CENTENE CORP annual report, FY2014

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Centene Corporation — FY2014 Form 10-K

Business context and reporting period. Annual report for the year ended December 31, 2014; the filing was signed February 23, 2015. Centene provides government-sponsored managed healthcare and specialty services. Managed Care generated 89% of external premium and service revenue, and Specialty Services 11%. Membership at year-end was 4.06 million, up 41% year over year. Kentucky Spirit, which stopped serving members in 2013, is reported as discontinued operations.

Financial performance and position

  • Revenue: Premium and service revenue was $15.67 billion, up 48.8%; total revenue, including premium tax and health insurer fee revenue, was $16.56 billion, up 52.4%.
  • Earnings: Earnings from operations were $464 million, up 67.5%. Net earnings attributable to Centene were $271 million, versus $165 million in 2013. Continuing-operations earnings attributable to common shareholders were $268 million; diluted continuing-operations EPS was $2.23, up 55.9%. Total diluted EPS was $2.25.
  • Margins and costs: Health Benefits Ratio (medical costs as a percentage of premium revenue) increased to 89.3% from 88.6%, primarily reflecting growth in complex-care membership. The ratio for ABD, LTC and Medicare rose to 93.5% from 90.4%. G&A expense ratio improved to 8.4% from 8.8%. The ACA health insurer fee added $126 million of expense; Centene recorded $195 million of related reimbursement revenue.
  • Cash flow: Operating cash flow was $1.223 billion, versus $382 million in 2013. Management attributed much of the increase to higher medical claims liabilities and accounts payable/accruals as the business grew. Investing used $848 million; financing provided $198 million. Cash and cash equivalents totaled $1.610 billion, including $64 million classified in discontinued operations.
  • Liquidity and debt: Working capital was $134 million, down from $241 million. Total debt was $893 million, including $75 million drawn on a $500 million revolving facility; Centene reported compliance with debt covenants and no availability restrictions from its debt-to-EBITDA covenant. Debt-to-capital was 33.9%. Investments and restricted deposits totaled $1.557 billion. Regulated subsidiaries held $1.699 billion of statutory capital and surplus against $851 million required.

Material changes versus the prior year

  • Growth reflected Medicaid and product expansions, Marketplace participation, new state and correctional-health contracts, and acquisitions/investments including U.S. Medical Management, the Louisiana Bayou Health contract assignment, and Ribera Salud. Specialty Services revenue rose 63.7%; Managed Care revenue rose 42.6%.
  • Year-end membership increased by 1.18 million. Premium rates provided an approximate net 1% composite increase across markets in 2014.
  • Medical costs rose 40.9%, slower than premium and service revenue growth, but the consolidated HBR nevertheless increased 70 basis points. The G&A ratio declined as expenses were leveraged over higher revenue.
  • Interest expense increased to $35 million from $27 million, reflecting additional Senior Notes and greater revolver borrowings. Centene issued $300 million of 4.75% Senior Notes due 2022 in 2014.
  • Fourth-quarter snapshot: Total revenue was $4.725 billion, versus $2.932 billion in Q4 2013; continuing-operations earnings attributable to common shareholders were $106 million, versus $48 million; diluted continuing-operations EPS was $0.87, versus $0.42.

Outlook, risks, contingencies and unusual items

  • Centene expected full-year 2015 benefits from contracts and expansions begun in 2014 and described additional 2015 program launches and planned acquisitions. It provided no specific earnings or revenue guidance in the supplied filing text.
  • Management expected approximately $630 million of net capital contributions to insurance subsidiaries and $120 million of capital expenditures in 2015. It expected available cash, investments, operating cash flow and credit-facility capacity to fund general operations and capital expenditures for at least 12 months. A further $200 million of 4.75% Senior Notes was issued in January 2015.
  • Kentucky litigation: A February 2015 appellate ruling found that Kentucky Spirit lacked a contractual right to terminate early and that a liquidated-damages provision applied. The state alleged $28–$40 million of expenditures, plus interest, and separately cited $92–$134 million of associated CMS expenditures. Centene disputed the claims, said it would seek further review, could not estimate the outcome, and had recorded no related receivable or liability at year-end. The matter could materially affect results, cash flow or financial position.
  • Key business risks include government funding, rate adequacy and contract renewals; medical-cost and claims-reserve estimation; Marketplace pricing, adverse selection and federal risk-stabilization payments; regulatory and compliance requirements; provider access and costs; acquisitions and integration; and cybersecurity/privacy. Texas represented 25% and Florida 14% of 2014 total revenue.
  • Other items to note: medical claims liability increased to $1.723 billion from $1.112 billion, and days in claims payable rose to 44.2 from 42.4. Management estimated a 1% change in the claims liability would affect 2014 net earnings by $11 million, before certain program effects. The company reported no 2014 impairment loss; its 2012 results included a $28 million impairment. The annual report received unqualified audit opinions, and management and the auditor concluded internal control over financial reporting was effective.

Investor verification priorities

  1. Track medical-cost experience, HBR—especially complex-care lines—and subsequent claims-reserve development against the $1.723 billion year-end liability.
  2. Confirm the resolution and potential financial exposure of the Kentucky Spirit litigation, including the distinction between state-claimed damages and CMS expenditures.
  3. Assess whether growth in new contracts and Marketplace membership produces adequate pricing and margins, and monitor Texas/Florida concentration and contract renewals.
  4. Reconcile strong operating cash flow with working-capital movements, planned 2015 capital contributions, acquisitions, debt issuance and regulated-subsidiary dividend restrictions.