Centene Corporation — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. Centene provides managed-care and specialty healthcare services, primarily in government-sponsored programs. Results include WellCare from its January 23, 2020 acquisition, which materially affects year-over-year comparisons.
Financial results and key metrics
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Total revenue | $29.09 billion | $18.98 billion | $82.83 billion | $55.78 billion |
| Net earnings attributable to Centene | $568 million | $95 million | $1.82 billion | $1.11 billion |
| Diluted EPS | $0.97 | $0.23 | $3.16 | $2.65 |
| Adjusted diluted EPS (non-GAAP) | $1.26 | $0.96 | $4.56 | $3.69 |
| Health benefits ratio (HBR) | 86.4% | 88.2% | 85.5% | 86.9% |
| SG&A expense ratio | 9.1% | 8.9% | 9.2% | 9.2% |
| Adjusted SG&A expense ratio (non-GAAP) | 8.9% | 8.8% | 8.7% | 9.1% |
Cash flow and liquidity: Operating cash flow was negative $952 million in Q3, which the company attributed to the health insurer fee payment. For the first nine months, operating cash flow was positive $2.52 billion, versus $2.13 billion in 2019. Nine-month investing cash flow was negative $2.70 billion, including the WellCare acquisition; financing cash flow was positive $383 million. At September 30, cash and cash equivalents were $12.20 billion, working capital was $5.5 billion, and total debt was $16.83 billion. The debt-to-capital ratio was 39.4%, down from 52.0% at year-end 2019.
Margins and membership: The lower HBR reflected the ACA risk-corridor settlement and reduced medical utilization during the pandemic, partly offset by state rate adjustments and risk-sharing effects. Management said utilization was normalizing as elective care resumed. Managed-care membership reached 25.2 million, up 65% year over year, including growth from WellCare and pandemic-related Medicaid and Marketplace enrollment.
Material changes and unusual items
- Revenue grew 53% in Q3 and 48% for the first nine months, driven substantially by WellCare, business growth and expansion, and reinstatement of the health insurer fee in 2020. The fee was suspended in 2019, affecting comparisons.
- Q3 GAAP and adjusted EPS each included a net $0.29 per-share benefit from three disclosed items: a $398 million pre-tax ACA risk-corridor settlement benefit ($0.52 per share), offset by a $275 million charitable contribution commitment ($0.35 per share), and a favorable $72 million tax settlement ($0.12 per share). The risk-corridor benefit was received substantially in October.
- The Q3 HBR also benefited from lower pandemic-period medical utilization. Centene said the pandemic’s overall impact was then expected to slightly benefit 2020 results, while noting that this outlook remained uncertain.
- WellCare was acquired for transaction value of approximately $19.6 billion, including assumed debt. Centene issued approximately 171 million shares and paid $6.1 billion in cash. Nine-month acquisition-related expenses were $446 million. Purchase-price allocation remained preliminary, including estimates for goodwill, intangible assets, medical claims liabilities and taxes.
- Nine-month results included a $104 million pre-tax gain on the Illinois divestiture, a $72 million non-cash impairment of a care-management software business, and $44 million of debt-extinguishment costs. Q3 2019 included a $271 million non-cash impairment.
- Interest expense rose to $184 million in Q3 from $99 million, and to $551 million for the first nine months from $299 million, reflecting acquisition-related borrowing and liquidity-preservation actions.
Outlook, risks and contingencies
- Management expected approximately $423 million of net dividends from insurance subsidiaries and approximately $230 million of additional capital expenditures during the remainder of 2020. It expected available cash, investments, operating cash flow and revolving-credit availability to fund operations and capital spending for at least 12 months from the filing date.
- In October 2020, after quarter-end, Centene issued $2.2 billion of 3.0% notes due 2030 and used proceeds with cash on hand to redeem its 2022 notes and $1.2 billion of 2025 notes. The company reported a $17 million pre-tax extinguishment loss in Q4.
- CMS’s October 2020 Medicare Star ratings showed about 30% of Medicare members in plans rated four stars or higher for the 2022 bonus year, versus 46% for 2021 and 86% for 2020. Centene warned that quality bonuses and rebates could be adversely affected in 2021 and 2022.
- Key risks include COVID-19’s uncertain effect on utilization, costs, membership and government payments; medical-claims estimation and pricing; state and federal funding, rates and contract renewals; ACA-related legal and regulatory developments; WellCare integration and synergy realization; debt and covenant obligations; and investment-market and interest-rate risk. A hypothetical immediate 1% rate increase was estimated to reduce fixed-income investment fair value by approximately $307 million.
- Legal and regulatory matters are routine but uncertain; accrued amounts were not material. The California taxpayer action challenging the tax treatment of a Centene subsidiary was appealed after summary judgment for the subsidiary. A Department of Justice investigation concerning a former VA contract remained unresolved, with potential liability not then estimable. The Ambetter class action described in the filing was dismissed with prejudice in September 2020.
Important facts for investors to verify
- How much reported earnings and HBR improvement depended on the one-time ACA risk-corridor settlement and unusually low pandemic-period utilization.
- Whether medical utilization, claims reserves and state rate or risk-sharing adjustments develop as management expected.
- WellCare integration progress, final purchase-accounting adjustments, acquisition costs and realized synergies.
- Effects of weaker Medicare Star ratings on future quality bonuses, rebates and membership.
- Debt maturities, refinancing and covenant headroom, and the availability of cash held in regulated subsidiaries subject to dividend restrictions.
- Developments in the VA investigation, California appeal and other government audits or proceedings.
Adjusted earnings and adjusted expense ratios are non-GAAP measures; the filing presents reconciliations and cautions that they are not substitutes for GAAP results.