Centene Corporation — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016. Centene completed its acquisition of Health Net on March 24, so reported results include only eight days of Health Net operations. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Business context and key results
Centene provides managed-care and specialty healthcare services, primarily through government-sponsored programs. The Health Net acquisition expanded its Medicaid, Medicare, commercial, TRICARE and Veterans Affairs businesses. Managed-care membership rose to 11.5 million from 4.4 million a year earlier, including 2.8 million TRICARE eligibles.
| Metric | Q1 2016 | Q1 2015 | Change / context |
|---|---|---|---|
| Total revenue | $6.953 billion | $5.131 billion | Up 36%; premium and service revenue rose 35% |
| Medical costs | $5.311 billion | $3.861 billion | Up 38% |
| Health Benefits Ratio (HBR) | 88.7% | 89.8% | Improved 1.1 percentage points |
| General and administrative expense | $722 million | $396 million | Includes $189 million in Health Net acquisition-related expenses |
| G&A expense ratio | 11.3% | 8.3% | 8.3% in Q1 2016 excluding acquisition-related expenses |
| Operating earnings | $20 million | $129 million | Down 84% |
| Net earnings attributable to Centene | $(17) million | $63 million | GAAP diluted EPS: $(0.14) vs. $0.51 |
| Operating cash flow | $195 million | $45 million | Higher than prior year; state payment timing affected both periods |
Profitability, cash, debt and liquidity
Reported pre-tax earnings were $2 million, with $17 million of income tax expense, resulting in a $15 million loss from continuing operations. Management reported adjusted diluted EPS of $0.74, excluding $0.83 per share of Health Net acquisition-related expenses and $0.04 of acquired-intangible amortization; the comparable adjusted figure for Q1 2015 was $0.55. This is a company-defined non-GAAP measure, not a substitute for GAAP results.
Cash and cash equivalents were $3.436 billion at quarter-end, compared with $1.760 billion at December 31, 2015. Investing activities used $836 million, including $782 million net cash for acquisitions; financing activities provided $2.317 billion, principally reflecting acquisition financing. Total debt was $4.280 billion, up from $1.221 billion at year-end. The debt-to-capital ratio increased to 44.6% from 36.0%.
Working capital was negative $320 million, versus negative $24 million at year-end. The company had $515 million drawn on its $1 billion revolving credit facility and reported compliance with its covenants, with no availability restriction from the leverage test. It stated that cash, investments, operating cash flow and credit availability should fund general operations and capital expenditures for at least 12 months from the filing date. Regulated subsidiaries had $3.674 billion of statutory capital and surplus against $2.169 billion of required minimums; estimated risk-based capital exceeded 350% of the Authorized Control Level, excluding the interim Health Insurer Fee impact.
Material changes and unusual items
- Health Net was acquired for approximately $5.982 billion including assumed debt. Consideration included $3.038 billion in Centene shares and $2.239 billion in cash. Preliminary acquisition accounting recorded $3.601 billion of goodwill and $1.5 billion of acquired intangible assets; valuations remained incomplete and subject to adjustment.
- Acquisition-related costs included $75 million of investment banking fees, $61 million of California undertaking contributions, $45 million of employee termination costs and $8 million of other acquisition and integration costs. The company also expected further restructuring and integration charges.
- Health Net-related borrowing contributed to higher interest expense: $33 million versus $10 million a year earlier. The company issued $2.4 billion of senior notes and established a new $1 billion revolving facility.
- The HBR improvement was attributed primarily to improved medical expense in higher-acuity populations and growth in Medicaid expansion and Marketplace membership, which had lower HBRs.
- The company recorded a $61 million present-value expense for a California undertaking to support health outcomes and healthcare infrastructure. Other commitments include specified California investments and a service center.
Outlook, risks and contingencies
Centene expected approximately $420 million of net capital contributions to insurance subsidiaries and approximately $300 million of additional capital expenditures during the remainder of 2016, funded through unregulated cash generation and revolver borrowings. Management cited Health Net integration and the full-year contribution of businesses launched or expanded in 2015 as growth drivers. The filing did not provide a specific full-year earnings or revenue forecast.
Key risks include controlling medical costs and estimating incurred-but-not-reported claims; government funding, premium rates, eligibility and contract renewals; ACA Marketplace pricing and the risk-adjustment, reinsurance and risk-corridor programs; regulatory and statutory-capital requirements; Health Net integration, realization of synergies and increased leverage; and investment-market exposure. A hypothetical immediate 1% rise in interest rates was estimated to reduce fixed-income investment fair value by $136 million and debt fair value by $126 million.
A continuing Kentucky Spirit dispute could result in material exposure. The Commonwealth asserted damages of $28 million to $40 million plus interest, as well as associated CMS expenditures of $92 million to $134 million, and seeks recovery under a $25 million performance bond. Centene had recorded no receivable or liability and said the outcome could materially affect results, cash flow or financial position when resolved.
Most important facts for investors to verify
- How Health Net’s full-quarter results, final purchase-price allocation and integration costs affect future earnings, leverage and anticipated synergies.
- Whether the HBR improvement and normalized G&A ratio persist as membership and product mix change.
- Whether the company generates adequate cash while meeting its planned $420 million capital contributions and $300 million capital expenditures, given negative working capital and higher debt.
- Developments in the Kentucky Spirit litigation, including potential liability and the status of the performance bond.
- Regulatory approvals, contract starts and renewals, and the company’s ability to meet California acquisition undertakings and capital requirements.