Humana Inc (HUM) 2003 Q3 法說會逐字稿

Good morning. My name is Libby and I will be your conference facilitator today. At this time I would like to welcome everyone to Humana’s third quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. 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 *, then the number 1, on your telephone keypad. If you would like to withdraw your question, press the # key.

I would now like to turn the call over to Regina Nethery, Vice President of Investor Relations. Thank you. Ms. Nethery, you may begin your conference.

Thank you and good morning everyone. We appreciate you joining us this morning for a review of Humana’s third quarter 2003 performance and an update on 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 Web site, 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 could differ materially. All participants in this conference call are advised to read Humana’s press release issued this morning, October 27, 2003. Call participants are also advised to read the following documents as filed by Humana with the Securities and Exchange Commission: our Form 10K for the year ended December 31, 2002, and our Form 10-Qs for the quarters ended March 31, 2003 and June 30, 2003. These SEC filings contain detailed discussions of important risk factors.

This morning’s earning press release includes operating cash flow measurements that are not in accordance with Generally Accepted Accounting Principles (GAAP). Our reconciliation from GAAP operating cash flows to the non-GAAP financial measures is included in this morning’s earnings press release. That release is available via the Investor Relations page of the Humana’s Web site.

Please note that all references to earnings per share made during the course of this call represented diluted earnings per common share.

Today’s call includes the question-and-answer session for industry analysts, but we encourage the investing public and media to listen in. And now, I’ll turn the all over to Humana’s Chief Executive Officer, Mike McCallister.

Good morning. Thanks for joining us to discuss Humana’s most recent quarterly performance and our prospects for the future.

Before I begin this morning’s discussion, I want to point out a change in the format of our press release. Given that regulation G from the Securities & Exchange Commission regarding non-GAAP financial measures have been effective for several months, we’ve gone back and reviewed related SEC interpretations and best practices and have tailored our third-quarter release accordingly.

In most instances our press release focuses on results and earnings guidance according to Generally Accepted Accounting Principles. However, given that GAAP does not necessarily represent run rate earnings, we have clearly indicated any items included in the GAAP results that investors should consider in evaluating our run rate operations.

With the exception of normalized cash flows, the numbers discussed in today’s call also are focused on GAAP. However, we have clearly indicated the impact of any unusual items included in any GAAP results or other financial measures.

That said, this morning we reported 38 cents in earnings per share for the third quarter of this year, a 23-percent improvement over the prior year’s quarter. As in recent quarters, our third quarter results demonstrate clear and significant progress in the earnings contribution from our Commercial segment with the continued strength of our Government segment.

Our Commercial segment has been the driver of our earnings growth in 2003 and we believe will continue to provide strong earnings growth as we move into 2004. That’s why our strategy focuses on the cost problem being faced by Commercial employers and consumers.

Our financial results are also demonstrating our ability to profitably grow our Commercial segment, and early indications are that we will continue to be able to meaningfully grow this segment in 2004.

We continue to anticipate the Commercial segment will earn in excess of $125 million on a pre-tax basis in 2003, inclusive of the $5 million in unusual charges. And we are forecasting pre-tax profits for that segment to grow an additional 35 percent in 2004 to over $170 million. What’s driving these improvements in our Commercial business? The answer is a two-pronged strategy that helps us excel in today’s environment while leading in the competitive environment of tomorrow.

Let me first address our efforts in traditional products where, as we shared with you last quarter, we have aligned our sales force with each of our lines of business. We have also rolled out industry-leading customer reporting capabilities, implemented a sales force automation system, enhanced our account management structure, and further developed our capabilities in the benefits consulting community.

As we have gained efficiencies through the consolidation of our service centers and other management realignments, we have also significantly grown our sales, underwriting and related support staff during 2003. These efforts have culminated in the anticipated 2004 sales results that we are sharing with you today.

We have been talking for some time now of Humana’s commitment to becoming a major player in the ASO space. Of the new membership we’re adding next year, approximately 60–70 percent are expected to be ASO customers, many of which have chosen our Smart offerings.

Technology investments are also a critical element of our service proposition and process redesign, affecting both our traditional products and our more innovative offerings. As I have previously shared with you, these investments are returning dividends in terms of higher rates of auto adjudication, electronic enrollment, electronic inbound contacts to our Customer Service Centers, and lower duplicate billings from providers.

Our members are also routinely performing both eligibility checks and claim inquiries online. For the first nine months of 2003 alone our members performed over 400,000 online eligibility checks, while nearly 675,000 claim inquiries were done online.

With growing awareness of pharmacy costs, primarily through today’s widespread use of tiering, our members are increasingly accessing the pharmacy tools on Humana.com. In 2001 our Web site pharmacy tools were accessed only 187,000 times. However, in 2002 that number jumped to 1.4 million, and year to date in 2003 our online pharmacy tools have been used 2.2 million times.

Our strategy is to solve the employers’ cost dilemma through a consumer centric value proposition. That leads me to the second element of our Commercial strategy — innovation.

The receptivity and activity with employers generated by our new products tells us we’re beginning to disrupt the industry. With our innovative products and processes we are emerging as a distinct force in the market. While the traditional products remain important, our consumer centric strategy is distinctive in our competitive space. Some of you listening to this call have often equated our SmartSuite products to the consumer directed health offerings many of our competitors are rolling out. That is simply not so.

We offer a consumer-directed plan known as “CoverageFirst” on a standalone basis. But CoverageFirst is only one of the product components of a much more global process redesign inside the broader Smart solution. We see no evidence in the market that our competitors are pursuing a comprehensive solution like our Smart products.

As I’ll describe more fully in just a moment, our Smart products involve creating a unique health benefits experience. The result is distinct consumer engagement and dramatic declines in medical cost trends for our customers. Of our first 13 groups with full replacement Smart products, we’re now averaging an annualized medical cost trend of 4.6 percent. This is consistent with the low to middle-single-digit cost trends experienced by Humana associates through the Smart products over the last couple of years.

So what makes us different?

A robust process built around a set of product options from which people can choose. Within a more permission-driven environment than the paternalistic approach employers historically have taken, employees have the option of choosing how to spend rather than having spending decisions imposed upon them.

Within our Smart product context we enable employees to carefully answer two questions: 1) How much coverage do I need? and, 2) Do I want to place greater cost impact on my paycheck or at the point of use? This is consumer engagement.

Products are important, but not the complete picture, so we wrap them with a support process that includes year-around consumer education, tools[Indiscernible].com, Humana Outreach Programs, and high-tech, high-touch support. The result, a better overall experience and lower medical cost trend.

Some of the key elements of our carefully developed SmartSuite and consumer engagement processes include the following differentiators:

Expanded choice for employees. Healthcare is not a one-size-fits-all environment. Employees can and should be offered solutions that can be closely tailored to their individual needs.

An active enrollment process to foster greater engagement by all employees. Employers should require their employees to think about their health plan choices every year and should give them time to focus on those decisions. Employers will find it increasingly advantageous for employees to spend committed time on this issue, particularly when it’s the employer still funding 80–85 percent of the costs of the benefit.

An electronic tool, we call a “Wizard” that helps employees evaluate their choices, and let them compare the potential out-of-pocket impact of “choose and use” alternatives.

Taking the standard insurance card to a new level. By combining member ID cards with a flexible spending account debit card, two things are accomplished: 1) the hassle of FSA reimbursement paperwork is eliminated. No more filling out claim forms. This also sends a subtle message to the consumer every time they pull out this card that this in fact a financial transaction.

Further, providers are pleased to have a quick and easy means of collecting the members’ balance due, a growing problem in the provider community and one that will impact network development and pricing.

Keeping the risk pool in tact. After all, the basic insurance model still requires that the healthy subsidize the sick. Actuarial management of an expanded choice environment becomes a distinct and growing advantage to Humana over time.

Planned Professor, our year-around comprehensive research base consumer education program, provides employers with a detailed communication plan for pre-enrollment, enrollment, and post-enrollment. In essence, a complete communication and education solution for the employer.

Electronic sophistication that provides user-friendly tools to help employees estimate costs to take advantage of FSAs, evaluate pharmacy costs, and most importantly, provide some transparency to provider costs. This supplies people with actionable information, a critical element of the guidance necessary to empower them.

Lastly, predictive tools that allow us to project with a high degree of accuracy which benefit options an employee will select given the employer contribution strategy. This obviously leads to enhanced underwriting and sets up an environment where employers can budget their healthcare expenditures with much more reasonableness and certainty.

A proprietary Smart Start actuarial software helps employers evaluate ‘what if’ contribution strategies on a real time basis. No waiting while actuaries return to the office to rerun models.

These differentiators are beginning to be recognized as our Smart products are taking hold in the marketplace. As of January 1st, we expect to have over 180,000 members in Smart products, 158,000 of which are on a full replacement basis.

Some employers are transitioning more slowly to the new world of products and have opted to incorporate only CoverageFirst in their employee offerings. As an example, the Office of Personnel Management has chosen to offer CoverageFirst as part of the Federal Employees Health Benefit Program in 15 markets.

However, as I indicated earlier, our Smart products are full replacement solutions. We’re seeing an interesting development in that a number of our large group accounts have already taken the first step in transition to full replacement in anticipation of adopting SmartSuite in 2005.

How does all of this position us for growth in 2004?

I’m very pleased to report that we’re expecting net medical membership additions of between six and nine percent for our Commercial segment in 2004. The majority of that growth will be concentrated in the first quarter with over 200,000 net new members expected. Again, 60–70 percent of this growth will be ASO.

Turning to pricing for 2004, benefit buy-downs for 2004 in our large group accounts are expected to be in line with 2003 buy-downs of 200 basis points. Small group buy-downs for 2004 are also running in line with the prior-year level of 550–600 basis points. We are expecting that premium yields in the range of 11–13 percent will be in the same range as medical cost trends for our Commercial segment in 2004. Our Commercial strategy is driving growth and revenues, income, and membership.

Turning to our Government segment, it continues to provide a solid base of diversified earnings as we expand our Commercial segment progress.

Beginning with TRICARE…

We were pleased by the Department of Defense’s decision to aware the new South region to Humana Military Healthcare Services. The Department of Defense advises us that they expect our new TRICARE contracts to become effective in mid-to-late 2004, although protests are still pending.

Pharmacy benefits will be carved away from our TRICARE contracts in 2004. However, as previously announced, we have anticipated that change in our earnings projections for next year. As in prior years, our TRICARE business is expected to experience pre-tax margins in the two to four percent range.

With respect to Medicare, our membership is stabilizing. In addition, we are evaluating our competitive positioning in our Medicare markets and are encouraged by the favorable market conditions we are seeing thus far, again based on today’s reimbursement structure. As a result, we anticipate next year’s ending Medicare+Choice membership to be in the range of 325,000–350,000.

In Washington, Medicare conferees continue to work toward a comprehensive Medicare Prescription drug and reform bill. While conferees have come to a consensus on several major issues, they continue to work on resolving the remainder of the issues in the next couple of weeks. We believe the chances of some changes to the program being enacted are better than they were a month ago, but other issues of significance still need to be worked out to ensure passage of a bill.

Our government relations and actuarial teams are well known and highly respected on the Hill, and we continue to provide technical assistance about bill provisions and their impact to legislative staff, members, and the Administration.

As we said in last quarter’s call, we filed all of our ACRs, assuming current law, and all of our earnings projections are done on that basis.

In summary, we believe our Commercial segment strategy is the most innovative of any in this space. We provide leading customer service and technology to support traditional products, then take the entire healthcare experience to a higher level through our Smart products.

Our Government business also continues to do well and we have developed great experience in this space. We intend to continue doing business on a number of fronts and are well positioned for future opportunities with the largest purchaser of U.S. Healthcare services.

With that, I’ll turn the call over to Jim Bloem for a review of the financials, both this quarter as well as looking out to 2004. Jim?

Thanks Mike, and good morning everyone.

Our third-quarter results represent a further milestone in the improvement of our Commercial segment. The Commercial results, together with another quarter of solid contribution from our Government segment, give us further confidence in Humana’s ability to continue to deliver high-quality earnings growth.

Let’s begin our financial review with a discussion of the principal components of our third quarter earnings.

First, consolidated revenues of $3.1 billion increased 10 percent over the $2.8 billion in revenues reported in the third quarter of 2002. We continue to project consolidated revenues of over $12 billion for 2003.

Third quarter Commercial premiums and Administrative Service fees of $1.7 billion were up 13 percent from the third quarter of last year.

As expected, two percent year-over-year growth in Commercial Medical membership largely was offset by a decline in medical membership in our Government segment. Thus, total medical membership was unchanged at 6.6 million. Our Commercial Medical membership now stands at 46 percent of our total medical membership.

We anticipate this percentage will continue to increase as indicated by the 2004 Commercial Medical membership growth guidance of six to nine percent that we’re sharing with you today. Our year to date Commercial Medical membership growth has laid the foundation for the forecasted 2004 increases in both membership and earnings.

On a per-member basis, Commercial premiums for the third quarter increased between 12–14 percent over the same period a year ago. This is slightly lower than the premium yields we had shared with you earlier, primarily due to increases in competitiveness in the small group market and switches of some of our larger accounts from a fully insured to an ASO basis.

The Commercial medical expense ratio of 83.7 percent improved 60 basis points from the third quarter of last year’s 84.3 percent. The SG&A ratio for the Commercial segment also has improved year over year, declining 40 basis points to 16.6 percent. The effectiveness of our multiyear investment strategies around consumer choice products and technology has demonstrated at a continued improvement in each ratio.

These improvements are the basis of both the Commercial membership, and more importantly, Commercial earnings growth we’re forecasting for 2004. We are on track with the staffing reductions announced in last year’s fourth quarter, and have reinvested in additional sales, underwriting, and corresponding service associates to support the anticipated increase in our 2004 business.

Turning to the Government segment, the third quarter 2003 medical expense ratio rose to 84 percent from just under 83 percent in the third quarter of 2002. This was primarily due to an increase in the medical expense ratio for TRICARE year over year. However, on a sequential basis, the TRICARE MER has shown steady improvement throughout the year.

Partially offsetting the year-over-year increase in the TRICARE MER is the improvement in our Medicare+Choice business. The Medicare+Choice results are continuing evidence of our focused approach to this important program, which positions us well for future potential opportunities.

The Government segment SG&A ratio also declined by 40 basis points year over year, coming in at 12.9 percent for the third quarter.

Our consolidated pre-tax margins also improved in the third quarter, increasing 30 basis points to over three percent year over year. Year to date our consolidated pre-tax margin is up 20 basis points compared to the same period in 2002, with Commercial pre-tax margin showing an improvement of 110 basis points.

Please note that these two improvements include $16 million of unusual items, over $5 million of which was allocated to the Commercial segment.

The combined results with the Commercial and Government segments produced a 23-percent increase in third party consolidated earnings per share of 38 cents. And we are pleased to reaffirm our earnings-per-share guidance for both 2003 and 2004. 2003 earnings-per-share is expected to be in the range of $1.40–$1.42, including a reduction of five cents for the unusual items reported earlier this year. For 2004, we continue to project earnings-per-share in a range of $1.55–$1.65, with the most likely estimate being in the middle of the range at $1.60 per share.

Focusing next on the balance sheet, our receivables increased by approximately $33 million during the quarter, all of which related to an increase in the TRICARE base receivables. You will recall that we collect the full base receivable from the Department of Defense during the first week of each month.

During the third quarter we also improved our capital structure and overall liquidity, and obviously completed a public offering of $300 million of 6.3 percent senior notes due in 2018. The bulk of the proceeds from the offering were used to term out the $265 million we had outstanding under our Conduit Commercial Paper Financing program at June 30th.

Consistent with the other $300 million of our interest-bearing debt, we simultaneously entered into interest rate swap agreements, effectively converting the 6.3 percent fixed interest rate to a 90-day variable rate. As a result, all of our interest-bearing debt is now long term with variable short-term rates. These short-term rates are naturally hedged by the rates earned on our short duration fixed income portfolio.

Turning now to our medical claims reserves, days and claims payable sequentially were lower by seven-tenths of a day, primarily due to normal check processing procedures. Checks for the majority of our process claims are mailed on Tuesday of each week. September 30 fell on a Tuesday this year, while the two previous quarterends feel on Monday. Therefore, as a result, the portion of our medical claims reserves related to processed claims dropped by approximately $79 million.

Also with respect to medical claims reserves, just as in prior quarters, we believe we have consistently applied our conservative reserving methodology in determining our best estimate of unpaid medical claims liabilities.

Further, we expect to continue to do so in the future. Accordingly, our earnings guidance does not include any anticipated benefit from favorable reserve development.

Looking now at cash flows, our third-quarter cash flows from operations of approximately $70 million were down by $13 million from the third quarter of last year, primarily due to changes in working capital items. These are such items as the timing of tax payments and accounts payable in addition to the other items just discussed.

Of greater importance, on a year-to-date basis, our GAAP operating cash flows provided cash from operations of $123 million, versus last year when we used cash flows of $101 million of operations through the first nine months. This represents an improvement of nearly $225 million.

When we adjust for the timing of the receipt of our Medicare premium payment, cash flows are $213 million higher for the first nine months of 2003 than for the same period in 2002. Continuing strong cash flows make us comfortable in raising our 2003 guidance for cash flows from operations to between $400–$425 million.

Turning to share repurchase activity, in July 2003, after reviewing our earnings progression, capital structure, and overall liquidity, our Board of Directors authorized the use of up to $100 million for the repurchase of our common shares, exclusive of any shares repurchased in connection with employee stock plans.

During the third quarter, there were no shares repurchased under the July 2003 authorization. However, during the same period the Company repurchased 1.4 million shares at a total cost of $23.1 million, an average of $16.38 per share in connection with employee stock plans.

Thus, since July 2002, the Company has purchased 10.1 million shares, or 5.9 percent of its then outstanding shares at a total cost of $118 million, or $11.74 per share, in connection with both share repurchase authorizations and employee stock plans.

To close, I’d like to reinforce Mike’s comments regarding our improved financial performance in the first nine months versus the same period a year ago. In the Commercial segment, Commercial medical membership, the total medical membership, increased to nearly 46 percent, while Commercial premiums and administrative fees, the total premiums and administrative fees decreased to 56 percent.

More importantly, Commercial pre-tax income, the consolidated pre-tax income, more than doubled to almost 44 percent.

In addition, throughout both nine-month periods, the Government segment continued to provide solid performance, as well as deliver an important source of diversified membership, revenues and income. A wide diversification of both Commercial and Government membership revenues and income is both a significant attribute of our progress over the last three years, as well as a substantial driver of our expectation of further success.

With that, we’ll open the phone lines for your questions. Operator, will you please introduce the first caller?

At this time I would like to remind everyone, in order to ask a question please press *, then the number 1, on your telephone keypad. We’ll pause for just a moment to compile the Q&A roster.

There are no questions at this time.

Well, thank you. Let me just close by noting that our two-pronged Commercial strategy is working. We’re growing our market share in traditional offerings and are in the early stages of a disruptive strategy. And that strategy is based on a simple premise: the company that can lower cost trend for employers will win in the marketplace.

Let me thank all the Humana associates who are on the call today for your great work in making all of this possible. Have a great day, everyone!

This concludes today’s conference call. You may now disconnect.