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Health Net Inc.’s (HNT - Analyst Report) third-quarter 2012 operating income, which includes combined net earnings from Western Region and Government Contracts segments, came in at 38 cents per share, declining substantially from the year-ago level of 84 cents per share. Operating income, however, modestly exceeded the Zacks Consensus Estimate of 36 cents per share.

Income from continuing operations, including adjustment to loss on sale of Northeast subsidiaries of $0.32 million in the third quarter of 2011, amounted to $20.48 million or 25 cents per share, compared with $57.81 million or 65 cents in the year-ago quarter.

Including a $4.7 million pre-tax loss from discontinued operations and services as well as pre-tax expenses amounting to $7.2 million, pertaining to Health Net’s general and administrative cost reduction efforts, the company reported net income of $18.0 million or 22 cents per share in the third quarter of 2012, reducing considerably from $61.8 million or 70 cents per share in the year-ago quarter.

The disappointing performance in the reported quarter was primarily due to weak operating performance of the Government Contracts segment along with higher health plan services expenses.

The company’s total revenue improved 3.3% year over year to $2.78 billion in the quarter. This came marginally below the Zacks Consensus Estimate of $2.81 billion.

Total expenses increased 5.8% year over year to $2.75 billion from $2.60 billion.

Segment Performance

Western Region: The segment posted revenues of $2.6 billion in the quarter, up 4% year over year. Net investment income for the segment increased to $16.4 million from $15.2 million in the year-ago quarter, while health plan services expenses increased 9.5% year over year to $2.3 billion from $2.1 billion.

Total enrollment in the segment declined 1% year over year to 2.6 million members as of September 30, 2012. Total commercial enrollment declined 9.5% to 1.3 million members, while enrollment in the company’s California health plans inched down 1.5% year over year. However, enrollment climbed 13.8% to 0.23 million in Medicare Advantage plans. Medicaid enrollment also increased 8.2% to 1.1 million in the reported quarter.

Medical care ratio (MCR) for Health Net’s health plan services in the segment increased to 88.5% during the reported quarter from 86.4% in the year-ago quarter, while Commercial MCR deteriorated to 86.7% from 84.8% in the prior quarter. Medicare Advantage MCR inched down to 90.1% from 90.7% in the year-ago quarter.

Government Contracts: Revenues from the segment declined to $169.8 million from $175.8 million in the third quarter of 2011, while expenses climbed to $148.7 million from $127.7 million.

Financial Update

As of September 30, 2012, Health Net had cash and investments of approximately $2.0 billion, at par with September 30, 2011. However, the company’s debt-to-total capital ratio decreased to 24.4% from 27.4% as of September 30, 2011.                       

Health Net’s cash outflow stood at $124.8 million in the reported quarter compared with an inflow of $520.7 million in the year-ago quarter.

Total assets of the company were $3.81 billion as of September 30, 2012, declining from $3.87 billion a year ago. Stockholders’ equity increased to $1.55 billion from $1.44 billion as of September 30, 2011.

Share Repurchase Update

During the reported quarter, Health Net repurchased 1.5 million shares at an average price of $23.79. The company had $350 million remaining under its current share repurchase authorization as of September 30, 2012.

Outlook for 2012

Health Net affirmed its earnings per share (EPS) guidance for 2012 in the band of $1.45 to $1.55. The EPS guidance for the combined Western Region and Government Contracts segments lies between $1.00 and $1.10.

Enrollment in the commercial business is expected to decline by 9%−10%, while enrollment in Medicare Advantage and Medicaid are expected to increase by 11%−13% and 7%−8%, respectively. The company expects the total Western Region enrollment to decline in the range of 1%−2%

Consolidated revenue is expected to be around $11.0−$11.5 billion, while tax rate for Health Net is expected to be 30%−31%. The company also expects selling cost ratio to be in the range of 2.3%−2.4% and general and administrative expense ratio to be in the range of 8.5%−8.7%.

Operating cash flow guidance for 2012 was affirmed at $10 million. Outstanding share count is expected to be around 83−84 million at the end of 2012.

Peer Comparison

Health Net’s peer, WellPoint Inc. (WLP - Analyst Report) will report its third-quarter financial results before the opening bell on November 7, 2012.

Zacks Rank

We retain our long-term Neutral recommendation on Health Net. The quantitative Zacks #3 Rank (short-term Hold) for the company indicates no clear directional pressure on the stock over the near term.

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