Centene Corporation (CNC) — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020; comparisons are with the corresponding 2019 periods. Amounts are in U.S. dollars. Centene acquired WellCare on January 23, 2020, so year-over-year comparisons reflect a significantly larger business.
Business context and key results
Centene provides government-sponsored and commercial healthcare plans and specialty services. Q2 membership was 24.6 million, up 64% year over year, principally reflecting WellCare and business growth.
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Total revenue | $27.712 billion | $18.356 billion | $53.737 billion | $36.800 billion |
| Earnings from operations | $2.018 billion | $643 million | $2.206 billion | $1.328 billion |
| Net earnings attributable to Centene | $1.206 billion | $495 million | $1.252 billion | $1.017 billion |
| Diluted EPS | $2.05 | $1.18 | $2.20 | $2.42 |
| Adjusted diluted EPS (non-GAAP) | $2.40 | $1.34 | $3.31 | $2.73 |
Q2 health benefits ratio (HBR) was 82.1%, versus 86.7%; the six-month HBR was 84.9%, versus 86.2%. Q2 SG&A ratio was 8.8%, versus 9.1%, and adjusted SG&A ratio was 8.5%, versus 9.0%. For the six months, the reported SG&A ratio was 9.3% in both periods; adjusted ratio improved to 8.6% from 9.2%.
Six-month operating cash flow was $3.474 billion, up from $2.233 billion. Investing activities used $3.032 billion, including the acquisition, while financing activities provided $379 million. Cash, cash equivalents and restricted cash totaled $12.955 billion at June 30, including $12.798 billion of cash and cash equivalents.
At June 30, total debt was $16.814 billion, including $16.708 billion of long-term debt. The debt-to-capital ratio was 40.0%, down from 52.0% at year-end 2019. Working capital was $4.9 billion, versus $7.4 billion. The company reported compliance with debt covenants and no revolving-facility availability limitation from its debt-to-EBITDA ratio.
Material changes and notable items
- Revenue rose 51% in Q2 and 46% for the first half. WellCare, membership growth and expansion contributed; the 2020 reinstatement of the health insurer fee also increased both revenue and expense. The fee was suspended in 2019.
- Management attributed the lower HBR and higher earnings in part to reduced medical utilization during COVID-19 restrictions. Utilization began increasing as restrictions eased late in Q2.
- WellCare added scale and Medicare and prescription-drug businesses. The transaction was valued at approximately $19.6 billion, including assumed debt; consideration included $6.079 billion cash and Centene shares valued at $11.431 billion. Goodwill recorded provisionally was $10.637 billion.
- Q2 results included $71 million of acquisition-related costs and $197 million of acquired-intangible amortization. First-half results included $384 million and $363 million, respectively, plus a $72 million non-cash impairment and $44 million debt-extinguishment cost.
- First-half diluted EPS declined 9% despite higher net earnings, with the acquisition-related increase in weighted-average shares among the factors. Adjusted results are non-GAAP and exclude specified items.
- Interest expense increased to $367 million for the first half from $200 million, reflecting acquisition financing and other borrowings. Centene deferred its planned redemption of $1.0 billion of 2022 notes amid COVID-related market volatility; it issued $2.0 billion of 2030 notes and redeemed its 2024 notes.
Outlook, commentary and risks
Centene did not provide a specific full-year earnings or EPS forecast in the supplied filing text. Management said the combined COVID-19 effects were expected to slightly benefit 2020 results, while emphasizing substantial uncertainty. The company expected available cash, operating cash flow and revolving-credit availability to fund operations and capital expenditures for at least 12 months from the filing date. It expected approximately $525 million in additional 2020 capital expenditures and about $40 million of net capital contributions to insurance subsidiaries.
Management cautioned that deferred care may lead to higher or more acute treatment costs as members return to care, while ongoing COVID-19 cases create incremental costs. Other stated risks include uncertainty in government payments and premium rates, WellCare integration and realization of synergies, claims and risk-adjustment estimates, competition, regulation and ACA litigation, and debt and capital-market conditions. Medicare Star ratings were a concern: approximately 46% of Medicare members were in plans rated 4 stars or higher for the 2021 bonus year, compared with 86% for the 2020 bonus year.
Contingencies include a roughly $450 million ACA risk-corridor claim that was not recorded as a receivable at June 30. The company also disclosed ongoing government inquiries and litigation; accrued amounts for legal and regulatory matters were not material, but outcomes could be adverse. A California tax case had been decided in Centene’s favor, subject to possible appeal. The filing also noted that CMS’s final risk-adjustment audit results were expected in August 2020.
Important facts for investors to verify
- How medical utilization and claims costs developed after Q2’s unusually low utilization, and whether reserve estimates remain adequate.
- Whether WellCare integration, expected synergies and the preliminary acquisition valuations deliver the anticipated financial benefits.
- The final CMS risk-adjustment and RADV outcomes, related premium adjustments, and status of the unrecorded $450 million risk-corridor claim.
- Debt repayment and refinancing plans, interest costs, covenant headroom and liquidity as the company funds integration and planned capital spending.
- Medicare Star-rating trends and their effects on 2021 quality bonuses, membership and revenue; also monitor government contract, ACA and regulatory developments.