HUM

Business Context and Reporting Period

Company: Humana Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2004
Business Overview: Humana is a major health benefits company offering coordinated health insurance coverage through traditional and Internet-based plans. As of March 31, 2004, the company served approximately 7.0 million medical members and 1.7 million specialty product members. Operations are divided into two segments: Commercial (employer groups and individuals) and Government (MedicareAdvantage, TRICARE, and Medicaid).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 12.1% year-over-year, driven primarily by a 38.0% increase in TRICARE premiums (due to a base contract price increase effective July 2003) and growth in fully insured commercial premiums.
• Profitability Surge: Net income more than doubled to $67.8 million. This improvement is largely attributed to the Government segment, which saw income before taxes rise from $10.2 million to $63.7 million. The prior year (Q1 2003) included $30.8 million in non-cash impairment and accelerated depreciation charges related to the Jacksonville service center and software abandonment, which were absent in Q1 2004.
• Membership Trends: Total medical membership grew 5.9% to 7.0 million. Notable growth occurred in Commercial ASO (up 52.3%) and TRICARE (up 6.1%), while fully insured commercial membership declined 2.1%.
• Cash Flow Timing: Net cash used in operating activities improved significantly (from a $108.2 million outflow to a $40.1 million outflow). This was primarily due to the timing of MedicareAdvantage premium receipts; the January 2004 payment was received in December 2003, reducing the cash inflow recorded in Q1 2004.

Guidance, Outlook, and Risks

• Acquisition: On April 1, 2004, Humana acquired Ochsner Health Plan for $82.5 million (plus up to $45 million in contingent consideration), adding approximately 152,000 commercial and 33,000 MedicareAdvantage members.
• Membership Outlook: Management forecasts MedicareAdvantage membership to grow to between 370,000 and 390,000 by year-end 2004. Commercial segment medical membership is expected to grow 6% to 8% for the remainder of 2004.
• TRICARE Transition: The company is transitioning TRICARE contracts. Current Regions 2 and 5 contracts end June 30, 2004, and Regions 3 and 4 end July 31, 2004. A new South Region contract begins August 1, 2004. This transition may cause a temporary decline in TRICARE membership and revenue in Q3 2004 before increasing in Q4.
• Legal and Regulatory Risks: Humana is a defendant in a consolidated class action lawsuit (In re Managed Care Litigation) alleging improper claim payments and "downcoding." The trial date is set for March 15, 2005. Additionally, the company faces ongoing government audits and regulatory scrutiny regarding claims payment practices and medical necessity decisions.
• Capital Allocation: The company repurchased 686,000 shares in Q1 2004 at an average price of $20.33. Approximately $75.5 million remains available under the $100 million repurchase authorization.

Investor Verification Checklist

• TRICARE Contract Transition: Verify the impact of the July/August 2004 contract transitions on Q3 and Q4 revenue and membership levels.
• Medical Expense Ratios: Monitor the Commercial segment MER, which increased 220 basis points to 83.5% due to a large account deterioration and leap year effects.
• Legal Proceedings: Track developments in the In re Managed Care Litigation class action, specifically the appellate court ruling on class certification.
• Ochsner Integration: Assess the financial performance and integration progress of the newly acquired Ochsner Health Plan.
• Cash Flow Volatility: Understand the seasonal timing of MedicareAdvantage premium receipts, which can cause significant fluctuations in quarterly operating cash flows.