Centene Corporation — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017; unaudited. Unless noted, amounts are in U.S. dollars. Centene provides managed-care and specialty healthcare services, primarily through government-sponsored and commercial programs.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenue | $11.898B | $10.846B | $35.576B | $28.696B |
| Earnings from operations | $340M | $342M | $1.018B | $739M |
| Net earnings attributable to Centene | $205M | $147M | $598M | $301M |
| Diluted EPS from continuing operations | $1.16 | $0.84 | $3.39 | $1.90 |
| Adjusted diluted EPS (non-GAAP) | $1.35 | $1.12 | $4.06 | $3.23 |
| Health benefits ratio (HBR) | 88.0% | 87.0% | 87.3% | 87.2% |
| SG&A expense ratio | 9.0% | 9.2% | 9.4% | 9.7% |
Q3 revenue increased 10% year over year; attributable earnings rose 39%. Nine-month revenue increased 24% and attributable earnings 99%. Nine-month comparisons are affected by the Health Net acquisition, completed March 24, 2016, so 2016 includes Health Net only from the acquisition date. Q3 operating earnings were approximately flat: Managed Care operating earnings fell $71M, largely from higher initial costs and HBR at new or expanded plans, higher-acuity membership, and a California Medicaid Expansion rate reduction; Specialty Services operating earnings rose $69M.
Q3 adjusted EPS excludes acquired-intangible amortization, acquisition-related expenses and the Penn Treaty assessment. Nine-month adjusted EPS also excludes these items. The filing reports a $56M estimated Penn Treaty guaranty-association assessment in SG&A for the first nine months of 2017.
Cash flow, balance sheet and liquidity
- For the first nine months, operating cash flow was $1.039B, versus $259M in 2016; investing cash use was $686M versus $1.632B; financing cash use was $3M versus $2.594B provided. Cash and cash equivalents ended the period at $4.281B, up from $3.930B at year-end 2016. Management separately reported Q3 operating cash flow of $97M.
- At September 30, 2017, total debt was $4.721B, including $150M drawn on the $1.0B revolving facility. Long-term debt was $4.717B. Debt-to-capital was 41.5%, versus 44.1% at December 31, 2016. The company reported compliance with debt covenants and no revolver availability restrictions from its leverage ratio.
- Current assets were $9.660B and current liabilities $9.709B, yielding negative working capital of $49M. Cash and investments were substantial, but some subsidiary capital is restricted from transfer to the parent. Management said available cash, investments, operating cash flow and revolver availability were expected to fund operations and capital expenditures for at least 12 months.
- Medical claims liability was $4.333B, compared with $3.929B at year-end 2016. Nine-month cash flow benefited from higher claims liabilities and unearned revenue, but was partly offset by a $749M increase in premium and related receivables, including state payment timing and Illinois capitation delays.
Outlook, material developments and risks
- Fidelis Care: Centene agreed to acquire substantially all assets of New York State Catholic Health Plan for $3.75B, subject to adjustments and regulatory and other conditions. Closing was expected in Q1 2018. The company expected to fund it with about $2.3B of new equity, including share consideration, and about $1.6B of new long-term debt, subject to market conditions. Completion, financing, integration, dilution and expected benefits remain uncertain.
- ACA and cost-sharing reductions: The federal government announced it would stop funding CSR subsidies. Centene estimated that failure to receive Q4 2017 CSR payments could reduce 2017 earnings by $0.07–$0.12 per diluted share. 2018 Marketplace rates in all states assumed no CSR funding. The filing describes continuing legal and legislative uncertainty.
- Membership and expansion: Managed-care membership was 12.311M, up 874,900, or 8%, year over year. Growth reflected Marketplace enrollment and state contract expansions and new programs. Management identified expected contributions from 2017 launches and 2018 contract starts, partially offset by California’s removal of in-home support services from Medicaid managed-care contracts in January 2018 and possible Indiana market-share pressure.
- Medicare quality: CMS’s 2018 rating-year results lowered a Health Net California plan to 3.5 stars from 4.0, reducing Centene’s parent rating to 3.5. The company said this could affect 2019 quality bonus payments and revenue; it intended to appeal and was evaluating the impact.
- Other exposures: The filing discusses a California gross-premiums-tax lawsuit, a federal securities class action relating to Health Net acquired liabilities, DOJ inquiries concerning Medicare risk-adjustment claims and Veterans Affairs contract billings, and routine regulatory matters. Potential losses were not clearly quantifiable for several matters; accrued legal and regulatory amounts were not material at filing. The Penn Treaty assessment was recognized as an unusual expense.
- Capital spending and regulation: For the remainder of 2017, management expected about $73M in net capital contributions to insurance subsidiaries and $175M in additional capital expenditures. The filing also describes government funding and rate changes, medical-cost estimation, contract renewals, regulatory changes, cyber and privacy events, acquisition integration, and leverage as key risks.
Most important facts for investors to verify
- Whether HBR deterioration at new or expanded plans, higher-acuity membership and rate pressure persists, and whether reserves develop as estimated.
- Actual Q4 CSR receipts and any resulting 2017 earnings effect; confirm the assumptions embedded in 2018 Marketplace rates.
- Fidelis transaction approvals, closing timing, final purchase consideration and equity/debt financing terms, including dilution and leverage effects.
- The financial and membership consequences of the 3.5-star parent rating and the outcome of Centene’s appeal.
- Cash conversion and receivable collections, particularly state payment timing and Illinois delays; assess liquidity alongside restricted subsidiary capital and debt obligations.
- Developments and potential exposure in the disclosed legal and government investigations, including the California tax case and DOJ inquiries.