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EX-32.2 - CERTIFICATION - CENTENE CORPexhibit322.htm
EX-32.1 - CERTIFICATION - CENTENE CORPexhibit321.htm
EX-31.2 - CERTIFICATION - CENTENE CORPexhibit312.htm
EX-31.1 - CERTIFICATION - CENTENE CORPexhibit311.htm
EX-12.1 - RATIO OF EARNINGS TO FIXED CHARGES - CENTENE CORPexhibit121.htm

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, 2016
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 14, 2016, the registrant had 170,892,049 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.
 



CAUTIONARY STATEMENT ON FORWARD-LOOKING STATEMENTS

All statements, other than statements of current or historical fact, contained in this filing or incorporated by reference herein are forward-looking statements.  We intend such forward looking statements to be covered by the safe-harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and we are including this statement for purposes of complying with these safe-harbor provisions. 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 (and the negative thereof) in connection with, among other things, any discussion of future operating or financial performance.  In particular, these statements include without limitation statements about our market opportunity, our growth strategy, competition, expected activities and future acquisitions, investments and the adequacy of our available cash resources.  These statements may be found in the various sections of this filing, such as Part I, Item 2. “Management's Discussion and Analysis of Financial Condition and Results of Operations,” Part II, Item 1. “Legal Proceedings,” and Part II, Item 1A. “Risk Factors.”  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. Except as may be otherwise required by law, 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.  You should not place undue reliance on any forward looking statements, as actual results may differ materially from projections, estimates, or other forward-looking statements due to a variety of important factors, 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 declines or unexpected trends;
changes in healthcare practices, new technologies, and advances in medicine;
increased health care costs;
inflation;
foreign currency fluctuations;
tax matters;
availability of debt and equity financing, on terms that are favorable to us;
disasters or major epidemics;
changes in economic, political or market conditions;
the outcome of legal and regulatory proceedings;
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;
provider, state, federal and other contract changes and timing of regulatory approval of contracts;
the expiration, suspension, or termination of our contracts with federal or state governments (including but not limited to Medicaid, Medicare, and TRICARE);
challenges to our contract awards;
rate cuts or other payment reductions or delays by governmental payors and other risks and uncertainties affecting our government businesses;
our ability to adequately price products on federally facilitated and state based Health Insurance Marketplaces;
cyber-attacks or other privacy or data security incidents;
the possibility that the expected synergies and value creation from acquired businesses, including, without limitation, the acquisition of Health Net, Inc., will not be realized, or will not be realized within the expected time period, including, but not limited to, as a result of conditions, terms, obligations or restrictions imposed by regulators in connection with their approval of, or consent to, the acquisition;
the exertion of management’s time and our resources, and other expenses incurred and business changes required in connection with complying with the undertakings in connection with certain regulatory approvals;
disruption from the acquisition making it more difficult to maintain business and operational relationships;
the risk that unexpected costs will be incurred in connection with, among other things, the acquisition and/or the integration;
changes in expected closing dates, estimated purchase price and accretion for acquisitions;
the risk that acquired businesses will not be integrated successfully; and



our ability to maintain or achieve improvement in the Centers for Medicare and Medicaid Services (CMS) Star ratings and other quality scores that impact revenue.

This list of important factors is not intended to be exhaustive. We discuss certain of these matters more fully, as well as certain other 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. 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. Due to these important factors and risks, we cannot give assurances with respect to our future performance, including without limitation our ability to maintain adequate 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 investors to more accurately assess the ongoing nature of the Company's operations and measure the Company's performance more consistently across periods. 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.

Specifically, the Company believes the presentation of non-GAAP financial information that excludes Health Net acquisition related expenses and amortization of acquired intangible assets allows investors to develop a more meaningful understanding of the Company's performance over time. The tables below provide a reconciliation of non-GAAP items ($ in millions, except per share data):

 
Three Months Ended
September 30,
 
Nine Months Ended
 September 30,
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
GAAP general and administrative expenses
$
940

 
$
458

 
$
2,611

 
$
1,291

Health Net acquisition related expenses
10

 
18

 
224

 
20

General and administrative expenses, excluding Health Net acquisition related expenses
$
930

 
$
440

 
$
2,387

 
$
1,271

 
 
 
 
 
 
 
 
GAAP net earnings from continuing operations
$
146

 
$
92

 
$
300

 
$
244

Health Net acquisition related expenses
10

 
18

 
224

 
20

Amortization of acquired intangible assets
43

 
6

 
95

 
18

Income tax effects of adjustments (1)
(5
)
 
(9
)
 
(106
)
 
(14
)
Adjusted net earnings from continuing operations
$
194

 
$
107

 
$
513

 
$
268

 
 
 
 
 
 
 
 
GAAP diluted earnings per share (EPS)
$
0.84

 
$
0.75

 
$
1.89

 
$
1.99

Health Net acquisition related expenses (2)
0.12

 
0.09

 
0.98

 
0.10

Amortization of acquired intangible assets (3)
0.15

 
0.03

 
0.36

 
0.09

Adjusted diluted EPS
$
1.11

 
$
0.87

 
$
3.23

 
$
2.18

(1) The income tax effects of adjustments are based on the effective income tax rates applicable to adjusted (non-GAAP) results. The amounts are based on the annual estimated effective income tax rate that would increase or decrease based on the exclusion of these expenses.
(2)
The Health Net acquisition related expenses per diluted share presented above are net of the income tax benefit (expense) of $(0.06) and $0.05 for the three months ended September 30, 2016 and 2015, respectively, and $0.44 and $0.06 for the nine months ended September 30, 2016 and 2015, respectively.
(3)
The amortization of acquired intangible assets per diluted share presented above are net of the income tax benefit of $0.09 and $0.02 for the three months ended September 30, 2016 and 2015, respectively, and $0.23 and $0.05 for the nine months ended September 30, 2016 and 2015, respectively.




PART I
FINANCIAL INFORMATION

ITEM 1. Financial Statements.
CENTENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In millions, except share data)
 
September 30, 2016
 
December 31, 2015
 
(Unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
2,982

 
$
1,760

Premium and related receivables
3,445

 
1,279

Short term investments
406

 
176

Other current assets
922

 
390

Total current assets
7,755

 
3,605

Long term investments
4,568

 
1,927

Restricted deposits
137

 
115

Property, software and equipment, net
725

 
518

Goodwill
4,730

 
842

Intangible assets, net
1,566

 
155

Other long term assets
153

 
177

Total assets
$
19,634

 
$
7,339

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

Current liabilities:
 

 
 

Medical claims liability
$
3,767

 
$
2,298

Accounts payable and accrued expenses
3,187

 
976

Return of premium payable
651

 
207

Unearned revenue
573

 
143

Current portion of long term debt
845

 
5

Total current liabilities
9,023

 
3,629

Long term debt
3,744

 
1,216

Other long term liabilities
995

 
170

Total liabilities
13,762

 
5,015

Commitments and contingencies


 


Redeemable noncontrolling interests
148

 
156

Stockholders’ equity:
 

 
 

Preferred stock, $0.001 par value; authorized 10,000,000 shares; no shares issued or outstanding at September 30, 2016 and December 31, 2015

 

Common stock, $0.001 par value; authorized 400,000,000 shares; 176,467,825 issued and 170,860,752 outstanding at September 30, 2016, and 126,855,477 issued and 120,342,981 outstanding at December 31, 2015

 

Additional paid-in capital
4,154

 
956

Accumulated other comprehensive earnings (loss)
46

 
(10
)
Retained earnings
1,655

 
1,358

Treasury stock, at cost (5,607,073 and 6,512,496 shares, respectively)
(145
)
 
(147
)
Total Centene stockholders’ equity
5,710

 
2,157

Noncontrolling interest
14

 
11

Total stockholders’ equity
5,724

 
2,168

Total liabilities and stockholders’ equity
$
19,634

 
$
7,339

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

1


CENTENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except share data)
(Unaudited)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Revenues:
 
 
 
 
 
 
 
Premium
$
9,625

 
$
4,983

 
$
25,299

 
$
13,974

Service
590

 
480

 
1,603

 
1,434

Premium and service revenues
10,215

 
5,463

 
26,902

 
15,408

Premium tax and health insurer fee
631

 
358

 
1,794

 
1,050

Total revenues
10,846

 
5,821

 
28,696

 
16,458

Expenses:
 
 
 
 
 
 
 
Medical costs
8,376

 
4,433

 
22,072

 
12,475

Cost of services
504

 
413

 
1,386

 
1,234

General and administrative expenses
940

 
458

 
2,611

 
1,291

Amortization of acquired intangible assets
43

 
6

 
95

 
18

Premium tax expense
512

 
274

 
1,460

 
794

Health insurer fee expense
129

 
54

 
333

 
161

Total operating expenses
10,504

 
5,638

 
27,957

 
15,973

Earnings from operations
342

 
183

 
739

 
485

Other income (expense):
 
 
 
 
 
 
 
Investment and other income
33

 
8

 
80

 
27

Interest expense
(57
)
 
(11
)
 
(142
)
 
(32
)
Earnings from continuing operations, before income tax expense
318

 
180

 
677

 
480

Income tax expense
171

 
87

 
376

 
234

Earnings from continuing operations, net of income tax expense
147

 
93

 
301

 
246

Discontinued operations, net of income tax benefit
(1
)
 
1

 
(3
)
 

Net earnings
146

 
94

 
298

 
246

(Earnings) attributable to noncontrolling interests
(1
)
 
(1
)
 
(1
)
 
(2
)
Net earnings attributable to Centene Corporation
$
145

 
$
93

 
$
297

 
$
244

 

 

 

 

Amounts attributable to Centene Corporation common shareholders:
Earnings from continuing operations, net of income tax expense
$
146

 
$
92

 
$
300

 
$
244

Discontinued operations, net of income tax benefit
(1
)
 
1

 
(3
)
 

Net earnings
$
145

 
$
93

 
$
297

 
$
244

 
 
 
 
 
 
 
 
Net earnings (loss) per common share attributable to Centene Corporation:
Basic:
 
 
 
 
 
 
 
Continuing operations
$
0.85

 
$
0.77

 
$
1.93

 
$
2.05

Discontinued operations

 
0.01

 
(0.02
)
 

Basic earnings per common share
$
0.85

 
$
0.78

 
$
1.91

 
$
2.05

 
 
 
 
 
 
 
 
Diluted:
 
 
 
 
 
 
 
Continuing operations
$
0.84

 
$
0.75

 
$
1.89

 
$
1.99

Discontinued operations
(0.01
)
 
0.01

 
(0.02
)
 

Diluted earnings per common share
$
0.83

 
$
0.76

 
$
1.87

 
$
1.99

 
 
 
 
 
 
 
 
Weighted average number of common shares outstanding:
 
 
 
 
Basic
170,774,587

 
119,121,524

 
155,680,769

 
118,970,853

Diluted
174,312,416

 
123,131,810

 
158,960,068

 
122,904,476

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

2


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

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Net earnings
$
146

 
$
94

 
$
298

 
$
246

Reclassification adjustment, net of tax
(1
)
 

 

 

Change in unrealized gain on investments, net of tax
5

 
2

 
57

 
3

Foreign currency translation adjustments
(1
)
 

 
(1
)
 
(4
)
Other comprehensive earnings (loss)
3

 
2

 
56

 
(1
)
Comprehensive earnings
149

 
96

 
354

 
245

Comprehensive (earnings) attributable to noncontrolling interests
(1
)
 
(1
)
 
(1
)
 
(2
)
Comprehensive earnings attributable to Centene Corporation
$
148

 
$
95

 
$
353

 
$
243


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


3


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

Nine Months Ended September 30, 2016

 
Centene Stockholders’ Equity
 
 
 
 
 
Common Stock
 
 
 
 
 
 
 
Treasury Stock
 
 
 
 
 
$.001 Par
Value
Shares
 
Amt
 
Additional
Paid-in
Capital
 
Accumulated
Other
Comprehensive
Earnings (Loss)
 
Retained
Earnings
 
$.001 Par
Value
Shares
 
Amt
 
Non
controlling
Interest
 
Total
Balance, December 31, 2015
126,855,477

 
$

 
$
956

 
$
(10
)
 
$
1,358

 
6,512,496

 
$
(147
)
 
$
11

 
$
2,168

Comprehensive Earnings:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net earnings

 

 

 

 
297

 

 

 

 
297

Other comprehensive earnings, net of $20 tax

 

 

 
56

 

 

 

 

 
56

Common stock issued for acquisitions
48,218,310

 

 
3,074

 

 

 
(1,375,596
)
 
31

 

 
3,105

Common stock issued for employee benefit plans
1,394,038

 

 
7

 

 

 

 

 

 
7

Common stock repurchases

 

 

 

 

 
470,173

 
(29
)
 

 
(29
)
Stock compensation expense

 

 
112

 

 

 

 

 

 
112

Excess tax benefits from stock compensation

 

 
5

 

 

 

 

 

 
5

Contribution from noncontrolling interest

 

 

 

 

 

 

 
3

 
3

Balance, September 30, 2016
176,467,825

 
$

 
$
4,154

 
$
46

 
$
1,655

 
5,607,073

 
$
(145
)
 
$
14

 
$
5,724

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



4


CENTENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)
 
Nine Months Ended September 30,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net earnings
$
298

 
$
246

Adjustments to reconcile net earnings to net cash provided by operating activities
Depreciation and amortization
189

 
82

Stock compensation expense
112

 
48

Deferred income taxes
(17
)
 
(14
)
Gain on contingent consideration
(2
)
 
(37
)
Goodwill and intangible adjustment

 
28

Changes in assets and liabilities
 

 
 

Premium and related receivables
(906
)
 
(360
)
Other current assets
(81
)
 
(103
)
Medical claims liabilities
15

 
394

Unearned revenue
301

 
(104
)
Accounts payable and accrued expenses
99

 
209

Other long term liabilities
156

 
101

Other operating activities, net
91

 
(33
)
Net cash provided by operating activities
255

 
457

Cash flows from investing activities:
 

 
 

Capital expenditures
(211
)
 
(101
)
Purchases of investments
(1,528
)
 
(1,077
)
Sales and maturities of investments
955

 
418

Investments in acquisitions, net of cash acquired
(848
)
 
(16
)
Other investing activities, net

 
7

Net cash used in investing activities
(1,632
)
 
(769
)
Cash flows from financing activities:
 

 
 

Proceeds from borrowings
6,956

 
1,305

Payment of long term debt
(4,257
)
 
(910
)
Common stock repurchases
(29
)
 
(9
)
Purchase of noncontrolling interest
(14
)
 

Debt issue costs
(59
)
 
(4
)
Other financing activities, net
1

 
(15
)
Net cash provided by financing activities
2,598

 
367

Effect of exchange rate changes on cash and cash equivalents
1

 

Net increase in cash and cash equivalents
1,222

 
55

Cash and cash equivalents, beginning of period
1,760

 
1,610

Cash and cash equivalents, end of period
$
2,982

 
$
1,665

Supplemental disclosures of cash flow information:
 

 
 

Interest paid
$
113

 
$
28

Income taxes paid
$
394

 
$
229

Equity issued in connection with acquisitions
$
3,105

 
$
12

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

5


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, 2015.  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, 2015 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 2015 amounts in the notes to the consolidated financial statements have been reclassified to conform to the 2016 presentation. These reclassifications have no effect on net earnings or stockholders’ equity as previously reported.

On March 24, 2016, the Company completed the acquisition of Health Net, Inc. (Health Net) for approximately $6.0 billion, including the assumption of debt. The acquisition was accounted for as a business combination, which requires that assets acquired and liabilities assumed be recognized at their fair values as of the acquisition date. Those estimated amounts are reflected in the accompanying financial statements.

As a result of the completion of the Health Net acquisition, the Company's results of operations for the three and nine months ended September 30, 2016 include the results of operations of Health Net from March 24, 2016 to September 30, 2016. The Health Net segment previously known as the Western Region Operations, with the exception of certain operations of its pharmaceutical services and behavioral health subsidiaries, is included in the Company's Managed Care segment. The portions of Health Net's Western Region Operations segment included in the Managed Care segment consist of the following Health Net operations: commercial, Medicare, Medicaid and dual eligible health plans, primarily in Arizona, California, Oregon, and Washington.

The Company's Specialty Services segment includes the Health Net segment previously known as Government Contracts as well as certain operations of its pharmaceutical services and behavioral health subsidiaries, primarily in Arizona, California, Oregon and Washington (which Health Net previously included in its Western Region Operations segment). Health Net's Government Contracts segment included its federal government-sponsored managed care support contract with the U.S. Department of Defense (DoD) under the TRICARE program in the North Region, its Military and Family Life Counseling (MFLC) contract with the DoD and other health care related government contracts, including the Veterans Choice and Patient Centered Community Care program (PC3/Choice) with the U.S. Department of Veterans Affairs (VA).

Recent Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) which introduces a lessee model that requires the majority of leases to be recognized on the balance sheet. The new standard also aligns many of the underlying principles of the new lessor model with those in Accounting Standards Codification 606, the FASB's new revenue recognition standard, and addresses other concerns related to the current lessee model. The standard also requires lessors to increase the transparency of their exposure to changes in value of their residual assets and how they manage that exposure. It is effective for annual and interim periods beginning after December 15, 2018. Early adoption is permitted. The Company is currently evaluating the effect of the new lease guidance.


6


In March 2016, the FASB issued an ASU which simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. Under the new guidance, an entity recognizes all excess tax benefits and tax deficiencies as income tax expense or benefit in the income statement. The ASU also allows an entity to elect as an accounting policy either to continue to estimate the total number of awards for which the requisite service period will not be rendered, as currently required, or to account for forfeitures when they occur. Finally, the ASU modifies the current exception to liability classification of an award when an employer uses a net-settlement feature to withhold shares to meet the employee's minimum statutory tax withholding requirement. The new standard is effective for annual periods beginning after December 15, 2016, including interim periods within those annual reporting periods. Early adoption is permitted. The Company is currently evaluating the effect of the employee share-based payment guidance.

In August 2016, the FASB issued an ASU which clarifies how entities should classify certain cash receipts and cash payments on the Consolidated Statements of Cash Flows. The new guidance also clarifies how the predominance principle should be applied when cash receipts and cash payments have aspects of more than one class of cash flows. The new standard is effective for annual periods beginning after December 15, 2017, including interim periods within those annual reporting periods. Early adoption is permitted. The Company is currently evaluating the effect of the new statement of cash flows guidance.

2. Summary of Significant Accounting Policies

A summary of the Company’s significant accounting policies is included in Note 2 entitled “Summary of Significant Accounting Policies” to the company’s Annual Report on Form 10-K for the year ended December 31, 2015. As a result of the Health Net acquisition, material changes to the Company's significant accounting policies during the three and nine months ended September 30, 2016 are described below:

Business Combinations

Business combinations are accounted for using the acquisition method of accounting. The Company allocates the fair value of purchase consideration to the assets acquired and liabilities assumed based on their fair values at the acquisition date. The excess of the fair value of consideration transferred over the fair value of the net assets acquired is recorded as goodwill. Goodwill is generally attributable to the value of the synergies between the combined companies and the value of the acquired assembled workforce, neither of which qualifies for recognition as an intangible asset.

The Company uses its best estimates and assumptions to value assets acquired and liabilities assumed at the acquisition date; however, these estimates are sometimes preliminary and in some instances, all information required to value the assets acquired and liabilities assumed may not be available or final as of the end of a reporting period subsequent to the business combination. If the accounting for the business combination is incomplete, provisional amounts are recorded. The provisional amounts are updated during the period determined, up to one year from the acquisition date. The Company includes the results of operations of acquired businesses in the Company's consolidated results prospectively from the date of acquisition.

Acquisition related expenses and post-acquisition restructuring costs are recognized separately from the business combination and are expensed as incurred.

Revenue Recognition

The Company's health plans generate revenues primarily from premiums received from the states in which it operates health plans. The Company receives a fixed premium per member per month pursuant to its state contracts. The Company generally receives premium payments during the month it provides services and recognizes premium revenue during the period in which it is obligated to provide services to its members. In some instances, the Company's base premiums are subject to an adjustment, or risk score, based on the acuity of its membership. Generally, the risk score is determined by the State analyzing submissions of processed claims data to determine the acuity of the Company's membership relative to the entire state's Medicaid membership. Some states enact premium taxes, similar assessments and provider pass-through payments, collectively premium taxes, and these taxes are recorded as a separate component of both revenues and operating expenses. Some contracts allow for additional premiums related to certain supplemental services provided such as maternity deliveries.


7


Revenues are recorded based on membership and eligibility data provided by the states, which is adjusted on a monthly basis by the states for retroactive additions or deletions to membership data. These eligibility adjustments are estimated monthly and subsequent adjustments are made in the period known. The Company continuously reviews and updates those estimates as new information becomes available. It is possible that new information could require us to make additional adjustments, which could be significant, to these estimates.

The Company's Medicare Advantage contracts are with the CMS. CMS deploys a risk adjustment model which apportions premiums paid to all health plans according to health severity and certain demographic factors. The CMS risk adjustment model pays more for members whose medical history would indicate that they are expected to have higher medical costs. Under this risk adjustment methodology, CMS calculates the risk adjusted premium payment using diagnosis data from hospital inpatient, hospital outpatient and physician treatment settings. The Company and the health care providers collect, compile and submit the necessary and available diagnosis data to CMS within prescribed deadlines. The Company estimates risk adjustment revenues based upon the diagnosis data submitted and expected to be submitted to CMS.
 
The Company's specialty services generate revenues under contracts with state and federal programs, healthcare organizations, and other commercial organizations, as well as from our own subsidiaries. Revenues are recognized when the related services are provided or as ratably earned over the covered period of services. The Company recognizes revenue related to administrative services under the T-3 TRICARE government-sponsored managed care support contract in the North Region for the DoD's TRICARE program (T-3 contract) on a straight-line basis over the option period, when the fees become fixed and determinable. The T-3 contract includes various performance-based incentives and penalties. For each of the incentives or penalties, the Company adjusts revenue accordingly based on the amount that it has earned or incurred at each interim date and are legally entitled to in the event of a contract termination.

Premium and Related Receivables and Unearned Revenue

Premium and service revenues collected in advance are recorded as unearned revenue. For performance-based contracts the Company does not recognize revenue subject to refund until data is sufficient to measure performance. Premiums and service revenues due to the Company are recorded as premium and related receivables and are recorded net of an allowance based on historical trends and management's judgment on the collectibility of these accounts. As the Company generally receives payments during the month in which services are provided, the allowance is typically not significant in comparison to total revenues and does not have a material impact on the presentation of the financial condition or results of operations.

Amounts receivable under government contracts are comprised primarily of contractually defined billings, accrued contract incentives under the terms of the contract and amounts related to change orders for services not originally specified in the contract. Pursuant to the Company's T-3 contract, the government has the right to unilaterally modify the contract in certain respects by issuing change orders directing it to implement terms or services that were not originally included in the contract. Following receipt of a change order, the Company has a contractual right to negotiate an equitable adjustment to the contract terms to account for the impact of the change order. The Company starts to perform under such change orders and begins to incur associated costs after it receives the government's unilateral modification, but before it has negotiated the final scope and/or value of the change order. In these situations, costs are expensed as incurred, and the Company estimates and records revenue when it has met all applicable revenue recognition criteria. These criteria include the requirements that change order amounts are determinable, that the Company has performed under the change orders, and that collectability of amounts payable to the Company is reasonably assured.

3. Health Net

On March 24, 2016, the Company acquired all of the issued and outstanding shares of Health Net, a publicly traded managed care organization that delivers health care services through health plans and government-sponsored managed care plans. The transaction was valued at approximately $5,990 million, including the assumption of $703 million of outstanding debt. The acquisition allows the Company to offer a more comprehensive and scalable portfolio of solutions and provides opportunity for additional growth across the combined company's markets.


8


The total consideration for the acquisition was $5,287 million, consisting of Centene common shares valued at $3,038 million (based on Centene's stock price of $62.70), $2,247 million in cash, and $2 million related to the fair value adjustment to stock based compensation associated with pre-combination service. Each Health Net share was converted into 0.622 of a validly issued, fully paid, non-assessable share of Centene common stock and $28.25 in cash. In total, 48,449,444 shares of Centene common stock were issued in connection with the transaction. The cash portion of the acquisition consideration was funded through the issuance of long-term debt as further discussed in Note 7. Debt. For the three and nine months ended September 30, 2016, the Company also recognized acquisition related expenses of $10 million and $224 million, respectively, that were recorded in general and administrative expense in the Consolidated Statements of Operations.

The acquisition of Health Net has been accounted for as a business combination using the acquisition method of accounting which requires assets acquired and liabilities assumed to be recognized at fair value as of the acquisition date. The valuation of all the assets acquired and liabilities assumed has not yet been finalized. As a result, preliminary estimates have been recorded and are subject to change. Any necessary adjustments from our preliminary estimates will be finalized within one year from the date of acquisition. Measurement period adjustments will be recorded in the period in which they are determined, as if they had been completed at the acquisition date.

Since the initial allocation of purchase price, the Company made adjustments and reclassifications to the fair value of certain assets and liabilities acquired, including the premium and related receivables, medical claims liability, accrued liabilities, return of premium payable and deferred taxes, resulting in a net increase of $275 million to goodwill. The Company will continue to revise its preliminary purchase price allocation as additional information becomes available during the remainder of the measurement period. The Company's preliminary allocation of the fair value of assets acquired and liabilities assumed as of the acquisition date of March 24, 2016 is as follows ($ in millions):

Assets Acquired and Liabilities Assumed
 
 
Cash and cash equivalents
 
$
1,401

Premium and related receivables (a)
 
1,258

Short term investments
 
74

Other current assets
 
448

Long term investments
 
2,037

Restricted deposits
 
30

Property, software and equipment, net
 
41

Intangible assets (b)
 
1,500

Other long term assets
 
136

Total assets acquired
 
6,925

 
 
 
Medical claims liability
 
1,453

Borrowings under revolving credit facility
 
285

Accounts payable and accrued expenses (c)
 
2,033

Return of premium payable
 
435

Unearned revenue
 
130

Long term deferred tax liabilities (d)
 
330

Long term debt (e)
 
418

Other long term liabilities
 
430

Total liabilities assumed
 
5,514

 
 
 
Total identifiable net assets
 
1,411

Goodwill (f)
 
3,876

Total assets acquired and liabilities assumed
 
$
5,287


The Company has made certain preliminary fair value adjustments based on information reviewed through September 30, 2016. Significant preliminary fair value adjustments are noted as follows:

(a)
The preliminary fair value of premium and related receivables approximated their historical cost, with the exception of the risk corridor receivable associated with the Health Insurance Marketplace. The fair value of the risk corridor receivable was estimated at $9 million.

9


(b)
The identifiable intangible assets acquired are to be measured at fair value as of the completion of the acquisition. The fair value of intangible assets is determined primarily using variations of the "income approach," which is based on the present value of the future after tax cash flows attributable to each identified intangible asset. Other valuation methods, including the market approach and cost approach, were also considered in estimating the fair value. The Company has estimated the preliminary fair value of intangibles to be $1.5 billion with a weighted average life of 10 years. The Company expects the identifiable intangible assets to include purchased contract rights, provider contracts, trade names and developed technology. The Company is still in the process of finalizing its intangible valuation.

(c)
Accounts payable and accrued expenses includes approximately $285 million related to premium deficiency reserves based on cost trends existing prior to the acquisition date. The premium deficiency reserves are primarily associated with losses in the individual commercial business, largely in California, unfavorable performance in the Arizona commercial business as well as unfavorable performance in the Medicare business primarily in Oregon and Arizona. The premium deficiency reserve for the individual PPO commercial contracts in California includes anticipated future losses in 2016 associated with substance abuse rehabilitation claims. During the third quarter, the Company lowered the premium deficiency reserve by $15 million, reflecting its revised estimate of substance abuse cost trends.

(d)
The preliminary deferred tax liabilities are presented net of $526 million of deferred tax assets.

(e)
Debt is required to be measured at fair value under the acquisition method of accounting. The fair value of Health Net's $400 million Senior Notes assumed in the acquisition was $418 million. The $18 million increase will be amortized as a reduction to interest expense over the remaining life of the debt.

(f)
The acquisition resulted in $3.9 billion of goodwill related primarily to buyer specific synergies expected from the acquisition and the assembled workforce of Health Net. This goodwill is not deductible for income tax purposes. The assignment of goodwill to the Company's respective segments has not been completed at this time.    

Statement of Operations

From the acquisition date through September 30, 2016, the Company's Consolidated Statements of Operations include total Health Net revenues of $3,981 million and $8,604 million for the three and nine months ended September 30, 2016, respectively. It is impracticable to determine the effect on net income resulting from the Health Net acquisition for the three and nine months ended September 30, 2016, as the Company immediately integrated Health Net into its ongoing operations.

Unaudited Pro Forma Financial Information

The unaudited pro forma total revenues for the nine months ended September 30, 2016 were $32,369 million. The following table presents supplemental pro forma information for the three and nine months ended September 30, 2015 ($ in millions, except per share data).
 
Three Months Ended
September 30, 2015
 
Nine Months Ended
September 30, 2015
Total revenues
$
9,960

 
$
28,617

Net earnings attributable to Centene Corporation
$
85

 
$
215

Diluted earnings per share
$
0.49

 
$
1.25


The pro forma results do not reflect any anticipated synergies, efficiencies, or other cost savings of the acquisition. Accordingly, the unaudited pro forma financial information is not indicative of the results if the acquisition had been completed on January 1, 2015 and is not a projection of future results. It is impracticable for the Company to determine the pro forma earnings information for the nine months ended September 30, 2016 due to the nature of obtaining that information as the Company immediately integrated Health Net into its ongoing operations.

The unaudited pro forma financial information reflects the historical results of Centene and Health Net adjusted as if the acquisition had occurred on January 1, 2015, primarily for the following:

Additional interest income associated with adjusting the amortized cost of Health Net's investment portfolio to fair value.
Elimination of historical Health Net intangible asset amortization expense and addition of amortization expense based on the current preliminary values of identifiable intangible assets.

10


Interest expense associated with financing the acquisition and amortization of the fair value adjustment to Health Net's debt.
Additional stock compensation expense related to the amortization of the fair value increase to Health Net rollover stock awards.
Increased tax expense due to the assumption that Centene would be subject to the IRS Regulation 162(m)(6) beginning in 2015.
Elimination of acquisition related costs.

Restructuring Related Charges

In connection with the Health Net acquisition, the Company undertook a restructuring plan as a result of the integration of Health Net's operations into its business, resulting in a reduction in workforce beginning in 2016 and expected to continue through early 2017. The restructuring related costs are classified as general and administrative expenses in the Consolidated Statements of Operations. Changes in the restructuring liability for the nine months ended September 30, 2016 were as follows ($ in millions):

 
 
September 30, 2016
 
 
Employee Termination Costs
 
Stock Based Compensation
 
Total
Total accrued restructuring costs as of December 31, 2015
 
$

 
$

 
$

Charges incurred
 
39

 
40

 
79

Paid/settled
 
(25
)
 
(40
)
 
(65
)
Total accrued restructuring costs as of September 30, 2016
 
$
14

 
$

 
$
14


For the three and nine months ended September 30, 2016, the Company recorded employee termination costs of $7 million and $39 million and stock based compensation of $2 million and $40 million, respectively, in the Managed Care Segment. The Company expects to record a total of approximately $50 million of employee termination costs and $44 million of stock based compensation in connection with the acquisition, the majority of which is expected to be incurred through 2016 and early 2017.

Commitments

In connection with obtaining regulatory approval of the Health Net acquisition from the California Department of Insurance and the California Department of Managed Health Care, the Company committed to certain undertakings (the Undertakings). The Undertakings included, among other items, operational commitments around premiums, dividend restrictions, minimum Risk Based Capital (RBC) levels, local offices, growth, accreditation, HEDIS scores and other quality measures, network adequacy, certifications, investments and capital expenditures. Specifically, the Company agreed to, among other things:

invest an additional $30 million through the California Organized Investment Network over the five years following completion of the acquisition;
build a service center in an economically distressed community in California, investing $200 million over ten years and employing at least 300 people;
contribute $65 million to improve enrollee health outcomes ($10 million over ten years), support locally-based consumer assistance programs ($5 million over five years) and strengthen the health care delivery system ($50 million over five years), (of which, the present value of $61 million was expensed in the nine months ended September 30, 2016 and classified as general and administrative expenses in the Consolidated Statements of Operations); and
invest $75 million of its investment portfolio in vehicles supporting California’s health care infrastructure.


11


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, 2016
 
December 31, 2015
 
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
$
288

 
$
2

 
$

 
$
290

 
$
431

 
$

 
$
(2
)
 
$
429

Corporate securities
1,915

 
30

 
(2
)
 
1,943

 
859

 
2

 
(8
)
 
853

Restricted certificates of deposit
6

 

 

 
6

 
5

 

 

 
5

Restricted cash equivalents
70

 

 

 
70

 
78

 

 

 
78

Municipal securities
1,638

 
24

 
(1
)
 
1,661

 
496

 
2

 
(1
)
 
497

Asset-backed securities
289

 
2

 

 
291

 
163

 

 
(1
)
 
162

Residential mortgage-backed securities
215

 
3

 
(1
)
 
217

 
66

 
1

 

 
67

Commercial mortgage-backed securities
341

 
15

 
(1
)
 
355

 
40

 

 

 
40

Cost and equity method investments
162

 

 

 
162

 
71

 

 

 
71

Life insurance contracts
116

 

 

 
116

 
16

 

 

 
16

Total
$
5,040

 
$
76

 
$
(5
)
 
$
5,111

 
$
2,225

 
$
5

 
$
(12
)
 
$
2,218


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, 2016, 95% of the Company’s investments in rated securities carry an investment grade rating by S&P and Moody's.  At September 30, 2016, 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 primarily 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 3.3 years at September 30, 2016.

In January 2016, the Company completed a 19% investment in a data analytics business and as a result, issued 1.1 million shares of Centene common stock, valued at $68 million, to the selling stockholders. The investment is being accounted for using the equity method of accounting.


12


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, 2016
 
December 31, 2015
 
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
$

 
$
4

 
$

 
$
2

 
$
(2
)
 
$
294

 
$

 
$
14

Corporate securities
(1
)
 
309

 
(1
)
 
80

 
(6
)
 
561

 
(2
)
 
41

Municipal securities
(1
)
 
231

 

 
32

 
(1
)
 
208

 

 
5

Asset-backed securities

 
29

 

 
21

 
(1
)
 
121

 

 
8

Residential mortgage-backed securities
(1
)
 
45

 

 

 

 
30

 

 

Commercial mortgage-backed securities
(1
)
 
119

 

 
1

 

 
34

 

 

Total
$
(4
)
 
$
737

 
$
(1
)
 
$
136

 
$
(10
)
 
$
1,248

 
$
(2
)
 
$
68


As of September 30, 2016, the gross unrealized losses were generated from 569 positions out of a total of 2,731 positions.  The change in fair value of fixed income securities is primarily 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.

The contractual maturities of short term and long term investments and restricted deposits are as follows ($ in millions):
 
September 30, 2016
 
December 31, 2015
 
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
$
406

 
$
406

 
$
122

 
$
123

 
$
176

 
$
176

 
$
93

 
$
93

One year through five years
1,978

 
2,000

 
14

 
14

 
1,662

 
1,654

 
22

 
22

Five years through ten years
1,098

 
1,116

 

 

 
267

 
268

 

 

Greater than ten years
577

 
589

 

 

 
5

 
5

 

 

Asset-backed securities
845

 
863

 

 

 

 

 

 

Total
$
4,904

 
$
4,974

 
$
136

 
$
137

 
$
2,110

 
$
2,103

 
$
115

 
$
115

 
Actual maturities may differ from contractual maturities due to call or prepayment options.  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.


13


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, 2016, 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
$
2,982

 
$

 
$

 
$
2,982

Investments available for sale:
 

 
 

 
 

 
 

U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
215

 
$
14

 
$

 
$
229

Corporate securities

 
1,943

 

 
1,943

Municipal securities

 
1,661

 

 
1,661

Asset-backed securities

 
291

 

 
291

Residential mortgage-backed securities

 
217

 

 
217

Commercial mortgage-backed securities

 
355

 

 
355

Total investments
$
215

 
$
4,481

 
$

 
$
4,696

Restricted deposits available for sale:
 

 
 

 
 

 
 

Cash and cash equivalents
$
70

 
$

 
$

 
$
70

Certificates of deposit
6

 

 

 
6

U.S. Treasury securities and obligations of U.S. government corporations and agencies
61

 

 

 
61

Total restricted deposits
$
137

 
$

 
$

 
$
137

Other long term assets: Interest rate swap agreements
$

 
$
25

 
$

 
$
25

Total assets at fair value
$
3,334

 
$
4,506

 
$

 
$
7,840



14


The following table summarizes fair value measurements by level at December 31, 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
$
1,760

 
$

 
$

 
$
1,760

Investments available for sale:
 

 
 

 
 

 
 

U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
325

 
$
72

 
$

 
$
397

Corporate securities

 
853

 

 
853

Municipal securities

 
497

 

 
497

Asset-backed securities

 
162

 

 
162

Residential mortgage-backed securities

 
67

 

 
67

Commercial mortgage-backed securities

 
40

 

 
40

Total investments
$
325

 
$
1,691

 
$

 
$
2,016

Restricted deposits available for sale:
 

 
 

 
 

 
 

Cash and cash equivalents
$
78

 
$

 
$

 
$
78

Certificates of deposit
5

 

 

 
5

U.S. Treasury securities and obligations of U.S. government corporations and agencies
32

 

 

 
32

Total restricted deposits
$
115

 
$

 
$

 
$
115

Other long term assets:
 
 
 
 
 
 
 
Interest rate swap agreements
$

 
$
11

 
$

 
$
11

Total assets at fair value
$
2,200

 
$
1,702

 
$

 
$
3,902

Liabilities
 
 
 
 
 
 
 
Other long term liabilities:
 
 
 
 
 
 
 
Interest rate swap agreements
$

 
$
2

 
$

 
$
2

Total liabilities at fair value
$

 
$
2

 
$

 
$
2

 
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, 2016, there were no transfers from Level I to Level II and $46 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 $278 million and $87 million as of September 30, 2016 and December 31, 2015, respectively.
   
6. Affordable Care Act

The Affordable Care Act (ACA) established risk spreading premium stabilization programs effective January 1, 2014. 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. 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.

During the second quarter of 2016, the Company recognized a $70 million net pre-tax benefit related to the reconciliation of 2015 risk adjustment and reinsurance programs. During the third quarter of 2016, the Company received information from CMS, indicating that some of the participants in the Arizona risk adjustment program were unable to pay the amounts owed. As a result, the uncollected portion has been allocated pro-rata to other insurers in the market. Accordingly, the Company reduced the pre-tax earnings by $19 million during the third quarter.


15


The Company's receivables (payables) for each of these programs are as follows ($ in millions):
 
September 30, 2016
 
December 31, 2015
Risk adjustment
$
(294
)
 
$
(108
)
Reinsurance
101

 
24

Risk corridor

 
(4
)
Minimum medical loss ratio
(18
)
 
(15
)

7. Debt
 
Debt consists of the following ($ in millions):
 
September 30, 2016
 
December 31, 2015
$425 million 5.75% Senior notes, due June 1, 2017
$
426

 
$
428

$400 million 6.375% Senior notes, due June 1, 2017
411

 

$1,400 million 5.625% Senior notes, due February 15, 2021
1,400

 

$1,000 million 4.75% Senior notes, due May 15, 2022
1,008

 
500

$1,000 million 6.125% Senior notes, due February 15, 2024
1,000

 

Fair value of interest rate swap agreements
25

 
9

Total senior notes
4,270

 
937

Revolving credit agreement
300

 
225

Mortgage notes payable
65

 
67

Capital leases and other
18

 
6

Debt issuance costs
(64
)
 
(14
)
Total debt
4,589

 
1,221

Less current portion
(845
)
 
(5
)
 Long term debt
$
3,744

 
$
1,216


Senior Notes

In February 2016, a wholly owned unrestricted subsidiary of the Company (Escrow Issuer) issued $1,400 million in aggregate principal amount of 5.625% Senior Notes ($1,400 Million Notes) at par due 2021 and $1,000 million in aggregate principal amount of 6.125% Senior Notes ($1,000 Million Notes) at par due 2024. In July 2016, the Company completed an exchange offer, whereby it offered to exchange all of the outstanding $1,400 Million Notes and the $1,000 Million Notes for identical securities that have been registered under the Securities Act of 1933. The Company used the net proceeds of the offering, together with borrowings under the Company's new $1,000 million revolving credit facility and cash on hand, primarily to fund the cash consideration for the Health Net acquisition, and to pay acquisition and offering related fees and expenses.

In connection with the February 2016 issuance, the Company entered into interest rate swap agreements for notional amounts of $600 million and $1,000 million, at floating rates of interest based on the three month LIBOR plus 4.22% and the three month LIBOR plus 4.44%, respectively. Gains and losses due to changes in the fair value of the interest rate swaps completely offset changes in the fair value of the hedged portion of the underlying debt and are recorded as an adjustment to the $1,400 Million Notes and $1,000 Million Notes.

In connection with the closing of the Health Net acquisition, the Company assumed the $400 million in aggregate principal amount of Health Net's 6.375% Senior Notes due 2017, recorded at acquisition date fair value of $418 million.

In June 2016, the Company issued an additional $500 million in aggregate principal amount of 4.75% Senior Notes due 2022 ($500 Million Add-on Notes) at a premium to yield of 4.41%. The $500 Million Add-on Notes were offered as additional debt securities under the indenture governing the $500 million in aggregate principal amount of 4.75% Senior Notes issued in April 2014. The Company used the net proceeds of the offering to repay amounts outstanding under its Revolving Credit Facility and to pay offering related fees and expenses.


16


The indentures governing the $425 million in aggregate principal amount of 5.75% Senior Notes due 2017, the $1,400 Million Notes, the $1,000 million of its 4.75% Senior Notes due 2022, and the $1,000 Million Notes contain non-financial and financial covenants of Centene Corporation, including requirements of a minimum fixed charge coverage ratio. The indentures governing the $400 million notes due 2017 contain non-financial and financial covenants of Health Net, Inc., including requirements of a minimum fixed charge coverage ratio. At September 30, 2016, the Company was in compliance with all covenants.

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 $2,350 million of notional amount of interest rate swap agreements consisting of:

$250 million expiring on June 1, 2017;
$600 million expiring on February 15, 2021;
$500 million expiring on May 15, 2022; and,
$1,000 million expiring on February 15, 2024.

Under the Swap Agreements, the Company receives a fixed rate of interest and pays an average variable rate of the three month LIBOR plus 3.88% adjusted quarterly. At September 30, 2016, the weighted average rate was 4.69%.

The Swap Agreements are formally designated and qualify as fair value hedges and are recorded at fair value in the Consolidated Balance Sheets 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 Statements of Operations. The Company does not hold or issue any derivative instrument for trading or speculative purposes.

Revolving Credit Agreement

In connection with the closing of the Health Net acquisition on March 24, 2016, the Company's existing unsecured $500 million revolving credit facility was terminated and simultaneously replaced with a new $1,000 million unsecured 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 March 24, 2021. As of September 30, 2016, the Company had $300 million of borrowings outstanding under the agreement with a weighted average interest rate of 4.25%, and the Company was in compliance with all covenants.

The revolving credit facility contains non-financial and financial covenants, including requirements of minimum fixed charge coverage ratios and maximum debt-to-EBITDA ratios. The Company is required to not exceed a maximum debt-to-EBITDA ratio of 3.5 to 1.0 prior to December 31, 2016 and 3.0 to 1.0 on and subsequent to December 31, 2016. As of September 30, 2016, there were no limitations on the availability under the revolving credit agreement as a result of the debt-to-EBITDA ratio.

Also, upon the closing of the Health Net acquisition, the Company assumed, fully repaid $285 million in outstanding borrowings under, and terminated the existing Health Net revolving credit facility.

Letters of Credit & Surety Bonds

The Company had outstanding letters of credit of $43 million as of September 30, 2016, which were not part of the revolving credit facility. The Company also had letters of credit for $48 million (valued at September 30, 2016 conversion rate), or €42 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 1.44% as of September 30, 2016. The Company had outstanding surety bonds of $370 million as of September 30, 2016.







17


8. Stockholders' Equity

In March 2016, the Company issued 48,449,444 shares of Centene common stock, with a fair value of approximately $3,038 million, paid approximately $2,247 million in cash in exchange for all the outstanding shares of Health Net common stock and outstanding equity awards, and recorded $2 million related to the fair value adjustment to stock based compensation associated with pre-combination service.

In January 2016, the Company completed a 19% investment in a data analytics business and as a result, issued 1,144,462 shares of Centene common stock to the selling stockholders. The investment is being accounted for using the equity method of accounting.
 
9. 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,
 
2016
 
2015
 
2016
 
2015
Earnings attributable to Centene Corporation:
 
 
 
 
 
 
 
Earnings from continuing operations, net of tax
$
146

 
$
92

 
$
300

 
$
244

Discontinued operations, net of tax
(1
)
 
1

 
(3
)
 

Net earnings
$
145

 
$
93

 
$
297

 
$
244

 
 
 
 
 
 
 
 
Shares used in computing per share amounts:
 

 
 
 
 
 
 
Weighted average number of common shares outstanding
170,774,587

 
119,121,524

 
155,680,769

 
118,970,853

Common stock equivalents (as determined by applying the treasury stock method)
3,537,829

 
4,010,286

 
3,279,299

 
3,933,623

Weighted average number of common shares and potential dilutive common shares outstanding
174,312,416

 
123,131,810

 
158,960,068

 
122,904,476

 
 
 
 
 
 
 
 
Net earnings per common share attributable to Centene Corporation:
Basic:
 
 
 
 
 
 
 
Continuing operations
$
0.85

 
$
0.77

 
$
1.93

 
$
2.05

Discontinued operations

 
0.01

 
(0.02
)
 

Basic earnings per common share
$
0.85

 
$
0.78

 
$
1.91

 
$
2.05

 
 
 
 
 
 
 
 
Diluted:
 
 
 
 
 
 
 
Continuing operations
$
0.84

 
$
0.75

 
$
1.89

 
$
1.99

Discontinued operations
(0.01
)
 
0.01

 
(0.02
)
 

Diluted earnings per common share
$
0.83

 
$
0.76

 
$
1.87

 
$
1.99


The calculation of diluted earnings per common share for the three and nine months ended September 30, 2016 excludes the impact of 51,593 and 48,380 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, 2015 excludes the impact of 28,716 and 84,644 shares, respectively, related to anti-dilutive restricted stock and restricted stock units.









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10. 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. Subsequent to the closing of the Health Net acquisition, the Managed Care segment also includes the operations previously included in Health Net's Western Region Operations Segment, with the exception of certain operations of its pharmaceutical services and behavioral health subsidiaries. The portions of Health Net's Western Region Operations segment included in the Managed Care segment consist of the following Health Net operations: commercial, Medicare, Medicaid and dual eligible health plans, primarily in Arizona, California, Oregon and Washington.

The Specialty Services segment consists of Centene’s specialty companies offering auxiliary healthcare services and products. Subsequent to the closing of the Health Net acquisition, the Specialty Services segment also includes the operations previously included in the Government Contracts segment of Health Net as well as certain operations of its pharmaceutical services and behavioral health subsidiaries, the latter of which Health Net previously included in its Western Region Operations segment. The Government Contracts business includes the Company's government-sponsored managed care support contract with the DoD under the TRICARE program in the North Region, the MFLC contract with the DoD, and other health care related government contracts, including PC3/Choice with the VA.

Segment information for the three months ended September 30, 2016, follows ($ in millions):
 
Managed Care
 
Specialty
Services
 
Eliminations
 
Consolidated
Total
Total revenues from external customers
$
10,010

 
$
836

 
$

 
$
10,846

Total revenues from internal customers
55

 
1,525

 
(1,580
)
 

Total revenues
$
10,065

 
$
2,361

 
$
(1,580
)
 
$
10,846

Earnings from operations
$
304

 
$
38

 
$

 
$
342


Segment information for the three months ended September 30, 2015, follows ($ in millions):
 
Managed Care
 
Specialty
Services
 
Eliminations
 
Consolidated
Total
Total revenues from external customers
$
5,278

 
$
543

 
$

 
$
5,821

Total revenues from internal customers
23

 
1,274

 
(1,297
)