Centene Corporation — FY2015 Form 10-K
Business context and reporting period
Annual report for the fiscal year ended December 31, 2015. Centene provides government-sponsored health coverage and related services through Managed Care and Specialty Services. Managed care membership reached 5.1 million across 23 states; the two segments represented approximately 90% and 10% of external premium and service revenue, respectively.
Financial and operating performance
| Metric | FY2015 | FY2014 | Change |
|---|---|---|---|
| Premium and service revenue | $21.265 billion | $15.667 billion | +36% |
| Total revenue, including premium taxes and insurer fees | $22.760 billion | $16.560 billion | +37% |
| Earnings from operations | $705 million | $464 million | +52% |
| Net earnings attributable to Centene | $355 million | $271 million | +31% |
| Diluted EPS from continuing operations | $2.89 | $2.23 | +30% |
| Operating cash flow | $658 million | $1.223 billion | Down $565 million |
| Health Benefits Ratio | 88.9% | 89.3% | Improved 0.4 percentage points |
| G&A expense ratio | 8.6% | 8.4% | Up 0.2 percentage points |
The filing also reports $356 million of earnings from continuing operations attributable to Centene common shareholders; total net earnings attributable to Centene were $355 million after discontinued operations. Adjusted EBITDA, a non-GAAP measure, was $948 million versus $636 million.
At year-end, cash and cash equivalents were $1.760 billion, investments and restricted deposits were $2.218 billion, total assets were $7.339 billion, and long-term debt was $1.216 billion. Working capital was negative $24 million, compared with positive $51 million in 2014. Total debt was $1.221 billion; the debt-to-capital ratio was 36.0%, versus 33.5%. The company reported compliance with its credit-facility covenants and aggregate regulated-subsidiary statutory capital and surplus of $2.284 billion against $1.195 billion in required minimums.
Material changes versus the prior year
- Revenue growth primarily reflected membership and program expansion, acquisitions and new or expanded state contracts. Membership increased 26% year over year; the filing attributes the increase to growth in several states and new programs.
- The HBR improved mainly with better costs in certain high-acuity populations and growth in Medicaid expansion and Marketplace membership, which generally carried lower HBRs.
- Operating cash flow fell from $1.223 billion to $658 million. Management cited working-capital timing, including a $360 million increase in premium receivables and delayed state reimbursement of the 2015 health insurer fee.
- Cash used in investing activities was $813 million, including investment-portfolio additions and $150 million of capital expenditures. Cash provided by financing activities was $305 million.
Outlook, commentary, risks and unusual items
- Centene expected to close its approximately $5.5 billion Health Net acquisition in early 2016, subject to remaining regulatory approvals and customary conditions. Management anticipated EPS accretion, but stated the estimate was preliminary and not assured.
- In February 2016, an escrow subsidiary issued $2.4 billion of senior notes: $1.4 billion at 5.625% due 2021 and $1.0 billion at 6.125% due 2024. The financing was intended to support the merger; if it does not close, the notes must be redeemed at par plus accrued interest. The combined company was expected to have approximately $4.136 billion of debt.
- Management expected 2016 capital contributions to insurance subsidiaries of approximately $250 million and capital expenditures of approximately $330 million, including spending on systems, integration and market expansion. It stated available liquidity should fund general operations and capital expenditures for at least 12 months from the filing date.
- FY2015 included $27 million of Health Net merger expenses, reducing diluted EPS by $0.14; a $34 million gain from reducing contingent consideration for the Michigan dual-eligible program; and a $38 million goodwill and intangible-asset impairment related to that program following higher opt-outs and attrition. The filing also records a $10 million gain on settlement of Louisiana-related contingent consideration and a $10 million charitable foundation contribution.
- The ACA health insurer fee expense was $215 million, compared with $126 million in 2014; the fee is nondeductible and contributed to a 48.6% effective tax rate.
- Material risks include the accuracy of medical claims reserves and pricing, government funding and contract renewals, regulatory changes, Marketplace pricing and risk-adjustment outcomes, provider costs, acquisition integration and merger financing. Texas and Florida together accounted for 36% of 2015 revenue.
- Kentucky Spirit litigation remains unresolved. A state appellate court affirmed that early termination breached the contract and that liquidated damages may apply. The Commonwealth alleges damages and related CMS expenditures; Centene disputes the claims. No receivable or liability was recorded because the outcome could not be estimated, and the resolution could materially affect results, cash flow or financial position.
- In January 2016, Centene disclosed six hard drives were unaccounted for; after an employee reported placing them in a locked receptacle for secure destruction, the company concluded its investigation.
Most important facts for investors to verify
- Whether the Health Net merger closed, its final financing and integration costs, realized synergies, and actual effect on diluted EPS and leverage.
- Subsequent development of the $2.298 billion medical claims liability, including reserve revisions and utilization trends.
- Collection timing for state premium receivables and reimbursement of the health insurer fee, and the sustainability of operating cash flow.
- Resolution and financial exposure from Kentucky Spirit litigation, plus performance and membership retention in the Michigan dual-eligible program.
- State contract renewals, rate adequacy and Marketplace risk-adjustment, reinsurance and risk-corridor settlements.