10-Q


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
____________________________________________
FORM 10-Q
____________________________________________
(Mark One)
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2015
OR

[  ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                  to
____________________________________________
Commission file number: 001-31826
____________________________________________
CENTENE CORPORATION
(Exact name of registrant as specified in its charter)

Delaware
42-1406317
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification Number)
 
 
7700 Forsyth Boulevard
 
St. Louis, Missouri
63105
(Address of principal executive offices)
(Zip Code)

Registrant’s telephone number, including area code:
 
(314) 725-4477
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: x Yes o No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer”, “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act.  Large accelerated filer x Accelerated filer o Non-accelerated filer o (do not check if a smaller reporting company) Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes  o    No  x

As of October 16, 2015, the registrant had 119,202,788 shares of common stock outstanding.




CENTENE CORPORATION
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS

 
 
PAGE
 
 
 
 
Part I
 
 
Financial Information
 
Item 1.
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
Part II
 
 
Other Information
 
Item 1.
Item 1A.
Item 2.
Item 6.
 


Table of Contents

CAUTIONARY STATEMENT ON FORWARD-LOOKING STATEMENTS

All statements, other than statements of current or historical fact, contained in this filing are forward-looking statements.  We have attempted to identify these statements by terminology including “believe,” “anticipate,” “plan,” “expect,” “estimate,” “intend,” “seek,” “target,” “goal,” “may,” “will,” “would,” “could,” “should,” “can,” “continue” and other similar words or expressions in connection with, among other things, any discussion of future operating or financial performance.  In particular, these statements include statements about our market opportunity, our growth strategy, competition, expected activities and future acquisitions, including our proposed merger with Health Net, Inc. (Health Net) (Proposed Merger), investments and the adequacy of our available cash resources.  These statements may be found in the various sections of this filing, including those entitled “Management's Discussion and Analysis of Financial Condition and Results of Operations,” Part II, Item 1A. “Risk Factors,” and Part II, Item 1 “Legal Proceedings.”  Readers are cautioned that matters subject to forward-looking statements involve known and unknown risks and uncertainties, including economic, regulatory, competitive and other factors that may cause our or our industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements.  These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions.

All forward-looking statements included in this filing are based on information available to us on the date of this filing and we undertake no obligation to update or revise the forward-looking statements included in this filing, whether as a result of new information, future events or otherwise, after the date of this filing.  Actual results may differ from projections or estimates due to a variety of important factors applicable to both us and Health Net, including but not limited to:

our ability to accurately predict and effectively manage health benefits and other operating expenses and reserves;
competition;
membership and revenue projections;
timing of regulatory contract approval;
changes in healthcare practices;
changes in federal or state laws or regulations, including the Patient Protection and Affordable Care Act and the Health Care and Education Affordability Reconciliation Act and any regulations enacted thereunder;
changes in expected contract start dates;
changes in expected closing dates, estimated purchase price and accretion for acquisitions;
inflation;
foreign currency fluctuations;
provider and state contract changes;
new technologies;
advances in medicine;
reduction in provider payments by governmental payors;
major epidemics;
disasters and numerous other factors affecting the delivery and cost of healthcare;
the expiration, cancellation or suspension of our or Health Net's managed care contracts by federal or state governments (including but not limited to Medicare and Medicaid);
the outcome of our or Health Net's pending legal proceedings;
availability of debt and equity financing, on terms that are favorable to us;
changes in economic, political and market conditions;
the ultimate closing date of the Proposed Merger;
the possibility that the expected synergies and value creation from the Proposed Merger will not be realized, or will not be realized within the expected time period;
the risk that acquired businesses will not be integrated successfully;
disruption from the Proposed Merger making it more difficult to maintain business and operational relationships;
the risk that unexpected costs related to the Proposed Merger will be incurred;
the possibility that the Proposed Merger does not close, including, but not limited to, due to the failure to satisfy the closing conditions thereto; and
the risk that financing for the Proposed Merger may not be available on favorable terms.

This list of important factors is not intended to be exhaustive. We discuss certain of these matters more fully, as well as certain risk factors that may affect our business operations, financial condition and results of operations, in our filings with the Securities and Exchange Commission, including our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.



Table of Contents

Other Information

The discussion in Part I, Item 2. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" under the heading "Results of Operations" contains financial information for new and existing businesses. Existing businesses are primarily state markets, significant geographic expansion in an existing state or product that we have managed for four complete quarters. New businesses are primarily new state markets, significant geographic expansion in an existing state or product that conversely, we have not managed for four complete quarters.

Item 1A “Risk Factors” of Part II of this filing contains a further discussion of these and other important factors that could cause actual results to differ from expectations. We disclaim any current intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Due to these important factors and risks, we cannot give assurances with respect to our future premium levels or our ability to control our future medical costs.

Non-GAAP Financial Presentation
The Company is providing certain non-GAAP financial measures in this report as the Company believes that these figures are helpful in allowing individuals to more accurately assess the ongoing nature of the Company's operations and measure the Company's performance more consistently. The Company uses the presented non-GAAP financial measures internally to allow management to focus on period-to-period changes in the Company's core business operations. Therefore, the Company believes that this information is meaningful in addition to the information contained in the GAAP presentation of financial information. The presentation of this additional non-GAAP financial information is not intended to be considered in isolation or as a substitute for the financial information prepared and presented in accordance with GAAP.




Table of Contents

PART I
FINANCIAL INFORMATION

ITEM 1. Financial Statements.
CENTENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In millions, except share data)
(Unaudited)
 
September 30, 2015
 
December 31, 2014
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
1,665

 
$
1,610

Premium and related receivables
1,281

 
912

Short term investments
162

 
177

Other current assets
488

 
335

Total current assets
3,596

 
3,034

Long term investments
1,992

 
1,280

Restricted deposits
106

 
100

Property, software and equipment, net
488

 
445

Goodwill
849

 
754

Intangible assets, net
161

 
120

Other long term assets
130

 
91

Total assets
$
7,322

 
$
5,824

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

Current liabilities:
 

 
 

Medical claims liability
$
2,144

 
$
1,723

Accounts payable and accrued expenses
1,035

 
768

Return of premium payable
313

 
236

Unearned revenue
66

 
168

Current portion of long term debt
5

 
5

Total current liabilities
3,563

 
2,900

Long term debt
1,276

 
874

Other long term liabilities
274

 
159

Total liabilities
5,113

 
3,933

Commitments and contingencies


 


Redeemable noncontrolling interests
156

 
148

Stockholders’ equity:
 

 
 

Preferred stock, $0.001 par value; authorized 10,000,000 shares; no shares issued or outstanding at September 30, 2015 and December 31, 2014

 

Common stock, $.001 par value; authorized 200,000,000 shares; 124,940,103 issued and 119,201,560 outstanding at September 30, 2015, and 124,274,864 issued and 118,433,416 outstanding at December 31, 2014

 

Additional paid-in capital
909

 
840

Accumulated other comprehensive loss
(2
)
 
(1
)
Retained earnings
1,247

 
1,003

Treasury stock, at cost (5,738,543 and 5,841,448 shares, respectively)
(103
)
 
(98
)
Total Centene stockholders’ equity
2,051

 
1,744

Noncontrolling interest
2

 
(1
)
Total stockholders’ equity
2,053

 
1,743

Total liabilities and stockholders’ equity
$
7,322

 
$
5,824

The accompanying notes to the consolidated financial statements are an integral part of these statements. 

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Table of Contents

CENTENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except share data)
(Unaudited)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
Revenues:
 
 
 
 
 
 
 
Premium
$
4,983

 
$
3,780

 
$
13,974

 
$
10,182

Service
480

 
379

 
1,434

 
1,070

Premium and service revenues
5,463

 
4,159

 
15,408

 
11,252

Premium tax and health insurer fee
358

 
193

 
1,050

 
584

Total revenues
5,821

 
4,352

 
16,458

 
11,836

Expenses:
 
 
 
 
 
 
 
Medical costs
4,433

 
3,390

 
12,475

 
9,093

Cost of services
413

 
327

 
1,234

 
935

General and administrative expenses
464

 
334

 
1,309

 
951

Premium tax expense
274

 
161

 
794

 
492

Health insurer fee expense
54

 
32

 
161

 
94

Total operating expenses
5,638

 
4,244

 
15,973

 
11,565

Earnings from operations
183

 
108

 
485

 
271

Other income (expense):
 
 
 
 
 
 
 
Investment and other income
8

 
6

 
27

 
18

Interest expense
(11
)
 
(9
)
 
(32
)
 
(25
)
Earnings from continuing operations, before income tax expense
180

 
105

 
480

 
264

Income tax expense
87

 
27

 
234

 
107

Earnings from continuing operations, net of income tax expense
93

 
78

 
246

 
157

Discontinued operations, net of income tax expense of $0, $0, $0, and $1, respectively
1

 
1

 

 
2

Net earnings
94

 
79

 
246

 
159

(Earnings) loss attributable to noncontrolling interests
(1
)
 
3

 
(2
)
 
5

Net earnings attributable to Centene Corporation
$
93

 
$
82

 
$
244

 
$
164

 
 
 
 
 
 
 
 
Amounts attributable to Centene Corporation common shareholders:
Earnings from continuing operations, net of income tax expense
$
92

 
$
81

 
$
244

 
$
162

Discontinued operations, net of income tax expense
1

 
1

 

 
2

Net earnings
$
93

 
$
82

 
$
244

 
$
164

 
 
 
 
 
 
 
 
Net earnings per common share attributable to Centene Corporation:
Basic:
 
 
 
 
 
 
 
Continuing operations
$
0.77

 
$
0.69

 
$
2.05

 
$
1.40

Discontinued operations
0.01

 
0.01

 

 
0.01

Basic earnings per common share
$
0.78

 
$
0.70

 
$
2.05

 
$
1.41

 
 
 
 
 
 
 
 
Diluted:
 
 
 
 
 
 
 
Continuing operations
$
0.75

 
$
0.67

 
$
1.99

 
$
1.35

Discontinued operations
0.01

 
0.01

 

 
0.02

Diluted earnings per common share
$
0.76

 
$
0.68

 
$
1.99

 
$
1.37

 
 
 
 
 
 
 
 
Weighted average number of common shares outstanding:
 
 
 
 
Basic
119,121,524

 
117,226,968

 
118,970,853

 
115,912,304

Diluted
123,131,810

 
121,363,750

 
122,904,476

 
119,873,398

The accompanying notes to the consolidated financial statements are an integral part of these statements.

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Table of Contents

CENTENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF COMPREHENSIVE EARNINGS
(In millions)
(Unaudited)

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
Net earnings
$
94

 
$
79

 
$
246

 
$
159

Reclassification adjustment, net of tax

 

 

 

Change in unrealized gain on investments, net of tax
2

 
(3
)
 
3

 
2

Foreign currency translation adjustments

 

 
(4
)
 

Other comprehensive earnings
2

 
(3
)
 
(1
)
 
2

Comprehensive earnings
96

 
76

 
245

 
161

Comprehensive (earnings) loss attributable to noncontrolling interests
(1
)
 
3

 
(2
)
 
5

Comprehensive earnings attributable to Centene Corporation
$
95

 
$
79

 
$
243

 
$
166


The accompanying notes to the consolidated financial statements are an integral part of this statement.


3

Table of Contents

CENTENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(In millions, except share data)
(Unaudited)

Nine Months Ended September 30, 2015

 
Centene Stockholders’ Equity
 
 
 
 
 
Common Stock
 
 
 
 
 
 
 
Treasury Stock
 
 
 
 
 
$.001 Par
Value
Shares
 
Amt
 
Additional
Paid-in
Capital
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Retained
Earnings
 
$.001 Par
Value
Shares
 
Amt
 
Non
controlling
Interest
 
Total
Balance, December 31, 2014
124,274,864

 
$

 
$
840

 
$
(1
)
 
$
1,003

 
5,841,448

 
$
(98
)
 
$
(1
)
 
$
1,743

Comprehensive Earnings:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net earnings

 

 

 

 
244

 

 

 

 
244

Change in unrealized gain on investments, net of $1 tax

 

 

 
3

 

 

 

 

 
3

Foreign currency translation

 

 

 
(4
)
 

 

 

 

 
(4
)
Total comprehensive earnings
 
 
 
 
 
 
 
 
 

 
 
 
 
 
 
 
243

Common stock issued for acquisition


 

 
8

 

 

 
(247,580
)
 
4

 

 
12

Common stock issued for employee benefit plans
665,239

 

 
6

 

 

 

 

 

 
6

Common stock repurchases

 

 

 

 

 
144,675

 
(9
)
 

 
(9
)
Stock compensation expense

 

 
48

 

 

 

 

 

 
48

Excess tax benefits from stock compensation

 

 
7

 

 

 

 

 

 
7

Contribution from noncontrolling interest

 

 

 

 

 

 

 
2

 
2

Reclassification to redeemable noncontrolling interest

 

 

 

 

 

 

 
1

 
1

Balance, September 30, 2015
124,940,103

 
$

 
$
909

 
$
(2
)
 
$
1,247

 
5,738,543

 
$
(103
)
 
$
2

 
$
2,053

 
The accompanying notes to the consolidated financial statements are an integral part of this statement.



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Table of Contents

CENTENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)
 
Nine Months Ended September 30,
 
2015
 
2014
Cash flows from operating activities:
 
 
 
Net earnings
$
246

 
$
159

Adjustments to reconcile net earnings to net cash provided by operating activities
Depreciation and amortization
82

 
65

Stock compensation expense
48

 
35

Deferred income taxes
(14
)
 
(65
)
Gain on settlement of contingent consideration
(37
)
 

Goodwill and intangible adjustment
28

 

Changes in assets and liabilities
 

 
 

Premium and related receivables
(360
)
 
(243
)
Other current assets
(103
)
 
(25
)
Other assets
(40
)
 
(51
)
Medical claims liabilities
394

 
476

Unearned revenue
(104
)
 
54

Accounts payable and accrued expenses
209

 
427

Other long term liabilities
101

 
17

Other operating activities
7

 
4

Net cash provided by operating activities
457

 
853

Cash flows from investing activities:
 

 
 

Capital expenditures
(101
)
 
(69
)
Purchases of investments
(1,077
)
 
(738
)
Sales and maturities of investments
418

 
320

Proceeds from asset sale
7

 

Investments in acquisitions, net of cash acquired
(16
)
 
(94
)
Net cash used in investing activities
(769
)
 
(581
)
Cash flows from financing activities:
 

 
 

Proceeds from exercise of stock options
5

 
6

Proceeds from borrowings
1,305

 
1,385

Payment of long term debt
(910
)
 
(1,118
)
Excess tax benefits from stock compensation
7

 
7

Common stock repurchases
(9
)
 
(6
)
Contribution from noncontrolling interest
2

 
5

Debt issue costs
(4
)
 
(6
)
Payment of contingent consideration obligation
(29
)
 

Net cash provided by financing activities
367

 
273

Net increase in cash and cash equivalents
55

 
545

Cash and cash equivalents, beginning of period
1,610

 
1,038

Cash and cash equivalents, end of period
$
1,665

 
$
1,583

Supplemental disclosures of cash flow information:
 

 
 

Interest paid
$
28

 
$
18

Health insurer fee paid
$
213

 
$
126

Income taxes paid
$
229

 
$
167

Equity issued in connection with acquisitions
$
12

 
$
190

 
The accompanying notes to the consolidated financial statements are an integral part of these statements.

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Table of Contents

CENTENE CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except share data)
(Unaudited)
   
1. Basis of Presentation

Basis of Presentation

The accompanying interim financial statements have been prepared under the presumption that users of the interim financial information have either read or have access to the audited financial statements included in the Form 10-K for the fiscal year ended December 31, 2014.  The unaudited interim financial statements herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission.  Accordingly, footnote disclosures which would substantially duplicate the disclosures contained in the December 31, 2014 audited financial statements have been omitted from these interim financial statements where appropriate.  In the opinion of management, these financial statements reflect all adjustments, consisting only of normal recurring adjustments, which are necessary for a fair presentation of the results of the interim periods presented.
 
Certain 2014 amounts in the notes to the consolidated financial statements have been reclassified to conform to the 2015 presentation. These reclassifications have no effect on net earnings or stockholders’ equity as previously reported.

On February 2, 2015, the Board of Directors declared a two-for-one split of Centene's common stock in the form of a 100% stock dividend distributed February 19, 2015 to stockholders of record on February 12, 2015. All share and per share information presented in this Form 10-Q has been adjusted for the two-for-one stock split.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) which supersedes existing revenue recognition standards with a single model unless those contracts are within the scope of other standards (e.g., an insurance entity's insurance contracts). Under the new standard, recognition of revenue occurs when a customer obtains control of promised goods or services in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. In August 2015, the FASB issued an ASU which deferred the effective date of the new revenue standard by one year. The new effective date is for annual and interim periods beginning after December 15, 2017. Early adoption is permitted. The Company is currently evaluating the effect of the new revenue recognition guidance.

In April 2015, the FASB issued an ASU which changes the presentation of debt issuance costs in financial statements. Under the new standard, debt issuance costs are presented in the balance sheet as a direct deduction of the related debt liability rather than as an asset. Amortization of the cost is reported as interest expense. The new standard is effective for annual and interim periods beginning after December 15, 2015 and early adoption is permitted. The Company elected to adopt this guidance beginning in the first quarter of 2015 and has applied the new standard retrospectively to all prior periods. The reclassification of debt issuance costs impacted the Consolidated Balance Sheets by decreasing both Other Long Term Assets and Long Term Debt by $14 million at December 31, 2014 and $15 million at September 30, 2015. These reclassifications have no effect on net earnings or stockholders' equity as previously reported.

In May 2015, the FASB issued an ASU which expands the disclosure requirements for insurance companies that issue short-duration contracts. The new standard will increase the level of disclosure around the Company's Medical Claims Liability to include the following: claims development by year; claim frequency; a rollforward of the claims liability; and a description of methods and assumptions used for determining the liability. It is effective for annual periods beginning after December 15, 2015 and interim periods beginning after December 15, 2016. Early adoption is permitted. The Company is currently evaluating the effect of the new disclosure requirements.


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In September 2015, the FASB issued an ASU which simplifies the accounting for measurement-period adjustments in business combinations. Under the new standard, an acquirer must recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. Additionally, the acquirer must present separately on the face of the income statement, or disclose in the notes, the portion of the amount recorded in the current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. It is effective for annual and interim periods beginning after December 15, 2016. Early adoption is permitted. The Company elected to adopt this guidance in the current fiscal quarter.

2. Health Net, Inc. Merger

On July 2, 2015, the Company announced that the Company and two direct, newly formed subsidiaries of the Company had entered into a definitive merger agreement with Health Net, Inc. (Health Net) under which the Company will acquire all of the issued and outstanding shares of Health Net. Under the terms of the agreement, at the closing of the transaction, Health Net stockholders (with limited exceptions) would receive 0.622 of a validly issued, fully paid, non-assessable share of Centene common stock and $28.25 in cash for each share of Health Net common stock. The transaction is valued at approximately $6.8 billion (based on the Centene closing stock price on July 1, 2015), including the assumption of debt.

The transaction is expected to close in early 2016 and is subject to approvals by relevant state insurance and healthcare regulators and other customary closing conditions. In August 2015, the Company announced the early termination of the waiting period required under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended. In October 2015, the Company and Health Net announced the transaction was approved by both the Centene and Health Net stockholders. The Company expects to fund the cash portion of the acquisition through a combination of existing cash on hand and debt financing.

3. Acquisitions and Redeemable Noncontrolling Interest

Acquisitions

Community Health Solutions of America, Inc.

In July 2014, the Company completed a transaction whereby Community Health Solutions of America, Inc. assigned its contract with the Louisiana Department of Health and Hospitals under the Bayou Health Shared Savings Program to the Company's subsidiary, Louisiana Healthcare Connections (LHC). The fair value of consideration transferred included the present value of the estimated contingent consideration, subject to membership retained by LHC in the first quarter of 2015. The fair value of contingent consideration was $18 million at December 31, 2014. During the first quarter of 2015, the Company determined the amount of the actual contingent consideration to be $8 million. A gain of $10 million related to the settlement of the obligation was recorded in General and Administrative expense.

LiveHealthier, Inc.

In January 2015, the Company acquired the remaining 79% of LiveHealthier, Inc. (LiveHealthier) for $28 million, bringing its total ownership to 100%. LiveHealthier is a provider of technology and service-based health management solutions. The fair value of consideration of $28 million consists of cash paid of $11 million, Centene common stock issued at closing of $13 million, and the fair value of estimated contingent consideration of $4 million to be paid in cash over a three year period. The contingent consideration will not exceed $9 million.

The Company's allocation of fair value resulted in goodwill of $26 million and other identifiable intangible assets of $15 million. The goodwill is not deductible for income tax purposes. The acquisition is recorded in the Managed Care segment.


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Fidelis SecureCare of Michigan, Inc.

In May 2015, the Company acquired 100% of Fidelis SecureCare of Michigan, Inc. (Fidelis) a subsidiary of Concerto Healthcare, for $57 million. Fidelis was previously selected by the Michigan Department of Community Health to provide integrated healthcare services to members who are dually eligible for Medicare and Medicaid in Macomb and Wayne counties. The fair value of consideration of $57 million consists of initial cash consideration of $7 million and the fair value of estimated contingent consideration of $50 million. The contingent consideration is based on duals membership and revenue per member during the first year of the contract (July 2015 - June 2016), including reconciliation payments settled over a two year period. The contingent consideration fair value is estimated based on expected membership during the first year of the contract as well as estimated revenue per member reflecting both member mix and risk adjustment. The Company's allocation of fair value resulted in goodwill of $29 million and other identifiable intangible assets of $23 million. 100% of the goodwill is deductible for income tax purposes. The acquisition is recorded in the Managed Care segment.

During the third quarter of 2015, the Company experienced higher than anticipated opt-out rates and member attrition in the dual demonstration program, resulting in lower than expected membership and lower blended premium rates. As a result, the fair value of estimated contingent consideration was reduced to $23 million, and the Company recorded a gain of $27 million in general and administrative expenses. In connection with the lower membership and revenue outlook, the Company conducted an impairment analysis of the identifiable intangible assets and goodwill, resulting in a reduction of goodwill and intangible assets of $28 million which was recorded in general and administrative expenses. At September 30, 2015, the Company had goodwill of $15 million and other identifiable intangible assets of $7 million remaining on the balance sheet.

Agate Resources, Inc.

In September 2015, the Company completed the acquisition of Agate Resources, Inc. (Agate) for $120 million. Agate is a diversified holding company that offers primarily Medicaid and other healthcare products and services to Oregon residents. The fair value of consideration of $120 million consists of initial cash consideration of $93 million, the present value of future cash payments of $18 million to be paid out over a three year period, and the fair value of estimated contingent consideration of $9 million. A portion of the contingent consideration is based on the achievement of underwriting targets and will be paid in cash over a three year period; the remainder is based on the receipt of a retrospective rate adjustment and is expected to be settled in cash in the fourth quarter of 2015.

The Company's preliminary allocation of fair value resulted in goodwill of $51 million and other identifiable intangible assets of $34 million. The Company has not finalized the allocation of the fair value of assets and liabilities. The goodwill is not deductible for income tax purposes. The acquisition is recorded in the Managed Care segment.

Redeemable Noncontrolling Interest

In January 2015, the Company sold 25% of its ownership in Celtic Insurance Company for $7 million. No gain or loss was recognized on the sale of the ownership interest. Celtic Insurance Company is included in the Managed Care segment. In connection with the sale of the ownership interest, the Company entered into a put agreement with the noncontrolling interest holder, allowing the noncontrolling interest holder to put its interest back to the Company beginning in 2022. As a result of put option agreements, the noncontrolling interest is considered redeemable and is classified in the Redeemable Noncontrolling Interest section of the consolidated balance sheets.

A reconciliation of the changes in the Redeemable Noncontrolling Interests is as follows ($ in millions):
Balance, December 31, 2014
$
148

Fair value of redeemable noncontrolling interest sold
7

Reclassification to redeemable noncontrolling interest
(1
)
Net earnings attributable to redeemable noncontrolling interests
2

Balance, September 30, 2015
$
156



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4. Short term and Long term Investments, Restricted Deposits

Short term and long term investments and restricted deposits by investment type consist of the following ($ in millions):
 
September 30, 2015
 
December 31, 2014
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized Losses
 
Fair
Value
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized Losses
 
Fair
Value
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
468

 
$
2

 
$

 
$
470

 
$
393

 
$
1

 
$
(2
)
 
$
392

Corporate securities
837

 
4

 
(4
)
 
837

 
556

 
2

 
(2
)
 
556

Restricted certificates of deposit
9

 

 

 
9

 
6

 

 

 
6

Restricted cash equivalents
78

 

 

 
78

 
79

 

 

 
79

Municipal securities
489

 
2

 
(2
)
 
489

 
174

 
1

 

 
175

Asset-backed securities
186

 

 

 
186

 
180

 

 

 
180

Residential mortgage-backed securities
75

 
2

 

 
77

 
84

 
1

 

 
85

Commercial mortgage-backed securities
26

 

 

 
26

 

 

 

 

Cost and equity method investments
72

 

 

 
72

 
68

 

 

 
68

Life insurance contracts
16

 

 

 
16

 
16

 

 

 
16

Total
$
2,256

 
$
10

 
$
(6
)
 
$
2,260

 
$
1,556

 
$
5

 
$
(4
)
 
$
1,557


The Company’s investments are classified as available-for-sale with the exception of life insurance contracts and certain cost and equity method investments.  The Company’s investment policies are designed to provide liquidity, preserve capital and maximize total return on invested assets with the focus on high credit quality securities.  The Company limits the size of investment in any single issuer other than U.S. treasury securities and obligations of U.S. government corporations and agencies. As of September 30, 2015, 38% of the Company’s investments in securities recorded at fair value that carry a rating by S&P or Moody’s were rated AAA/Aaa, 62% were rated AA-/Aa3 or higher, and 88% were rated A-/A3 or higher.  At September 30, 2015, the Company held certificates of deposit, life insurance contracts and cost and equity method investments which did not carry a credit rating.

The Company's residential mortgage-backed securities are all issued by the Federal National Mortgage Association, Government National Mortgage Association or Federal Home Loan Mortgage Corporation, which carry implicit or explicit guarantees of the U.S. government. The Company's commercial mortgage-backed securities are primarily senior tranches with a weighted average rating of AA+ and a weighted average duration of 2.0 years at September 30, 2015.


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Table of Contents

The fair value of available-for-sale investments with gross unrealized losses by investment type and length of time that individual securities have been in a continuous unrealized loss position were as follows ($ in millions):
 
September 30, 2015
 
December 31, 2014
 
Less Than 12 Months
 
12 Months or More
 
Less Than 12 Months
 
12 Months or More
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
 
Fair
Value
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$

 
$
68

 
$

 
$
16

 
$

 
$
72

 
$
(2
)
 
$
180

Corporate securities
(3
)
 
317

 
(1
)
 
41

 
(2
)
 
311

 

 
1

Municipal securities
(1
)
 
120

 
(1
)
 
5

 

 
20

 

 
7

Asset-backed securities

 
68

 

 
13

 

 
70

 

 
10

Residential mortgage-backed securities

 

 

 

 

 
18

 

 

Total
$
(4
)
 
$
573

 
$
(2
)
 
$
75

 
$
(2
)
 
$
491

 
$
(2
)
 
$
198


As of September 30, 2015, the gross unrealized losses were generated from 202 positions out of a total of 680 positions.  The change in fair value of fixed income securities is a result of movement in interest rates subsequent to the purchase of the security.

For each security in an unrealized loss position, the Company assesses whether it intends to sell the security or if it is more likely than not the Company will be required to sell the security before recovery of the amortized cost basis for reasons such as liquidity, contractual or regulatory purposes.  If the security meets this criterion, the decline in fair value is other-than-temporary and is recorded in earnings.  The Company does not intend to sell these securities prior to maturity and it is not likely that the Company will be required to sell these securities prior to maturity; therefore, there is no indication of other-than-temporary impairment for these securities.

During the nine months ended September 30, 2015, the Company recognized $8 million of income from equity method investments.

The contractual maturities of short term and long term investments and restricted deposits are as follows ($ in millions):
 
September 30, 2015
 
December 31, 2014
 
Investments
 
Restricted Deposits
 
Investments
 
Restricted Deposits
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
One year or less
$
162

 
$
162

 
$
95

 
$
95

 
$
176

 
$
177

 
$
92

 
$
92

One year through five years
1,613

 
1,616

 
11

 
11

 
1,121

 
1,121

 
8

 
8

Five years through ten years
268

 
268

 

 

 
121

 
120

 

 

Greater than ten years
107

 
108

 

 

 
38

 
39

 

 

Total
$
2,150

 
$
2,154

 
$
106

 
$
106

 
$
1,456

 
$
1,457

 
$
100

 
$
100

 
Actual maturities may differ from contractual maturities due to call or prepayment options.  Asset-backed and mortgage-backed securities are included in the one year through five years category, while cost and equity method investments and life insurance contracts are included in the five years through ten years category.  The Company has an option to redeem at amortized cost substantially all of the securities included in the greater than ten years category listed above.

The Company continuously monitors investments for other-than-temporary impairment.  Certain investments have experienced a decline in fair value due to changes in credit quality, market interest rates and/or general economic conditions.  The Company recognizes an impairment loss for cost and equity method investments when evidence demonstrates that it is other-than-temporarily impaired.  Evidence of a loss in value that is other-than-temporary may include the absence of an ability to recover the carrying amount of the investment or the inability of the investee to sustain a level of earnings that would justify the carrying amount of the investment.


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Table of Contents

5. Fair Value Measurements

Assets and liabilities recorded at fair value in the consolidated balance sheets are categorized based upon observable or unobservable inputs used to estimate fair value.  Level inputs are as follows:
 
Level Input:
 
Input Definition:
Level I
 
Inputs are unadjusted, quoted prices for identical assets or liabilities in active markets at the measurement date.
 
 
 
Level II
 
Inputs other than quoted prices included in Level I that are observable for the asset or liability through corroboration with market data at the measurement date.
 
 
 
Level III
 
Unobservable inputs that reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date.
 
The following table summarizes fair value measurements by level at September 30, 2015, for assets and liabilities measured at fair value on a recurring basis ($ in millions):  
 
Level I
 
Level II
 
Level III
 
Total
Assets
 
 
 
 
 
 
 
Cash and cash equivalents
$
1,665

 
$

 
$

 
$
1,665

Investments available for sale:
 

 
 

 
 

 
 

U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
437

 
$
14

 
$

 
$
451

Corporate securities

 
837

 

 
837

Municipal securities

 
489

 

 
489

Asset-backed securities

 
186

 

 
186

Residential mortgage-backed securities

 
77

 

 
77

Commercial mortgage-backed securities

 
26

 

 
26

Total investments
$
437

 
$
1,629

 
$

 
$
2,066

Restricted deposits available for sale:
 

 
 

 
 

 
 

Cash and cash equivalents
$
78

 
$

 
$

 
$
78

Certificates of deposit
9

 

 

 
9

U.S. Treasury securities and obligations of U.S. government corporations and agencies
19

 

 

 
19

Total restricted deposits
$
106

 
$

 
$

 
$
106

Other long term assets: Interest rate swap agreements
$

 
$
18

 
$

 
$
18

Total assets at fair value
$
2,208

 
$
1,647

 
$

 
$
3,855



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Table of Contents

The following table summarizes fair value measurements by level at December 31, 2014, for assets and liabilities measured at fair value on a recurring basis ($ in millions): 
 
Level I
 
Level II
 
Level III
 
Total
Assets
 
 
 
 
 
 
 
Cash and cash equivalents
$
1,610

 
$

 
$

 
$
1,610

Investments available for sale:
 

 
 

 
 

 
 

U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
360

 
$
17

 
$

 
$
377

Corporate securities

 
556

 

 
556

Municipal securities

 
175

 

 
175

Asset-backed securities

 
180

 

 
180

Residential mortgage-backed securities

 
85

 

 
85

Commercial mortgage-backed securities

 

 

 

Total investments
$
360

 
$
1,013

 
$

 
$
1,373

Restricted deposits available for sale:
 

 
 

 
 

 
 

Cash and cash equivalents
$
79

 
$

 
$

 
$
79

Certificates of deposit
6

 

 

 
6

U.S. Treasury securities and obligations of U.S. government corporations and agencies
15

 

 

 
15

Total restricted deposits
$
100

 
$

 
$

 
$
100

Other long term assets: Interest rate swap agreements
$

 
$
11

 
$

 
$
11

Total assets at fair value
$
2,070

 
$
1,024

 
$

 
$
3,094

 
The Company periodically transfers U.S. Treasury securities and obligations of U.S. government corporations and agencies between Level I and Level II fair value measurements dependent upon the level of trading activity for the specific securities at the measurement date.  The Company’s policy regarding the timing of transfers between Level I and Level II is to measure and record the transfers at the end of the reporting period.  At September 30, 2015, there were less than $1 million of transfers from Level I to Level II and $2 million of transfers from Level II to Level I.  The Company utilizes matrix pricing services to estimate fair value for securities which are not actively traded on the measurement date.  The Company designates these securities as Level II fair value measurements.  The aggregate carrying amount of the Company’s life insurance contracts and other non-majority owned investments, which approximates fair value, was $88 million and $84 million as of September 30, 2015 and December 31, 2014, respectively.
   
6. Health Insurance Marketplace

The Affordable Care Act (ACA) established risk spreading premium stabilization programs effective January 1, 2014 for the Health Insurance Marketplace product. These programs, commonly referred to as the “three Rs,” include a permanent risk adjustment program, a transitional reinsurance program, and a temporary risk corridor program. Additionally, the ACA established a minimum annual medical loss ratio for the Health Insurance Marketplace. Each of the three R programs are taken into consideration to determine if the Company’s estimated annual medical costs are less than the minimum loss ratio and require an adjustment to Premium revenue to meet the minimum medical loss ratio.

In June 2015, CMS released final results on reinsurance and risk-adjustment for the 2014 plan year. These final results had an insignificant impact to the Company for the 2014 plan year.

The Company's receivables (payables) for each of these programs are as follows ($ in millions):
 
September 30, 2015
 
December 31, 2014
Risk adjustment
$
(77
)
 
$
(44
)
Reinsurance
14

 
11

Risk corridor
(31
)
 
(9
)
Minimum medical loss ratio
(14
)
 
(6
)


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Table of Contents

7. Debt
 
Debt consists of the following ($ in millions):
 
September 30, 2015
 
December 31, 2014
$425 million 5.75% Senior notes, due June 1, 2017
$
428

 
$
429

$500 million 4.75% Senior notes, due May 15, 2022
500

 
300

Fair value of interest rate swap agreements
18

 
11

Senior notes
946

 
740

Revolving credit agreement
275

 
75

Mortgage notes payable
68

 
70

Capital leases
7

 
8

Debt issuance costs
(15
)
 
(14
)
Total debt
1,281

 
879

Less current portion
(5
)
 
(5
)
 Long term debt
$
1,276

 
$
874


Senior Notes

In January 2015, the Company issued an additional $200 million of 4.75% Senior Notes ($200 Million Add-on Notes) at par. The $200 Million Add-on Notes were offered as additional debt securities under the indenture governing the $300 million of 4.75% Senior Notes issued in April 2014. In connection with the January 2015 issuance, the Company entered into interest rate swap agreements for a notional amount of $200 million at a floating rate of interest based on the three month LIBOR plus 2.88%. Gains and losses due to changes in the fair value of the interest rate swap completely offset changes in the fair value of the hedged portion of the underlying debt and are recorded as an adjustment to the $200 Million Add-on Notes.

The indentures governing both the $425 million notes due 2017 and the $500 million notes due 2022 contain non-financial and financial covenants, including requirements of a minimum fixed charge coverage ratio.

Interest Rate Swaps

The Company uses interest rate swap agreements to convert a portion of its interest rate exposure from fixed rates to floating rates to more closely align interest expense with interest income received on its cash equivalent and variable rate investment balances. The Company has $750 million of notional amount of interest rate swap agreements consisting of $250 million which are scheduled to expire on June 1, 2017 and $500 million that are scheduled to expire May 15, 2022. Under the Swap Agreements, the Company receives a fixed rate of interest and pays an average variable rate of the three month LIBOR plus 2.85% adjusted quarterly. At September 30, 2015, the weighted average rate was 3.16%.

The Swap Agreements are formally designated and qualify as fair value hedges and are recorded at fair value in the Consolidated Balance Sheet in other assets or other liabilities. Gains and losses due to changes in fair value of the interest rate swap agreements completely offset changes in the fair value of the hedged portion of the underlying debt. Therefore, no gain or loss has been recognized due to hedge ineffectiveness. Offsetting changes in fair value of both the interest rate swaps and the hedged portion of the underlying debt both were recognized in interest expense in the Consolidated Statement of Operations. The Company does not hold or issue any derivative instrument for trading or speculative purposes.

Revolving Credit Agreement

The Company has an unsecured $500 million revolving credit facility. Borrowings under the agreement bear interest based upon LIBOR rates, the Federal Funds Rate or the Prime Rate. The agreement has a maturity date of June 1, 2018, provided it will mature 90 days prior to the maturity date of the Company's 5.75% Senior Notes due 2017 if such notes are not refinanced (or extended), certain financial conditions are not met, or the Company does not carry $100 million of unrestricted cash. As of September 30, 2015, the Company had $275 million of borrowings outstanding under the agreement with a weighted average interest rate of 3.01%.

The agreement contains non-financial and financial covenants, including requirements of minimum fixed charge coverage ratios, maximum debt-to-EBITDA ratios and minimum tangible net worth. The Company is required to not exceed a maximum debt-to-EBITDA ratio of 3.0 to 1.0. As of September 30, 2015, there were no limitations on the availability under the revolving credit agreement as a result of the debt-to-EBITDA ratio.

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Table of Contents


Letters of Credit & Surety Bonds

The Company had outstanding letters of credit of $46 million as of September 30, 2015, which were not part of the revolving credit facility. The Company also had letters of credit for $52 million (valued at September 30, 2015 conversion rate), or €46 million, representing its proportional share of the letters of credit issued to support Ribera Salud’s outstanding debt, which are a part of the revolving credit facility. Collectively, the letters of credit bore interest at 1.55% as of September 30, 2015. The Company had outstanding surety bonds of $304 million as of September 30, 2015.

8. Earnings Per Share

The following table sets forth the calculation of basic and diluted net earnings per common share ($ in millions, except per share data):

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
Earnings attributable to Centene Corporation:
 
 
 
 
 
 
 
Earnings from continuing operations, net of tax
$
92

 
$
81

 
$
244

 
$
162

Discontinued operations, net of tax
1

 
1

 

 
2

Net earnings
$
93

 
$
82

 
$
244

 
$
164

 
 
 
 
 
 
 
 
Shares used in computing per share amounts:
 

 
 
 
 
 
 
Weighted average number of common shares outstanding
119,121,524

 
117,226,968

 
118,970,853

 
115,912,304

Common stock equivalents (as determined by applying the treasury stock method)
4,010,286

 
4,136,782

 
3,933,623

 
3,961,094

Weighted average number of common shares and potential dilutive common shares outstanding
123,131,810

 
121,363,750

 
122,904,476

 
119,873,398

 
 
 
 
 
 
 
 
Net earnings per common share attributable to Centene Corporation:
Basic:
 
 
 
 
 
 
 
Continuing operations
$
0.77

 
$
0.69

 
$
2.05

 
$
1.40

Discontinued operations
0.01

 
0.01

 

 
0.01

Basic earnings per common share
$
0.78

 
$
0.70

 
$
2.05

 
$
1.41

 
 
 
 
 
 
 
 
Diluted:
 
 
 
 
 
 
 
Continuing operations
$
0.75

 
$
0.67

 
$
1.99

 
$
1.35

Discontinued operations
0.01

 
0.01

 

 
0.02

Diluted earnings per common share
$
0.76

 
$
0.68

 
$
1.99

 
$
1.37


The calculation of diluted earnings per common share for the three and nine months ended September 30, 2015 excludes the impact of 28,716 and 84,644 shares, respectively, related to anti-dilutive restricted stock and restricted stock units. The calculation of diluted earnings per common share for the three and nine months ended September 30, 2014 excludes the impact of 47,520 shares and 117,756 shares, respectively, related to anti-dilutive restricted stock and restricted stock units.


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Table of Contents

9. Segment Information

Centene operates in two segments: Managed Care and Specialty Services.  The Managed Care segment consists of Centene’s health plans including all of the functions needed to operate them.  The Specialty Services segment consists of Centene’s specialty companies offering auxiliary healthcare services and products.
 
Segment information for the three months ended September 30, 2015, follows ($ in millions):
 
Managed Care
 
Specialty
Services
 
Eliminations
 
Consolidated
Total
Premium and service revenues from external customers
$
4,922

 
$
541

 
$

 
$
5,463

Premium and service revenues from internal customers
24

 
1,274

 
(1,298
)
 

Total premium and service revenues
$
4,946

 
$
1,815

 
$
(1,298
)
 
$
5,463

Earnings from operations
$
138

 
$
45

 
$

 
$
183


Segment information for the three months ended September 30, 2014, follows ($ in millions):
 
Managed Care
 
Specialty
Services
 
Eliminations
 
Consolidated
Total
Premium and service revenues from external customers
$
3,730

 
$
429

 
$

 
$
4,159

Premium and service revenues from internal customers
16

 
806

 
(822
)
 

Total premium and service revenues
$
3,746

 
$
1,235

 
$
(822
)
 
$
4,159

Earnings from operations
$
80

 
$
28

 
$

 
$
108


Segment information for the nine months ended September 30, 2015, follows ($ in millions):
 
Managed Care
 
Specialty
Services
 
Eliminations
 
Consolidated
Total
Premium and service revenues from external customers
$
13,812

 
$
1,596

 
$

 
$
15,408

Premium and service revenues from internal customers
73

 
3,525

 
(3,598
)
 

Total premium and service revenues
$
13,885

 
$
5,121

 
$
(3,598
)
 
$
15,408

Earnings from operations
$
358

 
$
127

 
$

 
$
485


Segment information for the nine months ended September 30, 2014, follows ($ in millions):
 
Managed Care
 
Specialty
Services
 
Eliminations
 
Consolidated
Total
Premium and service revenues from external customers
$
9,925

 
$
1,327

 
$

 
$
11,252

Premium and service revenues from internal customers
42

 
2,121

 
(2,163
)
 

Total premium and service revenues
$
9,967

 
$
3,448

 
$
(2,163
)
 
$
11,252

Earnings from operations
$
188

 
$
83

 
$

 
$
271


10. Contingencies
On July 5, 2013, the Company's subsidiary, Kentucky Spirit Health Plan, Inc. (Kentucky Spirit), terminated its contract with the Commonwealth of Kentucky (the Commonwealth). Kentucky Spirit believes it had a contractual right to terminate the contract and filed a lawsuit in Franklin Circuit Court seeking a declaration of this right. The Commonwealth has alleged that Kentucky Spirit's exit constitutes a material breach of contract.  The Commonwealth seeks to recover substantial damages and to enforce its rights under Kentucky Spirit's $25 million performance bond. The Commonwealth's attorneys have asserted that the Commonwealth's expenditures due to Kentucky Spirit's departure range from $28 million to $40 million plus interest, and that the associated CMS expenditures range from $92 million to $134 million. Kentucky Spirit disputes the Commonwealth's alleged damages, and is pursuing its own litigation claims for damages against the Commonwealth.


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Table of Contents

On February 6, 2015, the Kentucky Court of Appeals affirmed a Franklin Circuit Court ruling that Kentucky Spirit does not have a contractual right to terminate the contract early. The Court of Appeals also found that the contract’s liquidated damages provision “is applicable in the event of a premature termination of the Contract term.” On September 8, 2015, Kentucky Spirit filed a motion for discretionary review seeking Kentucky Supreme Court review of the finding that Kentucky Spirit's departure constituted a breach of contract. On October 9, 2015, the Commonwealth filed a response opposing discretionary review.

Kentucky Spirit also filed a lawsuit in April 2013, amended in October 2014, in Franklin Circuit Court seeking damages against the Commonwealth for losses sustained due to the Commonwealth's alleged breaches. On December 9, 2014, the Franklin Circuit Court denied the Commonwealth's motion for partial summary judgment on Kentucky Spirit's damages claims. On March 15, 2015, the Franklin Circuit Court denied the Commonwealth's motion to stay discovery and ordered that discovery proceed on those claims.

On May 26, 2015, the Commonwealth issued a demand for indemnification to its actuarial firm, for "all defense costs, and any resultant monetary awards in favor of Kentucky Spirit, arising from or related to Kentucky Spirit's claims which are predicated upon the alleged omissions and errors in the Data Book and the certified actuarially sound rates." On August 19, 2015, the actuarial firm moved to intervene in the litigation. The Franklin Circuit Court granted the actuarial firm's motion on September 8, 2015 and ordered a forty-five day stay of all pretrial proceedings in order for the firm to review the record. Also, on August 19, 2015, the actuarial firm filed a petition seeking a declaratory judgment that it is not liable to the Commonwealth for indemnification related to the claims asserted by Kentucky Spirit against the Commonwealth. On October 5, 2015, the Commonwealth filed an answer to the actuarial firm's petition and asserted counterclaims/cross-claims against the firm.

On March 9, 2015, the Secretary of the Kentucky Cabinet for Health and Family Services (CHFS) issued a determination letter finding that Kentucky Spirit owed the Commonwealth $40 million in actual damages plus prejudgment interest at 8 percent. On March 18, 2015, in a letter to the Kentucky Finance and Administration Cabinet (FAC), Kentucky Spirit contested CHFS' jurisdiction to make such a determination. The FAC did not issue a decision within the required 120 days. On August 13, 2015, Kentucky Spirit filed a declaratory judgment action against the Commonwealth in Franklin Circuit Court seeking a declaration that the Commonwealth may not purport to issue a decision against Kentucky Spirit awarding damages to itself when the matter is already before the Kentucky courts, and that the Commonwealth has waived its claims against Kentucky Spirit for damages arising out of the contract.

The resolution of the Kentucky litigation matters may result in a range of possible outcomes.  If Kentucky Spirit prevails on its claims, it would be entitled to damages.  If the Commonwealth prevails, a liability to the Commonwealth could be recorded.  The Company is unable to estimate the ultimate outcome resulting from the Kentucky litigation.  As a result, the Company has not recorded any receivable or any liability for potential damages under the contract as of September 30, 2015.  While uncertain, the ultimate resolution of the pending litigation could have a material effect on the financial position, cash flow or results of operations of the Company in the period it is resolved or becomes known.

Excluding the Kentucky matters discussed above, the Company is also routinely subjected to legal proceedings in the normal course of business.  While the ultimate resolution of such matters in the normal course of business is uncertain, the Company does not expect the results of any of these matters individually, or in the aggregate, to have a material effect on its financial position, results of operations or cash flows.

11. Subsequent Event
In October 2015, the Company's stockholders approved a proposal to increase the Company's authorized shares of common stock from 200 million to 400 million.

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Table of Contents


ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this filing.  The discussion contains forward-looking statements that involve known and unknown risks and uncertainties, including those set forth under Part II, Item 1A. “Risk Factors” of this Form 10-Q.

OVERVIEW

In 2013, we classified the operations for Kentucky Spirit Health Plan (KSHP) as discontinued operations for all periods presented in our consolidated financial statements. The following discussion and analysis, with the exception of cash flow information, is presented in the context of continuing operations unless otherwise identified.

On February 2, 2015, the Board of Directors declared a two-for-one split of Centene's common stock in the form of a 100% stock dividend distributed February 19, 2015 to stockholders of record on February 12, 2015. All share and per share information presented in this Form 10-Q has been adjusted for the two-for-one stock split.

Key financial metrics for the third quarter of 2015 are summarized as follows:
Quarter-end managed care membership of 4.8 million, an increase of 933,600 members, or 24% year over year.
Premium and service revenues of $5.5 billion, representing 31% growth year over year.
Health Benefits Ratio of 89.0%, compared to 89.7% in 2014.
General and Administrative expense ratio of 8.5%, compared to 8.0% in 2014.
Operating cash flows of $62 million for the third quarter of 2015.
Diluted net earnings per share of $0.75, or $0.84 excluding $0.09 of diluted EPS of Health Net merger related expenses, compared to $0.67 in 2014.

The following items contributed to our revenue and membership growth over the last year:

California. In December 2014, the ABD membership of our California subsidiary, California Health and Wellness, increased as a result of the mandatory transition of the ABD population to managed care. The enrollment of this population to managed care was previously voluntary.

Centurion. In February 2015, Centurion began operating under a new contract with the State of Vermont Department of Corrections to provide comprehensive correctional healthcare services.

In July 2015, Centurion began operating under a new contract with the Mississippi Department of Corrections to provide comprehensive correctional healthcare services.

Florida. In May 2014, our Florida subsidiary, Sunshine Health, began operating under a new contract in 9 of 11 regions of the Managed Medical Assistance (MMA) program. The MMA program includes TANF recipients as well as ABD and dual-eligible members. In addition, we began operating as the sole provider under a new statewide contract for the Child Welfare Specialty Plan (Foster Care). Enrollment for both the MMA program and Foster Care began in May 2014 and was implemented by region through August 2014.

Health Insurance Marketplaces (HIM). In January 2015, we expanded our participation in Health Insurance Marketplaces to include members in certain regions of Illinois and Wisconsin.

Illinois. In March 2014, our Illinois subsidiary, IlliniCare Health, began operating under a new contract as part of the Illinois Medicare-Medicaid Alignment Initiative serving dual-eligible members in Cook, DuPage, Lake, Kane, Kankakee and Will counties (Greater Chicago region).

In July 2014, IlliniCare Health began operating under a new contract with the Cook County Health and Hospitals System to perform third party administrative services to members enrolled in the CountyCare program, as well as care coordination, behavioral health, vision care and pharmacy benefit management services.

In September 2014, IlliniCare Health began serving additional Medicaid members under the state's Medicaid and Medicaid expansion programs.

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Indiana. In February 2015, our Indiana subsidiary, Managed Health Services, began operating under an expanded contract with the Indiana Family & Social Services Administration to provide Medicaid services under the state's Healthy Indiana Plan 2.0 program.

In April 2015, Managed Health Services began operating under an expanded contract with the Indiana Family & Social Services Administration to provide services to its ABD Medicaid enrollees who qualify for the new Hoosier Care Connect Program.

Louisiana. In July 2014, we completed the transaction whereby Community Health Solutions of America, Inc. (CHS) assigned its contract with the Louisiana Department of Health and Hospitals under the Bayou Health Shared Savings Program to our subsidiary, Louisiana Healthcare Connections (LHC).

In February 2015, LHC began operating under a new contract with the Louisiana Department of Health and Hospitals to serve Bayou Health (Medicaid) beneficiaries. Members previously served under the shared savings program were transitioned to the at-risk program on February 1, 2015.

Michigan. In May 2015, we completed the acquisition of Fidelis SecureCare of Michigan, Inc. (Fidelis). Fidelis began operating under a new contract with the Michigan Department of Community Health and the Centers for Medicare and Medicaid Services to provide integrated healthcare services to members who are dually eligible for Medicare and Medicaid in Macomb and Wayne counties in May 2015. Passive enrollment began in July 2015.

Mississippi. In July 2014, our Mississippi subsidiary, Magnolia Health, began operating as one of two contractors under a new statewide managed care contract serving members enrolled in the Mississippi Coordinated Access Network program. Program expansion began in December 2014 and continued through July 2015.

In January 2015, Magnolia Health began operating under a new temporary six-month contract with the State of Mississippi to provide services under the Children's Health Insurance Program (CHIP). In July 2015, Magnolia Health began operating under a two-year CHIP contract with the State of Mississippi.

New Hampshire. In September 2014, our New Hampshire subsidiary, New Hampshire Healthy Families, began serving members under the state's Medicaid expansion program.

Ohio. In May 2014, our Ohio subsidiary, Buckeye Health Plan (Buckeye), began operating under a new contract with the Ohio Department of Medicaid and the Centers for Medicare and Medicaid Services to serve Medicaid members in a dual-eligible demonstration program in three of seven regions: Northeast (Cleveland), Northwest (Toledo) and West Central (Dayton). This three-year program, which is part of the Integrated Care Delivery System expansion, serves those who have both Medicare and Medicaid eligibility. Passive enrollment for Medicaid began in May 2014 and implementation was completed in July 2014. Passive enrollment for Medicare began in January 2015.

Oregon. In September 2015, we completed the acquisition of Agate Resources, Inc., a diversified holding company, that offers primarily Medicaid and other healthcare products and services to Oregon residents through Trillium Community Health Plan.

South Carolina. In February 2015, our South Carolina subsidiary, Absolute Total Care, began operating under a new contract with the South Carolina Department of Health and Human Services and the Centers for Medicare and Medicaid Services to serve dual-eligible members as part of the state's dual demonstration program.

Texas. In September 2014, we began operating under a new contract with the Texas Health and Human Services Commission (HHSC) to expand our operations and serve STAR+PLUS members in two Medicaid Rural Service Areas. We also began providing expanded coverage in September 2014 under our STAR+PLUS contracts to provide acute care services for intellectually and developmentally disabled members. In March 2015, we began operating under an expanded STAR+PLUS contract with the Texas HHSC to include nursing facility benefits.

In March 2015, we also began operating under a new contract with the Texas HHSC and the Centers for Medicare and Medicaid Services to serve dual-eligible members in three counties as part of the state's dual demonstration program.


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In addition, in July 2014, we completed an investment accounted for under the equity method for the purchase of a noncontrolling interest in Ribera Salud S.A. (Ribera Salud), a Spanish health management group. Centene is a joint shareholder with Ribera Salud's remaining investor, Banco Sabadell S.A.

We expect the following items to contribute to our future growth potential:

We expect to realize the full year benefit in 2015 of business commenced during 2014 in Florida, Illinois, Louisiana, Mississippi, New Hampshire, Ohio and Texas as discussed above.

In October 2015, our subsidiary, Superior HealthPlan, Inc., was awarded a contract by the Texas HHSC to serve seven delivery areas for STAR Kids Medicaid recipients, more than any other successful bidder. The new contract is expected to commence in the second half of 2016.

In October 2015, our subsidiary, Cenpatico Integrated Care, in partnership with University of Arizona Health Plan, began operating under a contract with the Arizona Department of Health Services/Division of Behavioral Health Services to be the Regional Behavioral Health Authority for the new southern geographic service area.

In October 2015, Sunshine Health began operating under a two-year, statewide contract with the Florida Healthy Kids Corporation to manage healthcare services for children ages five through 18 in all 11 regions of Florida.
 
In September 2015, our subsidiary, Peach State Health Plan, was one of the Care Management Organizations selected to serve Medicaid recipients enrolled in the Georgia Families, PeachCare for Kids and Planning for Healthy Babies programs. The contract renewal is expected to commence in July 2016, pending regulatory approvals.

In August 2015, our subsidiary, Coordinated Care of Washington, was selected by the Washington State Health Care Authority as the sole provider for the Apple Health Foster Care contract. The new contract is expected to commence in the first quarter of 2016, pending regulatory approvals.

In July 2015, we entered into a definitive merger agreement with Health Net, Inc. (Health Net) under which we will acquire all of the issued and outstanding shares of Health Net. The transaction is valued at approximately $6.8 billion (based on the Centene closing stock price on July 1, 2015), including the assumption of debt. The transaction is expected to close in early 2016.

In the fourth quarter of 2015, Louisiana Healthcare Connections expects to begin operating under an expanded contract to include behavioral health benefits, and Magnolia Health anticipates operating under an expanded contract to include the inpatient benefit for Medicaid and ABD members.


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MEMBERSHIP

From September 30, 2014 to September 30, 2015, we increased our managed care membership by 933,600, or 24%.  The following table sets forth our membership by state for our managed care organizations:
 
September 30,
2015
 
December 31,
2014
 
September 30,
2014
Arizona
223,600

 
204,000

 
202,500

Arkansas
40,900

 
38,400

 
36,600

California
183,900

 
163,900

 
144,700

Florida
486,500

 
425,700

 
411,200

Georgia
406,700

 
389,100

 
382,600

Illinois
211,300

 
87,800

 
31,300

Indiana
276,700

 
197,700

 
199,500

Kansas
137,500

 
143,300

 
144,200

Louisiana
358,800

 
152,900

 
150,800

Massachusetts
63,700

 
48,400

 
46,600

Michigan
6,600

 

 

Minnesota
9,400

 
9,500

 
9,500

Mississippi
301,000

 
108,700

 
99,300

Missouri
88,400

 
71,000

 
64,900

New Hampshire
71,900

 
62,700

 
56,600

Ohio
308,100

 
280,100

 
261,000

Oregon
99,800

 

 

South Carolina
104,800

 
109,700

 
106,500

Tennessee
20,200

 
21,000

 
21,200

Texas
976,500

 
971,000

 
961,100

Vermont
1,500

 

 

Washington
208,600

 
194,400

 
192,500

Wisconsin
78,100

 
83,200

 
74,700

Total at-risk membership
4,664,500

 
3,762,500

 
3,597,300

Non-risk membership
169,900

 
298,400

 
303,500

Total
4,834,400

 
4,060,900

 
3,900,800


At September 30, 2015, we served 442,600 Medicaid members in Medicaid expansion programs in California, Illinois, Massachusetts, New Hampshire, Ohio, Oregon and Washington and Indiana HIP 2.0, included in the table above.

The following table sets forth our membership by line of business:
 
September 30,
2015
 
December 31,
2014
 
September 30,
2014
Medicaid
3,469,800

 
2,754,900

 
2,578,300

CHIP & Foster Care
245,200

 
222,700

 
247,700

ABD, Medicare & Duals
444,100

 
392,700

 
383,400

LTC
73,800

 
60,800

 
55,200

Health Insurance Marketplaces
155,600

 
74,500

 
76,000

Hybrid Programs 1

 
18,900

 
19,900

Behavioral Health
216,700

 
197,000

 
195,500

Correctional Healthcare Services
59,300

 
41,000

 
41,300

Total at-risk membership
4,664,500

 
3,762,500

 
3,597,300

Non-risk membership
169,900

 
298,400

 
303,500

Total
4,834,400

 
4,060,900

 
3,900,800

 
 
 
 
 
 
1 In February 2015, hybrid programs were converted to Medicaid expansion contracts.
 

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The following table identifies our dual-eligible membership by line of business. The membership tables above include these members.
 
September 30,
2015
 
December 31,
2014
 
September 30,
2014
ABD
107,400

 
118,300
 
119,300

LTC
54,200

 
35,900
 
35,500

Medicare
11,400

 
7,200
 
7,100

Medicaid / Medicare Duals
27,900

 
3,200
 
2,700

Total
200,900

 
164,600
 
164,600



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RESULTS OF OPERATIONS

The following discussion and analysis is based on our consolidated statements of operations, which reflect our results of operations for the three and nine months ended September 30, 2015 and 2014, prepared in accordance with generally accepted accounting principles in the United States. 

Summarized comparative financial data for the three and nine months ended September 30, 2015 and 2014 is as follows ($ in millions, except per share data):
 
Three Months Ended September 30,