Humana Inc. — Q2 2010 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2010; unaudited. Humana provides health and supplemental benefits through Government (Medicare, military, Medicaid) and Commercial businesses. At quarter-end it served approximately 10.3 million medical members and 7.3 million specialty members.
Financial performance
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Total revenue | $8.653bn | $7.899bn | $17.093bn | $15.611bn |
| Operating income | $562.1m | $466.5m | $1,005.3m | $787.1m |
| Net income | $340.1m | $281.8m | $598.8m | $487.5m |
| Diluted EPS | $2.00 | $1.67 | $3.52 | $2.89 |
| Operating cash flow | Not provided quarterly | $1,080.0m | $207.4m |
- Q2 revenue rose 9.5% and net income rose 20.7%; six-month revenue increased 9.5% and net income 22.8% year over year.
- Q2 consolidated benefit ratio was 81.9%, down 1.4 percentage points; six-month ratio was 82.6%, down 1.0 point. SG&A ratio was 13.6% in Q2 versus 12.8%, and 13.5% for the half versus 13.4%.
- Government segment pretax income increased 30.6% in Q2 to $528.4m and 41.5% for the half to $807.5m. Commercial pretax income fell 78.8% in Q2 to $7.5m and 10.9% for the half to $145.2m.
- At June 30, cash and cash equivalents were $2.0bn; current and long-term investment securities totaled $8.3bn. Long-term debt was $1.674bn, equal to 20.5% of total capitalization. The $1.0bn revolving credit facility had no borrowings and $996.5m available; the company reported a 0.7:1 leverage ratio and compliance with covenants.
Material changes and unusual items
- Government premium growth, chiefly Medicare Advantage membership and per-member premiums, drove overall revenue gains. Medicare Advantage membership rose 15.5% year over year to 1.732m; stand-alone PDP membership fell 10.0% to 1.793m.
- Commercial fully insured medical membership declined 9.0% to 1.703m, attributed to pricing discipline, competition, unemployment, and employer coverage losses. Specialty membership grew 10.8%.
- Humana recorded a $147.5m charge in Q2 to write down deferred acquisition costs for individual major medical policies, following reform-related recoverability analysis. Management said this reduced diluted EPS by approximately $0.55.
- Favorable reserve releases not considered ordinary totaled approximately $37.5m in Q2 and $137.5m for the first half, or $0.14 and $0.51 per diluted share, respectively. Additional Q2 recognition of first-quarter 2010 favorable releases was approximately $79.5m, or $0.30 per diluted share; it did not affect year-to-date results.
- Operating cash flow improved by $872.6m year over year, attributed to earnings, enrollment and working-capital timing. The company repurchased 1.03m shares for $50.0m in the first half.
Outlook, risks and contingencies
- No specific earnings or revenue guidance is provided in the supplied filing text. Management said liquidity resources were adequate for operating and regulatory needs, capital expenditures, debt repayment or refinancing, and share repurchases for at least the next 12 months. Expected 2010 capital expenditures were approximately $200m.
- Health insurance reform’s full effects remained uncertain pending regulations. Potential impacts include minimum medical-loss ratios and rebates, additional benefits and administrative costs, Medicare Advantage payment reductions beginning in 2012, and a nondeductible industry assessment beginning in 2014. The 2011 Medicare Advantage payment rates were flat; Humana said it had designed products to address those rates.
- CMS audits of Medicare Advantage risk-adjustment coding could lead to retroactive contract-level payment adjustments. Humana could not estimate the impact and warned that specified audit methods and extrapolation, if applied without relief, could materially adversely affect results, financial position and cash flows.
- The TRICARE South contract was extended through March 31, 2011. Humana had not won the successor contract at the filing date; it submitted revised proposal materials July 30, 2010. Management said military-services goodwill of $49.8m could be impaired in Q4 2010 if the current contract is not extended and Humana does not win the new contract.
- Puerto Rico Medicaid contracts for two regions were extended through September 2010, with extension terms pending; new contracts were expected to begin October 1, 2010.
- Other matters include provider-payment litigation and regulatory reviews. A derivative-action settlement, including governance measures and up to $325,000 in plaintiffs’ legal fees, was awaiting a court fairness hearing scheduled for September 21, 2010. Management cautioned that litigation or investigations could have material adverse effects.
Important facts for investors to verify
- How much reported earnings growth depended on favorable reserve releases, and whether underlying benefit trends persist without those items.
- The eventual financial and operating effects of health reform, particularly minimum benefit-ratio rules, Medicare payment changes, and the future industry assessment.
- CMS audit methodology, potential retroactive risk-adjustment recoveries, and any resulting revisions to revenue estimates.
- TRICARE South successor-contract outcome and any resulting goodwill impairment, exit costs, or transition effects.
- Commercial membership and profitability trends after the acquisition-cost write-down, and whether the Q2 benefit-ratio improvement is sustainable.
- Working-capital timing behind the sharp increase in operating cash flow, along with liquidity needs and regulated-subsidiary dividend restrictions.