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 June 30, 2008

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 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):

     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 July 25, 2008, was approximately 27,468,000.

 

 

MOLINA HEALTHCARE, INC.

Index

Part I — Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 2008 (unaudited) and December 31, 2007			3
Consolidated Statements of Income for the three month and six month periods ended June 30, 2008 and 2007 (unaudited)			4
Consolidated Statements of Comprehensive Income for the three month and six month periods ended June 30, 2008 and 2007 (unaudited)			5
Consolidated Statements of Cash Flows for the six months ended June 30, 2008 and 2007 (unaudited)			6
Notes to Condensed Consolidated Financial Statements (unaudited)			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			17
Item 3. Quantitative and Qualitative Disclosures About Market Risk			36
Item 4. Controls and Procedures			37
Part II — Other Information
Item 1. Legal Proceedings			38
Item 1A. Risk Factors			38
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			39
Item 4. Submission of Matters to a Vote of Security Holders			40
Item 5. Other Information			40
Item 6. Exhibits			40
Signatures			41
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

PART I — FINANCIAL INFORMATION

Item 1: Financial Statements.

MOLINA HEALTHCARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

		June 30,				December 31,
		2008				2007
		(Unaudited)
		(Amounts in thousands, except per-share data)
ASSETS
Current assets:
Cash and cash equivalents		$	425,424			$	459,064
Investments			196,268				242,855
Receivables			113,597				111,537
Deferred income taxes			11,557				8,616
Prepaid expenses and other current assets			14,484				12,521
Total current assets			761,330				834,593
Property and equipment, net			59,191				49,555
Goodwill and intangible assets, net			204,182				207,223
Investments			66,786				—
Restricted investments			29,875				29,019
Receivable for ceded life and annuity contracts			28,143				29,240
Other assets			22,247				21,675
Total assets		$	1,171,754			$	1,171,305
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Medical claims and benefits payable		$	305,541			$	311,606
Accounts payable and accrued liabilities			61,872				69,266
Deferred revenue			50,170				40,104
Income taxes payable			11,137				5,946
Total current liabilities			428,720				429,922
Long-term debt			200,000				200,000
Deferred income taxes			5,297				10,136
Liability for ceded life and annuity contracts			28,143				29,240
Other long-term liabilities			17,139				14,529
Total liabilities			679,299				680,827
Stockholders’ equity:
Common stock, $0.001 par value; 80,000 shares authorized, outstanding 27,453 shares at June 30, 2008 and 28,444 shares at December 31, 2007			29				28
Preferred stock, $0.001 par value; 20,000 shares authorized, no shares issued and outstanding			—				—
Additional paid-in capital			191,326				185,808
Accumulated other comprehensive (loss) income			(2,975	)			272
Retained earnings			354,431				324,760
Treasury stock, at cost; 2,332 shares at June 30, 2008 and 1,201 shares at December 31, 2007			(50,356	)			(20,390	)
Total stockholders’ equity			492,455				490,478
Total liabilities and stockholders’ equity		$	1,171,754			$	1,171,305

See accompanying notes.

CONSOLIDATED STATEMENTS OF INCOME

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2008				2007				2008				2007
		(Amounts in thousands, except
		net income per share)
		(Unaudited)
Revenue:
Premium revenue		$	761,153			$	607,127			$	1,490,791			$	1,163,362
Investment income			5,338				6,761				12,742				13,429
Total revenue			766,491				613,888				1,503,533				1,176,791
Expenses:
Medical care costs			640,829				516,865				1,267,176				993,342
General and administrative expenses			87,074				67,208				165,166				130,596
Depreciation and amortization			8,330				6,749				16,482				13,192
Impairment charge on purchased software			—				782				—				782
Total expenses			736,233				591,604				1,448,824				1,137,912
Operating income			30,258				22,284				54,709				38,879
Interest expense			(2,307	)			(725	)			(4,579	)			(1,850	)
Income before income taxes			27,951				21,559				50,130				37,029
Provision for income taxes			11,435				8,245				20,459				14,123
Net income		$	16,516			$	13,314			$	29,671			$	22,906
Net income per share:
Basic		$	0.59			$	0.47			$	1.05			$	0.81
Diluted		$	0.59			$	0.47			$	1.05			$	0.81
Weighted average shares outstanding:
Basic			27,997				28,233				28,229				28,192
Diluted			28,044				28,343				28,324				28,309

See accompanying notes.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2008				2007				2008				2007
		(Amounts in thousands)								(Amounts in thousands)
		(Unaudited)								(Unaudited)
Net income		$	16,516			$	13,314			$	29,671			$	22,906
Other comprehensive (loss) income, net of tax:
Unrealized (loss) gain on investments			(1,092	)			78				(3,247	)			196
Other comprehensive (loss) income			(1,092	)			78				(3,247	)			196
Comprehensive income		$	15,424			$	13,392			$	26,424			$	23,102

See accompanying notes.

CONSOLIDATED STATEMENTS OF CASH FLOWS

		Six Months Ended
		June 30,
		2008				2007
		(Amounts in thousands)
		(Unaudited)
Operating activities
Net income		$	29,671			$	22,906
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			16,482				13,192
Amortization of deferred financing costs			813				475
Deferred income taxes			(5,649	)			(4,763	)
Stock-based compensation			3,587				3,644
Changes in operating assets and liabilities:
Receivables			(2,060	)			4,526
Prepaid expenses and other current assets			(1,963	)			(1,353	)
Medical claims and benefits payable			(6,065	)			13,191
Deferred revenue			10,066				26,205
Accounts payable and accrued liabilities			(10,620	)			4,619
Income taxes			5,191				5,232
Net cash provided by operating activities			39,453				87,874
Investing activities
Purchases of equipment			(17,098	)			(10,440	)
Purchases of investments			(163,447	)			(42,816	)
Sales and maturities of investments			137,805				46,117
Increase in restricted cash			(856	)			(3,326	)
Cash paid in business purchase transaction			(1,000	)			—
Increase in other assets			(2,177	)			(864	)
Increase in other long-term liabilities			2,610				4,484
Net cash used in investing activities			(44,163	)			(6,845	)
Financing activities
Treasury stock purchases			(29,966	)			—
Repayment of amounts borrowed under credit facility			—				(15,000	)
Payment of credit facility fees			—				(475	)
Tax (expense) benefit from employee stock compensation recorded as additional paid-in capital			(156	)			642
Proceeds from exercise of stock options and employee stock purchases			1,192				1,656
Net cash used in financing activities			(28,930	)			(13,177	)
Net (decrease) increase in cash and cash equivalents			(33,640	)			67,852
Cash and cash equivalents at beginning of period			459,064				403,650
Cash and cash equivalents at end of period		$	425,424			$	471,502
Supplemental cash flow information
Cash paid during the period for:
Income taxes		$	20,307			$	9,715
Interest		$	3,892			$	2,041
Schedule of non-cash investing and financing activities:
Unrealized (loss) gain on investments		$	(5,443	)		$	312
Deferred taxes			2,196				(116	)
Net unrealized (loss) gain on investments		$	(3,247	)		$	196
Retirement of common stock used for stock-based compensation		$	(366	)		$	(117	)
Accrued purchases of equipment		$	1,595			$	354
Cumulative effect of adoption of Financial Interpretation No. 48, Accounting for Uncertainty in Income Taxes		$	—			$	445
Details of business purchase transaction:
Fair value of assets acquired		$	2,262			$	—
Common stock issued to seller			(1,262	)			—
Net cash paid in business purchase transaction		$	1,000			$	—
Business purchase transactions adjustments:
Accounts payable and accrued liabilities		$	1,265			$	—
Deferred taxes			65				873
Goodwill and intangible assets, net		$	1,330			$	873

See accompanying notes.

MOLINA HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
June 30, 2008

1. Basis of Presentation

Organization and Operations

     Molina Healthcare, Inc. (the “Company”) 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 State Children’s Health Insurance Program, or SCHIP. We also serve a small number of members who are dually eligible under both the Medicaid and the Medicare programs, and commencing in January 2007 we began to serve a small number of low-income Medicare members. We conduct our business primarily through nine licensed health plans in the states of California, Michigan, Missouri, Nevada, New Mexico, Ohio, Texas, Utah, and Washington. The health plans are locally operated by our respective wholly owned subsidiaries in those nine states, each of which is licensed as a health maintenance organization, or HMO.

     Our results of operations include the results of the November 1, 2007 acquisition of Mercy CarePlus, a Medicaid managed care organization based in St. Louis, Missouri.

Consolidated and Interim Financial Information

     The condensed consolidated financial statements include the accounts of the Company 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, which consist solely of normal recurring adjustments, have been included. All significant intercompany balances and transactions have been eliminated in consolidation. The condensed consolidated results of income for the current interim period are not necessarily indicative of the results for the entire year ending December 31, 2008. 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, 2007. Accordingly, certain disclosures that would substantially duplicate the disclosures contained in the December 31, 2007 audited consolidated financial statements have been omitted. These unaudited condensed consolidated interim financial statements should be read in conjunction with our December 31, 2007 audited financial statements. Certain 2007 amounts in the condensed consolidated statement of cash flows regarding stock-based compensation have been reclassified to conform to the 2008 presentation.

2. Significant Accounting Policies

Earnings Per Share

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

		Three Months Ended June 30,								Six Months Ended June 30,
		2008				2007				2008				2007
Shares outstanding at the beginning of the period			28,479,000				28,199,000				28,444,000				28,119,000
Weighted average number of treasury shares purchased			(489,000	)			—				(244,000	)			—
Weighted average number of shares issued under employee stock plans			7,000				34,000				29,000				74,000
Denominator for basic earnings per share			27,997,000				28,233,000				28,229,000				28,193,000
Dilutive effect of employee stock options and restricted stock			47,000				110,000				95,000				116,000
Denominator for diluted earnings per share			28,044,000				28,343,000				28,324,000				28,309,000

Stock-Based Compensation

     At June 30, 2008, 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 (net of tax) for the three and six months ended June 30, 2008 and 2007 was as follows:

		Three Months Ended								Six Months
		June 30,								Ended June 30,
		2008				2007				2008				2007
		(in thousands)
Stock options (including shares issued under our employee stock purchase plan)		$	452			$	567			$	817			$	1,086
Restricted stock awards			775				534				1,306				1,173
Total stock-based compensation expense, net of tax		$	1,227			$	1,101			$	2,123			$	2,259

     As of June 30, 2008, unrecognized compensation expense related to stock options totaled $2.6 million, which we expect to recognize over a weighted-average period of 2.2 years. Also as of June 30, 2008, unrecognized compensation expense related to restricted stock awards totaled $16.9 million, which we expect to recognize over a weighted-average period of 3.2 years.

     We account for stock-based compensation in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Share-Based Payment. Restricted stock awards are valued based on the closing market price of our common stock on the grant date. The Black-Scholes valuation model is used to estimate the fair value of stock options at grant date. The risk-free interest rate is based on the implied yield available at June 30, 2008 on U.S. treasury zero coupon issues for the expected option term. The expected volatility is based on historical volatility levels of our common stock. Beginning in the first quarter of 2008, we used an expected term for each option award based on historical experience of employee post-vesting exercise and termination behavior. Prior to 2008, the expected option term of each award granted was calculated using the “simplified method” in accordance with Staff Accounting Bulletin No. 107. This change did not produce materially different valuation results for the stock options awarded in the first half of 2008. For both restricted stock and stock option awards, the expense is recognized over the vesting period, generally straight-line over four years. The assumptions used in the Black-Scholes valuation model for options awarded in the three and six months ended June 30, 2008 and 2007 were as follows:

		Three Months Ended June 30,								Six Months Ended June 30,
		2008				2007				2008				2007
Risk-free interest rate			2.9	%			4.7	%			2.5	%			4.5	%
Expected volatility			45.7	%			48.7	%			45.3	%			48.8	%
Expected option term (in years)			4				6				4				6
Expected dividend yield		None				None				None				None
Grant date weighted-average fair value per share		$	9.68			$	16.96			$	12.80			$	16.54

Stock option activity for the six months ended June 30, 2008 was as follows:

														Weighted-
						Weighted-								Average
						Average				Aggregate				Remaining
						Exercise				Intrinsic				Contractual
		Options				Price				Value				Term
										(in thousands)				(in years)
Outstanding as of December 31, 2007			733,713			$	30.45
Granted			12,000				33.57
Exercised			(6,081	)			28.33			$	31
Forfeited			(32,475	)			35.43
Outstanding as of June 30, 2008			707,157			$	30.30			$	344				7.2
Exercisable and expected to vest as of June 30, 2008			652,701			$	30.17			$	344				7.1
Exercisable as of June 30, 2008			423,110			$	29.07			$	344				6.5

     Restricted stock activity for the six months ended June 30, 2008 was as follows:

						Weighted-
						Average				Aggregate
						Grant Date				Market
		Shares				Fair Value				Value
										(in thousands)
Unvested balance as of December 31, 2007			235,413			$	34.14
Granted			374,000				31.02			$	11,601
Vested			(52,061	)			30.92			$	1,524
Forfeited			(29,235	)			34.62
Unvested balance as of June 30, 2008			528,117			$	32.22

Impairment Charge

     During the six months ended June 30, 2007, an impairment charge of $782,000 was recorded related to commercial software no longer used for operations. No such charge occurred during the six months ended June 30, 2008.

New Accounting Pronouncements

     In May 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)(the “FSP”). The FSP requires the proceeds from the issuance of such convertible debt instruments to be allocated between a liability component and an equity component. The resulting debt discount is amortized over the period the convertible debt is expected to be outstanding, as additional non-cash interest expense. The change in accounting treatment is effective for fiscal years beginning after December 15, 2008, and shall be applied retrospectively to prior periods. The FSP changes the accounting treatment for our $200.0 million 3.75% Convertible Senior Notes due 2014, which were issued in October 2007 (see Note 6 to the condensed consolidated financial statements included in this quarterly report, “Long-Term Debt”). The impact of this new accounting treatment will result in an increase to non-cash interest expense beginning in fiscal year 2009 for financial statements covering past and future periods. Assuming a 7.9% interest rate, we have estimated the incremental impact of the FSP to our results of operations in 2009 to be $3.4 million, or $0.13 per diluted share, net of tax. This estimate assumes a 38% effective tax rate and 27 million diluted shares outstanding. We estimate the retroactive adjustment for prior periods will be approximately $0.8 million, or $0.02 per diluted share, net of tax, for 2007, and $2.9 million, or $0.10 per diluted share, net of tax, for 2008.

     In December 2007, the FASB issued SFAS 141(R), Business Combinations and SFAS 160, Noncontrolling Interests in Consolidated Financial Statements. The standards are intended to improve, simplify, and converge internationally the accounting for business combinations and the reporting of noncontrolling (minority) interests in consolidated financial statements. SFAS 141(R) requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination. SFAS 141(R) is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. SFAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Earlier adoption is prohibited.

     SFAS 160 is designed to improve the relevance, comparability, and transparency of financial information provided to investors by requiring all entities to report minority interests in subsidiaries in the same way—as equity in the consolidated financial statements. Moreover, SFAS 160 eliminates the diversity that currently exists in accounting for transactions between an entity and minority interests by requiring they be treated as equity transactions. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited. In addition, SFAS 160 shall be applied prospectively as of the beginning of the fiscal year in which it is initially applied, except for the presentation and disclosure

requirements. The presentation and disclosure requirements shall be applied retrospectively for all periods presented. We do not have any material outstanding minority interests and, therefore, SFAS 160 is not applicable to us at this time.

     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. Fair Value Measurements

     As of June 30, 2008, we had cash and cash equivalents of $425.4 million, investments totaling $263.1 million, and restricted investments of $29.9 million. The cash equivalents consist of highly liquid securities with original or purchase date remaining maturities of up to three months that are readily convertible into known amounts of cash. Our investments consisted of investment grade debt securities and are designated as available-for-sale. Of the $263.1 million total, $196.3 million are classified as current assets, and $66.8 million are classified as non-current assets (see further discussion below). Our investment policies require that all of our investments have final maturities of ten years or less (excluding auction rate and variable rate securities where interest rates are periodically reset) and that the average maturity be four years or less. The restricted investments, classified as non-current assets and designated as held-to-maturity, consist of interest-bearing deposits and U.S. treasury securities required by the respective states in which we operate. Investments and restricted investments are subject to interest rate risk and will decrease in value if market rates increase. All non-restricted investments are reported at fair market value on the balance sheet. All restricted investments are carried at amortized cost, which approximates market value. We have the ability to hold these 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. Declines in interest rates over time will reduce our investment income.

     In September 2006, the FASB issued SFAS 157, Fair Value Measurements. SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States, and expands disclosures about fair value measurements. We adopted the provisions of SFAS 157 as of January 1, 2008 for our financial instruments. Although the adoption of SFAS 157 did not materially impact our financial position, results of operations, or cash flow, we are now required to provide additional disclosures as part of our financial statements.

     SFAS 157 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers are: 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 June 30, 2008, we held investments in auction rate securities, totaling $71.8 million, with a fair value of $66.8 million, which are required to be measured at fair value on a recurring basis. Our auction rate securities are designated as available-for-sale securities and are reflected at fair value. Prior to January 1, 2008, these securities were recorded at fair value based on quoted prices in active markets (i.e., SFAS 157 Level 1 data). Liquidity for these auction rate securities is typically provided by an auction process which allows holders to sell their notes, and which resets the applicable interest rate at pre-determined intervals, usually every 7, 28, or 35 days. However, due to recent events in the credit markets, the auction events for some of these instruments failed during the first half of 2008. An auction failure means that the parties wishing to sell their securities could not be matched with an adequate volume of buyers. Therefore, the fair values of these securities were estimated using a discounted cash flow analysis or other type of valuation model as of June 30, 2008. These analyses considered, among other things, 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 be expected to 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.

     As a result of the declines in fair value for our investments in auction rate securities, which we deem to be temporary and attribute to liquidity issues rather than to credit issues, we recorded net unrealized losses of $1.7

million and $5.0 million for the three and six months ended June 30, 2008, respectively, to accumulated other comprehensive income. Substantially all of the $66.8 million in auction rate security instruments held by us at June 30, 2008 were in securities collateralized by student loans, which loans are guaranteed by the U.S. government. Due to our belief that the market for these student loan collateralized instruments may take in excess of twelve months to fully recover, we have classified these investments as non-current, and have included them in investments on the unaudited condensed consolidated balance sheet at June 30, 2008. As of June 30, 2008, we continue to earn interest on our auction rate security instruments. 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) income. 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 subject to the disclosure requirements of SFAS 157 at June 30, 2008, were as follows:

		Fair Value Measurements at Reporting Date Using
						Quoted
						Prices in
						Active				Significant
						Markets for				Other
						Identical				Observable				Significant
		June 30,				Assets				Inputs				Unobservable Inputs
		2008				(Level 1)				(Level 2)				(Level 3)
		(in thousands)
Auction rate securities		$	66,786			$	—			$	—			$	66,786
Other available-for-sale securities			196,268				196,268				—				—
Total assets measured at fair value		$	263,054			$	196,268			$	—			$	66,786

     Based on market conditions which resulted in the absence of quoted prices in active markets for our auction rate securities, we changed our valuation methodology for auction rate securities to a discounted cash flow analysis during the first quarter of 2008. Accordingly, since our initial adoption of SFAS 157 on January 1, 2008, these securities changed from Level 1 to Level 3 within SFAS 157’s hierarchy. The following table presents our assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as defined in SFAS 157 at June 30, 2008:

		Fair Value
		Measurements
		Using Significant
		Unobservable Inputs
		(Level 3)
Auction Rate Securities		(in thousands)
Balance at December 31, 2007		$	—
Transfers to Level 3			82,150
Total losses (realized or unrealized):
Included in earnings			—
Included in other comprehensive income			(4,964	)
Purchases (settlements), net			(10,400	)
Balance at June 30, 2008		$	66,786
The amount of total losses for the period included in other comprehensive income attributable to the change in unrealized losses relating to assets still held at June 30, 2008		$	(4,964	)

4. Receivables

     Receivables consist primarily of amounts due from the various states in which we operate. All receivables are subject to potential retroactive adjustment. As 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:

		June 30,				December 31,
		2008				2007
		(in thousands)
California		$	18,773			$	23,046
Michigan			7,892				6,419
Missouri			18,228				15,986
Ohio			30,752				28,522
Utah			23,997				23,987
Washington			8,535				8,308
Others			5,420				5,269
Total receivables		$	113,597			$	111,537

Substantially all receivables due our California and Missouri health plans at June 30, 2008 were collected in July 2008.

     Our Utah health plan’s agreement with the state of Utah calls for the reimbursement of medical costs incurred in serving our members plus an administrative fee of 9% of that medical cost amount, plus a portion of any cost savings realized as defined in the agreement. Our Utah health plan bills the state of Utah monthly for actual paid health care claims plus administrative fees. Our receivable balance from the state of Utah includes: (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, are not billable to the state of Utah until such claims are actually paid.

     As of June 30, 2008, the receivable due our Ohio health plan included approximately $8.5 million of accrued delivery payments due from the state of Ohio and approximately $21.7 million due from a capitated provider group. Our agreement with that group calls for us to pay for certain medical services incurred by the group’s members, and then to deduct the amount of such payments from the monthly capitation paid to the group. This receivable also includes an estimate of our liability for claims incurred by members of this group for which we have not made payment. 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 condensed consolidated balance sheets. At June 30, 2008, this receivable comprised approximately $14.3 million paid on behalf of the provider group, which will be deducted from capitation payments in the months of July and August 2008. An additional $7.5 million receivable has been recorded to reflect amounts included in “Medical claims and benefits payable” in our condensed consolidated balance sheets that are the responsibility of the capitated provider group. Our Ohio health plan has withheld approximately $9.0 million from capitation payments due this provider group and placed the funds in an escrow account. The Ohio health plan is entitled to the escrow amount if the provider is unable to repay amounts owed to us. The escrow amount is included in “Restricted investments” in our condensed consolidated balance sheets. Monthly gross capitation paid to the provider group is approximately $10.5 million.

5. Other Assets

     Other assets include an investment in a vision services provider (see Note 9, “Related Party Transactions”), deferred financing costs associated with our secured credit agreement, and certain investments held in connection with our deferred employee compensation program. A liability approximately equal to the assets held in connection with our deferred employee compensation program is included in other long-term liabilities.

6. Long-Term Debt

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 of $193.4 million. The Notes rank equally in right of payment with our existing and future senior indebtedness, and 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:

•		During any fiscal quarter after our fiscal quarter ending 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 conditions noted above 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 equal to the sum of, for each of the 20 Volume-Weighted Average Price (the “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.

Credit Facility

     In 2005, we entered into the Amended and Restated Credit Agreement, dated as of March 9, 2005, among Molina Healthcare Inc., certain lenders, and Bank of America N.A., as Administrative Agent (the “Credit Facility”). Effective May 2007, we entered into a third amendment of the Credit Facility that increased the size of the revolving line of credit to $200.0 million, maturing in May 2012. The Credit Facility is intended to be used for working capital and general corporate purposes, and subject to obtaining commitments from existing or new lenders and satisfaction of other specified conditions, we may increase the Credit Facility to up to $250.0 million.

     Borrowings under the Credit Facility are based, at our election, on the London Interbank Offered Rate, or LIBOR, or the base rate plus an applicable margin. The base rate equals the higher of Bank of America’s prime rate or 0.500% above the federal funds rate. We also pay a commitment fee on the total unused commitments of the lenders under the Credit Facility. The applicable margins and commitment fee are based on our ratio of consolidated funded debt to consolidated earnings before interest, taxes, depreciation and amortization, or EBITDA. The applicable margins range between 0.750% and 1.750% for LIBOR loans and between 0.000% and 0.750% for base rate loans. The commitment fee ranges between 0.150% and 0.275%. In addition, we are required to pay a fee for

each letter of credit issued under the Credit Facility equal to the applicable margin for LIBOR loans and a customary fronting fee. As of June 30, 2008 and December 31, 2007, there were no amounts outstanding under the Credit Facility.

     Our obligations under the Credit Facility are secured by a lien on substantially all of our assets and by a pledge of the capital stock of our Michigan, New Mexico, Utah, and Washington health plan subsidiaries. The Credit Facility includes usual and customary covenants for credit facilities of this type, including covenants limiting liens, mergers, asset sales, other fundamental changes, debt, acquisitions, dividends and other distributions, capital expenditures, investments, and a fixed charge coverage ratio. The amended Credit Facility also requires us to maintain a ratio of total consolidated debt to total consolidated EBITDA of not more than 2.75 to 1.00 at any time. At June 30, 2008, we were in compliance with all financial covenants in the Credit Facility.

7. Stockholders’ Equity

     In April 2008, our board of directors authorized the repurchase of up to $30 million of our common stock on the open market or through privately negotiated transactions. We used working capital to fund the repurchases under this program. The timing and amount of repurchases were primarily made pursuant to a trading plan dated as of May 2, 2008. The trading plan became effective May 5, 2008, and terminated when the aggregate cost of the repurchases totaled $30 million on June 12, 2008. During the quarter ended June 30, 2008, we repurchased approximately 1.1 million shares. We did not repurchase any shares during the quarter ended March 31, 2008. See Note 10, “Subsequent Events,” regarding the authorization to repurchase additional shares.

     On June 30, 2008, we issued a total of 48,186 shares of our common stock in connection with our acquisition of the assets of The Game of Work, LLC.

8. 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.

     Malpractice Action. On February 1, 2007, a complaint was filed in the Superior Court of the State of California for the County of Riverside by plaintiff Staci Robyn Ward through her guardian ad litem, Case No. 465374. The complaint purports to allege claims for medical malpractice against several unaffiliated physicians, medical groups, and hospitals, including Molina Medical Centers and one of its physician employees. The plaintiff alleges that the defendants failed to properly diagnose her medical condition which has resulted in her severe and permanent disability. On July 22, 2007, the plaintiff passed away. The proceeding is in the discovery stage, and no prediction can be made as to the outcome.

     Starko. Our New Mexico HMO is named as a defendant in a class action lawsuit brought by New Mexico pharmacies and pharmacists, Starko, Inc., et al. v. NMHSD, et al., No. CV-97-06599, Second Judicial District Court, State of New Mexico. The lawsuit was originally filed in August 1997 against the New Mexico Human Services Department (“NMHSD”). In February 2001, the plaintiffs named health maintenance organizations participating in the New Mexico Medicaid program as defendants (the “HMOs”), including Cimarron Health Plan, the predecessor of our New Mexico HMO. The plaintiffs assert that NMHSD and the HMOs failed to pay pharmacy dispensing fees under an alleged New Mexico statutory mandate. On July 10, 2007, the court dismissed all damages claims against Molina Healthcare of New Mexico, leaving at that time only a pending action for injunctive and declaratory relief. On August 15, 2007, the court dismissed all remaining claims against Molina Healthcare of New Mexico, including the action for injunctive and declaratory relief. The plaintiffs have filed an appeal with respect to the court’s dismissal orders and the parties have submitted their respective appellate briefs and are awaiting oral argument. Under the terms of the stock purchase agreement pursuant to which we acquired Health Care Horizons, Inc., the parent company to Molina Healthcare of New Mexico, an indemnification escrow account was established and funded with $6.0 million to indemnify Molina Healthcare of New Mexico against the costs of such litigation and any eventual liability or settlement costs. As of June 30, 2008, approximately $4.2 million remained in the indemnification escrow fund.

     We are involved in other 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, individually or in the aggregate, when finally concluded and determined, are not likely, in our opinion, to have a material adverse effect on our 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 consolidated financial position, results of operations, or cash flows.

Regulatory Capital and Dividend Restrictions

     Our principal operations are conducted through our HMO subsidiaries operating in California, Michigan, Missouri, Nevada, New Mexico, Ohio, Texas, Washington, and Utah. Our HMOs 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 subsidiaries must comply with these regulations, they may not have the financial flexibility to transfer funds to us. The net assets in these subsidiaries (after intercompany eliminations), which may not be transferable to us in the form of cash dividends, loans, or advances, were $337.0 million at June 30, 2008 and $332.2 million at December 31, 2007. The National Association of Insurance Commissioners, or NAIC, adopted model rules effective December 31, 1998, which, if implemented by a state, set new minimum capitalization requirements for insurance companies, HMOs, and other entities bearing risk for health care coverage. The requirements take the form of risk-based capital, 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 and Missouri have established their own minimum capitalization requirements for insurance companies.

     As of June 30, 2008, our HMOs had aggregate statutory capital and surplus of approximately $349.7 million, compared with the required minimum aggregate statutory capital and surplus of approximately $207.6 million. All of our HMOs were in compliance with the minimum capital requirements at June 30, 2008. We have the ability and commitment to provide additional capital to each of our HMOs when necessary to ensure that they continue to meet statutory and regulatory capital requirements.

9. 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 in excess of 20%. As of June 30, 2008 and 2007, our carrying amount for this investment totaled $3.6 million and $1.4 million, respectively. Effective July 1, 2007, we paid this provider a $0.9 million network access fee, which was fully amortized as of June 30, 2008. Advances outstanding to this provider totaling $315,000 were offset in full to capitation payments during the quarter ended June 30, 2008. For the three months ended June 30, 2008 and 2007, we paid $3.6 million and $3.1 million, respectively, for medical service fees to this provider. For the six months ended June 30, 2008 and 2007, we paid $7.1 million and $5.9 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 $54,000 and $23,000 for the three months ended June 30, 2008 and 2007,

respectively, and $110,000 and $43,000 for the six months ended June 30, 2008 and 2007, respectively. We believe that the claims submitted to us by Pacific Hospital were reimbursed at prevailing market rates. In 2006, we entered into an additional agreement with Pacific Hospital as part of a capitation arrangement. Under this arrangement, we pay Pacific Hospital a fixed monthly fee based on member type. We paid Pacific Hospital for capitation services totaling approximately $818,000 and $1.0 million for the three months ended June 30, 2008 and 2007, respectively, and $1.7 million and $2.1 million for the six months ended June 30, 2008 and 2007, respectively. We believe that this agreement with Pacific Hospital is based on prevailing market rates for similar services. Also as of June 30, 2008, we had an advance outstanding to this provider totaling $0.2 million which is offsetting capitation payments in 2008.

     In 2006, we assumed an office lease from Millworks Capital Ventures which at that time had a remaining term of 52 months. Millworks Capital Ventures is owned by John C. Molina, our Chief Financial Officer, and his wife. The monthly base lease payment is approximately $18,000 and is subject to an annual increase. Based on a market report prepared by an independent realtor, we believe the terms and conditions of the assumed lease were at that time at fair market value. We are currently using the office space under the lease for an office expansion. Payments made under this lease totaled $75,000 and $56,000 for the three months ended June 30, 2008 and 2007, respectively, and $132,000 and $131,000 for the six months ended June 30, 2008 and 2007, respectively.

     We lease two medical clinics that are owned by the Mary R. Molina Living Trust and the Molina Marital Trust. These leases have 5 five-year renewal options. Rental expense for these leases totaled $24,000 for each of the three-month periods ended June 30, 2008 and 2007, respectively, and $49,000 for each of the six-month periods ended June 30, 2008 and 2007, respectively.

10. Subsequent Event

     On July 22, 2008, our board of directors authorized the repurchase of up to one million shares of our common stock. The repurchase program will be funded using our working capital, and the timing and amount of any shares repurchased will be made pursuant to a trading plan. The repurchase program extends through December 31, 2008, but we reserve the right to suspend or discontinue the program at any time.

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, the following factors:

	•		the achievement of savings from the successful management of the medical care ratio of our health plans;
	•		an increase in enrollment in both our Medicaid and Medicare populations consistent with our expectations;
	•		our ability to reduce administrative costs in the event enrollment or revenue is lower than expected;
	•		increased administrative costs in support of the Company’s efforts to expand Medicare membership;
	•		our ability to accurately estimate incurred but not reported medical costs;
	•		the securing of projected premium rate increases under the government contracts of our health plans, in particular in the states of Michigan and Texas and in connection with our Medicare plans;
	•		the January 1, 2008 increase in Michigan state taxes and the success of our efforts to mitigate the impact of that tax increase;
	•		the budget crisis in California and the pressure to reduce HMO rates in that state, including current PMPM rates under our existing contracts;
	•		the final terms as implemented of the Rogers Amendment to the Deficit Reduction Act of 2005 regarding the rates to be paid to non-contracting hospitals by our California health plan;
	•		changes in market interest rates and actions by the Federal Reserve Bank Board;
	•		the potential termination or expiration without renewal of the government contracts of our health plans;
	•		the imposition of fines or assessments by state or federal regulators for perceived operating deficiencies;
	•		our dependence upon a relatively small number of government contracts and subcontracts for our revenue;
	•		limitations in our ability to control our medical costs and other operating expenses;
	•		risks related to our new Medicare Advantage plans with prescription drug coverage, or MAPD plans, including our lack of operating experience with such plans, compliance issues, and confusion regarding the new plans among Medicare beneficiaries, providers, pharmacists, and regulators;

	•		the successful and cost-effective integration of Mercy CarePlus, including risks related to our lack of prior operating experience in Missouri;
	•		risks related to our lack of experience with members in Ohio, Texas, and Missouri;
	•		the availability of adequate financing to fund and/or capitalize our acquisitions and start-up activities;
	•		membership eligibility processes and methodologies;
	•		unexpected changes in demographics, member utilization patterns, healthcare practices, or healthcare technologies;
	•		high dollar claims related to catastrophic illness or conditions, increases in respiratory illnesses, or increases in the number of premature infants among our plans’ members;
	•		risks related to the continued solvency of our major providers and provider groups;
	•		failure to maintain effective, efficient, and secure information systems and claims processing technology;
	•		the unfavorable resolution of pending litigation or arbitration;
	•		risks associated with the potential negative perception among regulators, governmental representatives, and the public of abuses occurring within the Medicaid or Medicare managed care sectors and the association or general attribution of such negative perceptions to us;
	•		funding decreases in the Medicaid, SCHIP, or Medicare programs or the failure to timely renew the SCHIP program;
	•		risks associated with our $200 million 3.75% Convertible Senior Notes due 2014;
	•		epidemics such as the avian flu; and
	•		changes to government laws and regulations or in the interpretation and enforcement of those laws and regulations, including the recently enacted citizenship certification requirements.

     Investors should refer to Part II, Item 1A of this Quarterly Report, and to Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2007, for a discussion of certain risk factors which could materially affect our business, financial condition, or future results. 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, 2007.

Overview

     Our financial performance for the three and six months ended June 30, 2008 compared with the same prior year periods is briefly summarized as follows:

		Three Months Ended June 30,								Six Months Ended June 30,
		2008				2007				2008				2007
		(Dollar amounts in thousands, except per-share data)
Earnings per diluted share		$	0.59			$	0.47			$	1.05			$	0.81
Premium revenue		$	761,153			$	607,127			$	1,490,791			$	1,163,362
Operating income		$	30,258			$	22,284			$	54,709			$	38,879
Net income		$	16,516			$	13,314			$	29,671			$	22,906
Medical care ratio			84.2	%			85.1	%			85.0	%			85.4	%
G&A expenses as a percentage of total revenue			11.4	%			10.9	%			11.0	%			11.1	%
Total ending membership											1,234,000				1,076,000

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 six months ended June 30, 2008, we received approximately 92% of our premium revenue as a fixed amount per member per month, or PMPM, pursuant to our contracts with state Medicaid agencies and 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 periodically adjust premium rates.

     The amount of these premiums may vary substantially between states and among various government programs. PMPM premiums for members of the State Children’s Health Insurance Program, or SCHIP, are generally among our lowest, with rates as low as approximately $80 PMPM in California and Utah. 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 $300 in New Mexico and Utah. Among our Medicaid Aged, Blind or Disabled (ABD) membership, PMPM premiums range from approximately $450 in California to over $1,000 in New Mexico and Ohio. Medicare revenue is approximately $1,200 PMPM. Approximately 3% of our premium revenue for the six months ended June 30, 2008 was realized under a Medicaid cost-plus reimbursement agreement that our Utah plan has with that state. For the six months ended June 30, 2008, we also received approximately 4% of our premium revenue in the form of “birth income” — a one-time payment for the delivery of a child — from the Medicaid programs in Michigan, Ohio, Texas, and Washington. Such payments are recognized as revenue in the month the birth occurs. Our premium revenue also included premiums generated from Medicare, totaling approximately $44.4 million and $19.5 million for the six months ended June 30, 2008 and 2007, respectively. All of our Medicare revenue is paid to us as a fixed PMPM amount.

     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, (2) 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, and (3) 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.

     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. Our contract is for a three-year period, and the minimum percentage is based on premiums and medical care costs over the entire contract period. Year to date, we have 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 because we exceeded the minimum percentage in the first half of 2008. At June 30, 2008, there is no remaining liability recorded under our interpretation of the existing terms of this contract provision. Any change to the terms of this provision, including revisions to the definitions of premium revenue or medical care costs, the period of time over which the minimum

percentage is measured or the manner of its measurement, or the percentage of revenue required to be spent on the defined medical care costs, may trigger a change in this amount. If the state of New Mexico disagrees with our interpretation of the existing contract terms, an adjustment to this amount may occur.

     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 may be subject to negotiation with the state. During 2007, as a result of an ongoing disagreement with the state of Utah, we wrote off the entire receivable, totaling $4.7 million. Our Utah health plan continues to work with the state to assure an appropriate determination of amounts due under the savings share agreement. When additional information is known, or agreement is reached with the state regarding the appropriate savings sharing payment amount, 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 June 30, 2008, we had a liability of approximately $9.0 million accrued pursuant to our profit-sharing agreement with the state of Texas, for the 2007 and 2008 contract years ending August 31. 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. We believe that the ultimate settlement will not differ materially from our estimate.

     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 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 as of the dates indicated:

		As of				As of				As of
		June 30,				December 31,				June 30,
Total Ending Membership by Health Plan:		2008				2007				2007
California			310,000				296,000				291,000
Michigan			212,000				209,000				217,000
Missouri (1)			76,000				68,000				—
Nevada (2)			—				—				—
New Mexico			81,000				73,000				66,000
Ohio			173,000				136,000				138,000
Texas			29,000				29,000				30,000
Utah			57,000				55,000				47,000
Washington			296,000				283,000				287,000
Total			1,234,000				1,149,000				1,076,000
Total Ending Membership by State for the Medicare Advantage Plans:
California			1,452				1,115				724
Michigan			1,469				1,090				459
Nevada			680				520				9
New Mexico			149				—				—
Texas			430				—				—
Utah			2,056				1,860				1,646
Washington			911				507				413
Total			7,147				5,092				3,251
Total Ending Membership by State for the Aged, Blind or Disabled Population:
California			12,092				11,837				10,728
Michigan			30,896				31,399				31,940
New Mexico			6,716				6,792				6,822
Ohio			15,355				14,887				15,117
Texas			15,999				16,018				16,603
Utah			6,993				6,795				6,876
Washington			3,049				2,814				2,693
Total			91,100				90,542				90,779

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

		Three Months Ended
		June 30,
										% of Increase
		2008				2007				(Decrease)
California			921,000				874,000				5.4	%
Michigan			639,000				658,000				(2.9	)
Missouri (1)			227,000				—				—
Nevada			2,000				—				—
New Mexico			239,000				197,000				21.3
Ohio			522,000				399,000				30.8
Texas			85,000				91,000				(6.6	)
Utah			164,000				145,000				13.1
Washington			879,000				860,000				2.2
Total			3,678,000				3,224,000				14.1	%

		Six Months Ended
		June 30,								% of Increase
		2008				2007				(Decrease)
California			1,829,000				1,760,000				3.9	%
Michigan			1,277,000				1,327,000				(3.8	)
Missouri			450,000				—				—
Nevada (2)			4,000				—				—
New Mexico			467,000				389,000				20.1
Ohio			935,000				739,000				26.5
Texas			170,000				157,000				8.3
Utah			321,000				296,000				8.4
Washington			1,738,000				1,716,000				1.3
Total			7,191,000				6,384,000				12.6	%

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 health 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 in a variety of ways, including per diem amounts, diagnostic-related groups, or DRGs, percent of billed charges, case rates, and capitation. We also have stop-loss agreements with the hospitals with which we contract. 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 capitation 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, 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 six months ended June 30, 2008 and 2007, medically related administrative costs were approximately $36.9 million and $30.8 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 June 30,
		2008												2007
										% of												% of
		Amount				PMPM				Total				Amount				PMPM				Total
Fee for service		$	410,619			$	111.65				64.1	%		$	336,654			$	104.41				65.1	%
Capitation			117,707				32.00				18.4				92,931				28.82				18.0
Pharmacy			88,676				24.11				13.8				65,930				20.45				12.8
Other			23,827				6.48				3.7				21,350				6.62				4.1
Total		$	640,829			$	174.24				100.0	%		$	516,865			$	160.30				100.0	%

		Six Months Ended June 30,
		2008												2007
										% of												% of
		Amount				PMPM				Total				Amount				PMPM				Total
Fee for service		$	822,628			$	114.40				64.9	%		$	644,534			$	100.96				64.9	%
Capitation			221,498				30.80				17.5				180,864				28.33				18.2
Pharmacy			174,958				24.33				13.8				126,509				19.82				12.7
Other			48,092				6.70				3.8				41,435				6.49				4.2
Total		$	1,267,176			$	176.23				100.0	%		$	993,342			$	155.60				100.0	%

     Our medical care costs include amounts that have been paid by us through the reporting date as well as estimated liabilities for medical care costs incurred but not paid by us as of the reporting date. See “Critical Accounting Policies” below for a comprehensive discussion of how we estimate such liabilities.

     G&A expenses largely consist of wage and benefit costs for our employees, premium taxes, and other administrative expenses. Some G&A services are provided locally, while others are delivered to our health plans from a centralized location. The primary centralized functions are claims processing, information systems, finance and accounting services, and legal and regulatory services. Locally provided functions include member services, plan administration, and provider relations. G&A expenses include premium taxes for each of our health plans in California, Michigan, New Mexico, Ohio, Texas, and Washington.

Results of Operations

     The following table sets forth selected operating ratios. All ratios with the exception of the medical care ratio are shown as a percentage of total revenue. The medical care ratio is shown as a percentage of premium revenue because there is a direct relationship between the premium revenue earned and the cost of health care.

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2008				2007				2008				2007
Premium revenue			99.3	%			98.9	%			99.2	%			98.9	%
Investment income			0.7				1.1				0.8				1.1
Total revenue			100.0	%			100.0	%			100.0	%			100.0	%
Ratio of direct medical care costs to premium revenue			81.9	%			82.5	%			82.5	%			82.7	%
Ratio of administrative costs included in medical care costs to premium revenue			2.3				2.6				2.5				2.7
Medical care ratio			84.2	%			85.1	%			85.0	%			85.4	%
General and administrative expense ratio, excluding premium taxes			8.2	%			7.7	%			8.0	%			7.8	%
Premium taxes included in general and administrative expenses			3.2				3.2				3.0				3.3
Total general and administrative expense ratio			11.4	%			10.9	%			11.0	%			11.1	%
Depreciation and amortization expense ratio			1.1	%			1.1	%			1.1	%			1.1	%
Effective tax rate			40.9	%			38.2	%			40.8	%			38.1	%
Operating income			3.9	%			3.6	%			3.6	%			3.3	%
Income before income taxes			3.6	%			3.5	%			3.3	%			3.1	%
Net income			2.2	%			2.2	%			2.0	%			1.9	%

Three Months Ended June 30, 2008 Compared with Three Months Ended June 30, 2007

     The following summarizes premium revenue, medical care costs, medical care ratio, and premium taxes by health plan for the three months ended June 30, 2008 and June 30, 2007 (dollars in thousands except PMPM amounts):

		Three Months Ended June 30, 2008
		Premium Revenue								Medical Care Costs								Medical				Premium Tax
		Total				PMPM				Total				PMPM				Care Ratio				Expense
California		$	104,136			$	113.00			$	88,449			$	95.98				84.9	%		$	3,242
Michigan			125,382				196.37				100,273				157.05				80.0				6,625
Missouri			54,250				238.84				45,050				198.34				83.0				—
Nevada			2,243				1,303.04				2,506				1,456.25				111.8				—
New Mexico			89,279				374.58				69,593				291.99				78.0				4,184
Ohio			147,114				281.73				133,816				256.26				91.0				6,672
Texas			25,742				303.09				19,669				231.58				76.4				460
Utah			35,385				214.89				31,932				193.92				90.2				—
Washington			177,619				202.11				145,840				165.95				82.1				2,993
Other (1)			3				—				3,701				—				—				(5	)
Total		$	761,153			$	206.96			$	640,829			$	174.24				84.2	%		$	24,171

		Three Months Ended June 30, 2007
		Premium Revenue								Medical Care Costs								Medical				Premium Tax
		Total				PMPM				Total				PMPM				Care Ratio				Expense
California		$	94,710			$	108.43			$	76,185			$	87.22				80.4	%		$	3,202
Michigan			121,427				184.43				101,184				153.68				83.3				7,364
New Mexico			61,337				312.44				52,949				269.71				86.3				1,394
Ohio			111,457				279.18				101,515				254.28				91.1				5,016
Texas			24,953				273.48				22,774				249.59				91.3				433
Utah			30,033				206.15				26,535				182.14				88.4				—
Washington			162,905				189.45				130,726				152.02				80.2				2,685
Other (1)			305				—				4,997				—				—				(19	)
Total		$	607,127			$	188.30			$	516,865			$	160.30				85.1	%		$	20,075

     Net Income

     Net income for the quarter ended June 30, 2008, increased to $16.5 million, or $0.59 per diluted share, compared with net income of $13.3 million, or $0.47 per diluted share, for the quarter ended June 30, 2007.

     Premium Revenue

     Premium revenue for the second quarter of 2008 was $761.1 million, an increase of $154.0 million, or 25.4%, over the $607.1 million of premium revenue for the second quarter of 2007. Medicare premium revenue for the second quarter of 2008 was $23.1 million compared with $10.5 million in the second quarter of 2007. Excluding the impact of the November 1, 2007 acquisition of our Missouri health plan, consolidated membership increased 7.6% between June 30, 2008 and June 30, 2007. Significant contributors to the $154.0 million increase in quarterly premium revenues included the following:

	•		A $54.3 million increase as a result of the acquisition of Mercy CarePlus in Missouri on November 1, 2007.
	•		A $35.7 million increase at the Ohio health plan due to higher enrollment, particularly in the Covered Families and Children (CFC) population.
	•		A $27.9 million increase at the New Mexico health plan due to higher enrollment, higher premium rates, and the recognition of $6.2 million in revenues associated with a minimum medical care ratio contract provision.