Humana Inc (HUM) 2002 Q3 法說會逐字稿

Good morning, my name is Ashley and I'll be your conference facilitator today. At this time I'd like to welcome everyone to the Humana conference call. After the speakers' remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press star and the number 1 on your telephone keypad.

This is Regina Nethery, Vice President of Investor Relations for Humana. We thank you for joining us for our earnings guidance. Participating in today's call are Mike McCallister, Humana's Chief Executive Officer, Jim Bloem, our Chief Financial Officer and Art Hipwell, our General Counsel. This morning's call and virtual slide presentation are being recorded for replay purposes. That replay will be available approximately two hours after the conclusion of this call on Humana's website, humana.com. As we begin this morning's call, I need to remind each of you of our cautionary statement. Certain of the matters discussed in this conference call are forward-looking and involve a number of risks and uncertainties. Actual results may differ materially. All participants in this conference call are advised to read Humana's press release, issued this morning, October 28, 2002, as well as the following documents as filed by Humana with the Securities and Exchange Commission. Our form 10-K for the year December 31, 2001, our form 10-Qs for the quarters ended March 31st, 2002 and June 30th, 2003. And our form S-3 filed October 8th, 2002. These SEC filings contain detailed discussions of important risk factors. New accounting rules related to the cessation of goodwill amortization became effective for all companies on January 1, 2002. Unless specifically described otherwise, all prior year numbers in this call have been adjusted to reflect the impact of the new goodwill accounting, allowing for an apples to apples comparison between 2002 and 2001 financial metrics. Today's call includes a question and answer session for industry analysts, but we encourage the investing public and media to listen in. Now I'll turn the call over to Mike McCallister to begin our review of the quarter.

Good morning. Today Humana released its results for the third quarter of 2002, recording 31 cents earnings per diluted share. That constitutes a 19% increase over the 26 cents in earnings per diluted share for the same period in 2001. We are raising our guidance for earnings per diluted share for 2002 as we expect the fourth quarter to approximate 32 to 33 cents, bringing us to the $1.18 to $1.19 for the year. We are maintaining our guidance for 2003 of $1.35 to $1.40 earnings per diluted share.

Results for the quarter include many positive developments. Our operating cashflows were strong, Tricare premiums increased nicely. And our commercial medical membership growth reached 3.1% year-to-date. Including an 11% growth year-to-date in our ASO business. This membership growth was achieved in conjunction with continued focus on pricing discipline. Our consumer engagement strategy is working. We now have a full 12 months of data from the initial pilot of our Smart Sweep product. Those results demonstrate a drop in the medical cost trend of approximately 1400 basis points. More importantly, $1.4 million of the $2.1 million in medical cost savings for our pilot group is attributable to a change in behavior on the part of the consumer. Validating our thesis that this product can have real impact.

We recently added another outside employer, Smart Sweep customer. Bringing the membership associated with this product to about 31,000 excluding Humana associates. Approximately 20% of that membership is effective in 2002, again, giving us a head start on our competition in building our actuarial database. Obviously, the more data we have on Smart Sweep groups, the better we can analyze the impact of consumer behavior modification for future pricing. When it comes to engaging the consumer, we recognize that it's not all about new products. Most employers are still buying the more traditional products and we're ready to meet them where they are. In doing so, it's imperative that we continue to provide the highest quality service to all of our customers, regardless of which product they buy.

The third quarter saw progress in many of our service metrics as well. 54% of our inbound contacts are now handled be it either IBR or the Internet compared to 32% a year ago. Over 60% of our large group membership is auto enrolled through EDI or the web versus 40% at the same time last year.

Electronic adjudication of claims is now running at over 70%, up from 62% in September 2001. And duplicate provider billings have declined to mid-single percentages from the low double-digit range last year. While we experience many positive developments in the quarter, our commercial segment had an outlayer market that masked our progress in this segment.

Reduction of our reliance upon capitation has been an element of our company's commercial HMO strategy for some time. In the Chicago market, we have delegated risk-based capitation arrangements with two major health systems. Which account for the majority of our capitation in that market. Additionally, that market is deligated capitation arrangements with a number of smaller physician groups. Over the past several months we've been transitioning many of these arrangements in Chicago to fee for service. Involving approximately 50,000 commercial HMO members.

Our pricing discipline incorporates incremental pricing to adjust for capitation migration where applicable. During the second quarter of this year, our Chicago market capitation transition began accelerating. Consequently, we further increased our commercial HMO pricing for Chicago by more than 4%, explicitly for the timing of network transition. In the third quarter, the Chicago commercial capitation transition timing negatively impacted unit medical costs [INAUDIBLE] to an increase in the commercial MER of about 250 bases points year over year for that market alone. This resulted in the third quarter escalation in medical expenses of about $8 million for Chicago. Because of our pricing adjustments during the second quarter we expect Chicago market results to be back in line in 2003.

With the exception of Chicago, our commercial segment market results are generally at or above plan. In addition to the Smart Sweep sales I referred to earlier, Humana One, our individual product, recently became available in Kentucky, bringing the number of states in which it is offered to five. Our small group products are now experiencing net positive growth as we cross the stabilization threshold at our secondary markets, while continuing to see enrollment growth in our primary markets. These elements, combined with the growth in our traditional large group products have contributed to the 3.1% increase year-to-date in organic medical membership for the commercial segment.

Turning to the government segment, the headline news there is an increase in the run rate revenues for our Tricare business. As you may recall, our Tricare business has been significantly impacted by congressionally legislated benefit changes, an increase in eligible beneficiaries, and a decrease in the use of military treatment facilities. We're also actively pursuing opportunities with respect to the RFP for the new Tricare regions, but will not be sharing any details associated with our bidding plan with you so as to protect our competitive position. Jim will discuss this status of the Tricare receivables in his comments in just a few moments.

With respect to Medicare Choice, our ACRs for 2003 filed in September, included approximately $100 million in benefit changes and $15 million in premium increases for individual members. We assume no change in current law as we analyze our benefit and premium changes needed for 2003. We anticipate 2003 will be another good year in Medicare, but we'll be serving fewer members as we continue to rationalize our business relative to CMS reimbursement and benefit modification head room. Our new Medicaid contract in Puerto Rico became effective this quarter, and are operating as expected. These contracts call for predictable reimbursement over the next three years, removing the noise associated with state budgetary pressures.

To recap, there were many positive developments this quarter which despite the issues, we experienced with our commercial business in Chicago, demonstrate clear operational progress. We are transforming the consumer experience and taking clear advantage of our industry-leading products and service levels to achieve organic growth. Our new product offerings are poised to grow. As employers seek solutions to their seemingly intractable health benefit cost problem. As we shared with you during our recent investor day, we also believe our efficiency gains provide further opportunity to reduce our administrative cost and we look forward to sharing these opportunities with you going forward. With that, I'll turn the call over to Jim for a review of the financials. Thanks, Mike, and good morning everyone.

Let's begin by reviewing our progress on EBITDA, in the third quarter, EBITDA or earnings before interest expense, income taxes and appreciation and amortization expenses totalled $111.6 million. Increasing $16.8 million or 18% over the third quarter of 2001. Third quarter EBITDA margin was 3.9%, versus 3.6% a year ago. For the first nine months of 2002, EBITDA increased by $48 million or 18%, to $315.9 million compared to the same period a year ago. Nine-month EBITDA margin was 3.8% versus 3.5% for the same period a year ago. We are pleased with the continued improvement of this key measure of the cash content of our operating income.

The mix of medical membership is another key metric we use to evaluate our progress. Within the commercial segment, we continue to experience growth in our ASO product lines. As Mike mentioned, our year-to-date commercial ASO business has grown by over 66,000 members or more than 11%. We also continue to see a shift to large group business in our fully insured commercial book. As of September 30, 2002, 65% of our commercial, fully insured members were classified as large group, compared with 61% at September 30, 2001. The shift toward a higher percentage of larger groups, which structurally have higher MERs, contributed significantly to the 30 basis point increase in the quarter's consolidated medical expense ratio year over year.

The mix of our medical membership also has impacted our consolidated selling, general and administrative expense ratio. Both our commercial and Tricare ASO memberships grew between 10 and 11% year-to-date, increasing our SG&A expense ratio. Additionally, this quarter's ratio also included the effect of sequentially higher marketing and advertising expenses as we prepare for heavy open enrollment.

Turning to the commercial segment results. As Mike noted, we took steps during the second quarter of this year to address the issues in Chicago that negatively impacted that market's performance by $8 million year over year in the third quarter. Excluding the performance of Chicago, same store commercial segment results improved by $7 million during the third quarter of 2002, compared to the third quarter of 2001. Premiums for our commercial fully insured medical business continue to yield 12 to 14%. And we continue to anticipate yields for the full year in the same range. We have been pricing for 2003 using the assumption that medical cost trends will accelerate slightly. And accordingly anticipate premium yields of 13 to 15% for 2003. The current run rate for our commercial medical cost trend remains at 11 to 13%. And we've forecast cost trends for the full year to also remain in that range. However, we have been pricing our 2003 accounts, assuming cost trends of 12 to 14%.

Looking at commercial membership. Our goal for 2002 has been to organically grow commercial medical membership by 3 to 3.5%, as of September 30, 2002, we are within that range. In 2003, we expect to increase a combined total of fully insured and ASO commercial members by 4 to 5%. Our stronger commercial capabilities allow for the required pricing discipline needed to achieve this target, within increased commercial profitability. Our third quarter 2002 consolidated pretax margin improved to 2.7% from 2.4% a year ago. Year-to-date our commercial margin improved to 2.5%, versus 2.2% for the same period in 2001.

Turning to the balance sheet, our Tricare receivables grew modestly in the third quarter. You may recall that during the second quarter of 2002, Tricare receivables increased by $132 million, including $56 million related to premiums for retroactive claims. During the third quarter, our Tricare receivables grew by $50 million. Of the $421 million in Tricare receivables outstanding at September 30, 2002, $190 million is the base receivable that we accrue and collect each month. We continue to anticipate that the majority of the nonbased receivables will be collected by the end of 2002. We already have collected $85 million of nonbased receivables during the month of October.

Looking ahead to 2003, we expect the Tricare base receivable to range from $225 million to $250 million. As much of the nonbased receivables become part of the monthly reimbursement cycle. Additional Tricare receivables also may be on the books in 2003 for any unpaid bid price adjustment issues, since bid price adjustment issues generally are paid only at contractually specified times. It's important to note that the significant increase in activity at Tricare continues to represent a solid opportunity for Humana.

With respect to days and claims payable. Our days and claims were relatively constant during the quarter, at approximately 47 days. Claim inventory levels at September 30, 2002, were at another all-time low, with fewer than 500,000 claims on hand, versus 1.1 million claims less than two years ago. The efficiency and increased constituent satisfaction represented by this improvement will enable us to begin to identify and remove additional administrative expense from our business during the fourth quarter and during 2003.

Looking briefly at our debt structure, our debt to total capitalization ratio is again at a five-year low of 26.4%, versus 28.7% at September 30, 2001. We recently filed a Universal Shelf registration with the SEC to register several types of securities for potential offerings. It's important to note that we have no specific use targeted for these securities at this time. Rather, like many seasoned issuers, we consider it prudent to file shelf registration, so that should an opportunity or need present itself, the process of offering public securities has a head start. Effective shelf registration can help reduce the normal issuance time from up to three months to as little as two weeks.

During the third quarter, we also made good progress toward our 2002 goal of $300 million of normalized cash operating flows, by generating $82.6 million of cashflow. The year-to-date total of $115.3 million compares with $65.6 million for the first nine months of 2001. An increase of $49.7 million or nearly 76%. With the expected collection of the majority of the September 30, 2002 Tricare receivables in the fourth quarter, $85 million of which we have received already, we continue to anticipate $300 million for this year compared to $166 million last year. We also expect that our 2003 normalized cash operating flows will be in the range of $325 million to $350 million.

Our balance sheet free cash totals $215 million. At the time of last quarter's call we announced a $100 million share repurchase program. As of the end of September, we had purchased two million seventy thousand shares, or approximately 1.2% of the previous total outstanding shares at a weighted average cost of $12.29 per share. With that, we'll open up the phone lines for your questions. Operator, will you please introduce the first caller?