Centene Corporation — Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2019. Amounts are in U.S. dollars; financial figures are in millions unless noted. Centene provides managed healthcare services, primarily through government-sponsored and commercial programs.
Financial performance and position
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Total revenues | $18,976 | $16,182 | $55,776 | $43,557 |
| Operating earnings | $176 | $41 | $1,504 | $1,070 |
| Net earnings attributable to Centene | $95 | $19 | $1,112 | $659 |
| Diluted EPS | $0.23 | $0.05 | $2.65 | $1.68 |
| Adjusted diluted EPS (non-GAAP) | $0.96 | $0.89 | $3.69 | $2.87 |
| Health benefits ratio (HBR) | 88.2% | 86.3% | 86.9% | 85.5% |
Q3 revenue increased 17% year over year; nine-month revenue increased 28%. Growth reflected acquisitions, Marketplace expansion, and new or expanded state programs. The 2019 health insurer fee moratorium reduced reported premium-tax and fee revenue and expense compared with 2018.
- Q3 SG&A expense ratio was 8.9%, versus 12.6%; adjusted ratio was 8.8%, versus 10.0%. Lower acquisition costs, particularly compared with Fidelis Care-related costs in Q3 2018, drove much of the reported improvement.
- Nine-month operating cash flow was $2,134, compared with $1,868. Q3 operating cash flow was negative $99, which management attributed to approximately $1.0 billion of payments related to 2018 risk-adjustment and minimum-MLR programs.
- At September 30, cash and cash equivalents were $6,215; short- and long-term investments were $8,719; and restricted deposits were $655. Current assets of $13,457 exceeded current liabilities of $13,280, leaving working capital of $177.
- Total debt was $7,041, including $66 current and $6,975 long-term. Debt-to-capital was 36.2%, compared with 37.8% at year-end 2018. The company reported compliance with debt covenants.
- Medical claims liability was $7,975. Nine-month incurred claims included a $641 favorable development from prior-year estimates.
Material changes and unusual items
- Centene recorded a $271 non-cash goodwill and intangible impairment in Q3—$259 goodwill and $12 intangible assets—substantially related to its U.S. Medical Management physician home health business. Management cited revised forecasts, including slower-than-expected Medicaid penetration and developments in shared-savings programs. The business continued to generate positive cash flow, but performance was below expectations.
- Q3 GAAP diluted EPS included a $0.57-per-share impairment adjustment. Adjusted diluted EPS excludes the impairment, acquired-intangible amortization, acquisition expenses, and other specified items; it is a non-GAAP measure.
- For the nine months, Centene recognized an approximately $131 pre-tax benefit in Q2 following final 2018 ACA risk-adjustment transfer results and related MLR and audit considerations. The Q3 cash-flow commentary cites approximately $1.0 billion in payments connected with 2018 risk adjustment and minimum-MLR programs.
- Fidelis Care, acquired July 1, 2018 for approximately $3.6 billion, was a major factor in year-over-year growth. Centene also increased its ownership of Ribera Salud to 90% in June 2019.
- After quarter-end, Centene borrowed $1,450 under a delayed-draw term facility and redeemed $1,400 of 5.625% senior notes due 2021. It expected a $30 pre-tax extinguishment loss in Q4 2019.
Outlook, management commentary, and risks
- Management expected available cash, investments, operating cash flow, and revolving-credit availability to fund general operations and capital expenditures for at least 12 months from the filing date. It expected approximately $79 of net capital contributions to insurance subsidiaries and $200 of additional capital expenditures during the remainder of 2019.
- The proposed WellCare acquisition was valued at approximately $17.3 billion, including WellCare debt, and was expected to close in the first half of 2020, subject to federal antitrust clearance, state approvals, and other conditions. Centene described an $8.4 billion financing commitment and intended to fund the cash portion primarily with debt. WellCare had agreed to sell its Missouri and Nebraska Medicaid plans to Anthem, subject to approvals and closing of the merger.
- Centene reported 15.27 million total members at September 30, 2019, up 6% year over year. However, Medicare Star ratings posed a headwind: management said 51% of Medicare members were in plans rated 4 stars or higher for the 2021 bonus year, versus 86% for the 2020 bonus year, potentially reducing quality bonuses and rebates.
- Key risks include medical-cost and claims-reserve estimation, government funding and contract changes, ACA and regulatory uncertainty, Marketplace pricing and risk adjustment, acquisition financing and integration, debt and interest-rate exposure, and litigation or investigations. The filing also identifies potential material exposure in a California gross-premiums-tax case, securities and derivative litigation, and government inquiries concerning Medicare risk adjustment and VA contract claims; outcomes and potential losses were not clear.
- State regulation restricts transfers from insurance subsidiaries. Aggregate statutory capital and surplus was $8,616 against minimum requirements of $3,225; that required amount was unavailable for dividends or return of capital to Centene.
- Management concluded disclosure controls were effective as of September 30, 2019, and reported no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether the higher HBR reflects persistent medical-cost pressure, and how Marketplace margins and state-directed payments develop.
- Cash-flow timing and settlement of ACA risk-adjustment and minimum-MLR balances, including the effect of subsequent payments.
- Underlying performance and valuation assumptions for USMM and any further impairment risk.
- WellCare closing conditions, divestiture approvals, financing costs, expected synergies, integration expenses, and pro forma leverage.
- Medicare Star-rating trends and the potential impact on future quality bonuses and rebates.
- Developments and any estimable exposure in the disclosed litigation, tax dispute, and government investigations.