Business context and reporting period
Centene Corporation filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2015. The company provides managed-care and specialty healthcare services, primarily through government-sponsored programs. Year-over-year growth reflected expanded and newly launched state programs, acquisitions, and increased membership.
Financial performance and position
- Third quarter: Total revenue was $5.821 billion, up 33.8%; premium and service revenue was $5.463 billion, up 31.4%. Operating earnings increased 69.4% to $183 million. Net earnings attributable to Centene were $93 million versus $82 million; diluted EPS was $0.76, including $0.01 from discontinued operations. Continuing-operations diluted EPS was $0.75.
- Nine months: Total revenue was $16.458 billion, up 39.1%; premium and service revenue was $15.408 billion, up 36.9%. Operating earnings rose 79.0% to $485 million. Net earnings attributable to Centene were $244 million versus $164 million, and diluted EPS was $1.99 versus $1.37.
- Margins and costs: The third-quarter Health Benefits Ratio (medical costs as a percentage of premium revenue, excluding premium tax and health insurer fee revenue) improved to 89.0% from 89.7%; the nine-month ratio was unchanged at 89.3%. The third-quarter general and administrative expense ratio increased to 8.5% from 8.0%, or 8.2% excluding Health Net merger expenses. The nine-month ratio was 8.5% in both years.
- Cash flow: Operating cash flow was $457 million for the first nine months, down from $853 million a year earlier; third-quarter operating cash flow was $62 million. Investing used $769 million and financing provided $367 million during the nine months. Cash and cash equivalents ended the quarter at $1.665 billion.
- Debt and liquidity: Total debt was $1.281 billion, up from $879 million at year-end 2014. Working capital was $33 million, down from $134 million. Debt-to-capital was 38.4%, versus 33.5% at year-end. Centene had $275 million drawn on its $500 million revolving facility and reported covenant compliance with no debt-to-EBITDA-based borrowing restrictions.
- Membership and segments: Managed-care membership reached 4.834 million, up 24% year over year; at-risk membership rose to 4.665 million. Third-quarter Managed Care operating earnings were $138 million and Specialty Services earnings were $45 million.
Material changes versus prior comparable periods
- Growth in state programs and expansions drove much of the revenue and membership increase, particularly in Florida, Illinois, Louisiana, Mississippi, Ohio, and Texas. Third-quarter premium and service revenue increased 31.4%, while medical costs increased 30.8%.
- Third-quarter operating earnings grew faster than revenue, but attributable net earnings grew 13.4%, partly reflecting a higher effective tax rate: 48.3% versus 25.7%. The filing attributes the elevated rate primarily to the nondeductible health insurer fee and notes a prior-year tax benefit from an IRS regulation.
- Nine-month operating cash flow declined despite higher earnings, with working-capital movements—including receivables and timing of state payments—affecting cash generation. Centene paid $213 million for the 2015 health insurer fee during the third quarter; most state reimbursements had not yet been received by quarter-end.
- Debt increased following additional senior-note issuance and revolver borrowing. Investments, including long-term investments, also increased substantially from year-end.
Outlook, management commentary, and risks
- Centene expected to contribute approximately $162 million of additional capital to insurance subsidiaries and spend about $50 million on capital expenditures during the remainder of 2015. Management expected available resources to fund general operations and capital expenditures for at least 12 months, excluding the proposed Health Net transaction.
- The proposed Health Net acquisition was valued at approximately $6.8 billion, including assumed debt, and was expected to close in early 2016 subject to regulatory and other conditions. The announced consideration was $28.25 cash plus 0.622 Centene shares per Health Net share. Centene expected to use cash on hand and debt financing for the cash portion. Management cited potential integration, financing, regulatory, and execution risks; the filing also warned the merger could increase leverage and dilute existing shareholders.
- Michigan dual-demonstration enrollment and blended premium rates were below expectations following higher opt-outs and member attrition. Centene reduced estimated contingent consideration by $27 million, recording a gain in G&A, and recorded a $28 million goodwill and intangible-asset impairment. These unusual items affected the quarter’s reported expenses.
- Centene recorded approximately $18 million of Health Net merger expenses in the quarter, reducing diluted EPS by $0.09; the nine-month amount was approximately $20 million, reducing diluted EPS by $0.10. State agreements provided for reimbursement of the ACA health insurer fee and related tax gross-up; management reported no EPS impact from the fee in 2015 periods presented.
- The Kentucky Spirit contract litigation remained unresolved. The Commonwealth asserted damages, including a $40 million state determination plus interest and asserted related CMS expenditures of $92 million to $134 million. Centene recorded neither a receivable nor a liability and said the ultimate outcome could materially affect results, cash flow, or financial position.
- Key broader risks include government funding and rate changes, medical-cost and claims-reserve estimation, regulation and contract renewals, marketplace risk adjustment and adverse selection, provider costs, acquisitions, cybersecurity, and interest-rate exposure. A hypothetical immediate 1% rate increase was estimated to reduce fixed-income investment fair value by about $74 million.
Important facts for investors to verify
- Whether membership growth and program expansions can be sustained while maintaining medical-cost performance, particularly in newer markets and dual-eligible programs.
- Whether operating cash flow improves as state receivables and health insurer fee reimbursements are collected, and how statutory capital contributions affect parent-company liquidity.
- The final financing, regulatory approvals, closing terms, leverage, dilution, integration costs, and expected benefits of the Health Net transaction.
- Developments in the Kentucky Spirit litigation and any resulting recorded liability, recovery, or cash impact.
- Whether Michigan membership and revenue assumptions stabilize and whether further goodwill or intangible-asset impairments or contingent-consideration changes arise.