Business context and reporting period
Centene Corporation filed this unaudited Form 10-Q for the quarter ended September 30, 2012. It operates Medicaid Managed Care and Specialty Services businesses. Growth came from new state contracts, geographic expansions and pharmacy benefit additions. At-risk managed-care membership reached 2.503 million, up 54.9% year over year.
Financial performance and liquidity
Amounts below are in millions, except per-share data and ratios.
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Premium and service revenues | $2,212.5 | $1,265.3 | $5,937.5 | $3,722.5 |
| Total revenues, including premium tax | $2,448.1 | $1,302.0 | $6,271.0 | $3,833.4 |
| Operating earnings (loss) | $(27.6) | $48.5 | $(40.2) | $142.9 |
| Net earnings (loss) attributable to Centene | $3.8 | $29.0 | $(7.2) | $81.1 |
| Diluted EPS | $0.07 | $0.55 | $(0.14) | $1.55 |
| Health Benefits Ratio (HBR) | 93.3% | 85.0% | 91.7% | 84.9% |
| General and administrative expense ratio | 8.2% | 11.3% | 8.6% | 11.5% |
- Q3 HBR excluding Kentucky was 88.7%; nine-month HBR excluding Kentucky was 89.1%. HBR measures medical costs as a percentage of premium revenues, excluding premium taxes.
- Operating cash flow for the first nine months was $307.3, versus $89.7 in 2011; investing cash outflow was $138.6 and financing cash inflow was $54.2. Cash and cash equivalents at September 30 were $796.6. Management separately reported Q3 operating cash flow of $317.2.
- At quarter-end, total debt was $395.3, including $40.0 drawn on the $350.0 revolving credit facility, with $310.0 still available. Debt to capital was 29.2% (25.0% excluding a $76.0 non-recourse mortgage note). Working capital was $96.4.
- Current assets were $1,376.5 and current liabilities $1,280.1. The latter included a $63.0 premium deficiency reserve and $919.0 of medical claims liability. Total stockholders’ equity was $957.1.
Material changes and unusual items
- Premium and service revenues rose 74.9% in Q3 and 59.5% for the nine-month period, primarily from membership growth, new state contracts and expansions. Total revenue growth also reflects a substantial increase in premium taxes, which had a corresponding expense.
- Medical costs and the Kentucky contract drove the higher HBR and operating loss. Centene recorded a $63.0 pre-tax Kentucky premium deficiency reserve in Q3 for expected losses from October 1, 2012 through the planned July 5, 2013 contract termination date. Kentucky operations also generated a Q3 operating loss of $28.5, according to management.
- Q3 results included a $17.9 pre-tax gain from an agreement to retire secured notes and a conversion feature for total consideration of $50.0, plus $1.5 of investment gains. The investment gains included liquidation of $75.5 of Georgia health-plan investments to address short-term liquidity needs amid delayed premium receipts.
- A $4.6 tax benefit arose from reversal of a reserve following clarification by a state taxing authority. Management said the determination was expected to have an approximately $2.5 favorable impact in 2013.
- A $28.0 impairment charge was recorded in Q2 for Celtic goodwill and intangible assets, reflecting high individual-policy medical costs and reduced expectations for future growth and profitability. The filing cites ACA requirements and increased exchange-market competition among the factors.
Outlook, risks and contingencies
- Centene expected available cash, investments, operating cash flow and credit-facility availability to fund general operations and capital expenditures for at least 12 months from the filing date. It expected approximately $200 of capital contributions in Q4 2012 to support growth, funded by unregulated cash generation and revolver borrowings.
- Management anticipated about $15 of additional 2012 capital expenditures, primarily for systems and market expansion. Kentucky contract exit costs of approximately $5–$7 were expected in Q4 2012 and 2013 and were not included in September 30 results.
- In October 2012, Centene notified Kentucky that it believed it could terminate the contract effective July 5, 2013, filed a damages dispute and sought declaratory relief in court. The right to terminate and related dispute remained unresolved; if termination does not occur as planned, the reserve may need to increase.
- The Ohio Medicaid contract award remained subject to litigation by a competing managed-care organization. Centene continued to carry $42.7 of goodwill and intangible assets tied to Buckeye pending resolution.
- A securities class action concerning earlier 2012 earnings guidance was voluntarily dismissed without prejudice in September 2012. The company said it did not expect the other discussed legal matters to materially affect its financial position or results, while noting litigation outcomes are uncertain.
- Key risks include medical-cost estimation and utilization, delayed or inadequate state premium payments, state funding and contract changes, regulatory and ACA implementation, required subsidiary capital and limits on dividends, and investment-market exposure. A hypothetical immediate 1% rise in rates was estimated to reduce fixed-income investment fair value by about $13.0.
Important facts for investors to verify
- Whether Kentucky can terminate the contract on the stated date, whether the $63.0 reserve adequately covers expected losses, and the final exit costs and litigation outcome.
- Whether elevated medical costs in Kentucky, Texas expansion areas and individual health policies improve, and how that affects HBR and underwriting profitability.
- Collection timing for state premiums, particularly Georgia receivables, and whether operating cash flow remains sustainable after working-capital timing effects.
- Final resolution of the Ohio contract challenge and the recoverability of the associated $42.7 in goodwill and intangible assets.
- Execution and funding of expected capital contributions, planned growth contracts, and the company’s ability to maintain regulatory capital while meeting its liquidity needs.