01—Abstract
Summary
Summary of the 10-K filed February 25, 2008. Cited figures are marked; the original filing is the authoritative source.
Centene Corporation (NYSE: CNC) closed 2007 as a multi-line healthcare enterprise with two segments: Medicaid Managed Care, which serves about 1.15 million members across seven states (Medicaid 74%a, SCHIP 20%, SSI 6% of membership), and Specialty Services (behavioral health, life and health management, long-term care, managed vision, nurse triage, pharmacy benefits management, treatment compliance).
Total revenue grew 48.8% to $2.92 billionb, driven by membership growth (58.7% over two years), premium rate increases (2.7% composite in 2007) and Specialty Services expansion. Net earnings rose to $73.4 million, or $1.64 diluted EPS, but this was flattered by a $32.1 million net gain from discontinued operations (FirstGuard). Earnings from continuing operations were $41.3 million, or $0.92 diluted EPS, up from $0.47 in 2006, which had been depressed by the FirstGuard write-downs.
Margin trends were mixed. The Medicaid and SCHIP health benefits ratio improved to 83.2%c from 84.3%, helped by premium yield and moderating pharmacy costs. The SSI HBR worsened to 92.0% as new Ohio SSI business ramped up.
Operating cash flow was $202.2 milliond and the company ended the year with $268.6 million in cash and about $390.6 million in investments. Liquidity is tighter than the cash figures suggest: working capital was negative $(40.5) million because the company deliberately placed investments in long-term maturities, and the company issued $175 million of 7.25% senior notes due 2014 in March 2007 to refinance revolver borrowings, lifting long-term debt to $206.4 million. Investors should weigh several risks.
Revenue depends heavily on state Medicaid, SCHIP and SSI funding, which federal policy changes (the Deficit Reduction Act, CMS rules on improper payments and intergovernmental transfers, and a proposed $17.4 billion cut) could pressure. Contracts are generally one to two years and can be terminated for convenience in several states.
Georgia, Texas, Ohio, Indiana and Wisconsin together provided most revenue, and Georgia alone was 23%. Securities class action litigation was dismissed in June 2007, with an appeal pending, and the company guided to a Georgia premium amendment worth about $20.8 million to be recorded in Q1 2008.
02—Key points
Key Highlights
- Revenue from continuing operations rose 48.8% to $2.92 billion in 2007, with Medicaid Managed Care membership reaching 1,146,600 at year-end (up 58.7% over two years).
- Diluted EPS was $1.64 including discontinued operations, but continuing operations contributed $0.92 per diluted share, up from $0.47 in 2006.
- Medicaid and SCHIP health benefits ratio improved to 83.2% from 84.3%, while the SSI HBR rose to 92.0% due to new Ohio SSI business.
- Operating cash flow was $202.2 million, and cash and cash equivalents were $268.6 million at December 31, 2007.
- Working capital was negative $(40.5) million by design, as investments were moved into longer-duration holdings; long-term debt rose to $206.4 million after a $175 million 7.25% senior notes issuance.
- Concentration risk is significant: Georgia (23%), Texas (25%), Ohio (16%), Indiana (11%) and Wisconsin (11%) each produced a meaningful share of revenue, and contracts are subject to state termination for convenience.
- A roughly $20.8 million retroactive Georgia premium amendment will be recognized in Q1 2008, and a pending appeal of the securities class action dismissal remains open.
03—Questions
Frequently Asked Questions
How much of Centene's 2007 earnings came from continuing operations versus one-time items?
Net earnings were $73.4 million, but continuing operations earned $41.3 million ($0.92 diluted EPS). The remaining $32.1 million came from discontinued operations, mainly a $32.6 million tax benefit from abandoning the FirstGuard subsidiaries' stock, plus a $7.5 million gain on the sale of FirstGuard Missouri, partly offset by operating and exit costs. Investors should focus on the continuing-operations figure for run-rate earnings.
What is driving Centene's revenue growth?
Growth came from three sources: Medicaid membership growth (new Texas, Ohio and Georgia business and the South Carolina entry), premium rate increases averaging 2.7% on a composite basis in 2007, and Specialty Services growth from the OptiCare, Bridgeway and US Script acquisitions and launches. Specialty Services external revenue rose to $245.4 million from $192.0 million.
How concentrated is Centene's revenue by state, and what are the contract risks?
Georgia (23%), Texas (25%), Ohio (16%), Indiana (11%) and Wisconsin (11%) each provided more than 10% of 2007 revenue. Most state contracts run one to two years, and several can be terminated for convenience or lack of funding. Federal changes to SCHIP, Medicaid funding and eligibility rules are also a material risk, and the company acknowledges that SCHIP funding runs only through March 2009.
Is Centene's balance sheet strong enough to support its growth?
Liquidity is adequate. The company held $268.6 million in cash, $390.6 million in investments, and $272 million of revolver availability, and it expects this to cover operations for at least 12 months. Leverage increased, however: long-term debt rose to $206.4 million, and stockholders' equity grew to $415.0 million. Regulated subsidiaries held statutory capital of $302.1 million against a $192.3 million requirement, leaving about $110 million of cushion.
What legal and regulatory issues could affect Centene's results?
The main legal issue is a securities class action covering purchasers from April to July 2006. The district court dismissed it in June 2007, and the plaintiffs have appealed, with a decision expected in 2008. A derivative suit has been dismissed. Separately, Peach State Health Plan faces a Georgia claim over dual-eligible SSI claim payments, and the amount is uncertain. Management does not expect any of these matters to be material individually or in aggregate.
04—Continue