utah health plan continues to work with the state to assure an appropriate determination of amounts due to us under the savings share agreement. When additional information is known, or agreement is reached with the state regarding the appropriate savings sharing payment amount for prior years, if any, we will adjust the amount of savings sharing revenue recorded in our financial statements as appropriate in light of such new information or agreement.

     As of September 30, 2009, we had a liability of approximately $7.2 million accrued pursuant to our profit-sharing agreement with the state of Texas for the 2009 contract year (ending August 31, 2009) and the 2010 contract year (ending August 31, 2010). During the nine months ended September 30, 2009, we paid the state of Texas $9.7 million relating to the 2008 contract year; the 2007 contract year is closed. Because the final settlement calculations include a claims run-out period of nearly one year, the amounts recorded, based on our estimates, may be adjusted.

     Medicare revenue paid to us is subject to retroactive adjustment for both member risk scores and member pharmacy cost experience. Based on member encounter data that we submit to the Centers for Medicare and Medicaid Services (CMS), our Medicare revenue is subject to adjustment for up to two years after the original year of service. This adjustment takes into account the acuity of each member’s medical needs relative to what was anticipated when premiums were originally set for that member. In the event that our membership (measured on an individual by individual basis) requires less acute medical care than was anticipated by the original premium amount, CMS may recover premium from us. In the event that our membership requires more acute medical care than was anticipated by the original premium amount, CMS may pay us additional retroactive premium. A similar retroactive reconciliation is undertaken by CMS for our Medicare members’ pharmacy utilization. That analysis is similar to the process for the adjustment of member risk scores, but is further complicated by member pharmacy cost sharing provisions attached to the Medicare pharmacy benefit that do not apply to the services measured by the member risk adjustment process. We estimate the amount of Medicare revenue that will ultimately be realized for the periods presented based on our knowledge of our members’ heath care utilization patterns and CMS practices. To the extent that the premium revenue ultimately received from CMS differs from recorded amounts, we will adjust reported Medicare revenue.

     Historically, membership growth has been the primary reason for our increasing revenues, although more recently our revenues have also grown due to the more care intensive benefits and related higher premiums associated with our ABD and Medicare members. We have increased our membership through both internal growth and acquisitions. The following table sets forth the approximate total number of members by state health plan as of the dates indicated:

		Sept. 30,				December 31,				Sept. 30,
		2009				2008				2008
Total Ending Membership by Health Plan:
California			355,000				322,000				313,000
Florida (1)			43,000				—				—
Michigan			210,000				206,000				207,000
Missouri			78,000				77,000				77,000
Nevada (2)			300				700				600
New Mexico			90,000				84,000				84,000
Ohio			208,000				176,000				179,000
Texas			31,000				31,000				29,000
Utah			69,000				61,000				55,000
Washington			327,000				299,000				295,000
Total			1,411,300				1,256,700				1,239,600
Total Ending Membership by State for the Medicare Advantage Plans:
California			1,900				1,500				1,600
Michigan			2,700				1,700				1,700
Nevada			300				700				600
New Mexico			400				300				200
Texas			500				400				400
Utah			3,500				2,400				2,200
Washington			1,100				1,000				1,000
Total			10,400				8,000				7,700
Total Ending Membership by State for the Aged, Blind or Disabled Population:
California			13,700				12,700				12,500
Florida (1)			8,700				—				—
Michigan			30,200				30,300				30,400
New Mexico			5,700				6,300				6,500
Ohio			19,600				19,000				19,700
Texas			17,500				16,200				16,200
Utah			7,700				7,300				7,000
Washington			3,200				3,000				3,000
Total			106,300				94,800				95,300

The following table provides details of member months (defined as the aggregation of each month’s ending membership for the period) by health plan for the periods indicated:

		Three Months Ended								% of				Nine Months Ended								% of
		September 30,								Increase				September 30,								Increase
		2009				2008				(Decrease)				2009				2008				(Decrease)
California			1,065,000				936,000				13.8	%			3,076,000				2,765,000				11.2
Florida (1)			109,000				—				—				245,000				—				—
Michigan			629,000				627,000				0.3				1,872,000				1,904,000				(1.7	)
Missouri			232,000				228,000				1.8				695,000				678,000				2.5
Nevada			1,000				2,000				(50.0	)			3,000				6,000				(50.0	)
New Mexico			264,000				249,000				6.0				763,000				716,000				6.6
Ohio			618,000				530,000				16.6				1,774,000				1,465,000				21.1
Texas			93,000				87,000				6.9				283,000				257,000				10.1
Utah			203,000				161,000				26.1				587,000				482,000				21.8
Washington			979,000				884,000				10.7				2,850,000				2,622,000				8.7
Total			4,193,000				3,704,000				13.2	%			12,148,000				10,895,000				11.5	%

Expenses

     Our operating expenses include expenses related to the provision of medical care services and general and administrative, or G&A, expenses. Our results of operations are impacted by our ability to effectively manage expenses related to medical care services and to accurately estimate costs incurred. Expenses related to medical care services are captured in the following four categories:

	•		Fee-for-service: Physician providers paid on a fee-for-service basis are paid according to a fee schedule set by the state or by our contracts with these providers. We pay hospitals on a fee-for-service basis in a variety of ways, including per diem amounts, diagnostic-related groups, or DRGs, percentage of billed charges, and case rates. We also pay a small portion of hospitals on a capitated basis. We also have stop-loss agreements with the hospitals with which we contract; under certain circumstances, we pay escalated charges in connection with these stop-loss agreements. Under all fee-for-service arrangements, we retain the financial responsibility for medical care provided. Expenses related to fee-for-service contracts are recorded in the period in which the related services are dispensed. The costs of drugs administered in a physician or hospital setting that are not billed through our pharmacy benefit managers are included in fee-for-service costs.
	•		Capitation: Many of our primary care physicians and a small portion of our specialists and hospitals are paid on a capitated basis. Under capitation contracts, we typically pay a fixed PMPM payment to the provider without regard to the frequency, extent, or nature of the medical services actually furnished. Under capitated contracts, we remain liable for the provision of certain health care services. Certain of our capitated contracts also contain incentive programs based on service delivery, quality of care, utilization management, and other criteria. Capitation payments are fixed in advance of the periods covered and are not subject to significant accounting estimates. These payments are expensed in the period the providers are obligated to provide services. The financial risk for pharmacy services for a small portion of our membership is delegated to capitated providers.
	•		Pharmacy: Pharmacy costs include all drug, injectibles, and immunization costs paid through our pharmacy benefit managers. As noted above, drugs and injectibles not paid through our pharmacy benefit managers are included in fee-for-service costs, except in those limited instances where we capitate drug and injectible costs.
	•		Other: Other medical care costs include medically related administrative costs, certain provider incentive costs, reinsurance cost, costs of operating our medical clinics, and other health care expense. Medically related administrative costs include, for example, expenses relating to health education, quality assurance, case management, disease management, 24-hour on-call nurses, and a portion of our information technology costs. Salary and benefit costs are a substantial portion of these expenses. For the nine month periods ended September 30, 2009 and 2008, medically related administrative costs were approximately $54.9 million and $56.2 million, respectively.

     The following table provides the details of our consolidated medical care costs for the periods indicated (dollars in thousands except PMPM amounts):

		Three months ended September 30,
		2009												2008
										% of												% of
		Amount				PMPM				Total				Amount				PMPM				Total
Fee for service		$	515,164			$	122.86				65.0	%		$	439,699			$	118.71				65.7	%
Capitation			140,551				33.52				17.7				113,920				30.76				17.0
Pharmacy			104,274				24.87				13.2				88,414				23.86				13.2
Other			32,782				7.82				4.1				27,322				7.38				4.1
Total		$	792,771			$	189.07				100.0	%		$	669,355			$	180.71				100.0	%