Centene Corporation — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018; filed October 23, 2018. Centene provides government-sponsored and commercial health coverage and related services. Results include Fidelis Care from its July 1, 2018 acquisition.
Financial and operating performance
Amounts below are in millions, except per-share data and ratios.
| Metric | Q3 2018 | Q3 2017 | First nine months 2018 | First nine months 2017 |
|---|---|---|---|---|
| Total revenue | $16,182 | $11,898 | $43,557 | $35,576 |
| Operating earnings | $41 | $340 | $1,070 | $1,018 |
| Net earnings attributable to Centene | $19 | $205 | $659 | $598 |
| Diluted EPS | $0.09 | $1.16 | $3.37 | $3.39 |
| Adjusted diluted EPS | $1.79 | $1.35 | $5.73 | $4.06 |
| Health benefits ratio (HBR) | 86.3% | 88.0% | 85.5% | 87.3% |
| SG&A ratio | 12.6% | 9.0% | 11.0% | 9.4% |
| Adjusted SG&A ratio | 10.0% | 8.9% | 10.0% | 9.2% |
Q3 operating margin was approximately 0.3% of revenue, versus 2.9% a year earlier. The sharp GAAP earnings decline chiefly reflects acquisition-related expenses; adjusted EPS increased year over year. Centene’s non-GAAP adjustments include acquired-intangible amortization and acquisition expenses, and adjusted results should be considered alongside GAAP results.
- Q3 revenue grew 36%; managed care membership was 14.4 million, up 17% year over year. Fidelis Care contributed $2,797 million of revenue from acquisition through quarter-end.
- For the first nine months, revenue increased 22% and Centene-attributable net earnings increased 10%. Nine-month diluted EPS was slightly lower than the prior-year period.
- Q3 HBR improvement included an estimated 100-basis-point benefit from a California Medicaid in-home support services (IHSS) reconciliation; Fidelis Care’s higher HBR partly offset improvement. The nine-month HBR benefit from the IHSS reconciliation was approximately 40 basis points.
- Specialty Services operating earnings were a loss of $51 million in Q3, versus earnings of $102 million a year earlier. Centene cited Veterans Affairs contract closeout costs and lower margins in other federal and behavioral health services.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $1,868 million, versus $1,039 million in 2017. Q3 operating cash flow was $548 million. The 2018 increase reflected earnings and higher medical claims liabilities, partly offset by higher receivables, including repayment of approximately $630 million of California Medicaid expansion rate overpayments.
- Nine-month investing cash outflow was $3,563 million, including acquisitions, investment portfolio additions and $489 million of capital expenditures. Financing cash inflow was $4,460 million, principally from a $2,779 million net equity offering and debt issuance.
- Cash and cash equivalents were $6,847 million at September 30, compared with $4,072 million at December 31, 2017. Working capital was $347 million, versus negative $629 million at year-end 2017.
- Total debt was $6,383 million, compared with $4,699 million at year-end 2017; the debt-to-capital ratio was 37.3%, versus 40.6%. The company reported compliance with debt covenants, $100 million drawn on its $1.5 billion revolving facility, and no availability limitation from its debt-to-EBITDA covenant.
- Regulated subsidiaries held $9,236 million of statutory capital and surplus against $3,374 million in required minimums. That required minimum amount was unavailable for dividends or return of capital to Centene.
Material changes, outlook and risks
- Fidelis Care acquisition: Centene acquired substantially all assets of Fidelis Care for approximately $3.47 billion. Preliminary purchase accounting includes $1.43 billion of goodwill and $1.0 billion of identifiable intangibles; valuation remained incomplete and subject to measurement-period adjustments. The deal was funded with equity and debt. Centene cautioned that integration, synergies and expected accretion are uncertain.
- Unusual Q3 items: SG&A included $399 million of acquisition-related expense, including the present value of a $324 million New York State contribution payable over five years. Other items included a $140 million estimated pre-tax IHSS reconciliation benefit, a $110 million pre-tax charge for VA contract settlements and severance, and a $30 million charitable foundation commitment. Management said these items had no net aggregate effect on diluted EPS.
- Outlook: Centene expected approximately $55 million of net capital contributions to insurance subsidiaries and $185 million of additional capital expenditures for the remainder of 2018. Management expected available cash, operating cash flow and revolving-credit capacity to fund general operations and capital expenditures for at least 12 months. The filing provides no clear numerical full-year earnings guidance.
- Management reported that the parent Medicare Star rating returned to 4.0 for the 2019 rating year, expected to positively affect Medicare Advantage quality bonus payments in 2020. Future performance also depends on new contracts and program launches, rate adequacy, medical-cost estimates, government funding and regulation, and successful acquisition integration.
- Risks and contingencies include pending California tax litigation, securities and derivative actions, an Ambetter class action, and federal investigations concerning Medicare risk-adjustment claims and VA contract billing. Centene said the potential liability in certain matters could not be determined; adverse outcomes could materially affect results or cash flows.
Important facts for investors to verify
- Whether the IHSS reconciliation estimate is finalized as expected and whether the benefit recurs or is one-time.
- Final Fidelis Care purchase accounting, integration costs, realized synergies and actual earnings contribution; management said acquisition-specific net income could not practicably be determined.
- Whether medical claims reserves and HBR remain adequate as membership and business mix change, including the impact of Fidelis Care and Marketplace enrollment.
- Resolution and potential financial exposure from the VA, Medicare, California tax and other legal or regulatory matters.
- Debt-service capacity, covenant headroom, regulated-subsidiary dividend restrictions, and funding of the New York contribution and planned capital spending.