Centene Corporation — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Centene operates Managed Care and Specialty Services businesses, primarily serving Medicaid and other government-sponsored healthcare programs. Unless noted, amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Premium and service revenue | $4.159 billion | $2.726 billion | $11.252 billion | $7.667 billion |
| Total revenue | $4.352 billion | $2.796 billion | $11.835 billion | $7.932 billion |
| Operating earnings | $107.9 million | $84.0 million | $270.6 million | $192.3 million |
| Net earnings attributable to Centene | $82.6 million | $49.4 million | $164.5 million | $111.9 million |
| Diluted earnings per share | $1.36 | $0.87 | $2.74 | $2.00 |
- Q3 premium and service revenue increased 52.6%; total revenue increased 55.7%. Nine-month premium and service revenue grew 46.8%; total revenue grew 49.2%.
- Q3 health benefits ratio (HBR) was 89.7%, up from 87.8%; nine-month HBR was 89.3%, up from 88.8%. Management attributed the increases primarily to a greater proportion of higher-acuity membership.
- Q3 general and administrative expense ratio improved to 8.0% from 9.1%; nine-month ratio improved to 8.4% from 8.8%, reflecting expense leverage on higher revenue.
- Operating cash flow was $853.7 million for the first nine months, versus $211.7 million a year earlier. Q3 operating cash flow was $441.8 million. Management said nine-month cash generation benefited substantially from higher medical claims liabilities and accounts payable/accrued expenses.
- At September 30, cash and cash equivalents totaled $1.583 billion, including $59.4 million classified with discontinued operations. Working capital was $133.4 million, down from $241.1 million at year-end 2013.
- Total debt was $954.9 million, compared with $668.8 million at December 31, 2013. The debt-to-capital ratio was 36.8%, versus 35.0% at year-end. The company had $140 million drawn on its $500 million revolving facility and reported no availability limitation from its debt-to-EBITDA covenant.
Material changes and notable items
- Membership reached 3.705 million, up 42% year over year; at-risk membership rose 30% to 3.402 million. Growth reflected program expansions and launches across several states, Marketplace participation, and acquisitions.
- Growth was broad-based, with Q3 Managed Care premium and service revenue up 49.1% and Specialty Services revenue up 61.6%. The filing cites expansions in Florida, Ohio, Washington and Illinois, new California and New Hampshire operations, AcariaHealth growth, and the USMM acquisition.
- Centene acquired 68% of U.S. Medical Management in January for total consideration of $213.7 million, including $81.0 million cash. The acquisition created a $140.5 million redeemable noncontrolling interest and includes put/call arrangements for remaining ownership interests.
- In July, Centene acquired Louisiana Bayou Health contract rights from Community Health Solutions of America. Consideration included cash, shares, and future payments: $41.9 million upon announcement of reprocurement winners and contingent consideration of up to $28.2 million tied to membership retention.
- Q3 diluted EPS included a $0.33 benefit from a prior-period tax adjustment, a $0.15 adverse impact from the health insurer fee in two states without signed reimbursement agreements, and $0.06 of acquisition transaction costs. Excluding these items, management presented Q3 diluted EPS of $1.22, compared with $0.88 in Q3 2013.
Outlook, risks and contingencies
- Management expected approximately $194 million of net capital contributions to insurance subsidiaries and about $30 million of additional capital expenditures during the remainder of 2014. It stated available cash, investments, operating cash flow and credit-facility availability were expected to fund operations and required CHS payments for at least 12 months from the filing date.
- Management identified prospective growth from planned 2015 program launches and expansions, subject to regulatory approvals, contract conditions and scheduled start dates. The filing does not provide a clear quantified earnings or revenue forecast.
- The Kentucky Spirit dispute remains a material uncertainty. Kentucky alleges damages and seeks enforcement of a $25 million performance bond; it reported estimated state expenditures of $28–$40 million plus interest and associated CMS expenditures of $92–$134 million. Centene disputes the claims, has its own damages action, recorded no related receivable or liability, and said the outcome could materially affect results, cash flow or financial position.
- The 2014 Affordable Care Act health insurer fee was $94.6 million in expense for the first nine months; $91.9 million of reimbursement revenue was recorded. Centene expected full-year fee expense of $126.2 million. Fifteen of 17 applicable states had signed reimbursement agreements at quarter-end.
- Regulated subsidiaries held $1.469 billion of aggregate statutory capital and surplus against $799.3 million of minimum requirements; estimated risk-based capital exceeded 350% of the Authorized Control Level, excluding the health insurer fee impact. Dividends remain subject to regulatory restrictions.
- Interest-rate exposure includes an estimated $30.0 million decrease in fixed-income investment fair value under an immediate 1 percentage-point rate increase. The filing also notes medical-cost estimation, government funding and contract changes, Marketplace pricing and adverse selection, regulatory requirements, acquisitions, and cybersecurity as significant risks.
Investor verification priorities
- Reconcile reported Q3 EPS with the $0.33 tax benefit, $0.15 health insurer fee impact and $0.06 acquisition costs; assess how recurring the reported earnings improvement is.
- Review HBR by member category, especially the higher 93.9% Q3 ratio for ABD, LTC and Medicare, and monitor medical claims reserve development as new programs mature.
- Track state reimbursement of the health insurer fee, including the two unsigned agreements and any timing-related receivable or cash-flow effects.
- Monitor the Kentucky appeals and damages litigation, including potential exposure associated with the performance bond and the state’s asserted damages.
- Assess leverage, liquidity and capital needs alongside planned subsidiary contributions, CHS deferred/contingent payments, revolving-facility covenants and restrictions on regulated-subsidiary dividends.
- Confirm regulatory approvals, contract awards and actual commencement of the growth initiatives described for 2015.