Centene Corporation — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013. Financial statements are unaudited. Amounts below are in U.S. dollars.
Business context and performance
Centene operates Medicaid Managed Care and Specialty Services businesses. At-risk managed care membership rose 25% year over year to 2.686 million. Management attributed growth chiefly to new and expanded state contracts in Kansas, Louisiana, Mississippi, Missouri, Texas and Washington, along with pharmacy benefit expansions.
Key financial metrics
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Premium and service revenues | $2.542 billion | $1.663 billion | +52.8% |
| Total revenues, including premium tax | $2.646 billion | $1.712 billion | +54.5% |
| Medical costs | $2.267 billion | $1.443 billion | +57.2% |
| Earnings from operations | $40.1 million | $34.2 million | +17.3% |
| Net earnings attributable to Centene | $23.0 million | $24.0 million | -4.1% |
| Diluted earnings per share | $0.42 | $0.45 | -6.7% |
| Operating cash flow | $43.0 million | $(32.1) million | Improved |
- The health benefits ratio (medical costs as a percentage of premium revenue, excluding premium taxes) increased to 90.4% from 88.2%. Management cited higher first-quarter flu costs and medical costs in newer business.
- The general and administrative expense ratio improved to 8.3% from 9.8%, as revenue growth leveraged expenses. G&A expense nevertheless increased 28.9% to $210.3 million.
- Cash and cash equivalents were $730.8 million at March 31, down from $844.0 million at year-end. Investing activities used $156.3 million, primarily reflecting investment portfolio purchases net of sales and maturities, plus capital expenditures.
- Working capital was $68.2 million, versus $176.5 million at December 31, 2012. Total assets were $2.887 billion and total equity was $986.5 million.
- Total debt was $536.2 million, including $532.7 million of long-term debt. The company had no revolver borrowings and reported covenant compliance; borrowing availability was limited by the facility’s debt-to-EBITDA covenant. The reported debt-to-capital ratio was 35.2%.
Material changes and unusual items
- Revenue growth substantially exceeded earnings growth. Premium and service revenues rose 52.8%, while attributable net earnings declined 4.1%; higher medical costs, interest expense and the effective tax rate contributed to the difference.
- Medicaid Managed Care revenue increased 58.0%, but segment operating earnings fell 44.4% to $7.5 million, primarily due to flu costs and costs in newer business. Specialty Services revenue rose 47.6% and operating earnings increased 57.5% to $32.6 million.
- Premium deficiency reserve declined from $41.5 million at December 31, 2012 to $18.1 million at March 31, 2013. The filing does not clearly quantify the Q1 earnings effect of this balance change.
- In April 2013, Centene completed its approximately $146.2 million AcariaHealth acquisition, financed with approximately 2.1 million shares and $55.4 million of cash.
Outlook, commentary and risks
- Management expected approximately $270 million of additional capital contributions to insurance subsidiaries and approximately $60 million of capital expenditures during the remainder of 2013. These were expected to be funded by unregulated cash flow and revolver borrowings. Management said available resources were expected to cover operations, the acquisition and capital expenditures for at least 12 months from the filing date.
- Management cited expected full-year benefits from businesses launched or expanded in 2012. Several prospective contracts and expansions were subject to execution, negotiations and/or regulatory approval, with enrollment or operations expected to begin during 2013 or later. The filing gives no specific earnings or revenue guidance.
- Centene disputed its Kentucky Medicaid contract, asserting a right to terminate effective July 5, 2013, and sought damages. Kentucky counterclaimed for declaratory relief and damages; the scheduled hearing concerned the termination right and possible liquidated damages. The outcome and financial exposure were uncertain.
- Centene was not awarded the Arizona acute-care contract serving approximately 16,200 members; the existing contract was set to end September 30, 2013. This contrasts with the company’s anticipated contract wins and expansion opportunities.
- Principal risks include medical-cost and claims-reserve estimation, inadequate state premium rates or delayed payments, state funding and contract changes, regulatory and ACA implementation uncertainty, contract losses, concentration in a limited number of states, and investment interest-rate and credit risk. A hypothetical immediate 1% rate increase was estimated to reduce fixed-income investment fair value by approximately $23.6 million.
Most important facts for investors to verify
- Whether the elevated 90.4% health benefits ratio and medical costs in new markets moderate, and whether medical claims reserves prove adequate.
- The resolution, termination date and potential damages or reserve implications of the Kentucky dispute; and the financial impact of losing the Arizona acute-care contract.
- Actual timing, regulatory approval and enrollment for announced contract awards and expansions, versus management’s growth expectations.
- AcariaHealth’s integration, performance and funding impact, including the shares issued and cash used.
- Whether cash generation, regulated-subsidiary capital needs and revolver covenant capacity support the stated 2013 investment plans and liquidity outlook.