Molina Medicaid Solutions - DHHR

e10vkthe contract period.Deferral of Service Revenue and Cost of Service Revenue — Molina Medicaid Solutions SegmentThe payments received by our Molina Medicaid Solutions segment under its state contracts are based on the performance of three elements of service. The first of these isthe design, development and implementation, or DDI, of a Medicaid Management Information System, or MMIS. The second element, following completion of the DDIelement, is the operation of the MMIS under a business process outsourcing, or BPO, arrangement. While providing BPO services, we also provide the state with the thirdcontracted element — training and IT support and hosting services (training and support).Because they include these three elements of service, our Molina Medicaid Solution segment contracts are multiple-element arrangements. We have no vendor specificobjective evidence, or VSOE, of fair value for any of the individual elements in these contracts, and at no point in the contract will we have VSOE for the undelivered elementsin the contract. We lack VSOE of the fair value of the individual elements of our Molina Medicaid Solutions contracts for the following reasons:• Each contract calls for the provision of its own specific set of products and services. While all contracts support the system of record for state MMIS, the actualservices and products we provide vary significantly between contracts; and• The nature of the MMIS installed varies significantly between our older contracts (proprietary mainframe systems) and our new contracts (commercial off-the-shelftechnology solutions).The absence of VSOE within the context of a multiple element arrangement requires us to delay recognition of any revenue for an MMIS contract until completion of theDDI phase of the contract. As a general principle, revenue recognition will therefore commence at the completion of the DDI phase, and all revenue will be recognized over theperiod that BPO services and training and IT support services are provided. Consistent with the deferral of revenue, recognition of all direct costs (such as direct labor, hardware,and software) associated with the DDI phase76Table of ContentsMOLINA HEALTHCARE, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)of our contracts is deferred until the commencement of revenue recognition. Deferred costs are recognized on a straight-line basis over the period of revenue recognition.Provisions specific to each contract may, however, lead us to modify this general principle. In those circumstances, the right of the state to refuse acceptance of services,as well as the related obligation to compensate us, may require us to delay recognition of all or part of our revenue until that contingency (the right of the state to refuseacceptance) has been removed. In those circumstances we defer recognition of any revenue at risk (whether DDI, BPO services or training and IT support services) until thecontingency had been removed. In these circumstances we would also defer recognition of incremental direct costs (such as direct labor, hardware, and software) associated withthe contract (whether DDI, BPO services or training and IT support services) on which revenue recognition is being deferred. Such deferred contract costs are recognized on astraight-line basis over the period of revenue recognition.We began to recognize revenue (and related deferred costs) associated with our Maine contract in September 2010. In Idaho, we expect to begin recognition of deferredcontact costs during 2011, in a manner consistent with our anticipated recognition of revenue. Unamortized deferred contract costs relating to the Molina Medicaid Solutionssegment at December 31, 2010 were $28.4 million.The recoverability of deferred contract costs associated with a particular contract is analyzed on a periodic basis using the undiscounted estimated cash flows of the wholecontract over its remaining contract term. If such undiscounted cash flows are insufficient to recover the long-lived assets and deferred contract costs, the deferred contract costsare written down by the amount of the cash flow deficiency. If a cash flow deficiency remains after reducing the balance of the deferred contract costs to zero, any remaininglong-lived assets are evaluated for impairment. Any such impairment recognized would equal the amount by which the carrying value of the long-lived assets exceeds the fairvalue of those assets.Goodwill and Intangible AssetsGoodwill represents the excess of the purchase price over the fair value of net assets acquired. Identifiable intangible assets (consisting principally of purchased contractrights and provider contracts) are amortized on a straight-line basis over the expected period to be benefited (generally between one and 15 years). See Note 9, “Goodwill andIntangible Assets.”Goodwill and indefinite-lived assets are not amortized, but are subject to impairment tests on an annual basis or more frequently if indicators of impairment exist. We usea discounted cash flow methodology to assess the fair values of our reporting units. If the carrying values of our reporting units exceed the fair values, we perform ahypothetical purchase price allocation. Impairment is measured by comparing the goodwill and indefinite-lived asset balance derived from the hypothetical purchase priceallocation to the carrying value of the goodwill and indefinite-lived asset balance. Based on the results of our impairment testing, no adjustments were required for the yearsended December 31, 2010, 2009 and 2008.Identifiable intangible assets associated with Molina Medicaid Solutions are classified as either contract backlog or customer relationships.The contract backlog intangible asset comprises all contractual cash flows anticipated to be received during the remaining contracted period for each specific contractrelating to work that was performed prior to the acquisition. The contract backlog intangible has been developed on a contract-by-contract basis. The amortization of thatportion of the contract backlog intangible associated with contracts for which revenue recognition has not yet commenced is deferred until revenue recognition has begun.Because each acquired contract constitutes a single revenue stream, amortization of the contract backlog intangible is recorded to contra-service revenue so that amortization ismatched to any revenues associated with contract performance that occurred prior to the acquisition date. The contract backlog intangible asset is amortized on a straight-linebasis for each specific contract over periods generally ranging from one to six years.77Table of ContentsMOLINA HEALTHCARE, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The customer relationship intangible asset comprises all contractual cash flows that are anticipated to be received during the option periods of each specific contract aswell as anticipated renewals of those contracts. The customer relationship intangible is amortized on a straight-line basis for each specific contract over periods generallyranging from four to nine years.The determination of the value of identifiable intangible assets requires us to make estimates and assumptions about estimated asset lives, future business trends, andgrowth. In addition to annual impairment testing, we continually evaluate whether events and circumstances have occurred that indicate the balance of identifiable intangibleassets may not be recoverable. In evaluating impairment, we compare the estimated fair value of the intangible asset to its underlying book value. Such evaluation issignificantly impacted by estimates and assumptions of future revenues, costs and expenses, and other factors. If an event occurs that would cause us to revise our estimates andassumptions used in analyzing the value of our identifiable intangible assets, such revision could result in a non-cash impairment charge that could have a material impact on ourfinancial results.Depreciation and AmortizationDepreciation and amortization related to our Health Plans segment is all recorded in “Depreciation and Amortization” in the consolidated statements of income.Depreciation and amortization related to our Molina Medicaid Solutions segment is recorded within three different captions in the consolidated statements of income as follows:• Amortization of purchased intangibles relating to customer relationships is reported as amortization in “Depreciation and Amortization;”• Amortization of purchased intangibles relating to contract backlog is recorded as a reduction of service revenue; and• Depreciation is recorded as cost of service revenue.The following table presents all depreciation and amortization recorded in our consolidated statements of income, regardless of whether the item appears as depreciationand amortization, a reduction of revenue, or as cost of service revenue, and reconciles that amount to the consolidated statements of cash flows.Year Ended December 31,2010 2009 2008(In thousands)Depreciation $ 27,230 $ 25,172 $ 20,718Amortization of intangible assets 18,474 12,938 12,970Depreciation and amortization reported in our consolidated statements of income 45,704 38,110 33,688Amortization recorded as reduction of service revenue 8,316 — —Depreciation recorded as cost of service revenue 6,745 — —Depreciation and amortization reported in our consolidated statements of cash flows $ 60,765 $ 38,110 $ 33,688Long-Lived Asset Impairmenthttp://sec.gov/Archives/edgar/data/1179929/000095012311023069/a58840e10vk.htm[1/6/2012 11:08:51 AM]