Centene Corporation (CNC) — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. Unaudited results; dollar amounts are in millions unless noted. Centene provides managed-care and specialty healthcare services, with most business serving government-sponsored programs.
Financial performance and position
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Total revenues | $18,356 | $14,181 | $36,800 | $27,375 |
| Operating earnings | $643 | $489 | $1,328 | $1,029 |
| Net earnings attributable to Centene | $495 | $300 | $1,017 | $640 |
| Diluted EPS | $1.18 | $0.75 | $2.42 | $1.70 |
| Adjusted diluted EPS (non-GAAP) | $1.34 | $0.90 | $2.73 | $1.98 |
| Health benefits ratio (HBR) | 86.7% | 85.7% | 86.2% | 85.0% |
| SG&A expense ratio | 9.1% | 9.6% | 9.3% | 10.0% |
- Revenue and membership: Q2 revenue grew 29% year over year; managed-care membership reached 15.0 million, up 17%. Q2 premium revenue was $16,554 and service revenue was $745.
- Cash flow: Operating cash flow was $917 in Q2 and $2,233 for the first half, versus $1,320 in the prior-year half. First-half investing cash outflow was $929 and financing cash inflow was $236. Capital expenditures were $336; operating cash flow less capital expenditures was approximately $1,897.
- Liquidity and debt: At June 30, cash and cash equivalents were $6,875; current assets were $13,596 and current liabilities $12,653, yielding reported working capital of $943. Total debt was $7,134, including $513 drawn on the $2,000 revolving facility; long-term debt was $7,047. Debt-to-capital was 36.8%, and the company reported compliance with debt covenants.
- Claims and investments: Medical claims liability was $7,447, including $5,521 of IBNR plus expected development on reported claims. Short- and long-term investments totaled $8,397 at fair value, with $630 of restricted deposits.
Changes versus the prior comparable period
- Q2 operating earnings rose 31%, attributable earnings 65%, and diluted EPS 57%. First-half attributable earnings increased 59% and diluted EPS 42%.
- Growth was driven mainly by the July 2018 Fidelis Care acquisition, Marketplace enrollment, and new or expanded state programs. Q2 Medicaid revenue increased 36%, commercial 23%, and Medicare 22% year over year.
- The HBR increased by 1.0 percentage point in Q2 and 1.2 points for the first half. Management cited normalized Marketplace margins, Fidelis Care’s higher HBR, and the 2019 health insurer fee (HIF) moratorium.
- SG&A ratios improved, with management attributing the reduction partly to Fidelis Care’s lower SG&A ratio. Specialty Services operating earnings declined 18% in Q2 and 9% for the first half, primarily due to the transition to transparent pharmacy pricing.
- The HIF was suspended for 2019: Centene recorded no HIF expense in the first half, compared with $354 in the 2018 half. The moratorium also affected reported revenue and the effective tax rate.
Outlook, commentary, risks and unusual items
- Liquidity outlook: Management expects available cash, investments, operating cash flow and revolving-facility availability to fund general operations and capital expenditures for at least 12 months from the filing date. It expected approximately $350 of additional capital expenditures during the remainder of 2019.
- WellCare transaction: The announced transaction 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 had an $8.4 billion financing commitment and intended primarily to debt-finance the cash portion. The filing discusses execution, approval, integration, dilution and leverage risks; anticipated adjusted-EPS accretion in the second year was not assured.
- Other business developments: Fidelis Care’s $3.6 billion acquisition accounting was finalized in Q2. Centene acquired an additional 40% of Ribera Salud for $54, bringing ownership to 90%; Q2 investment and other income included a $16 gain related to Ribera Salud. The company reported a $131 net pre-tax benefit for the first half from ACA risk-adjustment, minimum-MLR and related estimates; final RADV results were pending at the filing date.
- Claims estimates: Prior-year claims development reduced incurred claims by $555 in the first half. Medical claims estimates depend on utilization, cost trends, mix and payment patterns; unfavorable reserve development could materially affect results.
- Legal and regulatory matters: Accrued legal and regulatory amounts were not material, but the company warned an adverse outcome could have a material effect. Disclosed matters included a California gross-premiums-tax case, a federal securities class action and related derivative litigation, DOJ investigations concerning Medicare risk-adjustment and VA claims, and an Ambetter provider-network and coverage class action.
- Other principal risks: Government funding, rates and contract renewals; healthcare cost and pricing accuracy; ACA and other regulatory changes; Marketplace risk adjustment and adverse selection; quality ratings; acquisitions and integration; indebtedness and financing; cyber and privacy incidents; and investment-market exposure. A hypothetical immediate 1% interest-rate rise was estimated to reduce fixed-income investment fair value by $263, partly offset by an estimated $86 decrease in debt fair value.
Most important facts for investors to verify
- Whether the higher HBR persists and how Marketplace, Fidelis Care and the HIF moratorium affect margins and earnings.
- Claims reserve adequacy and the eventual impact of CMS risk-adjustment and RADV determinations.
- WellCare regulatory approvals, financing terms, closing timing, integration costs and expected leverage.
- Cash-flow sustainability, debt maturities and covenant headroom, particularly as acquisition financing proceeds.
- Developments and potential financial exposure in the California tax, securities, Medicare/VA investigation and Ambetter litigation matters.
Adjusted earnings and adjusted EPS are non-GAAP measures; the filing reconciles them to GAAP and includes acquisition-related and intangible-amortization adjustments.