Centene Corporation — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; unaudited. Amounts are in U.S. dollars. Centene completed its acquisition of WellCare on January 23, 2020, materially changing the company’s scale and making year-over-year comparisons less representative of organic growth.
Financial performance and position
| Metric | Q1 2020 | Q1 2019 / prior date |
|---|---|---|
| Total revenue | $26.025 billion | $18.444 billion; up 41% |
| Premium and service revenue | $24.172 billion | $16.838 billion; up 44% |
| Medical costs | $20.420 billion | $13.882 billion |
| Health benefits ratio (HBR) | 88.0% | 85.7% |
| SG&A expense ratio | 9.9%; adjusted ratio 8.6% | 9.6%; adjusted ratio 9.5% |
| Operating earnings | $188 million | $685 million; down 73% |
| Net earnings attributable to Centene | $46 million; diluted EPS $0.08 | $522 million; diluted EPS $1.24 |
| Adjusted net earnings / diluted EPS | $476 million / $0.86 | $585 million / $1.39 |
| Operating cash flow | $(240) million | $1.316 billion |
| Cash and cash equivalents | $9.308 billion | $12.123 billion at Dec. 31, 2019 |
| Total debt | $17.279 billion | $13.726 billion at Dec. 31, 2019 |
| Working capital | $3.0 billion | $7.4 billion at Dec. 31, 2019 |
Revenue growth reflected WellCare, expansion in existing markets and the reinstated health insurer fee; the filing reports a net 1% composite premium-rate change across markets. The HBR increase reflected Marketplace margin normalization and newer or expanded markets, partly offset by the health insurer fee. The reported SG&A ratio included acquisition costs; the adjusted ratio improved with WellCare’s lower cost ratio and higher revenue.
Q1 GAAP earnings included $313 million of acquisition-related costs, $166 million of acquired-intangible amortization, a $72 million non-cash software impairment and $44 million of debt-extinguishment costs. A $93 million pre-tax gain on the Illinois divestiture partly offset these items. Adjusted figures are non-GAAP measures and exclude specified items.
Operating cash use was attributed partly to an approximately $700 million delay in New York premium payments and working-capital needs from growth in the Medicare prescription drug plan business. Investing cash use was $3.272 billion, including $3.048 billion for acquisitions, partly offset by $456 million of divestiture proceeds. Financing activities provided $839 million.
Material changes and transactions
- WellCare acquisition: Transaction value was approximately $19.6 billion, including assumed debt. Consideration included $11.4 billion in Centene shares, $6.1 billion in cash and replacement equity awards. Centene issued approximately 171 million shares. Preliminary purchase accounting recorded $10.6 billion of goodwill and $7.0 billion of acquired intangible assets; valuations remain subject to adjustment.
- Membership: Managed-care membership reached 23.8 million, up 9.0 million, or 61%, year over year. The total included 4.4 million Medicare PDP members following the acquisition.
- Debt and liquidity actions: Centene issued $2.0 billion of 3.375% notes due 2030 and redeemed $1.0 billion of 6.125% notes due 2024. It deferred the planned early redemption of $1.0 billion of notes due 2022 amid COVID-related market volatility and reported $588 million drawn on its revolving facility.
- Other changes: The health insurer fee expense was $345 million, versus none in Q1 2019 during the fee moratorium. Centene repurchased $500 million of shares through its repurchase program, using divestiture proceeds.
Outlook, risks and contingencies
- COVID-19: Management expected pandemic-driven unemployment to increase membership and add an estimated $4.0 billion to original full-year 2020 revenue guidance. It also cited lower near-term utilization, especially dental and vision, possible later deferred-care costs, COVID testing and treatment costs, support investments, and lower investment income. Management maintained its prior adjusted diluted EPS guidance range; the filing text does not provide a clear numerical range. Centene said it did not expect the combined impacts to significantly affect its bottom line at that time.
- Liquidity and spending: Management expected approximately $210 million of net dividends from insurance subsidiaries and about $950 million of additional capital expenditures during the rest of 2020. It believed available cash, investments, operating cash flow and revolving-credit availability would cover general operations and capital expenditures for at least 12 months from the filing date. Regulated-subsidiary dividends and transfers are subject to restrictions.
- Operating outlook: Management cited Medicare Star ratings as a potential headwind: approximately 46% of Medicare members were in plans rated four stars or higher for the 2021 bonus year, compared with 86% for the 2020 bonus year. New business and contract starts could support growth, but contract awards, readiness reviews and timing remain uncertain.
- Risks: Key exposures include COVID-19 effects on utilization, costs, membership and government payment timing; medical-cost and claims-reserve estimation; government funding, rates and contract renewals; Medicare ratings and risk-adjustment audits; ACA and regulatory developments; acquisition integration and realization of synergies; and substantial indebtedness and capital-market access. A 1% immediate increase in interest rates was estimated to reduce fixed-income investment fair value by about $323 million.
- Legal and regulatory matters: The filing describes routine proceedings and investigations; accrued legal and regulatory amounts were not material, but outcomes may be uncertain. A California taxpayer case received a favorable summary-judgment ruling in March 2020, subject to possible appeal. A U.S. Department of Justice investigation concerns alleged improper VA contract claims; potential liability could not be determined. An Ambetter class-certification hearing was scheduled for May 2020. After quarter-end, the Supreme Court ruled on April 27, 2020 that the federal government must pay amounts due under the ACA risk-corridor program; Centene intended to pursue a claim and had recorded no receivable as of March 31.
Investor facts to verify
- Confirm the numerical full-year 2020 adjusted EPS and revenue guidance ranges from subsequent company disclosures; the filing states the EPS range was maintained but does not specify it here.
- Track WellCare integration, final purchase-accounting adjustments, acquisition costs, and whether expected synergies and adjusted earnings benefits are realized.
- Monitor medical-cost trends and claims-reserve development, including whether deferred care returns at higher acuity and how COVID-related costs are reimbursed.
- Check collection timing for the approximately $700 million New York premium payment delay and the effect of working capital on operating cash flow.
- Assess debt, available liquidity, regulated-subsidiary capital restrictions, and the consequences of deferred debt redemption and capital-market conditions.
- Follow Medicare Star ratings, government contract outcomes, the risk-corridor claim, and the unresolved legal and regulatory proceedings.