Centene Corporation — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. This is an annual filing, not a standalone fourth-quarter report; quarterly figures below are included where reported. Centene provides managed-care and specialty healthcare services, primarily for government-sponsored programs. Health Net was acquired on March 24, 2016, so 2016 results include its operations from the acquisition date.
Financial performance and liquidity
| Metric | 2016 | 2015 |
|---|---|---|
| Total revenue | $40.607 billion | $22.760 billion |
| Earnings from operations | $1.260 billion | $705 million |
| Net earnings attributable to Centene, continuing operations | $559 million | $356 million |
| Diluted EPS, continuing operations | $3.41 | $2.89 |
| Adjusted diluted EPS, non-GAAP | $4.43 | $3.14 |
| Adjusted EBITDA, non-GAAP | $1.804 billion | $921 million |
| Operating cash flow | $1.851 billion | $658 million |
| Cash and cash equivalents at year-end | $3.930 billion | $1.760 billion |
| Total debt | $4.655 billion | $1.221 billion |
- Total revenue rose 78%, and year-end managed-care membership increased 124% to 11.4 million, including 2.847 million TRICARE eligibles.
- The health benefits ratio (medical costs as a percentage of premium revenue) improved to 86.5% from 88.9%. The SG&A ratio increased to 9.8% from 8.5%; excluding Health Net acquisition-related expenses, it was 9.2% in 2016 versus 8.3% in 2015.
- Medical costs were $30.636 billion; SG&A was $3.676 billion, including $234 million of Health Net acquisition-related expenses. Interest expense increased to $217 million from $43 million.
- Working capital was negative $258 million, compared with negative $24 million. Debt to capital increased to 44.1% from 36.0%. The company reported covenant compliance and $100 million drawn on its $1.0 billion revolving credit facility.
- Fourth-quarter revenue was $11.911 billion; earnings from continuing operations attributable to common shareholders were $255 million, and diluted continuing-operations EPS was $1.45.
Changes versus the prior year and notable items
- Health Net drove much of the year-over-year growth, adding $13.454 billion of revenue from acquisition through year-end. The transaction was valued at approximately $5.990 billion, including assumed debt; consideration included cash and Centene shares. Managed Care operating earnings increased to $1.070 billion from $513 million, while Specialty Services operating earnings were $190 million versus $192 million.
- Reported continuing-operations diluted EPS rose 18%; adjusted diluted EPS rose 41%. Adjusted measures exclude specified items and are not GAAP results.
- A retroactive California Medicaid contract amendment produced a $195 million favorable minimum-MLR impact, including amounts attributable to periods before 2016 or before Health Net’s acquisition. Centene also recorded a $50 million charitable contribution associated with the change.
- Other significant 2016 items included $234 million of Health Net acquisition-related expenses, $147 million of acquired-intangible amortization, and $11 million of debt-extinguishment expense. The company reported a 51.8% effective tax rate.
- Operating cash flow benefited from working-capital movements, including higher accrued expenses and medical claims liabilities; management cited an approximately $445 million fourth-quarter benefit related to finalizing acquisition-date opening-balance-sheet cash flows. State payment timing also affected cash flow.
Outlook, risks and contingencies
- Management expected a full-year contribution from Health Net in 2017 and cited additional state and contract launches as growth drivers. It did not provide a specific 2017 EPS or revenue forecast in the supplied filing text.
- For 2017, Centene expected approximately $250 million of net capital contributions to insurance subsidiaries and about $520 million of capital expenditures, principally for systems integration, enhancements and market expansion. Management stated that available cash, investments, operating cash flow and credit-facility availability were expected to fund operations and capital expenditures for at least 12 months from the filing date.
- Key uncertainties include government funding, Medicaid and Medicare rate adequacy, potential ACA repeal or changes, Marketplace pricing and risk-pool volatility, medical-cost forecasting and claims-reserve adequacy, contract renewals, quality ratings, provider relationships, cyber and privacy risks, and Health Net integration and synergy execution.
- Management disclosed Illinois capitation-payment delays and that many state customers had not yet reimbursed the company for the 2016 health-insurer fee, which Centene paid at $513 million. These timing issues affect receivables and liquidity.
- Health Net integration involved restructuring and regulatory undertakings, including California investments, a service center commitment and healthcare-related contributions. The filing states that these obligations may add costs or constrain operations.
- Contingencies include a California taxpayer action concerning whether Health Net California owes gross-premiums tax, a putative federal securities class action alleging deficiencies in disclosures about acquired liabilities, and a Department of Justice investigative demand concerning Health Net Medicare risk-adjustment submissions. The company said outcomes could not be determined for these matters; accrued legal and regulatory amounts were not material as of the report date. Kentucky Spirit litigation was settled in November 2016 for an immaterial payment.
- KPMG issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded disclosure controls were effective.
Important facts for investors to verify
- How much of revenue and earnings growth reflects Health Net, and whether integration savings and operating performance meet management’s expectations.
- Whether the 2016 HBR improvement persists without the California retroactive minimum-MLR benefit, and how medical claims estimates develop. The filing estimates a 1% change in claims liability would affect 2016 net earnings by approximately $25 million, before certain program effects.
- Timing and collectability of state receivables, including Illinois capitation amounts and health-insurer-fee reimbursements, and the resulting effect on operating cash flow.
- Debt reduction capacity, refinancing needs, covenant headroom and the impact of higher interest expense; year-end debt was $4.655 billion and debt to capital was 44.1%.
- Developments in ACA policy and Marketplace economics, government contract renewals and new-program readiness, and the outcomes of the disclosed legal and regulatory matters.