UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to ____
Commission file number 1-5975
HUMANA INC.
(Exact name of registrant as specified in its charter)
Delaware 61-0647538
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
500 West Main Street
Louisville, Kentucky 40202
(Address of principal executive offices) (Zip Code)
(502) 580-1000
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act
of 1934 during the preceding 12 months, and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Outstanding at
Class of Common Stock October 31, 1998
$.16 2/3 par value 167,380,593 shares
1 of 26
Humana Inc.
Form 10-Q
September 30, 1998
Page of
Form 10-Q
Part I: Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Operations for
the quarters and nine months ended September 30, 1998 and 1997 3
Condensed Consolidated Balance Sheets at September 30, 1998
and December 31, 1997 4
Condensed Consolidated Statements of Cash Flows for the
nine months ended September 30, 1998 and 1997 5
Notes to Condensed Consolidated Financial Statements 6-10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11-21
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 22
Part II: Other Information
Items 1 to 6 23-25
Exhibits
Ratio of Earnings to Fixed Charges
Financial Data Schedule
2
Humana Inc.
Condensed Consolidated Statements of Operations
For the quarters and nine months ended September 30, 1998 and 1997
Unaudited
(Dollars in millions, except per share results)
Quarter Nine Months
1998 1997 1998 1997
Revenues:
Premiums $ 2,421 $ 1,935 $ 7,170 $ 5,543
Investment and other income 43 33 142 93
Total revenues 2,464 1,968 7,312 5,636
Operating expenses:
Medical expenses 2,081 1,596 6,031 4,567
Selling, general and
administrative 351 274 1,001 793
Depreciation and amortization 32 26 97 75
Asset write-downs and
other special charges 34 34
Total operating expenses 2,498 1,896 7,163 5,435
Income (loss) from operations (34) 72 149 201
Interest expense 13 3 35 7
Income (loss) before income taxes (47) 69 114 194
Income tax provision (benefit) (17) 25 42 69
Net income (loss) $ (30) $ 44 $ 72 $ 125
Earnings (loss) per common share $ (.18) $ .27 $ .43 $ .77
Earnings (loss) per common share -
assuming dilution $ (.18) $ .27 $ .43 $ .76
See accompanying notes.
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Humana Inc.
Condensed Consolidated Balance Sheets
Unaudited
(Dollars in millions, except per share amounts)
September 30, December 31,
1998 1997
Assets
Current assets:
Cash and cash equivalents $ 478 $ 627
Marketable securities 1,563 1,507
Premiums receivable, less allowance
for doubtful accounts $51 - September 30, 1998
and $48 - December 31, 1997 245 351
Other 264 265
Total current assets 2,550 2,750
Long-term marketable securities 306 512
Property and equipment, net 429 420
Cost in excess of net assets acquired 1,197 1,224
Other 529 512
Total assets $ 5,011 $ 5,418
Liabilities and Stockholders' Equity
Current liabilities:
Medical and other expenses payable $ 1,468 $ 1,478
Trade accounts payable and accrued expenses 383 481
Unearned premium revenues 68 304
Total current liabilities 1,919 2,263
Long-term medical and other expenses payable 463 597
Long-term debt 907 889
Professional liability and other obligations 93 168
Total liabilities 3,382 3,917
Commitments and contingencies
Stockholders' equity:
Preferred stock, $1 par; authorized 10,000,000
shares; none issued
Common stock, $.16 2/3 par; authorized
300,000,000 shares; issued and outstanding
166,977,319 shares - September 30, 1998 and
164,058,225 shares - December 31, 1997 28 27
Other 1,601 1,474
Total stockholders' equity 1,629 1,501
Total liabilities and stockholders' equity $ 5,011 $ 5,418
See accompanying notes.
4
Humana Inc.
Condensed Consolidated Statements of Cash Flows
For the nine months ended September 30, 1998 and 1997
Unaudited
(Dollars in millions)
1998 1997
Net cash flows from operating activities $ (251) $ 65
Cash flows from investing activities:
Acquisition of health plan assets (456)
Purchases of property and equipment (84) (55)
Purchases of marketable securities (769) (389)
Maturities and sales of marketable securities 927 257
Other (21) 12
Net cash provided by (used in) investing activities 53 (631)
Cash flows from financing activities:
Repayment of line of credit (300)
Net commercial paper borrowings 317 390
Proceeds from issuance of common stock 34 10
Other (2)
Net cash provided by financing activities 49 400
Decrease in cash and cash equivalents (149) (166)
Cash and cash equivalents at beginning of period 627 322
Cash and cash equivalents at end of period $ 478 $ 156
Interest payments $ 34 $ 2
Income tax payments, net $ 69 $ 5
See accompanying notes.
5
Humana Inc.
Notes To Condensed Consolidated Financial Statements
Unaudited
(A) Basis of Presentation
The accompanying condensed consolidated financial statements are presented in
accordance with the requirements of Form 10-Q and consequently do not include
all of the disclosures normally required by generally accepted accounting
principles or those normally made in an annual report on Form 10-K.
Accordingly, for further information, the reader of this Form 10-Q may wish
to refer to the Form 10-K of Humana Inc. (the "Company") for the year ended
December 31, 1997.
The preparation of the Company's condensed consolidated financial statements
in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect (a) the reported
amounts of assets and liabilities, (b) disclosure of contingent assets and
liabilities at the date of the financial statements and (c) reported amounts
of revenues and expenditures during the reporting period. Actual results
could differ from those estimates.
The financial information has been prepared in accordance with the Company's
customary accounting practices and has not been audited. In the opinion of
management, the information presented reflects all adjustments necessary for
a fair statement of interim results. All such adjustments are of a normal
and recurring nature.
(B) Special Charges
On August 10, 1998, the Company and United HealthCare Corporation ("United")
announced their mutual agreement to terminate the previously announced
Agreement and Plan of Merger, dated May 27, 1998. The merger, among other
things, was expected to improve the operating results of certain of the
Company's products and markets. Following the merger's termination, the
Company conducted a strategic evaluation of each of its markets and product
offerings. As a result of this strategic evaluation, which included
assessing the anticipated impact of the Company's competitive and cost
environment, the Company recognized special charges of $132 million
($84 million after tax, or $.50 per diluted share) during the third quarter
of 1998. The special charges include provisions for expected losses on
insurance contracts ($46 million), costs related to the Company's contractual
relationships with various physician practice management companies
($27 million) and costs for exiting markets and discontinuing products
($16 million). The special charges also include $43 million related to
write-downs of miscellaneous assets, loss on disposal of non-strategic
assets, merger dissolution costs and a one-time associate incentive for
non-officer employees. The beneficial effect of these charges for the
quarter and nine months ended September 30, 1998 was approximately $6 million
($4 million after tax, or $.02 per diluted share). The beneficial effect
consists primarily of charges against liabilities for expected losses on
insurance contracts.
The special charges have been included in the accompanying consolidated
statements of operations for the quarter and nine months ended September 30,
1998, as follows: the provision for expected losses on insurance contracts
and costs related to the Company's contractual relationships with
6
Humana Inc.
Notes To Condensed Consolidated Financial Statements, continued
Unaudited
various physician practice management companies have been included in medical
expenses ($73 million); costs for exiting markets and discontinuing products,
asset write-downs, loss on disposal of non-strategic assets and merger
dissolution costs have been included in asset write-downs and other special
charges ($34 million); and the costs of transferring pharmacy benefit
processing to a third party and the one-time associate incentive for
non-officer employees have been included in selling, general and
administrative expenses ($25 million).
(C) Commitments and Contingencies
The Company's Medicare risk contracts with the federal government are renewed
for a one-year term each December 31 unless terminated 90 days prior thereto.
In 1997, Congress passed legislation which revised the structure of and
reimbursement for private health plan options for Medicare enrollees.
Management is unable to predict the impact the modification of federal
reimbursement will have on the Company's financial position, results of
operations or cash flows. The Company also maintains annual contracts with
various states and a two-year contract with the Commonwealth of Puerto Rico,
scheduled to expire March 31, 1999, to provide health care to Medicaid-
eligible individuals. Additionally, the Company's contract with the United
States Department of Defense to administer the TRICARE program is a one-year
contract renewable annually for up to two additional years. With the
exception of the contract with the Commonwealth of Puerto Rico, one of the
aforementioned markets the Company plans to exit, the loss of any of these
contracts or significant changes in these programs as a result of
administrative or legislative action, including reductions in payments or
increases in benefits without corresponding increases in payments, would have a
material adverse effect on the revenues, profitability and business prospects
of the Company.
Resolution of various loss contingencies, including litigation pending against
the Company in the ordinary course of business, is not expected to have a
material adverse effect on the Company's financial position, results of
operations or cash flows.
(D) Earnings Per Common Share
The Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS No. 128")
which specifies the computation, presentation and disclosure requirements for
earnings per share effective for periods ending after December 15, 1997. In
accordance with SFAS No. 128, earnings per share data for the quarter and nine
months ended September 30, 1997 have been restated.
7
Humana Inc.
Notes To Condensed Consolidated Financial Statements, continued
Unaudited
Detail supporting the computation of earnings (loss) per common share and
earnings (loss) per common share-assuming dilution follows:
Dollars in millions, except per share results
Per Share
Quarter Ended September 30, 1998 Net Income (Loss) Shares Results
Loss per common share $ (30) 167,023,422 $ (.18)
Effect of dilutive stock options -
Loss per common share -
assuming dilution $ (30) 167,023,422 $ (.18)
Quarter Ended September 30, 1997
Earnings per common share $ 44 163,705,430 $ .27
Effect of dilutive stock options 2,578,919
Earnings per common share -
assuming dilution $ 44 166,284,349 $ .27
Nine Months Ended September 30, 1998
Earnings per common share $ 72 166,160,332 $ .43
Effect of dilutive stock options 1,992,625
Earnings per common share -
assuming dilution $ 72 168,152,957 $ .43
Nine Months Ended September 30, 1997
Earnings per common share $ 125 163,221,517 $ .77
Effect of dilutive stock options 2,468,474
Earnings per common share -
assuming dilution $ 125 165,689,991 $ .76
For the quarter ended September 30, 1998, all 10,112,842 outstanding options
to purchase shares were excluded from the computation given the Company's
recording of a net loss during the quarter. For the quarter ended September
30, 1997, options to purchase 213,000 shares were not included in the
computation because the options' exercise prices were greater than the
average market price of the common shares during the quarter (1,522,276 and
2,090,409 for the nine months ended September 30, 1998 and 1997,
respectively).
(E) Long-Term Debt
The Company repaid the outstanding balance under its five-year revolving
credit agreement ("Credit Agreement") during the quarter ended March 31, 1998,
using funds obtained through its commercial paper program. As a result,
borrowings under the commercial paper program, which is backed by the Credit
Agreement, totaled approximately $907 million at September 30, 1998, with an
average interest rate during both the quarter and nine months then ended of
5.9 percent.
8
Humana Inc.
Notes To Condensed Consolidated Financial Statements, continued
Unaudited
Borrowings under both the Credit Agreement and commercial paper program have
been classified as long-term debt based on management's ability and intent to
refinance borrowings on a long-term basis.
(F) Acquisitions and Dispositions
On February 28, 1997, the Company acquired Health Direct, Inc. ("Health
Direct") from Advocate Health Care for $23 million in cash. This transaction,
which was recorded using the purchase method of accounting, added
approximately 50,000 medical members to the Company's Chicago, Illinois,
membership.
On September 8, 1997, the Company acquired Physician Corporation of America
("PCA") for total consideration of $411 million in cash, consisting primarily
of $7 per share for PCA's outstanding common stock and the assumption of $121
million in debt. The purchase was funded with borrowings under the Company's
commercial paper program. PCA served approximately 1.1 million medical
members and provided comprehensive health services through its HMOs in
Florida, Texas and Puerto Rico. In addition, PCA provided workers'
compensation third-party administrative management services. Prior to
November 1996, PCA also was a direct writer of workers' compensation
insurance in Florida. Long-term medical and other expenses payable in the
accompanying consolidated balance sheets includes the long-term portion of
workers' compensation liabilities related to this business. This transaction
was recorded using the purchase method of accounting.
On October 17, 1997, the Company acquired ChoiceCare Corporation
("ChoiceCare") for approximately $250 million in cash. The purchase was
funded with borrowings under the Company's commercial paper program.
ChoiceCare provided health services products to approximately 250,000 medical
members in the Greater Cincinnati, Ohio, area. This transaction was recorded
using the purchase method of accounting.
On January 31, 1997, the Company completed the sale of its Washington, D.C.,
health plan to Kaiser Foundation Health Plan of the Mid-Atlantic States, Inc.
Effective April 1, 1997, the Company also completed the sale of its Alabama
operations, exclusive of its small-group business and Alabama TRICARE
operations, to PrimeHealth of Alabama, Inc. On October 31, 1997, the Company
also sold The Lexington Hospital in Lexington, Kentucky, to Jewish Hospital
Healthcare Services, Inc. These sale transactions did not have a material
impact on the Company's financial position, results of operations or cash
flows.
9
Humana Inc.
Notes To Condensed Consolidated Financial Statements, continued
Unaudited
(G) Adoption of New Generally Accepted Accounting Principles
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS No.
130"), issued by the FASB in June 1997. Comprehensive income is defined
therein as all changes in equity during the period except those resulting
from shareholder equity contributions and distributions. Comprehensive
income (loss), comprised of net income (loss) and unrealized investment gains
and losses, totaled ($22 million) and $63 million for the quarters ended
September 30, 1998 and 1997, respectively, and $75 million and $145 million
for the nine months ended September 30, 1998 and 1997, respectively.
In addition, effective January 1, 1998, the Company adopted Statement of
Position 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use" ("SOP 98-1"), issued by the AICPA's Accounting
Standards Executive Committee in March 1998. SOP 98-1 specifies the costs to
be capitalized in connection with obtaining or developing computer software
to be used solely to meet the Company's internal needs. The adoption of
SOP 98-1 did not have a material impact on the Company's financial position
or results of operations.
(H) Impact of Recently Issued Accounting Pronouncements
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities"
("SFAS No. 133"). In general, SFAS No. 133 requires that all derivatives be
recognized as either assets or liabilities in the balance sheet at their face
value, and sets forth the manner in which gains or losses thereon are to
be recorded. The treatment of such gains and losses is dependent upon the
type of exposure, if any, for which the derivative is designated as a hedge.
This statement is effective for periods beginning after June 15, 1999. Given
that the Company currently holds no derivative instruments, adoption of SFAS
No. 133 is not expected to have a significant impact on the Company.
In June 1997, the FASB issued Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related Information"
("SFAS No. 131"). SFAS No. 131 requires, if certain quantitative thresholds
are met, public companies to report separate financial information about
operating segments, as well as certain information about their products and
services, the geographic areas in which they operate and their major
customers. This statement is effective for financial statements for fiscal
years beginning after December 15, 1997. The Company is continuing to assess
the disclosure impacts of adopting SFAS No. 131.
10
Humana Inc.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
This discussion and analysis contains both historical and forward-looking
information. The forward-looking statements may be significantly impacted by
risks and uncertainties, and are made pursuant to the safe harbor provisions
of the Private Securities Litigation Reform Act of 1995. There can be no
assurance that anticipated future results will be achieved because actual
results may differ materially from those projected in the forward-looking
statements. Readers are cautioned that a number of factors, which are
described herein and in the Company's Annual Report on Form 10-K for the year
ended December 31, 1997, could adversely affect the Company's ability to
obtain these results. These include the effects of either federal or state
health care reform or other legislation, renewal of the Company's Medicare
risk contracts with the federal government, renewal of the Company's contract
with the federal government to administer the TRICARE program, and renewal of
the Company's Medicaid contracts with various state governments and the
Commonwealth of Puerto Rico. Such factors also include the effects of other
general business conditions, including but not limited to, the Company's
ability to integrate its acquisitions, the Company's ability to appropriately
address the "Year 2000" computer system issue, government regulation,
competition, premium rate and yield changes, retrospective premium
adjustments relating to federal government contracts, medical cost trends,
changes in Commercial and Medicare risk membership, capital requirements,
the ability of health care providers (including physician practice management
companies) to assume financial risk, general economic conditions and the
retention of key employees. In addition, past financial performance is not
necessarily a reliable indicator of future performance.
Introduction
The Company offers managed health care products that integrate medical
management with the delivery of health care services through a network of
providers. This network of providers may share financial risk or have
incentives to deliver quality medical services in a cost-effective manner.
These products are marketed primarily through health maintenance organizations
("HMOs") and preferred provider organizations ("PPOs") that encourage or
require the use of contracting providers. HMOs and PPOs control health care
costs by various means, including pre-admission approval for hospital
inpatient services and pre-authorization of outpatient surgical procedures.
The Company also offers various specialty and administrative service products
including dental, group life and workers' compensation.
The Company's HMO and PPO products are marketed primarily to employers and
other groups ("Commercial") as well as Medicare- and Medicaid-eligible
individuals. The products marketed to Medicare-eligible individuals are
either HMO products ("Medicare risk") or indemnity insurance policies that
supplement Medicare benefits ("Medicare supplement"). The Medicare risk
product provides managed care services that include all Medicare benefits and,
in certain circumstances, additional managed care services. The Company also
maintains annual contracts with various states and a two-year contract with
the Commonwealth of Puerto Rico, scheduled to expire March 31, 1999, to
provide health care to Medicaid-eligible individuals. The Company
11
Humana Inc.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
also offers administrative services ("ASO") to employers who self-insure their
employee health plans. In total, the Company's products are licensed in 47
states, the District of Columbia and Puerto Rico, with approximately 22
percent of its membership in the state of Florida.
The Company is in the third year of its managed care support contract with the
United States Department of Defense to administer the TRICARE program. Under
the TRICARE contract, which is renewable annually for up to two additional
years, the Company provides managed care services to the beneficiaries of
active military personnel and retired military personnel and their
beneficiaries located in the southeastern United States.
Special Charges
On August 10, 1998, the Company and United HealthCare Corporation ("United")
announced their mutual agreement to terminate the previously announced
Agreement and Plan of Merger, dated May 27, 1998. The merger, among other
things, was expected to improve the operating results of certain of the
Company's products and markets. Following the merger's termination, the
Company conducted a strategic evaluation of each of its markets and product
offerings. As a result of this strategic evaluation, which included
assessing the anticipated impact of the Company's competitive and cost
environment, the Company recognized special charges of $132 million ($84
million after tax, or $.50 per diluted share) during the third quarter of
1998. The special charges include provisions for expected losses on
insurance contracts ($46 million), costs related to the Company's contractual
relationships with various physician practice management companies ($27
million) and costs for exiting markets and discontinuing products ($16
million). The special charges also include $43 million related to write-downs
of miscellaneous assets, loss on disposal of non-strategic assets, merger
dissolution costs and a one-time associate incentive for non-officer
employees.
The special charges have been included in the accompanying consolidated
statements of operations for the quarter and nine months ended September 30,
1998, as follows: the provision for expected losses on insurance contracts
and costs related to the Company's contractual relationships with various
physician practice management companies have been included in medical expenses
($73 million); costs for exiting markets and discontinuing products, asset
write-downs, loss on disposal of non-strategic assets and merger dissolution
costs have been included in asset write-downs and other special charges ($34
million); and the costs of transferring the Company's pharmacy benefit
processing to a third party and the one-time associate incentive for non-
officer employees have been included in selling, general and administrative
expenses ($25 million).
Comparison of Results of Operations
In order to enhance comparability, the following discussion comparing the
quarter ended September 30, 1998 to September 30, 1997, and the nine months
ended September 30, 1998 to the corresponding nine month period in 1997,
excludes the special charges discussed above, but includes the beneficial
effect thereof. The beneficial effect of these charges for the quarter and
nine months
12
Humana Inc.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
ended September 30, 1998 was approximately $6 million ($4 million after tax,
or $.02 per diluted share). The beneficial effect consists primarily of
charges against liabilities for expected losses on insurance contracts.
Quarters Ended September 30, 1998 and 1997
Income before income taxes totaled $85 million for the quarter ended September
30, 1998 (the "1998 quarter"), compared to $69 million for the quarter ended
September 30, 1997 (the "1997 quarter"). Net income was $54 million, or $.32
per diluted share, in the 1998 quarter, compared to $44 million, or $.27 per
diluted share, in the 1997 quarter. This earnings increase primarily resulted
from favorable margins in the Company's small-group Commercial business,
Medicare risk membership growth, continuing reductions in the Company's
administrative cost ratio and the 1997 acquisitions of Physician Corporation
of America ("PCA") and ChoiceCare Corporation ("ChoiceCare").
The Company's premium revenues increased 25 percent to $2.4 billion for the
1998 quarter, compared to $1.9 billion for the same period in 1997. The
premium revenue increase was attributable to $319 million related to PCA and
ChoiceCare, same-plan Commercial and Medicare risk membership growth and
increased Commercial premium yields. Same-plan Commercial premium yields
increased 5.0 percent for the 1998 quarter and are expected to continue to
increase at that rate throughout the remainder of 1998. While the Company's
Medicare risk statutory premium rate increased by slightly less than 2
percent, the changing geographical mix of the Company's Medicare risk
membership resulted in a 0.2 percent decline in the same-plan Medicare risk
premium yield during the 1998 quarter.
The Company's same-plan fully insured Commercial membership increased 33,300
members during the 1998 quarter, compared to an increase of 24,000 for the
same period in 1997, while its Commercial same-plan ASO membership decreased
13,100. The Company's same-plan Medicare risk membership increased 4,300
during the 1998 quarter, compared to a same-plan increase of 18,800 members
for the same period in 1997. While this growth in Medicare risk membership
reflects enrollment gains in both the Company's newer and base Medicare risk
markets, it also reflects the Company's slowing of its sales efforts in
certain high cost Medicare markets.
In addition to these same-plan membership results, PCA and ChoiceCare
membership totaled 573,400 Commercial, 603,400 Medicaid, 52,800 Medicare risk
and 45,100 ASO members. At September 30, 1998, the Company's medical
membership totaled approximately 6.2 million. Management expects same-plan
Commercial membership to increase at a low to mid single digit rate during
1998, and expects a mid to high single digit rate increase in Medicare risk
membership.
13
Humana Inc.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
The Company's medical expense ratio for the 1998 quarter was 82.9 percent,
increasing from 82.5 percent for the same period in 1997 as a result of the
PCA and ChoiceCare acquisitions. Excluding the effect of these acquisitions,
the Company's medical expense ratio improved to 82.2 percent from 82.4 percent
in the 1997 quarter. This improvement resulted from the aforementioned
Commercial premium increase and a 2.6 percent improvement in both Commercial
and Medicare risk days per thousand, partially offset by pharmacy rate and
utilization increases system wide.
During the 1998 quarter, the Company's administrative cost ratio improved to
14.8 percent from 15.5 percent in the 1997 quarter. This year-over-year
improvement in the administrative cost ratio reflects the impacts of the PCA
and ChoiceCare acquisitions and the Company's efforts to rationalize staffing
levels and streamline the organizational structure. Continued improvement is
expected in the administrative cost ratio during the fourth quarter of 1998.
Investment income totaled $35 million and $29 million for the 1998 and 1997
quarters, respectively. The increase is primarily attributable to a larger
investment portfolio resulting from the addition of PCA and ChoiceCare. The
tax equivalent yield on invested assets approximated 7 percent and 8 percent
for the 1998 and 1997 quarters, respectively.
Nine Months Ended September 30, 1998 and 1997
Income before income taxes totaled $246 million for the nine months ended
September 30, 1998 (the "1998 period"), compared to $194 million for the same
period in 1997 (the "1997 period"). Net income was $156 million, or $.93 per
diluted share, in the 1998 period, compared to $125 million, or $.76 per
diluted share, in the 1997 period. This earnings increase was primarily a
result of favorable margins in the Company's small-group Commercial business,
Commercial and Medicare risk membership growth, administrative cost ratio
reductions and the PCA and ChoiceCare acquisitions. These favorable items
were partially offset by the effects of increased Medicare risk hospital
utilization and increased pharmacy costs system wide.
The Company's premium revenues increased 29 percent to $7.2 billion for the
1998 period, compared to $5.5 billion for the 1997 period. The premium
revenue increase was attributable to $1.2 billion related to PCA and
ChoiceCare, same-plan Commercial and Medicare risk membership growth and
increased Commercial premium yields. Same-plan Commercial premium yields
increased 4.7 percent for the 1998 period, while the Medicare risk premium
yield declined 0.7 percent due to the aforementioned Medicare risk statutory
premium rate increase of slightly less than 2 percent, offset by the impact of
the changing geographical mix of the Company's Medicare risk membership.
14
Humana Inc.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
The Company's same-plan fully insured Commercial membership increased 43,300
members during the 1998 period, compared to a decline of 82,200 for the same
period in 1997, and its Commercial same-plan ASO membership increased 38,600.
The Company's same-plan Medicare risk membership increased 25,600 during the
1998 period, compared to a same-plan increase of 49,300 members for the same
period in 1997. While this growth in Medicare risk membership reflects
enrollment gains in both the Company's newer and base Medicare risk markets,
it also reflects the Company's slowing of its sales efforts in certain high
cost Medicare markets.
Same-plan membership results exclude the addition of the PCA and ChoiceCare
membership, as set forth in the discussion of quarterly results, and the sale
of the Company's Washington, D.C., health plan and Alabama operations.
Reflecting the effects of the PCA and ChoiceCare acquisitions, the Company's
medical expense ratio increased to 83.1 percent in the 1998 period, from 82.4
percent in the 1997 period. Excluding these acquisitions, the medical expense
ratio for the 1998 period improved slightly to 82.3 percent, due largely to
the aforementioned Commercial premium increase and a modest improvement in
Commercial days per thousand, partially offset by increased pharmacy rates and
utilization system wide, as well as higher Medicare risk days per thousand.
The Company's administrative cost ratio was 15.0 percent and 15.7 percent for
the 1998 and 1997 periods, respectively. This improvement results primarily
from the impacts of the PCA and ChoiceCare acquisitions and the Company's
efforts to rationalize staffing levels and streamline the organizational
structure.
Investment income totaled $115 million in the 1998 period, compared to $82
million in the 1997 period. This increase is primarily attributable to a
larger investment portfolio resulting from the addition of PCA and ChoiceCare.
The tax equivalent yield on invested assets approximated 8 percent for each of
the 1998 and 1997 periods.
Liquidity
During the 1998 period, $251 million was used in the Company's operating
activities, compared to $65 million being provided by operations in the 1997
period. This net cash used in operations during the 1998 period can be
attributed in large part to the timing of receipts of cash for Medicare
premiums ($235 million), payment of claims related to the PCA workers'
compensation "run-off business" ($103 million), and the cash payment for the
purchase of reinsurance tail coverage related to the Company's internally-
managed professional liability exposures ($40 million).
The Company's subsidiaries operate in states that require minimum levels of
equity and regulate the payment of dividends to the parent company. As a
result, the Company's ability to use operating subsidiaries' cash flows is
restricted to the extent of the subsidiaries' abilities to obtain regulatory
approval to pay dividends.
15
Humana Inc.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
The Company maintains a five-year revolving credit agreement ("Credit
Agreement") which provides a line of credit of up to $1.5 billion. Principal
amounts outstanding under the Credit Agreement bear interest at rates ranging
from LIBOR plus 12 basis points to LIBOR plus 30 basis points, depending on
the ratio of debt to debt plus net worth. The Credit Agreement, under which
there were no outstanding borrowings at September 30, 1998, contains customary
covenants and events of default.
The Company also maintains a commercial paper program and issues debt
securities thereunder. At September 30, 1998, borrowings under the commercial
paper program totaled approximately $907 million, with an average interest
rate during both the quarter and nine months then ended of 5.9 percent. The
commercial paper program is backed by the Credit Agreement. Borrowings under
both the Credit Agreement and commercial paper program have been classified as
long-term debt based on management's ability and intent to refinance
borrowings on a long-term basis.
Management believes that existing working capital, future operating cash flows
and funds available under the Credit Agreement and commercial paper program
are sufficient to meet future liquidity needs. Management also believes the
aforementioned sources of funds are adequate to allow the Company to pursue
strategic acquisition and expansion opportunities, as well as fund capital
requirements.
Capital Resources
The Company's ongoing capital expenditures relate primarily to administrative
facilities and related information systems necessary for activities such as
claims processing, billing and collections, medical utilization review and
customer service. Excluding acquisitions, planned capital spending in 1998
will approximate $100 million for the expansion and improvement of such items.
Impact of the Year 2000 Issue
The Year 2000 problem is the result of the two potential malfunctions that
could have an impact on the Company's systems and equipment. The first
problem arises due to computers being programmed to use two rather than four
digits to define the applicable year. The second problem arises where
embedded microchips and micro-controllers have been designed using two rather
than four digits to define the applicable year. Certain of the Company's
computer programs, building infrastructure components (e.g.,
telecommunications, alarm and HVAC systems) and medical devices that are date
sensitive, may recognize a date using "00" as the year 1900 rather than the
year 2000. If uncorrected, the problem could result in computer system and
program failures or equipment malfunctions that could result in a disruption
of business operations (such as the payment of claims, billing and collection,
and enrollment verification).
16
Humana Inc.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
Humana's Information Systems organization operates in a centralized manner.
The Company's Data Center and the majority of its programming and support
staff are located at its corporate offices in Louisville, Kentucky. Evolving
from a project team organized in 1996, a Year 2000 Project Management Office
is now in place to oversee the progress made in the assessment and correction
of the Company's Year 2000 exposures.
In general, the Company's Year 2000 Project consists of four phases --
assessment, remediation, validation, and implementation -- and is categorized
into the following four divisions:
Information Technology (IT) - software essential for day-to-day operations
(including both internally developed software and third party software
which interfaces therewith).
IT Infrastructure - mainframe, network, telecommunications interfaces and
self-contained operating systems.
Third party business partners and intermediaries - entities on which the
Company relies for transmission and receipt of claims, and encounter,
membership and payment information, including federal and state
governmental agencies such as the Health Care Financing Administration
("HCFA").
Non-IT Infrastructure - telecommunications equipment, elevators, public
safety equipment (i.e., security, and fire), medical equipment and HVAC
systems.
Having commenced the assessment of its Year 2000 exposures in 1996, the
Company has begun remediation of its internally developed software and third
party software applications. The Company's goal is to have modified all
critical mainframe systems and components in time for such systems and
components to utilize the updated Year 2000 logic no later than early 1999.
This schedule will permit the majority of the modified programs to run in a
production environment for a considerable period of time before encountering
Year 2000 data. During 1999, the Company plans to monitor the processing
results and conduct Year 2000 system tests to ensure that the updated logic
will properly function after December 31, 1999. In addition, the Company is
in the process of contacting vendors, third party business partners and
intermediaries in an effort to obtain the information necessary to address the
Year 2000 issues. The Company anticipates completing, in all material
respects, its Year 2000 Project by the end of the third quarter 1999. The
Company's efforts are currently on schedule.
The Year 2000 project is currently estimated to have a minimum total cost of
approximately $24 million, of which the Company has incurred approximately
$12 million project-to-date through September 1998 -- approximately $11
million year-to-date through September 1998. In 1998, Year 2000 expenses
represent less than 20 percent of the Information Systems budget. These
costs are being expensed as incurred and are expected to be funded through
operating cash flow.
17
Humana Inc.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
From a forward-looking perspective, the extent and magnitude of the Year 2000
problem, as it will affect the Company both before and for some period after
January 1, 2000, are difficult to predict or quantify for a number of reasons.
The Company has recently undertaken the development of contingency plans in
the event that its Year 2000 Project is not accurately or timely completed.
While the Company presently believes that the timely completion of its Year
2000 Project will limit exposure so that the Year 2000 will not pose material
operational problems, the Company does not have control of third party
systems. Although the Company is contacting third parties, the Company has
not received assurances that all third party interfaces will be timely
converted. Additionally, if Year 2000 modifications or upgrades are not
accomplished in a timely manner or proper contingency plans are not
implemented, the Company's Year 2000 related failures could have a material
adverse impact on operations.
The costs of the project and the date on which the Company plans to complete
the necessary Year 2000 modifications are based on management's best
estimates, which were derived utilizing numerous assumptions of future events
including the continued availability of certain resources and other factors.
However, there can be no guarantee that these estimates will be achieved and
actual results could differ materially from those plans. Specific factors
that might cause such material differences include, but are not limited to,
the availability and cost of personnel trained in this area, the ability to
locate and correct all relevant computer codes, the ability of the Company's
significant suppliers, customers and others with which it conducts business,
including federal and state governmental agencies, to identify and resolve
their own Year 2000 issues.
Impact of Recently Issued Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS No. 133"). In general,
SFAS No. 133 requires that all derivatives be recognized as either assets or
liabilities in the balance sheet at their face value, and sets forth the
manner in which gains or losses thereon are to be recorded. The treatment of
such gains and losses is dependent upon the type of exposure, if any, for
which the derivative is designated as a hedge. This statement is effective
for periods beginning after June 15, 1999. Given that the Company currently
holds no derivative instruments, adoption of SFAS No. 133 is not expected to
have a significant impact on the Company.
In June 1997, the FASB issued Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related Information"
("SFAS No. 131"). SFAS No. 131 requires, if certain quantitative thresholds
are met, public companies to report separate financial information about
operating segments, as well as certain information about their products and
services, the geographic areas in which they operate and their major
customers. This statement is effective for financial statements for fiscal
years beginning after December 15, 1997. The Company is continuing to assess
the disclosure impacts of adopting SFAS No. 131.
18
Humana Inc.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
1998 1997
Quarterly Membership
Commercial members at:
March 31 3,249,600 2,577,800
June 30 3,260,700 2,577,600
September 30 3,235,800 3,056,400
December 31 3,258,600
Medicare risk members at:
March 31 495,800 374,200
June 30 501,000 389,600
September 30 502,800 462,400
December 31 480,800
TRICARE members at:
March 31 1,103,500 1,103,100
June 30 1,096,300 1,107,300
September 30 1,090,400 1,107,300
December 31 1,112,200
Medicaid members at:
March 31 632,200 53,200
June 30 630,200 51,000
September 30 637,900 638,400
December 31 635,200
Medicare supplement members at:
March 31 64,600 93,500
June 30 61,800 74,600
September 30 58,600 71,200
December 31 68,800
Administrative services members at:
March 31 682,200 566,300
June 30 693,400 555,000
September 30 673,900 584,500
December 31 651,200
Total medical members at:
March 31 6,227,900 4,768,100
June 30 6,243,400 4,755,100
September 30 6,199,400 5,920,200
December 31 6,206,800
Specialty members at:
March 31 2,647,800 2,172,900
June 30 2,477,800 2,127,200
September 30 2,597,800 2,358,200
December 31 2,440,600
19
Humana Inc.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
Supplemental Consolidated Statement of Quarterly Operations (Unaudited)
(Dollars in millions, except per share results)
1998
First Second Third(a) Total
Revenues:
Premiums:
Commercial $ 1,290 $ 1,305 $ 1,325 $ 3,920
Medicare risk 722 730 732 2,184
TRICARE 185 210 205 600
Medicaid 137 135 142 414
Medicare supplement 18 17 17 52
Total premiums 2,352 2,397 2,421 7,170
Investment and other income 50 49 43 142
Total revenues 2,402 2,446 2,464 7,312
Operating expenses:
Medical expenses 1,955 1,995 2,081 6,031
Selling, general and administrative 324 326 351 1,001
Depreciation and amortization 32 33 32 97
Asset write-downs and other
special charges 34 34
Total operating expenses 2,311 2,354 2,498 7,163
Income (loss) from operations 91 92 (34) 149
Interest expense 12 10 13 35
Income (loss) before income taxes 79 82 (47) 114
Income tax provision (benefit) 29 30 (17) 42
Net income (loss) $ 50 $ 52 $ (30) $ 72
Earnings (loss) per common share $ .30 $ .31 $ (.18) $ .43
Earnings (loss) per common share -
assuming dilution $ .30 $ .31 $ (.18) $ .43
Medical expense ratio 83.1% 83.3% 85.9% 84.1%
Administrative expense ratio 15.2% 15.0% 15.8% 15.3%
(a) Includes special charges of $132 million ($84 million after tax, or $.50
per diluted share) primarily related to the costs of certain market exits and
product discontinuances, asset write-downs and a one-time associate incentive
for employees, excluding officers.
20
Humana Inc.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
Supplemental Consolidated Statement of Quarterly Operations (Unaudited)
(Dollars in millions, except per share results)
1997
First Second Third Fourth Total
Revenues:
Premiums
Commercial $ 1,028 $ 1,013 $ 1,074 $ 1,272 $ 4,387
Medicare risk 550 571 610 695 2,426
TRICARE 183 184 185 212 764
Medicaid 19 18 47 140 224
Medicare supplement 23 19 19 18 79
Total premiums 1,803 1,805 1,935 2,337 7,880
Investment and other income 29 31 33 63 156
Total revenues 1,832 1,836 1,968 2,400 8,036
Operating expenses:
Medical expenses 1,484 1,487 1,596 1,955 6,522
Selling, general
and administrative 261 258 274 323 1,116
Depreciation and amortization 24 25 26 33 108
Total operating expenses 1,769 1,770 1,896 2,311 7,746
Income from operations 63 66 72 89 290
Interest expense 3 1 3 13 20
Income before income taxes 60 65 69 76 270
Income tax provision 21 23 25 28 97
Net income $ 39 $ 42 $ 44 $ 48 $ 173
Earnings per common share $ .24 $ .26 $ .27 $ .29 $ 1.06
Earnings per common share -
assuming dilution $ .24 $ .25 $ .27 $ .29 $ 1.05
Medical expense ratio 82.3% 82.3% 82.5% 83.6% 82.8%
Administrative cost ratio 15.8% 15.7% 15.5% 15.2% 15.5%
21
Humana Inc.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Since the date of the Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1997, no material changes have occurred in the Company's
exposure to market risk associated with the Company's investments in market
risk sensitive financial instruments, as set forth in the "Management's
Discussion and Analysis of Financial Conditions and Results of Operations"
included in such Form 10-K.
22
Humana Inc.
Part II: Other Information
Item 1: Legal Proceedings
A class action lawsuit styled Mary Forsyth, et al v. Humana Inc., et al, Case
#CV-5-89-249-PMP (L.R.L.), was filed on March 29, 1989, in the United States
District Court for the District of Nevada. On August 18, 1997, the Company
filed a Petition for Writ of Certiorari in the United States Supreme Court
("Petition") requesting the Supreme Court to reverse the Ninth Circuit's
decision to reinstate the claim under the Racketeer Influenced and Corrupt
Organizations Act ("RICO") on behalf of a class of insureds who paid
coinsurance at Humana hospitals (the "Co-Payer Class"). The petition was
granted by the Supreme Court on June 22, 1998. Oral arguments on the
Company's Petition will be heard on November 30, 1998. The Ninth Circuit
also reinstated an antitrust claim that had been dismissed by the District
Court. The Company requested summary judgment in the District Court on that
Claim on October 6, 1997. That request was denied on September 21, 1998. The
Company has requested the District Court to reconsider its decision. The
plaintiffs have filed their Fourth Amended Complaint and a motion for leave
to file a Fifth Amended Complaint reasserting an ERISA claim and adding new
RICO and antitrust claims. The Company filed a motion to dismiss the Fourth
Amended Complaint and a motion opposing the plaintiffs' request to file the
Fifth Amended Complaint. The motions are pending before the District Court.
The trial which was scheduled to begin on February 23, 1998, on the claims
has been postponed.
Damages for claims for personal injuries and medical benefit denials are
usual in the Company's business. Personal injury claims are covered by
insurance from the Company's wholly-owned captive insurance subsidiary and
excess carriers, except to the extent that claimants seek punitive damages,
which may not be covered by insurance if awarded. Punitive damages generally
are not paid where claims are settled and generally are awarded only where a
court determines there has been a willful act or omission to act.
Management does not believe that any pending legal actions will have a
material adverse effect on the Company's financial position, results of
operations or cash flows.
Items 2 - 5:
None.
23
Humana Inc.
Part II: Other Information, continued
Item 6: Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit 12 - Statement re: Computation of Ratio of Earnings to
Fixed Charges, filed herewith.
Exhibit 27 - Financial Data Schedule for Nine Months Ended
September 30, 1998.
(b) Forms 8-K:
On September 15, 1998, the Company filed a report on Form 8-K
regarding its announcement of plans to exit certain unprofitable
markets and the recording of a $132 million pretax charge, as
discussed in both Items 1 and 2 of this Form 10-Q.
24
Humana Inc.
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HUMANA INC.
Date: November 16, 1998 /s/ James E. Murray
James E. Murray
Senior Vice President and
Chief Financial Officer
(Principal Accounting Officer)
Date: November 16, 1998 /s/ Arthur P. Hipwell
Arthur P. Hipwell
Senior Vice President and
General Counsel
25
Humana Inc.
Exhibit 12
Ratio of Earnings to Fixed Charges
For the quarters and nine months ended September 30, 1998 and 1997
Unaudited
(Dollars in millions)
Quarter Ended Nine months Ended
September 30, September 30,
1998 1997 1998 1997
Earnings:
Income (loss) before income taxes $ (47) $ 69 $ 114 $ 194
Fixed charges 15 5 43 13
$ (32) $ 74 $ 157 $ 207
Fixed charges:
Interest charged to expense $ 13 $ 3 $ 35 $ 7
One-third of rent expense 2 2 8 6
$ 15 $ 5 $ 43 $ 13
Ratio of earnings to fixed charges (a) 14.1 3.6 (a) 15.2
The one-third of rent expense included in fixed charges is that proportion
deemed representative of the interest portion.
(a) Exclusive of the special charges of $132 million before income taxes, the
ratio of earnings to fixed charges for the quarter and nine months ended
September 30, 1998, would have been 6.5 and 6.7, respectively.
5
1,000,000
JAN-01-1998
9-MOS
DEC-31-1998
SEP-30-1998
478
1,563
296
51
6
2,550
766
337
5,011
1,919
907
0
0
28
1,601
5,011
7,170
7,312
6,031
7,163
0
0
35
114
42
72
0
0
0
72
.43
.43
