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SCHEDULE 14A

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NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
To Be Held Wednesday, May 9, 2007

 

 

 

Dear Fellow Stockholder:

 

Our 2007 annual meeting of stockholders will be held at 10:00 a.m. local time on Wednesday, May 9, 2007, in the Huntington Conference Room at the Molina Healthcare Corporate Headquarters located at One Golden Shore Drive, Long Beach, California, 90802, for the following purposes:

 

1. To elect three Class II directors to hold office until the 2010 annual meeting.

 

2. To transact such other business as may properly come before the meeting or any adjournment or postponement thereof.

 

The foregoing items of business are more fully described in the proxy statement accompanying this notice. The board of directors has fixed the close of business on March 19, 2007 as the record date for the determination of stockholders entitled to notice of and to vote at the annual meeting and at any continuation, adjournment, or postponement thereof.

 

Every stockholder vote is important. Please sign, date, and promptly return the enclosed proxy card in the enclosed envelope, or vote by telephone or Internet (instructions are on your proxy card), so that your shares will be represented whether or not you attend the annual meeting.

 

By order of the board of directors,

 

 

Joseph M. Molina, M.D.

Chairman of the Board, Chief Executive Officer,
and President

 

Long Beach, California

April 6, 2007

 

TABLE OF CONTENTS

 

 

 

ANNUAL MEETING OF STOCKHOLDERS
To Be Held Wednesday, May 9, 2007

 

 

Who is soliciting my vote?

 

The board of directors of Molina Healthcare is soliciting your vote at the 2007 annual meeting of Molina Healthcare’s stockholders.

 

What will I be voting on?

 

The election of three Class II directors to hold office until 2010 (see page 9).

 

How many votes do I have?

 

You will have one vote for every share of Molina Healthcare common stock you owned on March 19, 2007, which was the record date.

 

How many votes can be cast by all stockholders?

 

28,184,626, consisting of one vote for each of Molina Healthcare’s shares of common stock that were outstanding on the record date. There is no cumulative voting.

 

How many votes must be present to hold the meeting?

 

A majority of the votes that can be cast, or 14,092,314 votes. We urge you to vote by proxy even if you plan to attend the annual meeting, so that we will know as soon as possible that enough votes will be present for us to hold the meeting.

 

How do I vote?

 

You can vote either in person at the annual meeting or by proxy whether or not you attend the annual meeting.

 

To vote by proxy, you must either

 

 

To ensure that your vote is counted, please remember to submit your vote by May 8, 2007, the day before the annual meeting.

 

If you want to vote in person at the annual meeting, and you hold your Molina Healthcare stock through a securities broker (that is, in street name), you must obtain a proxy from your broker and bring that proxy to the meeting.

 

Can I change my vote?

 

Yes. Just send in a new proxy card with a later date, or cast a new vote by telephone or Internet, or send a written notice of revocation to Molina Healthcare’s Corporate Secretary at 2277 Fair Oaks Boulevard, Suite 440, Sacramento, California 95825. If you attend the annual meeting and want to vote in person, you can request that your previously submitted proxy not be used.

 

What if I do not vote for some of the matters listed on my proxy card?

 

If you return a signed proxy card without indicating your vote, in accordance with the board’s recommendation, your shares will be voted for the three director nominees listed on the card.

 

How are my votes counted?

 

You may vote for a director, or withhold authority to vote for a director. Each nominee for director will be elected if the votes for the director exceed the votes withheld for the director.

 

How many votes are required to elect the three directors?

 

If a majority of the shares of common stock represented at the meeting vote for a director, that director will be elected.

 

Can my shares be voted if I do not return my proxy card and do not attend the annual meeting?

 

If you do not vote your shares held in street name, your broker can vote your shares on matters that the New York Stock Exchange (NYSE) has ruled discretionary. The election of directors is a discretionary item. NYSE member brokers that do not receive instructions from beneficial owners may vote your shares at their discretion.

 

If you do not vote the shares registered directly in your name, not in the name of a bank or broker, your shares will not be voted.

 

Could other matters be decided at the annual meeting?

 

We do not know of any other matters that will be considered at the annual meeting besides the election of the three director nominees. If any other matters arise at the annual meeting, the proxies will be voted at the discretion of the proxy holders.

 

What happens if the meeting is postponed or adjourned?

 

Your proxy will still be good and may be voted at the postponed or adjourned meeting. You will still be able to change or revoke your proxy until it is voted.

 

Do I need proof of stock ownership to attend the annual meeting?

 

Yes, you will need proof of ownership of Molina Healthcare stock to enter the meeting.

 

When you arrive at the annual meeting, you may be asked to present photo identification, such as a driver’s license. If you are a stockholder of record, you will be on the list of Molina Healthcare’s registered stockholders. If your shares are held in the name of a bank, broker, or other holder of record, a recent brokerage statement or letter from a bank or broker is an example of proof of ownership. We will admit you only if we are able to verify that you are a Molina Healthcare stockholder.

 

How can I access Molina Healthcare’s proxy materials and annual report electronically?

 

This proxy statement and the 2006 annual report are available on Molina Healthcare’s website at www.molinahealthcare.com. Click on “Investor Relations,” and then click on one of the links under the

heading “Featured Reports.” Most stockholders can elect not to receive paper copies of future proxy statements and annual reports and can instead view those documents on the Internet.

 

If you are a stockholder of record, you can choose this option and save Molina Healthcare the cost of producing and mailing these documents by following the instructions provided when you vote over the Internet. If you hold your Molina Healthcare stock through a bank, broker, or other holder of record, please refer to the information provided by that entity for instructions on how to elect not to receive paper copies of future proxy statements and annual reports.

 

If you choose not to receive paper copies of future proxy statements and annual reports, you will receive an e-mail message next year containing the Internet address to use to access Molina Healthcare’s proxy statement and annual report. Your choice will remain in effect until you tell us otherwise.

 

If you received these materials by mail, you should have also received with them Molina Healthcare’s annual report to stockholders for 2006. The 2006 annual report is also available on Molina Healthcare’s website at www.molinahealthcare.com. We urge you to read these documents carefully. In accordance with the rules of the Securities and Exchange Commission (the SEC), the Company’s Performance Graph appears in the 2006 Annual Report on Form 10-K.

 

Molina Healthcare continually strives to maintain high standards of ethical conduct: reporting results with accuracy and transparency; and maintaining full compliance with the laws, rules, and regulations that govern Molina Healthcare’s business.

 

The current charters of the audit committee, corporate governance and nominating committee, and compensation committee, as well as Molina Healthcare’s Corporate Governance Guidelines and Code of Business Conduct and Ethics, are available in the “Investor Relations” section of Molina Healthcare’s website, www.molinahealthcare.com, under the link for “Corporate Governance.” Molina Healthcare stockholders may obtain printed copies of these documents free of charge by writing to Molina Healthcare, Inc., Juan Jose Orellana, Vice President of Investor Relations, One Golden Shore, Long Beach, California 90802.

 

The corporate governance and nominating committee’s mandate is to review and shape corporate governance policies and identify qualified individuals for nomination to the board of directors. All of the members of the committee meet the independence standards contained in the NYSE corporate governance rules and Molina Healthcare’s Corporate Governance Guidelines.

 

Molina Healthcare has designated the chair of the board’s corporate governance and nominating committee — Ronna E. Romney — as its lead director. The lead director presides at executive sessions of the independent directors, serves as a liaison between the chairman and the independent directors, approves information sent to the board, approves meeting agendas for the board, and approves meeting schedules to ensure that there is sufficient time for discussion of all agenda items.

 

The committee considers all qualified candidates identified by members of the committee, by other members of the board of directors, by senior management, and by security holders. Stockholders who would like to propose a director candidate for consideration by the committee may do so by submitting the candidate’s name, résumé, and biographical information to the attention of the Corporate Secretary as described below under “Submission of Future Stockholder Proposals.” All proposals for nominations received by the Corporate Secretary will be presented to the committee for its consideration.

 

The committee reviews each candidate’s biographical information and assesses each candidate’s independence, skills, and expertise based on a variety of factors, including breadth of experience reflecting that the candidate will be able to make a meaningful contribution to the board’s discussion of and decision-

making regarding the array of complex issues facing the Company; understanding of the Company’s business environment; the possession of expertise that would complement the attributes of our existing directors; whether the candidate will appropriately balance the legitimate interests and concerns of all stockholders and other stakeholders in reaching decisions rather than advancing the interests of a particular constituency; and whether the candidate will be able to devote sufficient time and energy to the performance of his or her duties as a director. Application of these factors involves the exercise of judgment by the board.

 

Based on its assessment of each candidate’s independence, skills, and qualifications, the committee will make recommendations regarding potential director candidates to the board.

 

The committee follows the same process and uses the same criteria for evaluating candidates proposed by stockholders, members of the board of directors, and members of senior management.

 

For the 2007 annual meeting, we did not receive notice of any director nominations from our stockholders.

 

Molina Healthcare’s Corporate Governance Guidelines embody many of our practices, policies, and procedures, which are the foundation of our commitment to sound corporate governance practices. The Guidelines are reviewed annually and revised as necessary. The Guidelines outline the responsibilities, operations, qualifications, and composition of the board. Our goal is that a majority of the members of the board be independent.

 

The Guidelines require that all members of the committees of the board be independent. Committee members are appointed by the board upon recommendation of the corporate governance and nominating committee. Committee membership and chairs are rotated periodically. The board and each committee have the power to hire and fire independent legal, financial, or other advisors, as they may deem necessary.

 

Meetings of the non-management directors are held as part of every regularly scheduled board meeting and are presided over by the lead independent director.

 

Directors are expected to prepare for, attend, and participate in all board meetings, meetings of the committees on which they serve, and the annual meeting of stockholders. All of the directors then in office attended Molina Healthcare’s 2006 annual meeting.

 

The corporate governance and nominating committee conducts an annual review of board performance, and each committee conducts its own self-evaluation. The results of these evaluations are reported to the board.

 

Directors have full and free access to senior management and other employees of Molina Healthcare. New directors are provided with an orientation program to familiarize them with Molina Healthcare’s business, and its legal, compliance, and regulatory profile. Molina Healthcare provides educational sessions on a variety of topics which all members of the board are expected to attend. These sessions are designed to allow directors to develop a deeper understanding of relevant health care, governmental, and business issues facing the Company.

 

The board reviews the compensation committee’s report on the performance of Dr. Molina, the Company’s current chief executive officer, in order to ensure that he is providing effective leadership for Molina Healthcare. The board also works with the compensation committee to evaluate potential successors to the chief executive officer.

 

The board of directors has determined that, except for Messrs. J. Mario Molina, John C. Molina, and Wayne B. Lowell, each of the directors of the Company has no material relationship with the Company and is otherwise “independent” in accordance with the applicable listing requirements of the NYSE. In making that determination, the board of directors considered all relevant facts and circumstances, including the director’s

commercial, industrial, banking, consulting, legal, accounting, charitable, and familial relationships. The board of directors applied the following standards, which provide that a director will not be considered independent if he or she:

 

 

The board has adopted a policy regarding the review, approval, and monitoring of transactions involving Molina Healthcare and related persons (directors and executive officers or their immediate family members). Such related persons are required to promptly and fully disclose to the Company’s general counsel all financial, social, ethical, personal, legal, or other potential conflicts of interest involving the Company. The general counsel shall confer as necessary with the lead independent director and/or with the Company’s corporate governance and nominating committee regarding the facts of the matter and the appropriate resolution of any conflict of interest situation in the best interests of the Company, including potential removal of the related person from a position of decision-making or operational authority with respect to the conflict situation, or other more significant steps depending upon the nature of the conflict.

 

Effective March 1, 2006, we assumed an office lease from Millworks Capital Ventures. Millworks Capital Ventures is owned by John C. Molina, our chief financial officer and a director nominee, and his wife. The lease term runs through June 2010. Based on a market report prepared by an independent realtor, we believe the terms and conditions of the assumed lease are at fair market value. Payments made under this lease totaled $170,000 in 2006.

 

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. Approximately $357,000 was paid under the agreement in 2006. We believe that the claims submitted to us by Pacific Hospital were reimbursed at prevailing market rates.

 

Effective June 1, 2006, the Company entered into an additional agreement with Pacific Hospital as part of a capitation arrangement. Under this arrangement, Pacific Hospital receives a fixed fee from us based on member type. Approximately $1,652,000 was paid to Pacific Hospital under this agreement in 2006. We believe that this agreement with Pacific Hospital is based on prevailing market rates for similar services.

 

One of our directors, Mr. Wayne B. Lowell, has previously served and continues to serve as a business consultant to the Company. For his consulting services, Mr. Lowell has been paid approximately $85,000, $205,000, and $283,000, in 2006, 2005, and 2004, respectively. It is our expectation that Mr. Lowell will

continue to provide us with his consulting services in the future. As a result of the consulting compensation paid to Mr. Lowell within the past three years, the board of directors has determined that he is not “independent” in accordance with the applicable listing requirements of the NYSE.

 

The persons listed on page 17 were the only members of the compensation committee during 2006. No member of the compensation committee was a part of a “compensation committee interlock” during fiscal year 2006 as described under SEC rules. In addition, none of our executive officers served as a director or member of the compensation committee of another entity that would constitute a “compensation committee interlock.” No member of the compensation committee had any material interest in a transaction with Molina Healthcare. Except for Dr. Mario Molina and Mr. John Molina, no director is a current or former employee of Molina Healthcare or any of its subsidiaries.

 

The board has adopted a Code of Business Conduct and Ethics governing all employees of Molina Healthcare and its reporting subsidiaries. A copy of the Code of Business Conduct and Ethics is available on our website at www.molinahealthcare.com. Click on “Investor Relations,” then “Corporate Governance.” There were no waivers of our Code of Business Conduct and Ethics during 2006. We intend to disclose amendments to, or waivers of, our Code of Business Conduct and Ethics, if any, on our website.

 

Molina Healthcare encourages employees to raise possible ethical issues. Molina Healthcare offers several channels by which employees and others may report ethical concerns or incidents, including, without limitation, concerns about accounting, internal controls, or auditing matters. We provide a Compliance Hotline that is available 24 hours a day, seven days a week. Individuals may choose to remain anonymous. We prohibit retaliatory action against any individual for raising legitimate concerns or questions regarding ethical matters, or for reporting suspected violations.

 

Stockholders or other interested parties who wish to communicate with a member or members of the board of directors, including the lead independent director or the non-management directors as a group, may do so by addressing their correspondence to the individual board member or board members, c/o the Molina Healthcare Corporate Secretary, Molina Healthcare Inc., 2277 Fair Oaks Boulevard, Suite 440, Sacramento, California 95825. The board of directors has approved a process pursuant to which the Corporate Secretary shall review and forward correspondence to the appropriate director or group of directors for response.

 

The following table shows the beneficial ownership of Molina healthcare common stock by our directors, certain executive officers, and more than 5% stockholders, at March 19, 2007. Percentage ownership calculations are based on 28,184,626 shares outstanding at March 19, 2007.

 

 

 

 

 

 

 

 

 

 

 

 

Mr. Dentino is counsel to Mrs. Mary R. Molina and has provided legal services to various Molina family members and entities in which they have interests. His address is 555 Capitol Mall, Suite 1500, Sacramento, California 95814.

 

 

 

Mr. Pedersen is the uncle of J. Mario Molina, M.D., John C. Molina, J.D. and M. Martha Bernadett, M.D.

 

 

Our nine-member board of directors is divided into three classes, with each class having three members. The terms of the three Class II directors expire at the 2007 annual meeting. Currently, the Class II directors are Charles Z. Fedak, John C. Molina, and Sally K. Richardson. The directors to be elected as Class II directors at the 2007 annual meeting will serve until the 2010 annual meeting. All directors serve until the expiration of their respective terms and until their respective successors are elected and qualified or until such director’s earlier resignation, removal from office, death, or incapacity. A plurality of the votes cast at the meeting shall elect each director.

 

The board of directors, upon recommendation of the corporate governance and nominating committee, has nominated the three incumbent directors — Charles Z. Fedak, John C. Molina, and Sally K. Richardson — for election as Class II directors at the 2007 annual meeting. Proxies can only be voted for the three named nominees.

 

In the event any nominee is unable or declines to serve as a director at the time of the meeting, the proxies will be voted for any nominee who may be designated by the board of directors to fill the vacancy. As of the date of this proxy statement, the board of directors is not aware of any nominee who is unable or will decline to serve as a director.

 

 

THE BOARD OF DIRECTORS RECOMMENDS THAT THE STOCKHOLDERS VOTE FOR THE ELECTION OF EACH THE THREE NOMINEES LISTED ABOVE.

 

 

The board of directors met eight times in 2006. During 2006, the audit committee met four times, the corporate governance and nominating committee met four times, and the compensation committee met four times. Each director attended at least 75% of the total number of meetings of the board and board committees of which he or she was a member in 2006, and each director attended the 2006 annual meeting of stockholders held on May 3, 2006.

 

Molina Healthcare’s non-management directors meet in executive session without any management directors in attendance each time the full board convenes for a regularly scheduled meeting, which is usually four times each year, and, if the board convenes a special meeting, the non-management directors may meet in executive session if the circumstances warrant. The lead independent director presides at each executive session of the non-management directors.

 

The standing committees of the board of directors are: (i) the audit committee; (ii) the corporate governance and nominating committee; and (iii) the compensation committee.

 

The audit committee performs a number of functions, including: (i) reviewing the adequacy of the Company’s internal system of accounting controls, (ii) meeting with the independent accountants and management to review and discuss various matters pertaining to the audit, including the Company’s financial statements, the report of the independent accountants on the results, scope, and terms of their work and the recommendations of the independent accountants concerning the financial practices, controls, procedures, and policies employed by the Company, (iii) resolving disagreements between management and the independent accountants regarding financial reporting, (iv) reviewing the financial statements of the Company, (v) selecting, evaluating, and, when appropriate, replacing the independent accountants, (vi) reviewing and approving fees to be paid to the independent accountants, (vii) reviewing and approving related-party transactions, (viii) reviewing and approving all permitted non-audit services to be performed by the independent accountants, (ix) establishing procedures for the receipt, retention, and treatment of complaints received by the Company regarding accounting, internal accounting controls, or auditing matters and the confidential, anonymous submission by the Company’s employees of concerns regarding questionable accounting or auditing matters, (x) considering other appropriate matters regarding the financial affairs of the Company, and (xi) fulfilling the other responsibilities set out in its charter, as adopted by the board. The report of the audit committee required by the rules of the SEC is included in this proxy statement.

 

The audit committee consists of Mr. Fedak (Chair), Ms. Romney, Mr. Szabo, and Mr. Orlando, each of whom is “independent” under applicable NYSE rules. The board has determined that each of Mr. Fedak and Mr. Orlando qualify as an “audit committee financial expert” as defined by the SEC. In addition to being independent according to the board’s independence standards as set out in its Corporate Governance Guidelines, each member of the audit committee is independent within the meaning of the corporate governance rules of the NYSE. Each member of the audit committee is also financially literate.

 

The audit committee charter is available for viewing in the “Investor Relations” section of Molina Healthcare’s website, www.molinahealthcare.com, under the link, “Corporate Governance.”

 

The corporate governance and nominating committee is responsible for identifying individuals qualified to become board members and recommending to the board the director nominees for the next annual meeting of stockholders. It leads the board in its annual review of the board’s performance and recommends to the board director candidates for each committee for appointment by the board. The committee takes a leadership role in shaping corporate governance policies and practices, including recommending to the board the Corporate Governance Guidelines and monitoring Molina Healthcare’s compliance with these Guidelines. The committee is responsible for reviewing and approving material related party transactions involving directors, executive officers, or their immediate family members. The committee also reviews Molina Healthcare’s Code

of Business Conduct and Ethics and other internal policies to monitor that the principles contained in the Code are being incorporated into Molina Healthcare’s culture and business practices.

 

The corporate governance and nominating committee currently consists of Ms. Romney (Chair), Ms. Richardson, and Dr. Murray, each of whom is “independent” under the NYSE listing standards. The corporate governance and nominating committee charter is available for viewing in the “Investor Relations” section of Molina Healthcare’s website, www.molinahealthcare.com, under the link, “Corporate Governance.”

 

The compensation committee is responsible for determining the compensation for Dr. Molina, Molina Healthcare’s chief executive officer, and also approves the compensation he recommends for other senior executive officers. The committee reviews and discusses with management the Compensation Discussion and Analysis, and, if appropriate, recommends to the board that the Compensation Discussion and Analysis be included in Molina Healthcare’s filings with the SEC. In addition, the committee administers Molina Healthcare’s 2002 Equity Incentive Plan and approves the grants made thereunder. The committee also reviews Molina Healthcare’s succession planning and executive development activities, as well as the performance of senior management.

 

The compensation committee also has the authority to retain special consultants or experts to advise the committee, as the committee may deem appropriate or necessary in its sole discretion. From time to time, the compensation committee has retained Pearl Meyer & Partners as its compensation consultant to provide the committee with comparative data on executive compensation and advice on Molina Healthcare’s compensation programs for senior management.

 

The compensation committee currently consists of Mr. Szabo (Chair), Mr. Fedak, Ms. Richardson, Mr. Orlando, and Dr. Murray. The board has determined that in addition to being independent according to the board’s independence standards as set out in its Corporate Governance Guidelines, each of the members of the compensation committee is independent according to the corporate governance rules of the NYSE. In addition, each of the members of the committee is a “non-employee director,” as defined in Section 16 of the Securities Exchange Act of 1934, and is also an “outside director,” as defined by Section 162(m) of the Internal Revenue Code.

 

A copy of the compensation committee charter is available for viewing in the “Investor Relations” section of Molina Healthcare’s website, www.molinahealthcare.com, under the link, “Corporate Governance.”

 

The compensation committee makes recommendations to the board with respect to the compensation level of directors, and the board determines their compensation. The compensation committee annually reviews benchmarking assessments of director compensation at comparable companies in order to determine competitive levels of compensation to attract qualified candidates for board service.

 

We pay each non-employee director an annual retainer of $35,000. We also pay an additional annual retainer of $7,500 to the chair of the audit committee, $5,000 to each audit committee member, and $2,500 to the chairs of each of the corporate governance and nominating committee and the compensation committee. We pay each non-employee director $1,200 for each board and committee meeting attended in person, except audit committee members receive $2,400 for each audit committee meeting attended. Non-employee directors also receive $600 for participation in each telephonic board meeting.

 

In order to link the financial interests of the non-employee directors to the interests of the stockholders, encourage support of the Company’s long-term goals, and align director compensation to the Company’s performance, each non-employee director also receives upon his or her initial election to the board of directors an option to purchase 10,000 shares of common stock, vesting in ratable one-third increments over three years, with an exercise price equal to the closing price of Molina Healthcare’s common stock as of the date of grant. In addition, each non-employee director is granted annually 5,000 shares of common stock, vesting in 1,250 share increments at the end of each fiscal quarter subsequent to the date of the annual stockholder meeting. The total value of this stock grant in 2006 was $170,400.

 

Directors who are employees of Molina Healthcare or its subsidiaries do not receive any compensation for their services as directors.

 

Molina Healthcare reimburses its board members for expenses incurred in attending board and committee meetings or performing other services for Molina Healthcare in their capacities as directors. Such expenses include food, lodging, and transportation.

 

NON-EMPLOYEE DIRECTOR COMPENSATION

 

 

 

 

Two of our directors, J. Mario Molina, M.D. and John C. Molina, J.D., and the following persons were our named executive officers at December 31, 2006. Dr. William P. Bracciodieta resigned from the Company effective February 6, 2007.

 

Mark L. Andrews, Esq., 49, has served as chief legal officer and general counsel since 1998. He also has served as a member of the executive committee of our company since 1998. Before joining our company, Mr. Andrews was a partner at Wilke, Fleury, Hoffelt, Gould & Birney of Sacramento, California, where he chaired that firm’s health care and employment law departments and represented Molina as outside counsel from 1994 through 1997. Mr. Andrews holds a juris doctorate degree from Hastings College of the Law.

 

Terry P. Bayer, 56, has served as our chief operating officer since November 2005. She had previously served as our executive vice president, health plan operations, since January 2005. Ms. Bayer has 25 years of healthcare management experience, including staff model clinic administration, provider contracting, managed care operations, disease management, and home care. Prior to joining us, her professional experience included regional responsibility at FHP, Inc. and multi-state responsibility as regional vice-president at Maxicare; Partners National Health Plan, a joint venture of Aetna Life Insurance Company and Veterans Health

Administration (VHA); and Lincoln National. She has also served as executive vice president of managed care at Matria Healthcare, president and chief operating officer of Praxis Clinical Services, and as Western Division President of AccentCare. She holds a juris doctorate from Stanford University, a master’s degree in public health from the University of California, Berkeley, and a bachelor’s degree in Communications from Northwestern University. Ms. Bayer is a member of the board of directors of Apria Healthcare Group Inc.

 

Dr. William P. Bracciodieta, M.B.A, age 61, was named as our chief medical officer in June 2006. He was responsible for the medical management of all of our health plan subsidiaries, including oversight of all utilization management, quality improvement, credentialing, pharmacy, and risk management activities. As previously reported, on February 6, 2007, Dr. Bracciodieta resigned as the Company’s chief medical officer.

 

Executive officers are appointed annually by the board of directors, subject to the terms of their employment agreements.

 

The following Report of the Audit Committee shall not be deemed to be “soliciting material” or to be “filed” with the Securities and Exchange Commission nor shall this information be incorporated by reference into any future filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except to the extent that the Company specifically incorporates it by reference into a filing.

 

The board of directors has determined that all four members of the Audit Committee are independent based upon the independence requirements under applicable laws, rules, and regulations. The Audit Committee operates under a written charter adopted by the board of directors, a copy of which is posted on our website at www.molinahealthcare.com.

 

Management is responsible for the implementation of Molina Healthcare’s internal controls, for the preparation of its consolidated financial statements in accordance with accounting principles generally accepted in the United States, and for various other financial reporting-related functions. Ernst & Young LLP, Molina Healthcare’s independent accountants, is responsible for performing an independent audit of Molina Healthcare’s consolidated financial statements and expressing an opinion, based upon its audit, as to the conformity of such financial statements with accounting principles generally accepted in the United States. The Audit Committee is responsible for, among other things, oversight and monitoring of these processes.

 

In this context, the Audit Committee met at least quarterly and held discussions with management and the independent accountants. Management represented to the Audit Committee that Molina Healthcare’s consolidated financial statements for the fiscal year ended December 31, 2006 were prepared in accordance with accounting principles generally accepted in the United States, and the Audit Committee has reviewed and discussed the consolidated financial statements with management and the independent accountants. The Audit Committee discussed with the independent accountants matters required to be discussed by Statement on Auditing Standards No. 61 (Communication with Audit Committees) relating to the conduct of the audit, as amended by Statement on Accounting Standards No. 90 (Audit Committee Communications).

 

The Audit Committee has received and reviewed the written disclosures and the letter from Ernst & Young LLP required by Independence Standards Board Standard No. 1 (Independence Discussions with Audit Committees) and has discussed with Ernst & Young LLP its independence from Molina Healthcare.

 

Based on the review discussed above, the Audit Committee approved the consolidated audited financial statements for inclusion in the Annual Report on Form 10-K for the year ended December 31, 2006 for filing with the Securities and Exchange Commission and so recommended to the board of directors. The board of

directors also approved the consolidated audited financial statements for inclusion in the Annual Report on Form 10-K for the year ended December 31, 2006 for filing with the Securities and Exchange Commission.

 

Audit Committee

 

Charles Z. Fedak,CPA, MBA, Chair

Ronna E. Romney

John P. Szabo, Jr.

Steven J. Orlando, CPA

 

April 5, 2007

 

The Compensation Committee reviewed and discussed the Compensation Discussion and Analysis with members of senior management and, based on its review, the Compensation Committee recommended to the board of directors of Molina Healthcare, Inc. that the Compensation Discussion and Analysis be included in this proxy statement and incorporated by reference in the Company’s Form 10-K as filed with the Securities and Exchange Commission.

 

THE COMPENSATION COMMITTEE:

 

John P. Szabo, Jr. (Chair)

Charles Z. Fedak, CPA, MBA

Frank E. Murray, MD

Steven J. Orlando, CPA

Sally K. Richardson

 

April 5, 2007

 

Overall Program Objectives

 

The Company strives to attract, motivate, and retain high-quality executives by providing total compensation that is performance-based and competitive within the labor market in which the Company competes for executive talent. The Company’s compensation program is intended to align the interests of management with the interests of stockholders by linking pay with performance, thereby incentivizing performance which furthers the ultimate objective of improving stockholder value.

 

The Company, through the activity of its compensation committee, seeks to achieve these objectives through three key compensation elements:

 

 

In making compensation decisions with respect to each of these three elements of compensation, the compensation committee considers the competitive market for executives and the compensation levels provided by comparable companies in our industry.

 

The compensation committee does not attempt to set each compensation element for each executive within a specific range related to levels provided by industry peers. Instead, the compensation committee uses market comparisons as one factor — albeit a significant factor — in making compensation decisions. Other factors considered when making individual executive compensation decisions regarding each of the three key compensation elements include individual contribution and performance, reporting structure, internal pay relationships, complexity and importance of role and responsibility, leadership, and growth potential.

 

Elements of Compensation

 

Set forth below is a discussion of each element of compensation, the reason the Company pays each element, and how that element fits into the Company’s overall compensation philosophy.

 

Base Salary.  The objective of base salary is to reflect job responsibilities, value to the Company, and individual performance with respect to market competitiveness. These salaries are determined based on a variety of factors, including:

 

 

Base salary amounts are generally reviewed annually. The compensation committee sets the base salary level of the Company’s chief executive officer, who in turn recommends for approval by the compensation committee the base salary levels of the Company’s other senior executive officers.

 

Annual Bonus Incentives for Named Executive Officers.  The compensation program provides for an annual bonus that is performance linked. The objective of the program is to compensate individuals based on the achievement of specific annual goals that are intended to correlate closely with the growth of long-term stockholder value.

 

For the chief executive officer and the chief financial officer, at the outset of the fiscal year the compensation committee sets overall objective Company performance goals for the year. The compensation committee then sets target bonus amounts which correspond to the respective performance goals. Once the fiscal year is concluded, achievement of the objective performance goals is assessed to determine the bonus payment for which the chief executive officer and chief financial officer are eligible. The objective performance goals established for fiscal 2006 are discussed below under “Fiscal Year 2006 Decisions.”

 

As it sets Company-wide performance goals, the compensation committee, working with senior management, also sets individual performance measures for each named executive officer. These measures allow the Company to incentivize performance objectives beyond purely financial measures, including, for example, exceptional performance of each executive’s particular functional responsibilities, his or her leadership, creativity and innovation, collaboration, the successful completion of a particular project or initiative, and other activities that are critical to driving long-term value for stockholders.

 

For the named executive officers other than the chief executive officer and chief financial officer, the preliminary bonus determination is based as a threshold matter upon the achievement of certain Company performance goals — generally earnings per share — combined with the recommendation of the chief executive officer and the Company’s assessment of each officer’s performance as measured against the individual goals set at the outset of the year. This assessment allows bonus decisions to take into account each named executive officer’s individual performance and unique contribution during the year. This portion of the bonus may be adjusted up or down depending on the level of performance against the individual goals.

 

Under the bonus program, the compensation committee has discretion as to whether annual bonuses for the Company’s named executive officers will be paid in cash, restricted stock, or a combination thereof. The compensation committee also retains discretion, in appropriate circumstances, to grant a lower bonus or no bonus at all.

 

Compliance with Section 162(m).  Section 162(m) of the Internal Revenue Code generally disallows a tax deduction to public corporations for compensation over $1 million paid for any fiscal year to the corporation’s chief executive officer and four other most highly compensated executive officers as of the end of the fiscal year. However, the statute exempts qualifying performance-based compensation from the $1 million deduction limit if certain requirements are met. To the extent practicable, the compensation committee seeks to design the components of compensation so that these requirements are met and full deductibility under Section 162(m) is allowed. In particular, the compensation committee seeks to establish objective performance measures under the Company’s 2005 Incentive Compensation Plan which was approved by stockholders at the Company’s 2005 annual meeting. The compensation committee believes, however, that stockholder interests are best served by not restricting the compensation committee’s discretion and flexibility in crafting compensation programs, even though such programs may result in certain non-deductible compensation expenses. Accordingly, the compensation committee may from time to time approve elements of compensation for certain officers that are not fully deductible under Section 162(m).

 

Long-term Incentive Compensation.  The long-term incentive program provides a periodic award — typically annual — that is performance based. The objective of the program is to align compensation for named executive officers over a multi-year period directly with the interests of stockholders of the Company by motivating and rewarding creation and preservation of long-term stockholder value. The level of long-term incentive compensation is determined based on an evaluation of competitive factors in conjunction with total compensation provided to the named executive officers and the goals of the compensation program as described above.

 

The Company’s long-term incentive compensation generally takes the form of a mix of restricted stock grants and option awards. These two vehicles reward stockholder value creation in slightly different ways. Stock options — which have exercise prices equal to the closing market price as of the date of grant — reward named executive officers only if the stock price increases. Restricted stock is impacted by all stock price changes, so the value to named executive officers is affected by both increases and decreases in stock price.

 

Stock options granted as long-term incentive compensation to named executed officers generally vest ratably over three to five years, contingent upon the named executive officer’s continued employment with the Company. The exercise price of stock options is equal to the closing price of the Company’s common stock on the New York Stock Exchange as of the date of grant. Likewise, restricted stock granted as long-term incentive compensation to named executive officers generally has ratable vesting over three to five years, contingent upon continued employment.

 

Pursuant to Company policy adopted in 2006, and subject to the existence of an open window period under the Company’s insider trading policy, equity incentive awards to the named executive officers are generally made on March 1st of each year, which is the same grant date as that used for annual incentive and retention awards made to any other Company employees receiving awards.

 

Because of the significant number of founders’ shares held by Dr. J. Mario Molina, the Company’s chief executive officer, and by John Molina, the chief financial officer, the compensation committee has historically not granted long-term equity based compensation to executive officers who are members of the Molina family. The compensation committee continued this practice in 2006. However, the compensation committee re-evaluates this matter annually, and recently made a grant of options to Dr. Molina and Mr. Molina as long-term equity compensation in order to further incentivize achievement of the Company’s long-term goals.

 

The compensation committee intends to review annually both the annual bonus program and the long-term incentive program to ensure that their key elements continue to meet the objectives described above.

 

Perquisites and Other Personal Benefits.  The Company does not provide named executive officers with any significant perquisites or other personal benefits.

 

Retirement Plans.  The Company does not maintain a retirement pension plan. However, the named executive officers are eligible to participate in the Molina 401(k) Salary Savings Plan. The purpose of this program is to provide all Molina Healthcare employees with tax-advantaged savings opportunities and income after retirement. Eligible pay under the plans is limited to Internal Revenue Code annual limits. The Company makes a dollar-for-dollar match on the first four percent (4%) of salary electively deferred under the 401(k) Plan by all participants.

 

Deferred Compensation Plan.  The Company has established an unfunded non-qualified deferred compensation plan for certain key employees, including the named executed officers. Under the deferred compensation plan, eligible participants can defer up to 100% of their base salary and 100% of their bonus to provide for tax-deferred growth. The funds deferred are invested in any of twenty different mutual funds, including bond, money market, and large and small cap stock funds.

 

Employee Stock Purchase Plan.  The named executive officers are eligible to participate in the Company’s 2002 Employee Stock Purchase Plan on an equal basis with all other employees. The Employee Stock Purchase Plan allows eligible employees to purchase from the Company shares of its common stock at a 15% discount to the market price during the successive six-month offering periods under the plan.

 

Health and Insurance Benefits.  With limited exceptions, the Company supports providing benefits to named executive officers that are substantially the same as those offered to salaried employees generally. The named executive officers are eligible to participate in company-sponsored benefit programs on the same terms and conditions as those made available to salaried employees generally. Basic health benefits, life insurance, disability benefits and similar programs are provided to ensure that employees have access to healthcare and income protection for themselves and their family members.

 

Process For Determining Executive Officer Compensation

 

The role of the Compensation Committee.  The compensation committee is responsible for evaluating the performance of and determining the compensation paid to the chief executive officer. The compensation committee is also responsible for evaluating and approving the compensation levels of other key executive officers subject to the recommendations made by the chief executive officer. The compensation committee reviews the design and structure of Molina Healthcare’s compensation programs to ensure that management’s interests are aligned with stockholders and that the compensation programs are aligned with Molina Healthcare’s strategic priorities. In furtherance of these goals, the compensation committee has periodically engaged Pearl Meyer & Partners to provide evaluations and advice regarding the Company’s executive compensation program and relevant benchmarks.

 

Benchmarking.  Market standards and benchmarking information on the performance and compensation at peer companies was obtained from publicly available sources and third-party proprietary databases, and reviewed with Pearl Meyer. The 15 companies considered to be peers for compensation benchmarking purposes were America Service Group Inc., Amerigroup Corp., Apria Healthcare Group, Inc., Centene Corp., Community Health Systems, Inc., Healthextras, Inc., Healthspring, Inc., Healthways, Inc., Horizon Health Corp., Magellan Health Services, Inc., Matria Healthcare, Inc., Sierra Health Services, Inc., Universal American Financial Corp., Universal Health Services, Inc., and Wellcare Health Plans, Inc.

 

Fiscal Year 2006 Decisions.  In February 2006, based upon peer group comparisons compiled by the compensation committee and prior analysis by Pearl Meyer, the compensation committee determined to raise the salary of Dr. Molina as chief executive officer from $675,000 to $775,000 for fiscal year 2006. The compensation committee also accepted the recommendation of Dr. Molina that the base salary of John Molina for fiscal year 2006 be increased from $450,000 to $700,000 commensurate with his job responsibilities. At the recommendation of the chief executive officer, the salaries of the other named executive officers were unchanged for 2006.

 

In addition, as had been recommended by Pearl Meyer, the compensation committee established three independent objective performance measures for fiscal year 2006 under the Company’s 2005 Incentive Compensation Plan for each of the chief executive officer and chief financial officer. In the event the

Company achieved earnings per diluted share of at least $1.94, the chief executive officer would be eligible for a bonus of $193,750, and the chief financial officer would be eligible for a bonus of $175,000. In addition, if the Company achieved a return on equity of 14% or more, the chief executive officer would be eligible for an additional bonus of $193,750 and the chief financial officer would be eligible for an additional bonus of $175,000. Finally, if the Company achieved total premium revenues of at least $1,832 million, the chief executive officer would be eligible for a bonus of $193,750 and the chief financial officer would be eligible for a bonus of $175,000. The compensation committee also approved a separate, potential general bonus amount outside the 2005 Incentive Compensation Plan of $193,750 for the chief executive officer and $175,000 for the chief financial officer for individual performance that could be awarded on a discretionary basis.

 

Because the Company achieved only one of the three objective performance measures during fiscal year 2006, the Company awarded the bonus amounts to the chief executive officer and chief financial officer set forth in the Summary Compensation Table below. The compensation committee also declined to award any additional discretionary bonus.

 

In fiscal 2006, the Company awarded long-term compensation for named executive officers other than the chief executive officer and the chief financial officer pursuant to the program described above resulting in the awards of stock options and restricted stock units identified in the Summary Compensation Table and other tables below.

 

The following table provides information concerning total compensation earned or paid to the chief executive officer, the chief financial officer, and the three other most highly compensated executive officers of the Company who served in such capacities as of December 31, 2006 for services rendered to the Company during the last year. These five officers are referred to as the named executive officers in this proxy statement. As a result of his resignation on February 9, 2007, William Bracciodieta is no longer an employee of the Company.

 

SUMMARY COMPENSATION TABLE

 

 

 

Grants of Plan-Based Awards

 

The following table provides information with respect to grants of plan-based awards made during fiscal year 2006 to the named executive officers. The options have an exercise price equal to the closing price of the Company’s common stock on the NYSE on the grant date, have a ten-year life, and vest in equal installments over three years beginning one year after grant date, subject to acceleration in certain circumstances.

 

GRANTS OF PLAN-BASED AWARDS

 

 

 

 

The following table provides information with respect to outstanding stock options held by the named executive officers as of the end of the fiscal year 2006.

 

OUTSTANDING EQUITY AWARDS AT FISCAL YEAR END

 

The following table provides additional information regarding the amounts received during fiscal year 2006 by the named executive officers upon exercise or vesting of stock options.

 

OPTION EXERCISES AND STOCK VESTED

 

 

 

 

 

Nonqualified Deferred Compensation

 

Pursuant to the Company’s unfunded and non-qualified 2005 Deferred Compensation Plan, eligible participants can defer up to 100% of their base salary and 100% of their bonus so that it can grow on a tax deferred basis. The investment options available to an executive under the deferral program are any of twenty different mutual funds, including bond, money market, and large and small cap stock funds.

 

The following table provides information for fiscal year 2006 for each named executive officer regarding such individual’s accounts in the 2005 Deferred Compensation Plan as of the end of fiscal year 2006.

 

NONQUALIFIED DEFERRED COMPENSATION

 

 

Potential Payments Upon Termination And Change In Control

 

We have entered into certain employment or change in control agreements that will require the Company to provide compensation to the named executive officers in the event of a termination of employment or a change in control of the Company.

 

We have entered into employment agreements with our chief executive officer, J. Mario Molina, our chief financial officer, John C. Molina, and our chief executive officer, Mark. L. Andrews.

 

Unless terminated, the agreements with each of Dr. Molina, Mr. Molina, Mr. Andrews are automatically renewed on an annual basis. Effective March 18, 2006, Dr. Molina’s annual salary was increased to $775,000, with a target bonus of up to 100% of his base salary. Effective February 20, 2006, John Molina’s annual salary was increased to $700,000, with a target bonus of up to 100% of his base salary. Mark L. Andrews had a base annual salary under his employment agreement of $430,000 in 2006, and a target bonus of up to 40% of his base salary. Each of the base annual salaries is subject to review and increase at least annually.

 

The agreements with each of Dr. Molina, Mr. Molina, and Mr. Andrews provide for the employees’ continued employment for a period of two years following the occurrence of a change of control (as defined below). Under the agreements, each executive’s terms and conditions of employment, including his or her rate of base salary, bonus opportunity, benefits, and title, position, duties, and responsibilities, are not to be modified in a manner adverse to the executive following the change of control. If an eligible executive’s employment is terminated by us without cause (as defined below) or is terminated by the executive for good reason (as defined below) within two years of a change of control, we will provide the executive as a severance payment with two times the executive’s annual base salary and target bonus for the year of termination, plus the target bonus for the year of termination, full vesting of Section 401(k) employer contributions and stock options, and continued health and welfare benefits for the earlier of three years or the date the executive receives substantially similar benefits from another employer. We will also make additional payments to the executive who incurs any excise taxes pursuant to the golden parachute provisions of the Internal Revenue Code in respect of the benefits and other payments provided under the agreement or otherwise on account of the change of control. The additional payments will be in an amount such that, after taking into account all applicable federal, state and local taxes applicable to such additional payments, the executive is able to retain from such additional payments an amount equal to the excise taxes that are imposed without regard to these additional payments.

 

Additionally, if the executive’s employment is terminated by us without cause or the executive resigns for good reason, the executive will be entitled to receive one year’s base salary, the target bonus for the year of the employment termination, full vesting of Section 401(k) employer contributions and stock options and continued health and welfare benefits for the earlier of eighteen months or the date the executive receives substantially similar benefits from another employer. Payment of severance benefits is contingent upon the executive’s signing a release agreement waiving claims against us.

 

A change of control generally means a merger or other change in corporate structure after which the majority of our stockholders are no longer stockholders, a sale of substantially all of our assets, or our approved dissolution or liquidation. Cause is generally defined as the occurrence of one or more acts of unlawful actions involving moral turpitude or gross negligence or willful failure to perform duties or intentional breach of obligations under the employment agreement. Good reason generally means the occurrence of one or more events that have an adverse effect on the executive’s terms and conditions of employment, including any reduction in the executive’s base salary, a material reduction of the executive’s benefits or substantial diminution of the executive’s incentive awards or fringe benefits, a material adverse change in the executive’s position, duties, reporting relationship, responsibilities or status with us, the relocation of the executive’s principal place of employment to a location more than 50 miles away from his prior place of employment or an uncured breach of the employment agreement. However, no reduction of salary or benefits will be good reason if the reduction applies to all executives proportionately.

 

The tables below reflect the approximate amount of compensation payable to each of the named executive officers of the Company in the event of termination of such executive’s employment under the various listed scenarios. The amount of compensation payable to each named executive officer in the event of voluntary termination, early retirement, involuntary not-for-cause termination, for cause termination, termination following a change of control, disability, or death, is shown below. The amounts shown assume that such termination was effective as of December 31, 2006, and exclude ordinary course amounts earned or benefits accrued as a result of prior service during the year. The various amounts listed are estimates only. The actual amounts to be paid can only be determined at the time of such executive’s separation from the Company.

 

The following table describes the potential payments upon termination or change in control of the Company for J. Mario Molina, the Company’s chief executive officer.

 

The following table describes the potential payments upon termination or change in control of the Company for John C. Molina, the Company’s chief financial officer.

 

 

The following table describes the potential payments upon termination or change in control of the Company for Mark L. Andrews, the Company’s chief legal officer.