Humana Inc (HUM) 2006 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the First Quarter 2006 KMG America Corporation Earnings Conference Call.

[OPERATOR INSTRUCTIONS]

I would now like to turn the presentation over to your host for today, Mr. Kenneth Kuk, President, Chairman and CEO. Please proceed, sir.

Good morning. Welcome to KMG America’s first quarter conference call. I have with me this morning Scott DeLong, our CFO, Jim Nelson, our general counsel, and Tom Sass, who’s in charge of operations. Before we begin, I want to mention that certain statements made during this call relating to KMG America’s future operations, performance, growth plans and expectations of future developments are forward-looking statements under federal securities laws. These statements are based on various assumptions and estimates that are subject to a number of risks and uncertainties. These risks are discussed in our first quarter 10-Q to be issued later today or possibly tomorrow on our Form 10-K for 2005.

In light of these risks, actual results may vary materially from those expressed in any forward-looking statements made during this call and should be considered carefully. KMG America assumes no obligation to publicly update or revise any forward-looking statements. We reported this morning that KMG America’s first quarter 2006 earnings per share number was $0.06 and the result was a penny or two below our expectations, but consistent with the full year of EPS guidance range we gave in March of $0.35 to $0.40 full year. The softness was a result of unexpected charges which amounted to a couple cents a share.

Additionally, the margin compression we discussed at the last quarterly call is evident in the results of the new activity, which once again produced losses of about $0.10 per share. This, too, was consistent with our previous annual guidance. Coincidentally, for the last several years, our insurance subsidiary has produced lower earnings on average in the first quarter than the remaining quarters of each year. And 2006 appears to be no different. There was good news in the claims level of our long-term care block, which reversed a trend of increasing claims over the last several quarters. Scott will speak in more detail about the financial results.

As of today, we have hired three new reps in ’06 and have one offer accepted, which will bring us to a total of 21 reps. The constraint on hiring reps is not the number of highly qualified people that have an interest in joining KMG America, but rather the startup costs associated with new reps and the impact on current year earnings. We have previously announced the intention to have 25 reps by the end of the second quarter, but for several reasons, we will not recruit more than one or two more reps over the next couple months.

Reps hired in June and July would have little impact on our sales results this year. Given our commitment to achieve EPS objective for the year, it seems prudent to focus now on the productivity of the existing reps. Additionally, we have the best chance of meeting our margin requirements with the existing longer tenured sales staff. First quarter sales results also were consistent with expectations. Within the group insurance industry as a whole, January sales typically account for most of the issued premium in the first quarter. And that was also the case for KMG America this year.

Group and stop-loss sales activity now focuses on the second quarter and July 1, where we see growing activity. We clearly have more traction in the stop-loss market than group life and disability, due to having participated in the stop-loss market longer. We are attempting to focus the sales organization on group life and disability by leveraging our stop-loss momentum with cross sales. Voluntary sales activity is skewed towards the last half of the year and there also we see nicely increasing levels of activity.

We stated at the last quarterly call that productivity per rep was in the range of $2.9 to $3.5 million depending on assumptions used. Any calculations now would be towards the lower end of that range, due to the passage of February and March with little incremental issued sales. We believe that we will achieve expected production levels per rep, given the quality of the sales representatives in our organization. We continue to gain momentum in the market as more and more consultants and brokers develop confidence in KMG America’s ability to deliver first-rate products and administrative services.

A very important issue is margins. I stated previous that, given the acceptance of KMA in the market as a mainstream participant, we see huge numbers of transactions. So, sales can be what we want them to be. You are aware of some of the margin issues for last January sales. Our concern is whether the margin issue was product-specific or related to KMG America being a new participant in the market. If it is the latter, we could see tight margins on group products as well, which would result in a slower earnings growth trajectory.

We do not have sufficient data yet to come to any conclusions, but we are monitoring margins closely. I can say that there is a growing sentiment within the stop-loss business, that pricing is firming and that the trend is expected to continue into the last half of 2006. Margin compression is a lesser issue with voluntary products because most are individual products with filed and approved rates. This means there is less room to negotiate pricing, so we can be more certain that a sale has full margins.

Product filings are progressing nicely. We are approved in 45 or 47 states for stop-loss, 39 of 47 states for group life and in all important states except Texas and 34 of 47 states for both short and long-term disability. And we continue to upgrade all of our voluntary products. Now, Scott will discuss the financial results in some detail.

Let me start by repeating that the 10-Q should be filed later today or possibly tomorrow and these conference call comments will be filed with the SEC later today. As in recent quarters, we compare the current quarter to the most recent prior quarter as well as to the year ago quarter. We added extra lines to the income statement in order to separate the performance of the Kanawha legacy business from the activity relating to our new sales and underwriting operation, the corporate office and costs associated with being a public company. We think the best comparison will continue to be to the most recent prior quarter as we are expecting sequential quarter-to-quarter growth relative to this new sales activity in both revenues and earnings.

And to reinforce that point, we said on our last earnings call that we reviewed last year’s fourth quarter earnings in the Kanawha legacy business as a good indication of our earnings run rate for 2006 for that business, which is important because earnings from the Kanawha legacy business will continue to be a significant contributor to overall earnings for KMG America this year. With this introduction, let me now get to first quarter results.

Operation income was $0.06 per fully diluted share or $0.02 below the analyst consensus estimate of $0.08, due primarily, as Ken indicated, to some unusual items that are likely to be one time in nature. These unusual items are briefly described in the press release and I can discuss them further during the Q&A session, if desired. The $0.06 per share this quarter compared to $0.07 last quarter and $0.05 in the first quarter last year. The decline from last quarter is attributable to stock option expensing as well as to these unusual items. Option expensing is new this quarter and amounted to almost a penny a share.

Earnings this quarter were reduced by about $0.02 a share compared to last quarter, as a result of the unusual items I just mentioned. We can also say that there is a good chance that some of the adverse effect this quarter could be reversed and flow back into earnings later this year because of the special nature of certain of these items. So, while we have not added back these unusual items in operating income this quarter, I think it would be reasonable to conclude that the earnings this quarter, adjusted for the financial effect of these usual items, is a fair representation of the current run rate as we look ahead to the rest of this year. It is with this in mind that we conclude that our $0.35 to $0.40 EPS guidance for the year continues to be reasonable.

Let me turn next to some detail about the results for the quarter, starting with the large employer activity, targeted by our new sales channel. Sales for the quarter were about $16 million of new annualized premium, composed of about 80% stop-loss, 8% group life and disability and the balance payroll deduct voluntary benefits. This translated into 4.5 million of net earned premium compared to 1.8 million last quarter.

The overall benefit ratio for this business in the first quarter was 68%, up from 62% last quarter, a bit under half of the increase is related to mix of business, which would have been expected. But most of the increase was due to one early large group life claim, which skewed the benefit ratio upward. But in spite of this life claim, we did add margin in the first quarter for the new large case activity taken as a whole, albeit at a compressed level compared to our target margins as we discussed on last quarter’s earnings call.

I’ll talk next about the current status of our investment portfolio. The average portfolio yield increased seven basis points this quarter, continuing the expected upward trend. We are getting quite close to being fully invested now, having ended the first quarter with about 50 million of cash and short-term investments of two years and less. We will likely convert another 30 million or so of short terms into longer term assets over the next several quarters as they approach maturity, assuming interest rates of at the 10-year point in the yield curve continue to rise. But we are essentially done with our bulk investing efforts of the past five quarters.

As we have said before, we would expect the average portfolio yield for the full year to increase to slightly over 5%, so we should get some growth in investment income in coming quarters, particularly with increasing investment cash flows from new product sales. The aggregate expense ratio, which is composed of total expenses including commissions plus net deferred acquisition costs divided by premiums and TPA fees, was flat this quarter versus last quarter at 50.6%. But this quarter, we did include option expensing for the first time.

This ratio has come down over the last quarters – five quarters, but progress has been slowed because of the substantial expense growth associated with building the new sales and underwriting organization along with other required expenses of public company ownership such as Sarbanes-Oxley Section 404 compliance. With premium growth coming from our new sales organization, we should be seeing more progress toward a lower expense ratio in coming quarters. We have said that this ratio will be in the low 30s when we are approaching scale in our mid-teens ROE target.

I’ll conclude with some comments about the performance of the Kanawha legacy business. Premium income compared to last quarter was up somewhat after adjusting for an experience rating refund in the acquired business segment and a one-time return of premium to policyholders in the state of Georgia under a statutory provision relating to mass cancelled policy forms, one of the unusual items I mentioned earlier. The benefit ratio in the senior segment improved markedly from the last three quarters of 2005 and was due to a reduced number of newly opened long-term care claims this quarter combined with favorable resolutions of older claims this quarter.

This positive result was offset by an unfavorable benefit ratio in the acquired business segment compared to last quarter. But most of this apparent deterioration is caused by the experience rating refunds mentioned above that reduce both premiums and benefits without any impact on the bottom line. The seemingly large increase in the benefit ratio in the legacy worksite segment was primarily the result of the unusual items mentioned earlier. If these distortions were removed, the benefit ratio and the legacy worksite segment is only slightly worse this quarter, due to an increase in Medicare supplement claims, which I am told are typically heaviest in the first quarter.

In spite of the unusual charges to earnings, we view the first quarter results as satisfactory from an earnings point of view. A stronger start to the year on sales would have made the full year sales objective a bit easier to achieve, but we have been selective on pricing as we feel that it is important that we add margin to the bottom line with the sales we make. Margins should improve as we implement our multi-product cross selling strategy and as we start renewing cases in the second half of this year and into next year, especially if stop-loss pricing firms as we expect. In summary, we continue to believe our $0.30 to $0.40 EPS target for the year remains achievable.

With that, I’ll turn it back to Ken for the Q&A session.

Thank you, Scott. We’re ready for questions.

[OPERATOR INSTRUCTIONS]

And your first question comes from the line of Craig Siegenthaler with Credit Suisse. Please proceed.

Hello. Good morning.

Good morning.

First question – when to deal with long-term care, it was really nice to see kind of good improvement here from some of the levels in ’05. I was just wondering what caused this. Was it rate increases or reserve strengthening over the last few years or – and what really drove this gain here?

This is Scott DeLong. I’ll answer that question. First of all, it wasn’t rate increases. We had indicated in the press release that we had fallen a little bit behind on that or at least gaining the approvals for the rate increases. What it was, was a lower incidence of newly arising claims in the first quarter, because each claim being long-term in nature generates a fairly significant open claim reserve. And then, that was accompanied by some favorable resolutions of claims that were already open coming into the first quarter. So, it was really – it was really claims activity as opposed to reserve changes or rate increases or anything more indirect.

Okay. Thank you. I just had a second question with portfolio yield. At 4.95%, you’re pretty much the lowest yield out there for all the companies we cover in the life insurance industry. I was just wondering, what’s your new money rate, and kind of what’s preventing KMA from taking advantage of the higher rates we’ve seen over the past three quarters?

So, Scott DeLong again. I’ll answer that as well. First of all, our portfolio yield, being as low as it is, is from the simple fact that we had to mark that investment portfolio to market on the transaction date on December 31, 2004, where interest rates were especially low. So, we started life as a new public company with a very low portfolio yield because of that purchase accounting effect. As far as new money rates, with the 10-year treasury now above 5%, we would expect to, given our investment strategy, to get a spread over the 10-year treasury rate of somewhere between 70 and 100 basis points, depending on the exact timing and exactly what we buy.

Would you say your effective portfolio yield, if you go back to the old Kanawha block, is maybe something in the range of about 6%?

Again, this is Scott DeLong. If you looked at it on a statutory basis, which was not mark-to-market, yes. I think, at the time of the transaction, our average portfolio yield was right around 6%.

Okay. Excellent. Thank you, very much.

And your next question comes from the line of Stewart Johnson with Friedman, Billings, Ramsey. Please proceed.

Good morning.

Good morning.

I wanted to focus my question on the cross selling opportunity that you’ve mentioned in your remarks. And it sounds like it’s going to be really centered around the stop-loss sales that you’d made earlier. And I’m looking at it two ways. One, that seems to be good because your stop-loss sales were above what I had expected. But at the same time, the life and disability sales were a bit lower than what I had expected. Going forward, could you tell us how this cross selling opportunity is going to work and then, secondly, of the business that you’ve sold, what comes up for renewal over the next six months that would allow you to take advantage of the higher pricing you’re expecting?

This is Ken Kuk. As you are aware, Stewart, we have a strategy of doing multiple product sales and the key to that is selling stop-loss, group life and voluntary together. We are somewhat constrained on our cross selling effort with the existing set of voluntary products that we have at Kanawha. And as you are aware, we are working those products now, refiling, updating and upgrading them so that they’re more appropriate to cross sell with our larger case group and stop-loss business.

With that said, we have done substantially more selling of stop-loss. And as we start to renew those, we will be working on adding the group products with those. Now, if you recall, on July 1 of ’05 was the start of our stop-loss selling, so that effort is underway right now as we’re clearly working on selling for July 1 and renewing those stop-loss cases that we sold on July 1.

Okay. So, the – and you’re confident that the pricing on the renewals, from what you’re seeing so far, will give you a higher margin than what you had last year?

Yes. I think that’s an industry phenomenon. I don’t think it’s specific to KMG America. But we are seeing and in talking with others within the industry, it’s becoming pretty apparent what’s going on with medical claims that pricing is improving rather substantially. So, we would expect that to be reflected on our July 1 renewals and throughout the last half of this year, both on renewals and on new sales.

Okay. And then, you also gave us an update on the state approvals. If I have it down correctly – 39 and 47 for group life and 34 or 47 for short-term, long-term disability. Both of those trail the approvals for the stop-loss, which was 45 or 47. Is that going to hamper the cross selling activity at all?

The reason that it trails is because stop-loss was filed about 75 days earlier than the group life product and even a little bit more than that on the disability. We are approved in all of the states for group life that we have a concentration of reps other than Texas. Texas is the only one of the large four that we’re waiting for and that still hasn’t been approved. Massachusetts was approved about 30 or 45 days ago.

Okay. Great. And then, I have one last question for Scott, the other income in the corporate and other segment. Can you give us an idea of how we might think about that line item going forward? It was a little less than what I had expected, but last quarter, also, was a bit [higher] than I had expected.

Stewart, you got me on that one. I wasn’t ready for that question.

I can follow up with you after the call.

And if I get an answer before the call is over, I’ll come back and give it to you.

No problem. Thanks, guys.

Thank you.

And your next question comes from the line of David Lewis with SunTrust Robinson Humphrey. Please proceed.

Thank you. Good morning.

Good morning.

A couple of questions. Ken, just to make sure I understand, you’re talking about the sales rep and I guess it’s running a little bit at the lower end of that $2.9 to $3.3 million range. Were you indicating, just because you’re through the big January renewal period or do you think it’s ultimately going to run at the lower end of that range?

Very little sales activity occurs in February and March. Those are – the first quarter sales are mostly January sales. So, any calculation that we would do now, we would add two months and virtually no incremental premium. With that said – so, the mathematical calculation would show a smaller number. With that said, we haven’t changed our opinion at all that $3.3 to $3.5 million per rep is very achievable and we’ve got a substantial number of reps that are clearly above that level right now.

Okay. Thanks for that clarification. And Scott, to make sure I understand on your earnings guidance. The $0.35 to $0.40 in 2006 does include the $0.02 of unusual items in the first quarter. Is that correct?

Yes. That’s right. We wouldn’t change our guidance as a result of that. As I had said, some of that is one time in nature and we won’t get it back. But because of the unique nature of some of those items, we could well get the earnings effect reverse back into earnings before the end of the year.

Okay. As I look at kind of the second quarter with the improved revenue growth, we probably assume the first quarter is more run rate at $0.08 and then we probably end up with $0.09 or something in the second quarter. Is that a good way to look at it?

David, this is Ken Kuk. We would have been at $0.08 or so in the first quarter without the unusual items. Clearly, we have premium growth occurring. We have investment income rising. And we’re doing a real prudent job of controlling expenses. The decision that we made to not hire quite as many reps, at least in the middle of ’06, I think is further indication that we’re very heavily focused on achieving that full year number. And so, I’m not saying that the second quarter will be $0.09. We don’t give quarterly guidance. But we continue to be comfortable at $0.35 to $0.40 full year, even after the first quarter.

Okay. Let’s talk a little bit about the rep hirings. Since you’re going to fall below the 25 rep target at midyear, and I assume, by the end of the year, is there any change in your outlook for roughly 75 million of sales for ’06?

We – this is Ken Kuk. The decision we are making to come up two or three reps short in the middle of the year will have no impact on sales for 2006. And depending on how the quarters – the subsequent quarters go, we still could be at 25 reps by the end of the year. So, I don’t know that it will have any impact on ’06 sales. The additional comment that I would have is that just in case we do come up short on sales, we have begun participating and looking at block purchases of liabilities, both in group life, potentially disability and stop-loss. And we’re not committed to do that.

But if we need to, to assure that we achieve our sales objectives, we will. That decision will be a function, not only of sales levels, but of margins. Typically, purchase of blocks of business will produce a lower margin than growing organically. However, if we do see that we are coming up short on margin, the alternative of doing a block purchase might be as attractive as organic growth.

And where are these blocks? Just non-core blocks from other participating companies in the market?

There’s actually a market for these kinds of transactions with people who are moving in or out of various segments. There’s a lot of legacy product within most life companies, that they are inclined to move around periodically. So, there is an active market there.

Okay. And just finally, talking back on the long-term care claim trends, which were favorable in the quarter, do you feel that some of these improved trends will continue or is it just too early and it could just be a one quarter phenomena?

This is Scott DeLong, David. While we certainly hope that they’ll continue, but newly opened claims are large and they can make quarterly results volatile. So, we had three quarters of the four last year, where we had rising newly opened claims. We’ve started out this year with a drop, which was certainly welcome. But there’s really no way of predicting whether that will be the start of a new trend or whether it was a random event. But in the meantime, we’ll take it.

David, Ken Kuk. I think the key thing is there was a concern that there was a ramp of claims that was going to continue. And clearly, that has been broken. So, if they bounce back up or if they stay at the existing level, at least the trend that appeared to be developing over three quarters has been broken.

That’s helpful. And I do have one final question. You had indicated, with the fourth quarter call, that you thought the pricing was a little softer than what you had hoped on your stop-loss coverages and therefore margins might be a little bit squeezed. Are you having any early indications of how some of claim trends are going there that might perform better than you originally anticipated?

David, this is Tom Sass. I think that what we’re going to see on the renewal side first is that we are seeing some firming in the market. So, we’re quite positive and upbeat about renewals and the ability to get more rate there. As far as the claims experience goes, it’s really too early and with such a small block just starting last June, to really get any credible data as far as claim results. We haven’t seen anything right now that gives us any concern about the way the claims are developing. And so, we’ve really been benchmarking more on our pricing side than we have on the claims side, just because of the lack of credible data.

That’s helpful. Thank you.

[OPERATOR INSTRUCTIONS]

And your next question comes from the line of Mike Grasher with Piper Jaffray. Please proceed.

Good morning, gentlemen. I wanted to follow up on David’s question for clarification’s sake on the sales reps. I think you mentioned, Ken, that you hired three new reps in ’06 and you have one offer outstanding. Would the combination of those two bring the total to 21?

Yes.

And then, you – perhaps you may or you may not end up with 25 by year end.

We will probably hire another rep or two over the next several weeks, just because we have potential reps in process. But we would unlikely go above 23, 22 possibly, in June. And then, we will monitor that and will actually monitor our earnings per share performance and decide if we will add more reps between, say, August and the end of the year.

Okay. Thanks for that. And then, Scott, could we talk a little bit just about the margins in the TPA? There seems to be some variability there over the last three quarters or so. I guess, what is the right margin to assume? And also, I noticed a change in the assets that are so dedicated to that business had fluctuated a bit. Can you elaborate on those items?

Well, I can on the first. The margins in the TPA business reflect a very substantial fixed cost component. So, revenues up to a certain point generate relatively thin margins. But once the fixed cost [amount] is covered, then the margins can be very attractive, I’m told as high as 30%. And what we had in the first quarter was strong sales activity. And I think we saw the benefit of the cost structure coming through that quarter. Now, as far as the assets, that’s another question I’m just not prepared to answer. I wasn’t anticipating that question, but I can look into it.

So, in terms of the variability on the margin side, though, it sounds like it’s going to be relative to the sales volume coming through.

Yes. That’s a big driver of margin is just the sheer revenue volume.

Thank you.

Mike, that business – this is Ken Kuk, that business is not an equity based business. It’s really a service business.

Sure.

And, as Scott said, incremental dollars will come in with a margin of something in the 30% range. So, it’s a very attractive business for us. Although it doesn’t contribute substantial dollars, it’s very attractive from an ROE perspective.

Right. Well, thank you.

And gentlemen, I’m showing no further questions at this time. Ladies and gentlemen, this does conclude the question-and-answer session. I’d now like to turn it back over to management for any closing remarks.

This is Ken Kuk. In closing, I’d say the pace of activity and change at KMG America is impressive. We don’t have the luxury of waiting for quarter end results to make decisions or to tweak our strategy. It’s a continuous, ongoing process. None of the recent events, either good or bad, has changed our feelings about the prospects for KMG America. What we’re doing isn’t easy, but we continue to make great strides throughout the organization. We thank you for your support and we will communicate new information to you as warranted. Thank you.

Ladies and gentlemen, thank you for your participation in today’s event. This does conclude the presentation and you may now disconnect. Have a great day.