Centene Corp (CNC) — Q2 2019 Earnings Call Transcript

Thank you, Ed. Good morning, everyone, and thank you for joining Centene’s second quarter 2019 earnings call. During the course of this morning’s call, we will discuss our second quarter results and provide updates on Centene’s markets and products. We will also provide commentary around the healthcare legislative and regulatory environment, as well as an update on the acquisition of WellCare. Let me begin with second quarter 2019 financials. We are pleased to report another solid quarter marked by robust top and bottom line growth and operating cash flows. Membership at quarter-end was 15 million recipients. This represents an increase of 2.2 million beneficiaries or 17% over the second quarter of 2018. Second quarter revenues increased 29% year-over-year to $18.4 billion. The HBR increased 100 basis points year-over-year to 86.7%. This was primarily attributable to the Marketplace business. As expected, margins have normalized from the favorable performance in 2018. The increase was also attributable to the HIF moratorium as well as the acquisition of Fidelis. We reported adjusted second quarter diluted earnings per share of $1.34. This compares to $0.90 reported in the same period last year, representing 49% year-over-year growth. Lastly, operating cash flows came in at $917 million or 1.9 times net earnings. This is the high end of our previously stated range of 1.5 times to 2 times net earnings. These solid results reflect the benefit of our ongoing diversification strategy, which has led us to become a $74 billion enterprise. We are no longer simply a Medicaid healthcare company. One has to look at the totality of this enterprise, as the scale and diversity allow us to absorb the ups and downs in rate cycles, markets, and subsidiary performance. This ensures that no one part of the portfolio can jeopardize our total organization. Jeff will provide further financial details including updated 2019 guidance in his prepared remarks. A quick comment on medical costs: they remain stable and in line with our expectations in the low single digits. Moving onto markets and product updates; first we’ll discuss Medicaid activity. Our Medicaid book of business continues to perform well in the second quarter. At June 30, we had 8.5 million recipients, representing year-over-year growth of 1.3 million or 18%. We continue to win Medicaid RFPs in new and existing states, upholding our industry-leading RFP win rate of 80%. Now onto state updates. In Oregon, in July, Centene successfully re-procured its Oregon Medicaid managed care contract. We expanded our presence under this new contract, adding three additional counties. We will now be operating in six counties including Metro Portland. Centene currently provides care to 92,000 beneficiaries in the state. The additional three counties will significantly increase our membership in Oregon. We look forward to continuing to work with the state, demonstrating the value of integrated care, focusing on social determinants of health, and maintaining sustainable cost control. The new contract is expected to commence January 2020 and will run through December 31, 2024. In Iowa, on July 1, we began operating in Iowa’s Medicaid managed care program, a new state for Centene. Operations commenced as expected, and we are now providing healthcare to approximately 254,000 beneficiaries. Iowa is committed to operating a sustainable Medicaid managed care program, as evidenced by the recent rate increase which we did anticipate. We expect to achieve a normal margin within the typical ramp-up period for any new Medicaid contract. Iowa marks Centene’s 32nd state of operation. In New York, it has been just over one year since we closed the Fidelis acquisition, and we could not be more pleased with the performance. The integration of the company is running smoothly, and we are realizing our synergy and accretion targets. In North Carolina, as we have previously noted, Centene won two large regions in North Carolina Medicaid RFP and has an active appeal for the balance of the state. We remain cautiously optimistic regarding our appeal. In Texas, Texas recently decided to delay the start of the procurement announcement until the end of August. We remain confident in the value we bring to the state. Louisiana has also delayed the announcement of its reprocurement. We now expect to hear late July and remain confident in our prospects there. Next, regarding Medicare, at June 30 we served just under 400,000 Medicare and MMP beneficiaries across 20 states. This represents a year-over-year increase of approximately 55,000 recipients. On a sequential basis, membership increased by over 4,500 recipients. As we previously commented, we expect 2019 MA revenue and membership to be flat compared to 2018. This is net of the actions taken by Fidelis to reestablish their poor star rating, which includes exiting 26 counties in 2019. Next year, we plan to expand into 100 counties in existing states and add one more new state, Nevada. We will begin our joint venture with Ascension in poor geographies in 2020. Further, Centene will return to a four-star MA parent rating, and the addition of WellCare’s high-performing MA portfolio will bolster our MA platform. Going forward, this should accelerate profitable long-term growth in 2020 and beyond. Now, Health Insurance Marketplace: the Marketplace business continues to perform well consistent with our expectations. At June 30, we served approximately 1.9 million exchange members across 20 states. This represents a sequential decline of 58,000 recipients, which is lower than our historic attrition rate. We continue to see higher member retention than in prior years, which we previously noted. Importantly, the key demographics of our membership remain in line with our previous remarks on this subject. Consistent with our previous comments, our Marketplace margins continue to be in the 5% to 10% range. We continue to anticipate another strong year of operations as the national leader of exchange products and expect to continue to grow this business in 2020. Next, international; in late June, we purchased an additional 40% ownership in Ribera Salud from Banco Sabadell, expanding our stake to 90%. We believe our knowledge and skills along with our leading-edge IT systems have further enhanced an already strong business in Spain. We continue to look for opportunities to expand our international business. Please note, our growing international business will not distract or impede our ability to pursue the growth opportunities in the U.S. I will now provide an update on the healthcare legislative regulatory environment. Although there appears to be no immediate plans to revisit comprehensive healthcare reform, Congress and the administration continue exploring ways to improve healthcare delivery systems. We support the administration’s decision to withdraw its rebate proposal to eliminate the existing safe harbor protection within Medicare and Medicaid. While Centene still needs to take up the matter, the House recently voted on a very bipartisan basis to eliminate the health insurance fee. Importantly, there are opportunities in which we can work together to bring down not only pharmaceutical costs, but costs across the entire healthcare delivery system. The administration’s approach to deal with the rebate tool is another example demonstrating how Centene does not focus on short-term headline volatility. We focus on the facts as we know them today. We continue to advocate for greater price transparency, which includes moving towards net pricing in the pharmacy space. In the same vein, we commend Congress on their bipartisan effort to take steps to reduce the amount of money Americans pay out of their pocket for their healthcare costs by ending surprise billing. We continue to see efforts both in Washington State that further stabilize the marketplace. The administration’s final rule allowing employers to offer HRAs as an option to pay for marketplace coverage provides an opportunity to have a positive impact on premiums. Also, pending waivers in Utah and Georgia aim to stabilize the marketplace and provide affordable comprehensive coverage to those between 100% and 250% of the Federal poverty level. This has the potential to improve affordability for those with and without subsidies. As exemplified by Georgia, states are taking the lead with meaningful discussions on how to improve and expand government healthcare programs. They are focusing on taking private sector solutions to enhance quality and lower the cost of healthcare. We are well positioned to be supportive of these efforts. We are encouraged by anything that moves us back from politics and into policy. Centene is committed to working with both parties on bipartisan solutions that strengthen the nation’s healthcare delivery system. I would now like to provide an update on the acquisition of WellCare. We were pleased that shareholders of both Centene and WellCare overwhelmingly approved the acquisition on June 24. We appreciate the mandate of our investors as they recognize the value of this transaction. Regulatory discussions are well underway and have been very constructive. Both companies are currently working through the state insurance approval process required for the completion of the transaction. The required Forms As and Es have been filed in 27 states. Additional approvals have been obtained in eight states, which is ahead of schedule. Where applicable, the divestiture process is underway, and we are pleased to be seeing a great deal of interest from potential acquirers. Centene and WellCare have each received a request for additional information and documented materials from the Department of Justice. This was expected given the size of this transaction. Both companies continue to work expeditiously and cooperatively with the DOJ. Integration planning is well underway. Our teams are doing extensive work to ensure a smooth and seamless combination of the companies. Both companies are fully engaged, and integration planning is progressing well. We remind you that the combined company will have estimated pro forma 2019 revenues in excess of $100 billion and EBITDA of $5 billion. We are comfortable with our previously communicated synergy and accretion targets. We continue to be comfortable that we will receive all necessary approvals to close the deal in the first half of 2020. Given the progress of activities to date, there may be an opportunity to close earlier in 2020. Shifting gears to our RADAR growth, we expect a composite Medicaid rate increase of approximately 1.5% to 2% for 2019. In summary, Centene continues to be a growth company both organically and through M&A. Our targeted pipeline remains robust. We continue to focus on margin expansion and are already realizing benefits from our Centene forward transformation project. The pending WellCare acquisition firmly solidifies our 2020 vision of maintaining our industry-leading position in the highly competitive government-sponsored healthcare market. We look forward to leveraging the strengths each company brings in terms of providing high-quality healthcare at lower costs to our recipients and state customers. We thank you for your continued interest in Centene. And I’ll now turn it over to Jeff.

Thank you, Michael, and good morning. This morning we reported solid second quarter 2019 results. Second quarter revenues were $18.4 billion, an increase of 29% over the second quarter of 2018, and adjusted diluted earnings per share was $1.34 this quarter compared to $0.90 last year. Adjusted diluted earnings per share for the second quarter of 2019 was driven by solid performance across our business segments. The reconciliation of the 2018 marketplace risk adjustment, which exceeded our expectations by $0.05 per diluted share, and $0.03 per diluted share associated with a gain on the Ribera Salud acquisition. Let me provide additional details for the quarter. Total revenues grew by approximately $4.2 billion over the second quarter of 2018, primarily as a result of the acquisition of Fidelis Care, growth in the Health Insurance Marketplace business, and expansions and new programs in many of our states in 2018 and 2019, particularly Arkansas, New Mexico, and Pennsylvania. This growth was partially offset by the health insurer fee moratorium in 2019. Moving on to HBR, our health benefits ratio was 86.7% in the second quarter of this year compared to 85.7% in last year’s second quarter and 85.7% in the first quarter of 2019. The HBR increase was primarily driven by the performance in the Marketplace business, the acquisition of Fidelis, which operates at a higher HBR, and the health insurer fee moratorium. As we have highlighted previously at our Investor Day, we expected a return to more normalized margins in 2019 for our marketplace business. Additionally, we continue to experience a higher membership retention rate compared to prior years. As members stay with us longer, it increases medical costs in the HBR. I just want to emphasize that this is a slight increase, and we are still well within our 5% to 10% pre-tax margin targets for the product. Sequentially, the 100 basis point increase in HBR from the first quarter of 2019 is primarily due to the performance and seasonality in the Health Insurance Marketplace business. Before I get into SG&A, let me provide an update on the Marketplace business. As expected and highlighted at our Investor Day, the final risk adjustment was lower than our year-end accrual by $238 million. Additionally, after adjusting for other risk-sharing programs, including MLRs and our estimated RADV adjustment and other programs, the net amount exceeded our expectations by approximately $31 million or $0.05 per diluted share. Recall, we had included approximately $100 million in our annual guidance. This benefit was driven by our Centene Forward program, and as highlighted during our Investor Day in June, we are reinvesting this amount and other Centene Forward initiatives in the back half of the year. Now on to SG&A. Our adjusted selling general and administrative expense ratio was 9% in the second quarter of this year compared to 9.6% last year and 9.5% in the first quarter of 2019. The year-over-year decrease was primarily driven by the acquisition of Fidelis Care, which lowered the ratio by 60 basis points. The sequential decrease is primarily due to the higher selling costs in the first quarter associated with the Marketplace and Medicare products. Additionally, we spent $0.04 per diluted share in business expansion costs during the second quarter. Investment in other income was $120 million during the second quarter compared to $65 million last year and $99 million last quarter. The increase reflects increased investment balances over 2018 as a result of the Fidelis Care acquisition, higher interest rates, and a gain of $16 million associated with this step-up in basis of our previously held equity investment in Ribera Salud upon acquiring a controlling interest. Sequentially, investment income increased due to the previously mentioned gain on the acquisition of Ribera Salud recognized in the second quarter. Interest expense was $101 million for the second quarter of 2019 compared to $80 million last year and $99 million last quarter. The increase year-over-year was driven by the additional debt to fund the Fidelis acquisition and higher interest rates associated with our interest rate swaps. Our effective tax rate for the second quarter was 25.7% compared to 36.9% in the second quarter of 2018, which reflects the impact of the health insurer fee moratorium. Now onto the balance sheet. Cash and investments totaled $15.9 billion at quarter-end, including $801 million held by unregulated subsidiaries. Our risk-based capital percentage for NAIC filers continues to be in excess of 350% of the authorized control level. Debt at quarter-end was $7.1 billion, which includes $513 million of borrowings on our revolving credit facility. Our debt to capital ratio was 36.3%, excluding our non-recourse debt, compared to 36.7% last year and 36.5% at the first quarter of 2019. Our medical claims liability totaled $7.4 billion at quarter-end and represents 47 days in claims payable compared to 48 days in the first quarter of 2019. We continue to expect the DCP to be in the mid-40 range on a run-rate basis with the inclusion of Fidelis. Cash flow provided by operations was $917 million in the second quarter or 1.9 times earnings. The cash provided by operating activities in the second quarter of 2019 was due to net earnings collections as premium and trade receivables and an increase in other long-term liabilities driven by the risk adjustment payable for the Health Insurance Marketplace business in 2019. Lastly, I would like to highlight a few of the changes to our 2019 annual guidance. We are increasing the total revenues guidance at the midpoint by $700 million to reflect the second quarter results and higher membership retention in the Marketplace business. Additionally, we are increasing our GAAP and adjusted diluted earnings per share guidance at the midpoints by $0.03 and $0.05 per share respectively associated with the second quarter performance and the gain from the Ribera Salud acquisition. While risk adjustment delivered an additional $0.05 per diluted share of earnings during the quarter, we are reinvesting the additional earnings and other initiatives to accelerate the Centene Forward program. Overall, the operating metrics for the second quarter were good across all of our business segments. We believe the continued growth in revenue provides opportunities for future earnings growth. That concludes my remarks. And operator, you may now open the line for questions.

Thanks. Good morning.

Good morning.

I just wanted to start on the exchanges. And maybe just update us in terms of the margin front. I know that you’re still within that 5% to 10% range. Just interested in terms of are you tracking sort of right to where you had thought previously? And any sense in terms of within that range you maybe sort of tracking for the year. Then just as a follow-up, just on the exchanges as well. Just interested, we’re seeing a lot of the rate filings coming out and the proposed rates for 2020. And just interested in your updated views on how the pricing environment appears to be trending for 2020 and the exchanges and just reviews on whether competition is increasing in the marketplace? Thanks.

Okay. I want to start off with the margins, make a little comment on competition, and then let Jeff and Kevin and others comment. The margins are well within a 5% to 10% targeted range. I cannot emphasize enough to everybody that in this business and I’ve said this historically at Investor Day so many times, you will see movement up and down within that range. Now in this instance, we commented our retention of membership has been longer than we have typically seen. That means we are going to get increased revenue because we’re retaining that membership. They will reach their maximum out-of-pocket. Some of the costs will go up, but we’ll still have increased revenue and increased earnings from that increase. It’s the nature of this insurance business. And it’s really what one expects. The longer we retain a member, the better it is because over time, we have demonstrated we’re keeping them for a long period of time while also bringing down the cost for that person. So as I said, it’s a little frustrating to see people concerned about a margin moving, which is doing so well within the range, is normal health insurance performance and shows that this business is really growing and performing as we expected. And we’ve commented earlier to expect this. So from a margin standpoint, it’s doing just what we wanted to do and what we expected to do. We see that continuing. And the longer you keep the member, the higher the MLR it might go. But also, you get all that incremental revenue in the end which gives you actual dollar earnings increases, and the shareholders, everybody benefit from it. I'll start off a little bit from the competitive standpoint, but we like competition. And we think it’s important; it just makes us better. We’ve also commented that in our segment, which is 400% the Federal poverty level and below, that it’s fully subsidized, highly subsidized, and therefore price in those types of issues do not give someone trying to commit on price an advantage. So I think this is a solid business. The actions we took in building it and becoming a leader of it I think it’s going to pay a lot of dividends for our shareholders going forward. Jeff, anything you want to add?

Yes. I think Michael addressed the member staying longer comment. The only thing I would like to bifurcate is we did talk about previously about margin normalization and if marketplace margins would be consistent with 2017, 2016, and 2015, and that 2018 was a very good year. And so that piece was completely expected in our forecast. And then the second piece, I think that Michael mentioned here was the member staying longer, which just to highlight, we’ve increased our guidance, our revenue guidance over $1.4 billion for the first and second quarters here, really due to the member retention and them staying longer. And I completely agree with the comments you stated.

I want to make one more comment. When we have a $75 billion business, similarly, you have a $20 billion, $30 billion business. And we have more complexity, you have more products, you have more states. It’s going to be some variability, but it’s really a very strong position to be in, and that it really affords us the offsets. With that side business, and now going international – even every market may have an issue. It’s no different than investors that have funds and have a stock that maybe is not performing if others have offset it. Marketplace is one of our key strengths, and I can’t emphasize that enough, Scott.

Got it. And it sounds like Michael, so just to clarify on 2020, with what you’re seeing the pricing at this point, it sounds like you’re still comfortable with the growth rates that you’ve been targeting in that market for next year.

Yes. I think I commented in my prepared remarks that I expected to grow next year. So, and I think that’s – and I still feel that way.

Good morning, Kevin.

Good morning, thanks. So I guess maybe two questions. First question being when you think about the guidance update, there are a few items in there. You had the $0.03 gain, and then you had the $0.05 that came in, but I think you’re spending $0.05 away. When you think about the components of the guidance raise, because I think the raise is a little bit less than what the beat leverage versus consensus in the quarter. How do you think about that guidance raise? How much of that is kind of core operational earnings versus kind of one-time things versus potential offsets as far as reinvestments?

I will make one comment and Jeff can go into all the detail you want, okay. But what we’re trying to say is that we have this Centene Forward, which is really working well. It’s going to – it’s used to free up funds to invest in technology and the things that are paying big dividends going forward, couldn’t be more pleased with it. What happened is we started to realize results in this quarter. And the shovel-ready projects won’t be ready until next quarter. So we had to take the earnings, but – and in fact said, we’ve taken the earnings this quarter. But next quarter, we’re going to have the expense. And Jeff, you might just further…

Yes. I mean, a couple of things I would say is that if you’re comparing to, I think, the consensus number, I think that was around $1.24, that’s $0.10. So we were at $1.34. So that’s a $0.10 beat. $0.05 is really driven by what Michael mentioned to Centene Forward, which we’re reinvesting in the back half of the year. And then you would have another, call it, $0.05, $0.03, from the Ribera Salud gain and call it $0.02 from operations, if you’re comparing to consensus. And so I would say the guidance raise was in line with that. It’s the $0.03 from the Ribera Salud gain plus $0.02 from operations, again if you’re comparing against consensus that we increase the guidance by.

Okay. That’s helpful. And then I guess the second question being, it looks like you raised the MLR guidance by 10 basis points. Can you talk a little bit about what was driving that? I would have thought that the better exchange enrollment and retention might have helped bring that MLR down a little bit.

Yes. So if you’re comparing to year-over-year and specifically for this year, I think Michael commented on the higher member retention. So, what we did have in the forecast was the margin normalization. And we talked about that at our December and probably Q1 earnings calls that we anticipated that exchange margins would be similar to 2017 and prior and then 2018 was a very good year. And so Michael commented on the membership retention and if members are staying longer, it’s increase in the HBR, the margins just a little bit, and that’s why we did the tenth on the increase in the HBR guidance.

In other words, Kevin, they stay longer, so they reach the maximum amount of profit. It doesn’t mean that their health conditions have deteriorated; if anything, over time, we’ll see improvements the longer we keep them. But that’s really why you see that jump – it’s a normalization of the business. And the good news is, I like the fact we’re retaining people, this is longer term; we’re going to have a very strong base there.

I mean, I clearly can see why the higher MLR versus a normal exchange person. But I thought a normal exchange person had below-average MLR. So even if it was higher than an average exchange person, it might be lower than your consolidated MLR. You’re saying that if you keep them longer, it’s actually higher than your consolidated MLR, which holds up your consolidated MLR?

No. No. It’s just higher than our previous expectations, Kevin. I mean, we had – I mean, if you look at the Q1 and Q2 how we raised guidance at the top line, that’s over – almost $1.4 billion of additional revenue. And what we’re saying is that that MLR is higher than our expectations that we originally had. So the members are staying longer, which is outside of our expectations well and we’re adjusting the forecast for that.

Hi. Good morning.

Good morning.

Thanks for taking my question. I wanted to follow up on MLR just with a cadence question. I think the first half; MLR is up about 120 basis points year-over-year. The guidance implies that the second half would be up a little less than that. Your update on exchange sounds like that drags the back half of the year up a little bit. So, I wondered kind of what’s the offset that makes that year-over-year change smaller in the second half? Is it Fidelis? Is that it exclusively or are there other factors? Thanks.

Well, I think if you’re comparing year-over-year first half to second half, obviously, Fidelis is a change, meaning we did not have that in the first half of last year, right? And we do have Fidelis in the first half of this year. And as we’ve commented, they were running higher HBR than the Centene-based business when we did the acquisition. So that is definitely a driver.