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 March 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 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 April 30, 1997 $.16 2/3 par value 162,949,696 shares 1 of 16 Humana Inc. March 31, 1997 Form 10-Q Page of Form 10-Q Part I: Financial Information Item 1. Financial Statements Condensed Consolidated Statement of Income for the quarters ended March 31, 1997 and 1996 3 Condensed Consolidated Balance Sheet at March 31, 1997 and December 31, 1996 4 Condensed Consolidated Statement of Cash Flows for the quarters ended March 31, 1997 and 1996 5 Notes to Condensed Consolidated Financial Statements 6-8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9-13 Part II: Other Information Items 1 to 6 14-16 Exhibits Exhibit 10 - Management Incentive Plan for Employees Exhibit 12 - Ratio of Earnings to Fixed Charges Exhibit 27 - Financial Data Schedule 2 Humana Inc. Condensed Consolidated Statement of Income For the quarters ended March 31, 1997 and 1996 Unaudited (Dollars in millions except per share results) 1997 1996 Revenues: Premiums $ 1,803 $ 1,560 Interest 26 25 Other income 3 3 Total revenues 1,832 1,588 Operating expenses: Medical costs 1,484 1,274 Selling, general and administrative 261 203 Depreciation and amortization 24 25 Total operating expenses 1,769 1,502 Income from operations 63 86 Interest expense 3 5 Income before income taxes 60 81 Provision for income taxes 21 28 Net income $ 39 $ 53 Earnings per common share $ .24 $ .32 Shares used in earnings per common share computation (000) 162,801 162,379 See accompanying notes. 3 Humana Inc. Condensed Consolidated Balance Sheet Unaudited (Dollars in millions except per share amounts) March 31, December 31, Assets 1997 1996 Current assets: Cash and cash equivalents $ 341 $ 322 Marketable securities 1,226 1,262 Premiums receivable, less allowance for doubtful accounts $42 - March 31, 1997 and $38 - December 31, 1996 209 211 Deferred income taxes 93 94 Other 143 113 Total current assets 2,012 2,002 Long-term marketable securities 148 143 Property and equipment, net 373 371 Cost in excess of net assets acquired 508 488 Other 144 149 Total assets $ 3,185 $ 3,153 Liabilities and Common Stockholders' Equity Current liabilities: Medical costs payable $ 1,063 $ 1,099 Trade accounts payable and accrued expenses 367 369 Income taxes payable 83 32 Total current liabilities 1,513 1,500 Long-term debt 203 225 Professional liability and other obligations 145 136 Total liabilities 1,861 1,861 Contingencies Common stockholders' equity: Common stock, $.16 2/3 par; authorized 300,000,000 shares; issued and outstanding 162,870,321 shares - March 31, 1997 and 162,681,123 shares - December 31, 1996 27 27 Other 1,297 1,265 Total common stockholders' equity 1,324 1,292 Total liabilities and common stockholders' equity $ 3,185 $ 3,153 See accompanying notes. 4 Humana Inc. Condensed Consolidated Statement of Cash Flows For the quarters ended March 31, 1997 and 1996 Unaudited (Dollars in millions) 1997 1996 Cash flows from operating activities: Net income $ 39 $ 53 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 24 25 Deferred income taxes 4 (2) Changes in operating assets and liabilities (5) 89 Other 2 (3) Net cash provided by operating activities 64 162 Cash flows from investing activities: Purchases and dispositions of property and equipment, net (16) (13) Acquisition of health plan assets (14) Purchases, sales and maturities of marketable securities, net 8 (33) Other (2) Net cash used in investing activities (24) (46) Cash flows from financing activities: Repayment of long-term debt (20) Change in commercial paper (22) Other 1 1 Net cash used in financing activities (21) (19) Increase in cash and cash equivalents 19 97 Cash and cash equivalents at beginning of period 322 182 Cash and cash equivalents at end of period $ 341 $ 279 Interest payments $ 2 $ 4 Income tax refunds, net $ (35) 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, 1996. 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) 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. Current legislative proposals are being considered that include modification of future reimbursement rates under the Medicare program and that encourage the use of managed health care by Medicare beneficiaries. Management is unable to predict the outcome of these proposals or the impact they may have on the Company's financial position, results of operations, or cash flows. Additionally, the Company's contract with the United States Department of Defense under the Civilian Health and Medical Program of the Uniformed Services ("CHAMPUS") is a one-year contract renewable annually for up to four additional years. The loss of these contracts or significant changes in these programs as a result of 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. 6 Humana Inc. Notes To Condensed Consolidated Financial Statements, continued Unaudited (C) Special Charges During the second quarter of 1996, the Company recognized special charges of $200 million before tax ($130 million after tax or $.80 per share). The special charges included provisions for expected future losses on insurance contracts ($105 million) as well as the estimated costs to be incurred in restructuring the Washington, D.C., health plan (which was sold January 31, 1997) and closing markets or discontinuing product lines in 16 market areas. The special charges also included the write-off of miscellaneous assets, a litigation settlement, and other costs. During the quarter ended March 31, 1997, the beneficial effect of these charges was approximately $11 million before tax ($7 million after tax or $.04 per share). Approximately $42 million (of the original $105 million) of the liability for expected future losses on insurance contracts and approximately $4 million of other costs reserves remain at March 31, 1997. During the fourth quarter of 1996, the Company recognized an additional special charge of $15 million before tax ($10 million after tax or $.06 per share). This charge included severance and facility costs related to planned workforce reductions, scheduled to be completed throughout 1997. (D) Long-Term Debt During April 1996, the Company implemented a commercial paper program and began issuing debt securities thereunder. At March 31, 1997, borrowings under the commmercial paper program totaled approximately $200 million, with an average rate of interest during the quarter of 5.6 percent. The commercial paper program is backed by the Company's $600 million revolving line of credit, which expires in September 2000. Borrowings under the 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. (E) Acquisition and Dispositions On February 28, 1997, the Company acquired Health Direct, Inc. ("Health Direct") from Advocate Health Care for $23 million cash. This transaction added more than 50,000 medical members to the Company's Chicago membership. 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 to PrimeHealth of Alabama, Inc. This later sale excluded the Company's small group business and Alabama CHAMPUS operations. These transactions, which will not have a material impact on the Company's financial position, results of operations, or cash flows, reduced total medical membership by approximately 141,000. 7 Humana Inc. Notes To Condensed Consolidated Financial Statements, continued Unaudited (F) Future Changes in the Presentation of Earnings per Common Share In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share," ("SFAS No. 128"). SFAS No. 128 specifies the computation, presentation, and disclosure requirements for earnings per share and will be effective for both interim and annual periods ending after December 15, 1997. Earlier application is not permitted. If applied on a proforma basis, there would be no difference between the basic and diluted earnings per share amounts computed using SFAS No. 128 for the three month periods ended March 31, 1997 and 1996. 8 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, 1996, 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 CHAMPUS contract with the federal government, and the effects of other general business conditions, including but not limited to, government regulation, competition, premium rate changes, retrospective premium adjustments relating to federal government contracts, medical cost trends, changes in Commercial and Medicare risk membership, capital requirements, general economic conditions, and the retention of key employees. In addition, past financial performance is not necessarily a reliable indicator of future performance and investors should not use historical performance to anticipate results or future period trends. 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 require or encourage 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, workers' compensation, and pharmacy benefit management services. 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 offers administrative services ("ASO") to employers who self-insure their employee health benefits. 9 Humana Inc. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, continued Special Charges During the second quarter of 1996, the Company recognized special charges of $200 million before tax ($130 million after tax or $.80 per share). The special charges included provisions for expected future losses on insurance contracts ($105 million) as well as the estimated costs to be incurred in restructuring the Washington, D.C., health plan (which was sold January 31, 1997) and closing markets or discontinuing product lines in 16 market areas. The special charges also included the write-off of miscellaneous assets, a litigation settlement, and other costs. During the quarter ended March 31, 1997, the beneficial effect of these charges was approximately $11 million before tax ($7 million after tax or $.04 per share). Approximately $42 million (of the original $105 million) of the liability for expected future losses on insurance contracts and approximately $4 million of other costs reserves remain at March 31, 1997. During the fourth quarter of 1996, the Company recognized an additional special charge of $15 million before tax ($10 million after tax or $.06 per share). This charge included severance and facility costs related to planned workforce reductions, scheduled to be completed throughout 1997. Results of Operations The Company's premium revenues increased 16 percent to $1.8 billion for the quarter ended March 31, 1997, compared to $1.6 billion for the same period in 1996. Premium revenues increased primarily due to the Company's revenues earned from its CHAMPUS contract as well as premium rate increases in its Commercial and Medicare risk products. The impact on premium revenues of Commercial membership declines was offset by Medicare risk membership increases. Commercial and Medicare risk premium rates increased 2.9 percent and 4.6 percent, respectively, for the quarter ended March 31, 1997. For 1997, Commercial premium rates are expected to increase approximately 3 to 3.5 percent, while Medicare risk premium rates are expected to increase approximately 4 to 5 percent. The Company's expected 1997 Medicare risk premium rate increase differs from the approximate 6 percent statutory increase as a result of a 1996 change in the geographic mix of the Company's members. 10 Humana Inc. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, continued Same-store Commercial membership decreased 113,400 members during the quarter ended March 31, 1997, compared to a decrease of 18,100 for the same period in 1996. This same-store membership decline, which excludes the sale of the Company's Washington, D.C., health plan (92,500 members) and the purchase of Health Direct (22,100 members), was due to the Company's more disciplined product pricing begun in the fall of 1996 and withdrawal from certain unprofitable markets. Same-store Medicare risk membership increased 15,100 members during the quarter compared to a same-store increase of 10,200 members for the same period in 1996. The Medicare risk membership growth is primarily the result of sales in new Medicare markets. Given the competitive large group Commercial pricing environment, the Company's new pricing discipline and the closing or sale of certain markets, management expects Commercial membership to be flat to down approximately 3 percent for 1997, while Medicare risk membership is expected to increase approximately 20 percent. The medical loss ratio for the quarter ended March 31, 1997, was 82.3 percent compared to 81.7 percent for the same period in 1996. The increase is principally the result of higher medical costs in new Medicare risk markets and increased pharmacy costs systemwide. Medical cost increases in these areas were partially offset by a slight improvement in Commercial and Medicare risk days per thousand trends. The administrative cost ratio was 15.8 percent and 14.7 percent for the quarters ended March 31, 1997 and 1996, respectively. The increase was due to planned spending on critical core processes necessary for long-term improvement in the areas of medical management, customer service and information systems. Management anticipates improvement in the administrative ratio during the third and fourth quarters of 1997 as membership increases and workforce reductions begin to take place. Interest income totaled $26 million and $25 million for the quarters ended March 31, 1997 and 1996, respectively. The increase is primarily attributable to increased levels of cash, cash equivalents and marketable securities. The tax equivalent yield on invested assets approximated 8 percent for each of the quarters ended March 31, 1997 and 1996. The Company's income before income taxes totaled $60 million for the quarter ended March 31, 1997, compared to $81 million for the quarter ended March 31, 1996. Net income was $39 million and $53 million or $.24 and $.32 per share for the quarters ended March 31, 1997 and 1996, respectively. 11 Humana Inc. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, continued Liquidity Cash provided by the Company's operations totaled $64 million and $162 million for the quarters ended March 31, 1997 and 1996, respectively. The decrease in net cash provided by operations was due to changes in operating assets and liabilities and a reduction of net income. Changes in operating assets and liabilities relate to the timing of receipts and disbursements for premiums receivable, medical costs, unearned premiums and other liabilities. 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. During April 1996, the Company implemented a commercial paper program and began issuing debt securities thereunder. At March 31, 1997, borrowings under the commmercial paper program totaled approximately $200 million, with an average rate of interest during the quarter of 5.6 percent. The commercial paper program is backed by the Company's $600 million revolving line of credit, which expires in September 2000. Borrowings under the 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 revolving 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 opportuities, as well as fund capital requirements. Capital Resources The Company's ongoing capital expenditures relate primarily to medical care facilities used by either employed or affiliated physicians, as well as 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 1997 will be approximately $80 to $90 million for the expansion and improvement of medical care facilities, administrative facilities and related information systems. 12 Humana Inc. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, continued Quarterly Membership 1997 1996 Commercial members at: March 31 2,631,000 2,862,900 June 30 2,861,900 September 30 2,846,400 December 31 2,814,800 Medicare risk members at: March 31 374,200 322,300 June 30 332,900 September 30 347,400 December 31 364,500 CHAMPUS eligible members at: March 31 1,103,100 June 30 September 30 1,075,300 December 31 1,103,000 Medicare supplement members at: March 31 93,500 109,600 June 30 106,000 September 30 101,800 December 31 97,700 Administrative services members at: March 31 566,300 444,700 June 30 447,900 September 30 458,300 December 31 471,000 Total medical members at: March 31 4,768,100 3,739,500 June 30 3,748,700 September 30 4,829,200 December 31 4,851,000 Specialty members at: March 31 2,172,900 1,811,300 June 30 1,863,800 September 30 1,895,900 December 31 1,884,200 13 Humana Inc. Part II: Other Information Item 1: Legal Proceedings 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, result of operations, or cash flows. Items 2 - 3: None Item 4: Submission of Matters to a Vote of Security Holders (a) The regular annual meeting of stockholders of Humana Inc. was held in Louisville, Kentucky on May 8, 1997, for the purpose of electing the Board of Directors and voting on the Company's 1997 Management Incentive Plan for Executive Management. (b) Proxies for the meeting were solicited pursuant to Section 14(a) of the Securities Exchange Act of 1934 and there was no solicitation in opposition to management's solicitations. All of management's nominees for directors were elected and the Company's 1997 Management Incentive Plan for Executive Management was approved. (c) Two proposals were submitted to a vote of security holders as follows: (1) The stockholders approved the election of the following persons as directors of the Company: Name For Withheld K. Frank Austen, M.D. 138,175,994 842,210 Michael E. Gellert 138,188,548 829,656 John R. Hall 138,194,678 823,526 David A. Jones 138,168,060 850,144 David A. Jones, Jr. 138,016,578 1,001,626 Irwin Lerner 138,152,717 865,487 W. Ann Reynolds, Ph.D 138,145,869 872,335 (2) The stockholders approved with 134,406,241 affirmative votes, 3,895,142 negative votes, and 716,821 abstentions, the proposal to adopt the Company's 1997 Management Incentive Plan for Executive Management. 14 Humana Inc. Part II: Other Information, continued Item 5: None Item 6: Exhibits and Reports on Form 8-K (a) Exhibits: Exhibit 10 - 1997 Management Incentive Plan for Employees, filed herewith. Exhibit 12 - Statement re: Computation of Ratio of Earnings to Fixed Charges, filed herewith. Exhibit 27 - Financial Data Schedule, filed herewith. (b) No reports on Form 8-K were filed during the quarter ended March 31, 1997. 15 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: May 15 , 1997 /s/ James E. Murray James E. Murray Chief Financial Officer (Principal Accounting Officer) Date: May 15, 1997 /s/ Arthur P. Hipwell Arthur P. Hipwell Senior Vice President and General Counsel 16