UNITEDHEALTH GROUP INC quarterly report, Q2 FY2015

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UnitedHealth Group Inc. — Q2 2015 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2015; comparisons are with the corresponding 2014 periods. Financial amounts are in U.S. dollars. The filing was dated July 29, 2015.

Business context and reporting period

UnitedHealth Group operates through UnitedHealthcare, which provides health coverage and benefits services, and Optum, which provides technology-enabled health services. Reportable segments are UnitedHealthcare, OptumHealth, OptumInsight and OptumRx.

Financial and operating results

  • Revenue: Q2 revenue was $36.3 billion, up 11%; first-half revenue was $72.0 billion, up 12%. Growth reflected increased membership across benefits businesses and growth across Optum.
  • Earnings: Q2 net earnings were $1.585 billion, up 13%, and diluted EPS was $1.64, up 15%. First-half net earnings were $2.998 billion, up 20%, and diluted EPS was $3.10, up 23%.
  • Margins and medical costs: Q2 operating margin was 8.0% versus 7.8%; first-half operating margin was 7.7% versus 7.2%. Medical care ratio was 81.4% in Q2 versus 81.6%, and 81.3% for the first half versus 82.0%. Management attributed the lower ratios mainly to premium increases covering the higher 2015 health insurance industry tax and medical cost management. Operating cost ratio increased to 16.1% in Q2 from 16.0%, and to 16.4% for the first half from 16.2%, partly reflecting acquisitions of higher-operating-cost services businesses.
  • Cash flow: First-half operating cash flow was $3.432 billion, up 42% from $2.422 billion. Cash and cash equivalents increased to $7.887 billion at June 30 from $7.495 billion at year-end. First-half capital expenditures were $716 million; acquisition cash outflow was $1.778 billion.
  • Liquidity and investments: Cash, cash equivalents and available-for-sale investments totaled $28.3 billion, including $7.9 billion cash, $18.8 billion debt securities and $1.6 billion equity securities. Only $654 million of cash was identified as available for general corporate use. U.S. regulated subsidiaries paid $2.4 billion in dividends to parent companies in the first half, with approximately $1.9 billion of ordinary dividend capacity remaining for the year.
  • Debt: Commercial paper and long-term debt had a carrying value of $17.926 billion at June 30, 2015; other financing obligations were $145 million. The company reported a 35.4% debt-to-debt-plus-equity ratio and compliance with its debt covenants. Credit rating outlooks were negative at Moody’s and S&P, and Fitch moved to a negative outlook in July.
  • Shareholder returns: First-half repurchases were $953 million. The board increased the annualized dividend rate to $2.00 per share from $1.50, effective with the June payment.

Material changes versus the prior comparable period

  • UnitedHealthcare revenue increased 10% in Q2 and 11% for the first half; Optum revenue increased 16% and 15%, respectively. Consolidated operating earnings rose 13% in Q2 and 20% for the first half.
  • UnitedHealthcare domestic medical membership grew by 1.61 million year over year, led by Medicaid, Medicare Advantage and commercial risk-based membership. International medical membership declined 14%.
  • Optum segment operating earnings rose year over year across OptumHealth, OptumInsight and OptumRx. OptumHealth margin declined, which management attributed mainly to growth in lower-margin businesses and investment for future growth.
  • First-half other comprehensive loss was $915 million, compared with $618 million of comprehensive income in 2014, primarily reflecting foreign-currency translation losses.
  • First-half acquisitions used $1.778 billion of cash versus $523 million in 2014; share repurchases were lower than the prior-year period.

Outlook, management commentary, risks and unusual items

  • Catamaran acquisition: On July 23, 2015, the company acquired Catamaran for $12.9 billion in cash and funded its outstanding debt and credit facility payoff. The company said the transaction would diversify OptumRx’s customer and business mix and expand its technology and service offerings. Purchase-price allocation and pro forma disclosures were not yet practicable. Management expected moderated share repurchases for the rest of 2015 due to the acquisition.
  • Acquisition financing: In July, the company issued $10.5 billion of senior notes, drew a $1.5 billion delayed-draw term loan and issued $2.4 billion of commercial paper to fund the acquisition. These are subsequent-period financings and are not reflected in June 30 debt balances.
  • Regulatory and pricing pressures: Management cited competition in commercial products, government payment rates, and medical-cost pressures including specialty drugs. Medicare Advantage funding reductions were being phased in through 2017. CMS’s 2016 final rate notice indicated an industry-average funding increase of 1.25%, which management said remained below rising medical costs. For 2015, 39% of Medicare Advantage members were in plans rated four stars or higher.
  • Health insurance industry tax: The company expected its 2015 share to be $1.8 billion. At June 30, it recorded a $1.8 billion related liability and a $900 million deferred cost asset.
  • Contingencies: A California regulator imposed an approximately $174 million fine in a claims-processing matter; the company challenged the decision and said it could not reasonably estimate any resulting loss. Government audits and investigations, including Medicare risk-adjustment data validation reviews, also remain difficult to quantify. Potential state guaranty-fund assessments related to Penn Treaty are likewise not estimable.
  • Other matters: The company reincorporated from Minnesota to Delaware on July 1, 2015, without changing business operations. It was evaluating the new revenue recognition standard, effective for annual and interim periods beginning after December 15, 2017. Management reported no material changes to previously disclosed risk factors and no material internal-control changes; disclosure controls were deemed effective.
  • Guidance: The provided filing text does not state a clear numerical full-year earnings or revenue guidance figure.

Important facts for investors to verify

  • Catamaran’s integration, purchase accounting, realized synergies and the effect of its acquisition financing on leverage, interest expense and cash flow.
  • Whether medical-cost trends, premium pricing and Medicare/Medicaid reimbursement rates sustain the reported medical care ratio and margins.
  • Membership trends, especially Medicaid and exchange growth, Medicare Advantage star ratings and the decline in international membership.
  • Resolution and potential financial exposure from the California fine, government audits and investigations, and Penn Treaty guaranty-fund assessments.
  • Available parent-company liquidity after considering regulated-subsidiary dividend restrictions, acquisition funding, debt maturities and the company’s negative credit outlooks.