Centene Corporation (NYSE:CNC) Q2 2023 Earnings Call Transcript

Centene Corporation (NYSE:CNC) Q2 2023 Earnings Call Transcript July 28, 2023

Centene Corporation misses on earnings expectations. Reported EPS is $1.77 EPS, expectations were $2.01.

Operator: Good day, and welcome to the Centene Second Quarter 2023 Earnings Conference Call. [Operator Instructions] Please note, today’s event is being recorded. I would now like to turn the conference over to Jennifer Gilligan, Senior Vice President, Investor Relations. Please go ahead, ma’am.

Jennifer Gilligan : Thank you, Rocco, and good morning, everyone. Thank you for joining us on our second quarter earnings results conference call. Sarah London, Chief Executive Officer; and Drew Asher, Executive Vice President and Chief Financial Officer of Centene, will host this morning’s call, which also can be accessed through our website at centene.com. Ken Fasola, Centene’s President, will also be available as a participant during Q&A. Any remarks that Centene may make about future expectations, plans and prospects constitute forward-looking statements for the purpose of the safe harbor provision under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by those forward-looking statements as a result of various important factors, including those discussed in Centene’s most recent Form 10-K filed on February 21, 2023, and other public SEC filings.

Centene anticipates that subsequent events and developments may cause its estimates to change. While the company may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so. The call will also refer to certain non-GAAP measures. A reconciliation of these measures, with the most directly comparable GAAP measures, can be found in our second quarter 2023 press release, which is available on the company’s website under the Investors section. The company is unable to provide a reconciliation of certain 2024 measures to the corresponding GAAP measures without unreasonable efforts due to the difficulty of predicting the timing and amounts of various items within a reasonable range.

With that, I would like to turn the call over to our CEO, Sarah London. Sarah?

Sarah London : Thank you, Jen, and good morning. Thank you for joining us for Centene’s Q2 earnings call. Our second quarter performance demonstrated Centene’s ability to deliver solid results amid a dynamic healthcare landscape. We reported $2.10 of adjusted diluted EPS for the quarter and lifted our 2023 premium and service revenue forecast by another $1.8 billion. We now expect to deliver at least $6.45 of adjusted EPS for full year 2023, a $0.05 increase compared to April guidance. We are proud of the progress we are making with respect to the execution of our strategy, achieving operational milestones, while delivering on the financial commitments we’ve made to our shareholders. Importantly, our balanced portfolio of core businesses delivered strong second quarter financials, with Marketplace growth and Medicaid performance both running slightly ahead of expectation.

Let me provide a few updates related to our progress in each business line, and then share the latest on our value creation work. Let’s start with Medicaid. Since our Q1 call, Medicaid redeterminations have formally kicked off in every one of our 30 active states. The time our team spent over the last 18 months preparing for redeterminations has positioned us well to support our state partners, establishing timely information exchange and shared workflow as well as reaching out directly to members to provide education around process and enrollment options. Year-to-date, we have made 9 million outreach attempts, with early indications of higher-than-normal member engagement. These outreach efforts, inclusive of more than 15,000 community events, also contribute to our ability to recapture members, even if initially disenrolled as part of redeterminations.

We are actively tracking the number of members that we are recapturing post-procedural disenrollment and expect the percentage to meaningfully advance as this process unfolds. At an enterprise level, net Medicaid membership is consistent with expectations. We have seen ebbs and flows from month to month as states continue to evolve and refine their processes. Given the recent news that CMS is requiring states — certain states to pause redeterminations and reinstate members who were dropped for procedural reasons, we will be closely tracking any impact this may have on the membership slope over the next few months. Much of the redeterminations’ journey remains ahead, and we continue to monitor the major levers, including rate, acuity and membership.

Based on our most recent analysis and informed by member lists and acuity projections from our state partners, our expectation around member acuity for 2023 remains unchanged. As we assess who is staying versus leaving, we are tracking consistent with the acuity modeling we discussed on our first quarter call in April. Medicaid rate conversations continue to be constructive. We are consistently seeing states take acuity adjustments into consideration in their rate updates. And at an enterprise level, we remain on track with our expectations for 2023. Overall, we are grateful for the partnership and trust placed with us by the states we serve and for the leadership CMS has shown in helping us to ensure that eligible Medicaid members do not experience unnecessary coverage gaps as states work through the unprecedented scale of this redetermination process.

From a Medicaid business development standpoint, we chalked an exciting new business win in June, as our team in Oklahoma was selected by the Oklahoma Healthcare Authority for statewide contracts to provide managed care for the SoonerSelect and SoonerSelect Children’s Specialty Plan programs. The team delivered a strong RFP response and was the sole source winner for the Children’s Specialty program, designed to serve children and families involved in the child welfare and juvenile systems, including foster care. This represents Centene’s 31st state and our sixth Sole Source Foster Care contract. Overall, Medicaid, our largest and longest-running business, delivered strong results in the second quarter, and our market teams continue to prove the value of the local approach, demonstrating innovative and comprehensive support for our members and state partners as we continue to execute against redeterminations in the coming months and quarters.

Turning to Medicare. Our quarter-end membership was 1.3 million, with approximately 47% of Medicare Advantage lives associated with value-based care arrangements, a 300 basis-point increase from Investor Day as we’ve added key VBC partners to our network. Second quarter results reflect some slightly higher outpatient claims experience within Medicare during the month of May. Drew will provide more detail on this as well as our bid posture for 2024, but it is worth noting that our increased 2023 adjusted EPS guidance incorporates our latest view of trend and pockets of slightly higher Medicare utilization in the back half of the year should that occur. Given our discussion in Q1 around Stars, I’d like to provide an update on what we expect to see in October and what we are seeing year-to-date around Stars’ improvement efforts that will inform future results.

As a reminder, on our Q1 call in April, I shared that we expected minimal progress in 4-star plans, but that we anticipated solid overall contract improvement, reflecting the operational investments we have made. With more complete program data, our projection show some more pressure on 4-star results, but we are still expecting solid overall contract progression, thanks to strong improvements in admin and ops and pharmacy measures, which have been our focus in this first cycle. With several contracts close to the bubble, variability in cut points means we could end the cycle with no 4-star contracts compared to our current single contract representing 2.7% of members. While this is disappointing, we do expect to see meaningful movement in our 3- and 3.5-star bands in October, and roughly 2/3 of our members are in plans showing year-over-year improvement.

Pulling up these underperforming contracts represents tangible progress in delivering economic value to Medicare as we look to 2025 and beyond. As a reminder, in Q1, we reset our quality strategy to maximize contracts that reach the 3.5-star threshold, consistent with our renewed focus on serving complex and dual-eligible members beginning with our 2024 bids. Put simply, Star strategy is different when you’re managing complex and duals populations. Strong performance at 3.5 stars with Centene’s target member mix will give our Medicare business the economics necessary to serve these populations well and support our multiyear performance goals. With this in mind, we have set a revised target of reaching 85% of members in 3.5 star plans by October of 2025.

We are closely monitoring in-year Star metrics and continue to see important markers of sustained improvement, consistent with our remarks on the Q1 call. A few examples include: a 27% reduction in year-over-year call volumes resulting from a redesigned member onboarding process that features digital outreach and member self-service; consistent 4-star performance in our core admin and ops metrics; call center service levels for members, providers and brokers at or above target with first call resolution in the mid-80s; year-to-date member provider and broker satisfaction scores in the mid-90s; and the addition of 24,000 new physicians across our Medicare network year-to-date as we look to ensure robust access options for our members. Medicare Advantage provides Centene with an important opportunity to serve low-income and medically complex seniors.

It also represents a significant long-term earnings opportunity as we strengthen the overall performance and trajectory of our program. Moving to Marketplace. Our Ambetter Health franchise continues to outperform. This truly differentiated asset creates a unique growth opportunity for Centene, both near and long term. We ended the quarter with 3.3 million Marketplace lives exceeding our previous projections. Our strong membership results were driven by strategic product design, long-standing and differentiated broker relationships and overall market growth. Our large and growing Marketplace platform is well positioned to provide coverage to beneficiaries losing Medicaid eligibility from redeterminations, and we are leveraging our networks and engagement tools to support members during this transition.

Where states allow, we are educating our Medicaid members about Marketplace options and are working to proactively communicate with members who we predict will likely be eligible for Marketplace in order to preserve continuity of coverage. During just May and June, Ambetter Health successfully outreached to potential members with more than 160,000 digital touch points via e-mail or SMS as part of our redetermination efforts. We expect this dynamic will continue to fuel growth in Marketplace throughout the remainder of the year and into 2024. Finally, our value-creation initiatives are advancing well. We continue to take a rigorous approach to streamlining core SG&A as we focus and fortify the organization for the future. This includes additional work to standardize our operating model, while maintaining the hyper local care that differentiates Centene in the market.

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The implementation of our new PBM contract remains on track, as we’ve achieved all first half 2023 milestones and look forward to our first go-live dates in early 2024. Our portfolio review work also continues. And in June, we closed the divestiture of Apixio to New Mountain Capital. We structured the transaction to maintain an ownership position as well as a long-term contract because of our view that Apixio’s proven artificial intelligence tools are uniquely positioned for this moment in healthcare technology. We believe that partnering with New Mountain will allow Apixio to innovate rapidly through continued investment, while we continue as an influential customer and minority owner. This is a great example of our thoughtful efforts to maximize long-term value as we reposition noncore assets.

In parallel, as our value-creation efforts create operating bandwidths, we continue to build our M&A pipeline and look forward to diversifying our capital deployment as strategic opportunities for inorganic growth emerge. Overall, Centene delivered another quarter of solid financial results, while executing against a robust list of transformative initiatives to move our company forward. With half of 2023 in the books, we are excited to leverage our positive momentum as we work to support our state partners throughout the duration of redeterminations, maintain our leadership position in Marketplace, and strategically realign our Medicare Advantage business, building momentum around Star and positioning our products for long-term growth and profitability.

Centene’s improved earnings power in 2023 is a direct result of the focus and hard work that our organization is demonstrating every single day across our markets. We remain confident in our ability to achieve greater than $6.60 of adjusted earnings per share in 2024 as we continue to execute against our strategic framework, creating value for members, customers and shareholders alike. With that, I’d like to turn the call over to Drew to review the quarter and our financial outlook in more detail. Drew?

Drew Asher: Thank you, Sarah. Today, we reported second quarter 2023 results of $35 billion in premium and service revenue and adjusted diluted earnings per share of $2.10, up over 18% from $1.77 in Q2 of 2022. Our Q2 consolidated HBR was 87.0%, consistent with our expectation and on track with our full year guidance range. Medicaid at 88.9% was a little favorable from the item that we mentioned on the first quarter call, and so far so good on matching rates with acuity, though it is still early in the redetermination process. Medicare at 86.2% was a little higher in the quarter than planned as we also saw May outpatient incurred claims higher than the January through April period, largely in outpatient surgery. With respect to progression, May outpatient trend was higher than April, then it came down in June.

July so far is steady with June. Inpatient was on track, and our previous guidance already assumed a Q1 Medicare HBR favorability would not continue. The commercial HBR of 81% was consistent with our expectations, inclusive of continued strong Marketplace growth of 200,000 members in the quarter. Recall that special enrollment period members start with a lower margin profile and therefore, higher HBR than full year members, due in part to risk adjustment mechanics, where the shorter duration doesn’t get full credit for health conditions. Though if retained for the following year, the SEP cohort has proven to be attractive. Our guidance contemplates growth to a peak of approximately 3.6 million members in Q4. On the topic of Marketplace risk adjustment, 2022 was recently finalized by CMS, and we received our first view of the 2023 risk adjustment from the Wakely data in June and July.

Overall, no surprises in Marketplace risk adjustment. And as of June 30, we have lowered our booked risk adjustment revenue estimates by a cumulative $314 million given the financial condition of a couple of Marketplace competitors. Though we have made this prudent adjustment to our revenue over each of the past five quarters, we plan on fully asserting our rights to collect what we are owed for risk adjustment. To be clear, we have already absorbed this $314 million hit, and this was the biggest reconciling item between the CMS published amount owed to us for 2022 and what was on our books prior to June of 2023. Moving to other P&L and balance sheet items. Our adjusted SG&A expense ratio was 8.6% in the second quarter compared to 8.2% last year, consistent with our updated mix of business.

Cash flow provided by operations was $2.5 billion in the second quarter, primarily driven by net earnings and the timing of premium payments from our state partners. Our domestic unregulated and unrestricted cash on hand at quarter end was $200 million. During the second quarter and through July, we repurchased 10.5 million shares of our common stock for $700 million. Year-to-date, we have repurchased 15.4 million shares for $1.08 billion. We also reduced debt by $300 million in the quarter and achieved debt to adjusted EBITDA of 2.9x. Our medical claims liability totaled $17 billion at quarter end and represents 52 days in claims payable compared to 54 in Q1 of ’23 and 55 in Q2 of ’22. The decrease was driven by state-directed payments that we collected over prior quarters and paid out in a lump sum in Q2, the largest related to California Hospital and Prop 56 payments, representing $713 million or 2.2 days sequentially.

Outside of adjusted earnings, during the second quarter, divestiture activity produced a net $0.11 gain in the quarter, and we also recognized additional real estate impairments of $0.02, consistent with our ongoing real estate optimization initiatives. Now let’s turn to the full year of 2023. We are pleased with the performance of the company in the first half of the year and are increasing our outlook to at least $6.45 of adjusted EPS for 2023. We are increasing 2023 premium and service revenue by $1.8 billion to reflect an additional $800 million of state-directed payments as well as refinement in Medicaid and Marketplace premium revenue progression throughout the year. Our 2023 guidance continues to include an approximate $200 million Premium Deficiency Reserve for Medicare, as we discussed on the Q1 call.

The PDR would be recorded in Q4 of 2023. 2023 guidance also includes a little over $1 billion in investment income, excluding divestiture gain and losses. To go a little bit deeper in Medicaid for 2023, during our first quarter call, we discussed many of our assumptions related to redeterminations that supported our forward projections. We have continued to monitor the actual member data against our projections by state and subpopulation. And as of July, we are tracking consistent with that updated forecast that we provided in April. The matching of rates to acuity continues to be a very important lever for the company as we navigate the redeterminations process. 14 of our 30 states provide rate updates between 7/1 and 10/1 each year. 12 of those have provided us rates, all of which include acuity adjustments.

The other two are still working on rate updates. And based upon discussions, we expect those also to include acuity adjustments. Beyond 2023, we are continually assessing our positioning for 2024, whether analyzing redetermination data and rate actions, assessing our 2024 bid assumptions in Medicare against current data, or examining our continued growth and performance of Marketplace. Accordingly, we continue to have confidence in our 2024 adjusted EPS floor of greater than $6.60. To give you a little bit more color on 2024, that $6.60 has an embedded forecasted ballpark $0.80 loss from Medicare Advantage. In other words, if we were merely breakeven in Medicare Advantage in 2024, that $6.60 would be approximately $7.40. Let me close by addressing some of the concerns I’ve heard over the past few months.

Number one, redeterminations. Our early results are playing out well compared to our assumptions, and states understand that in order to have actuarial soundness, acuity adjustments are necessary. Still plenty of execution ahead, but being on track is a good start. Number two, Medicare trend. We came into the year assuming double-digit outpatient trend, and did so again for 2024. And as you know, our Medicare business is under construction for 2024, as we are investing in certain products and pulling back in others. Based upon current forecasts, we expect our Medicare segment to produce approximately 14% of our premium and service revenue in 2024 compared to 16% in the current quarter. And any change in our view of 2024 margin in Medicare, better or worse by the time we get to the fourth quarter of 2023, merely flexes the PDR we booked in 2023 up or down.

Number three, growth. We couldn’t be more pleased with our performance in the Oklahoma RFP for both broad Medicaid and foster care, and we look forward to the State of North Carolina implementing Medicaid expansion. We continue to execute well in Marketplace, where our industry-best overall position has enabled us to grow Marketplace membership 62% year-over-year. And while yes, we have to get through the rest of redeterminations, we still have value creation initiatives to execute upon and we have years of work ahead on Stars, there’s a lot to like here. So while the market trades us at 10x to 11x earnings, we’ll keep on executing, buying Centene shares and building up our M&A pipeline to acquire as we create operational capacity. Thank you for your interest in Centene.

Operator, Rocco, you can open the line up for questions.

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Q&A Session

Operator: [Operator Instructions] Today’s first question comes from Stephen Baxter at Wells Fargo.

Stephen Baxter : I still think there’s maybe a little bit of confusion out there about the adjustments you’re talking about on the exchanges in the quarter. Maybe you could break down those adjustments a little bit further, just so we can really assess core performance. I guess potentially, what was the benefit related to the 2022 plan year that you saw in the quarter? And then you’re also talking about lowering booked revenue, I think, related to the financial conditions of some of the potential payers in the market. Is that related to 2022, or 2023, or some combination of both? I guess just trying to understand the underlying components of that $350 million figure you cited a little bit better?

Sarah London : Stephen, thanks for the question. I appreciate it. This is obviously an important dynamic to understand. I’ll let Drew walk through the mechanics and address your question, but there’s one important point and takeaway that I do want to make sure we don’t lose, which is that it is a testament to strength and experience of our Ambetter team, that were not only demonstrating tremendous growth, but ensuring that growth is profitable through prudent risk adjustment planning. And I think that’s sort of the overlay to all of this, but let me make sure that Drew walks through all of the mechanics.

Drew Asher: Yes, Stephen. And understandably, it’s a little complicated. And it’s difficult to define some of these numbers with public information heretofore. So let me try to make it clear. So let’s start with 2022 risk adjustment. The CMS final announcement was that we were owed $648 million. And as you did and others, you could look back at our 10-K and see that we had $58 million on our books at year-end. So it’s a $590 million difference. You heard the $300 million-plus item, that’s almost completely related to the 2022 year. We have a little bit of that for ’23 as one of those competitors was in the exchanges in certain markets for about half a year this year and appeared to be out now. So 300 — over 300 is the largest reconciling item.

And then similar to what you heard yesterday from one of my peers, there is margin on estimates. Just like in IBNR, you put margin on estimates because you never want to book to an exact 50-50 outcome. And so that margin rolls every year. That’s about $100 million. So that doesn’t drop to the bottom line. It gets reestablished. And then breakage for minimum MLRs where we’re really performing well in some of our contracts. We have RADV accruals. And so you get through all of that, you get down to $39 million would have been the P&L benefit for — recognized in ’23 for the final issuance of what we are owed by CMS, and that was recognized over first and second quarter. Now let me jump to 2023. 2023, you can see we’ve shifted — we’ve got about $300 million on our books for 2022 receivable.

We’ve shifted to about $1.5 billion net payable for 2023, which demonstrates the strength of the acuity of the population and our estimates, partially informed by the Wakely data we got in June and July of where we expect to be relative to our peers. And we also booked that with some margin consistently year-to-year, and we’ll see how that shakes out. But we see that as a good sign. And you always have to look at that in tandem with the acuity of the population, including our excellent growth this year.

Operator: And our next question today comes from Josh Raskin at Nephron Research.