Molina Healthcare Inc. (MOH) reported fourth quarter operating earnings of 51 cents per share, which surpassed the Zacks Consensus Estimate of 39 cents. However, results lagged operating earnings of 58 cents in the year-ago quarter.

Including a $1.34 per share non-cash Missouri health plan impairment charge, a 21 cent income related to contract amendment and a 10 cent cost related to acquisition-related arbitrage settlement and provider termination, operating loss for the reported quarter amounted to 72 cents.

Net loss for the quarter came in at $33 million or 72 cents per share, compared to a net income of $17.6 million or 39 cents per share in the prior-year quarter. Results benefited from increased premium, service revenues and increased memberships. However, this growth momentum was muted by increased expenses and higher medical care costs.

Quarterly Results

Total revenue for the reported quarter climbed to $1.31 billion from $1.08 billion in the fourth quarter of 2010. Molina will defer the recognition of any revenue or recoverable direct cost in Idaho till the Medicaid Management Information System in the state receives certification from the Centers for Medicare and Medicaid Services.

Premium revenues augmented 20.3% year over year to $1.25 billion, primarily due to a 14.7% per-member-per-month (PMPM) revenue increase, aided by a membership growth (on the basis of member-month) of 4.9%. Moreover, Molina’s service revenue jumped to $49.2 million from $36.5 million in the year-ago quarter, while investment income increased to $1.74 million from $1.38 million. Additionally, the company recorded a rental income of $0.55 million in the reported quarter. Medicare premium revenue for the reported quarter spiked to $105.9 million from $76.5 million in the year-ago quarter.

Total operating expenses also climbed 20.2% year over year to $1.26 billion, primarily driven by general and administrative (G&A) expenses that rose to $125.0 million from $100.4 million, cost of service revenue that increased to $39.0 million from $36.8 million and premium tax expenses that escalated to $44.0 million from $35.2 million in the prior-year quarter. However, depreciation and amortization (D&A) costs declined to $12.1 million from $12.5 million in the prior-year quarter. Additionally, interest expense increased to $3.9 million from $3.5 million in the year-ago quarter, mainlydue to a $48.6 million term loan taken in December 2011.

Medical care costs increased to $1.04 billion from $862 million in the fourth quarter of 2010, although medical care ratio (ratio of medical care costs to premium revenue) remained almost flat at 82.7%. Besides, total medical care costs increased 15% on a PMPM basis.

Full-Year 2011 Highlights

For full-year 2011, Molina reported operating income of $1.82 per share, which surpassed the Zacks Consensus Estimate of $1.55 but lagged $1.98 earned in 2010. Operating income for 2011 excludes a $1.34 per share non-cash Missouri health plan impairment charge, a 7 cent income related to contract amendment and a 10 cent cost related to acquisition-related arbitrage settlement and provider termination.

Molina’s total revenue amounted to $4.8 billion in 2011, showing a modest year-over-year increase from $4.1 billion. Moreover, premium revenue came in at $4.6 billion, up 15% year over year from $4.0 billion.

Additionally, total expenses increased to $4.6 billion from $4.0 billion. Net income came in at $20.8 million or 45 cents per share, compared with $55.0 million or $1.32 per share in 2010.

Financial Update

Molina exited 2011 with $893.0 million in cash and investments, while the parent company had cash and investments of $23.6 million. At the end of the year, Molina’s total assets increased to $1.65 billion from $1.51 billion at 2010-end, while shareholders’ equity elevated to $755.1 million from $719.1 million.

In 2011, cash flow from operations increased to $225.4 million from $161.4 million in 2010. The huge difference is attributed to deferred revenue expenses of $8.2 million in 2011, compared with $41.9 million in 2010.

Business Update

On December 7, 2011, Molina purchased Molina Center, an office building in California, for $81 million. The purchase consideration was paid out of a $48.6 million term loan, while the remaining $32.4 million was paid from the company’s cash balance.

Guidance

Management lowered the earnings per share guidance for fiscal 2012 to $1.75 per share from $1.80 projected in January 2012. Molina’s earnings before interest, taxes, depreciation and amortization (EBITDA) are expected to be about $213 million, while income before tax is predicted to be $133 million.

Meanwhile, total revenue is expected to be around $6.0 billion. Total revenue comprises premium revenue, service revenue and investment income, which are predicted to be $5.8 billion, $185 million and $6 million, respectively.

On the expense side, medical care costs are expected to be approximately $5.0 billion. Meanwhile, service costs are projected to be $158 million and G&A expenses are likely to be $464 million. Additionally, Molina projects depreciation and amortization to be about $35 million and $15 million, respectively, while it anticipates that interest expense would be around $17 million.

Furthermore, the company estimates premium tax expense to be $169 million along with an effective tax rate of 38%. As a result, net income is projected to be $83 million.

In terms of ratios, Molina expects medical care ratio to be 86% in 2012. Additionally, service revenue ratio is projected to be 85% and G&A ratio is projected to be 7.8%.

Outstanding shares are expected to increase to 47.3 million at 2012-end from 46.4 million as of December 31, 2011.

Our Take

Molina witnessed a year-over-year deterioration in operating results, despite substantial premium growth. The company also delivered significant revenue growth and record high cash flows, which led to a stronger balance sheet.However,rising medical costs are leading to margin compression. Besides, higher operating expenses pose a risk to the company’s operating leverage.

Nevertheless, we believe that thesteady increase in premium revenues and membership growth will drive earnings in future.Additionally,the company’s efficient growth strategy through acquisitions and a strong portfolio beyond managed care will likely attract long-term investors. However, the company needs to implement some cost control measures.

Molina’s competitor UnitedHealth Group Inc. (UNH) declared its fourth-quarter 2011 earnings of $1.17 per share, substantially higher than the Zacks Consensus Estimate of $1.02.

Another peer, Coventry Health Care Inc. (CVH) reported fourth-quarter 2011 operating earnings per share of 58 cents, which lagged the Zacks Consensus Estimate of 64 cents as well as 96 cents reported in the year-ago quarter.

Molina currently carries a Zacks #2 Rank, implying a short-term ‘Buy’ rating. Considering the fundamentals, we maintain a long-term ‘Outperform’ recommendation on the shares.

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