Centene Corporation — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Amounts are in U.S. dollars; financial amounts are in millions unless stated otherwise. Centene provides managed care and specialty health services, primarily for government-sponsored and commercial programs. The Fidelis Care acquisition closed July 1, after quarter-end.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $14,181 (+19%) | $11,954 | $27,375 (+16%) | $23,678 |
| Operating earnings | $489 (+12%) | $438 | $1,029 (+52%) | $678 |
| Net earnings attributable to Centene | $300 (+18%) | $254 | $640 (+63%) | $393 |
| Diluted EPS | $1.50 (+4%) | $1.44 | $3.39 (+52%) | $2.23 |
| Adjusted diluted EPS (non-GAAP) | $1.80 | $1.59 | $3.96 | $2.71 |
- Q2 health benefits ratio (HBR) improved to 85.7% from 86.3%; the six-month ratio was 85.0% versus 87.0%. Management attributed the improvement mainly to Marketplace membership growth and the 2018 health insurer fee’s effect on the ratio, partly offset by California minimum medical loss ratio changes in Q2 and flu-related costs in the first half.
- Q2 SG&A ratio increased to 9.6% from 9.3%; the six-month ratio rose to 10.0% from 9.5% (adjusted 10.0% versus 9.3%). Management cited growth in the higher-SG&A Marketplace business. Q2 cost-of-services ratio was 86.4%, up from 85.1%, reflecting lower margins in federal services and acquired specialty pharmacy and correctional businesses.
- Q2 revenue growth reflected Marketplace growth, acquisitions and program expansions, reinstatement of the health insurer fee, and approximately $500 million of California pass-through payments recorded in both revenue and expense. Six-month California pass-through payments were approximately $400 million.
- Adjusted EPS is a non-GAAP measure. Q2 adjustments included acquired-intangible amortization, acquisition costs, and $30 million of California minimum-MLR changes; the six-month comparison also excludes a $47 million Penn Treaty assessment in 2017.
Cash flow, debt and liquidity
- First-half operating cash flow was $1,320, compared with $942 in 2017; investing cash flow was $(1,253), and financing cash flow was $4,378. Cash, cash equivalents and restricted cash totaled $8,534 at June 30, including $1,827 of restricted cash. Balance-sheet cash and cash equivalents were $6,707.
- Q2 operating cash flow was $(526), principally due to repayment of approximately $630 million of previously accrued California Medicaid expansion rate overpayments. Thus, the positive six-month operating cash flow reflects the first-quarter contribution as well as the Q2 outflow.
- Total debt was $6,279, up from $4,699 at year-end 2017, including $1,800 of 5.375% senior notes issued in May to help finance Fidelis Care. The company reported a 37.0% debt-to-capital ratio versus 40.6% at year-end.
- Working capital was $2,515, compared with negative $629 at year-end, largely reflecting equity proceeds raised before the acquisition. The $1.5 billion revolving facility had no borrowings outstanding; Centene reported covenant compliance and no availability limitations. Cash and investments at regulated subsidiaries are subject to dividend and transfer restrictions; $2,341 of capital and surplus was unavailable for dividends or return of capital.
- First-half capital expenditures were $362, versus $181 in 2017. Cash flows and reported liquidity were affected by acquisition financing raised before the Fidelis closing.
Material developments, outlook and risks
- Fidelis Care: Centene acquired substantially all of Fidelis Care’s assets on July 1 for approximately $3.75 billion cash, expanding its presence in New York. The acquisition was financed with equity and debt raised in May. Purchase-price allocation was not complete. A New York regulatory undertaking requires a $340 million contribution over five years; its approximately $324 million present value was expected to be expensed in Q3 2018.
- Other growth activity: 2018 acquisitions included Community Medical Group, MHM Services and an additional stake in Interpreta; Centene also increased its RxAdvance investment to 28%. Managed care membership reached 12.8 million, up 5% year over year, with Marketplace membership at 1.50 million versus 1.08 million.
- Risk-adjustment uncertainty: CMS announced in July that it was suspending payment and collection of ACA risk-adjustment transfers pending resolution of litigation. Centene reported a net risk-adjustment payable of approximately $1.3 billion at June 30. Management stated that using actual premiums rather than statewide average premiums for the 2017 plan year would produce an approximately $100 million one-time revenue and pre-tax earnings benefit; the ultimate impact depended on resolution of the issue.
- Outlook: No full-year EPS guidance is provided in the supplied filing text. For the remainder of 2018, Centene expected approximately $65 million of net capital contributions to insurance subsidiaries and approximately $400 million of additional capital expenditures. Management expected available cash, investments, operating cash flow and revolving-credit availability to fund operations and capital expenditures for at least 12 months from the filing date.
- Key operating and regulatory risks: Government funding, contract renewals and payment timing; medical-cost estimation and claims reserves; Marketplace pricing and ACA policy changes; Medicare Star ratings; acquisition integration and realization of expected benefits; restricted subsidiary capital; and interest-rate and investment-market exposure. A 1% immediate rate increase was estimated to reduce fixed-income investment fair value by approximately $193 million.
- Contingencies: Centene said accrued legal and regulatory amounts were not material, while noting that some outcomes could materially affect results. Disclosed matters included a California gross-premiums-tax action, securities and derivative litigation, an Ambetter class action, and DOJ inquiries involving Medicare risk-adjustment submissions and Veterans Affairs contract claims. The company said it could not determine potential liability for certain investigations.
Important facts for investors to verify
- How CMS resolves the risk-adjustment suspension and the ultimate settlement and cash implications of Centene’s approximately $1.3 billion payable.
- Whether California’s Medicaid expansion rate and minimum-MLR issues result in further charges, recoveries or premium adjustments, beyond the Q2 $30 million pre-tax impact.
- Fidelis Care’s finalized purchase accounting, integration costs, earnings contribution and the timing and accounting for the New York contribution.
- Whether membership and revenue growth translate into sustainable margins, given the higher SG&A and service-cost ratios and dependence on government contracts and Marketplace pricing.
- Development of the disclosed legal and regulatory matters, including any losses or operational changes not estimable at the filing date.