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EX-32.2 - CERTIFICATION - CENTENE CORPexhibit322q12018.htm
EX-32.1 - CERTIFICATION - CENTENE CORPexhibit321q12018.htm
EX-31.2 - CERTIFICATION - CENTENE CORPexhibit312q12018.htm
EX-31.1 - CERTIFICATION - CENTENE CORPexhibit311q12018.htm
EX-12.1 - RATIO OF EARNINGS TO FIXED CHARGES - CENTENE CORPexhibit121q12018.htm
EX-10.1 - EMPLOYEE STOCK PURCHASE PLAN - CENTENE CORPexhibit101q12018.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 March 31, 2018
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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “small reporting company”, and “emerging growth 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 
 
Emerging growth company 
o 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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 April 13, 2018, the registrant had 178,533,259 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 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, growth strategy, competition, expected activities and future acquisitions, including our proposed acquisition of New York State Catholic Health Plan, Inc., d/b/a Fidelis Care New York (Fidelis Care) (Proposed Fidelis Acquisition or Fidelis Care Transaction), 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 healthcare costs;
changes in economic, political or market conditions;
changes in federal or state laws or regulations, including changes with respect to income tax reform or government healthcare programs as well as changes with respect to the Patient Protection and Affordable Care Act and the Health Care and Education Affordability Reconciliation Act and any regulations enacted thereunder that may result from changing political conditions;
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;
tax matters;
disasters or major epidemics;
the outcome of legal and regulatory proceedings;
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 or Fidelis Care's contracts with federal or state governments (including but not limited to Medicaid, Medicare, TRICARE or other customers);
the difficulty of predicting the timing or outcome of pending or future litigation or government investigations;
challenges to our or Fidelis Care's contract awards;
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 (Health Net Acquisition) of Health Net, Inc. (Health Net), and the Proposed Fidelis Acquisition, will not be realized, or will not be realized within the expected time period, including, but not limited to, as a result of any failure to obtain any regulatory, governmental or third party consents or approvals in connection with the Proposed Fidelis Acquisition (including any such approvals under the New York Non-For-Profit Corporation Law) or any conditions, terms, obligations or restrictions imposed in connection with the receipt of such consents or approvals;
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 any regulatory, governmental or third party consents or approvals for the Health Net Acquisition or the Proposed Fidelis Acquisition;

i


disruption caused by significant completed and pending acquisitions, including the Health Net Acquisition and the Proposed Fidelis Acquisition, making it more difficult to maintain business and operational relationships;
the risk that unexpected costs will be incurred in connection with the completion and/or integration of acquisition transactions, including among others, the Health Net Acquisition and the Proposed Fidelis Acquisition;
changes in expected closing dates, estimated purchase price and accretion for acquisitions;
the risk that acquired businesses and pending acquisitions, including Health Net and Fidelis Care, will not be integrated successfully;
the risk that the conditions to the completion of the Proposed Fidelis Acquisition may not be satisfied or completed on a timely basis, or at all;
failure to obtain or receive any required regulatory approvals, consents or clearances for the Proposed Fidelis Acquisition, and the risk that, even if so obtained or received, regulatory authorities impose conditions on the completion of the transaction that could require the exertion of management's time and our resources, or otherwise have an adverse effect on Centene or the completion of the Proposed Fidelis Acquisition;
business uncertainties and contractual restrictions while the Proposed Fidelis Acquisition is pending, which could adversely affect our business and operations;
change of control provisions or other provisions in certain agreements to which Fidelis Care is a party, which may be triggered by the completion of the Proposed Fidelis Acquisition;
loss of management personnel and other key employees due to uncertainties associated with the Proposed Fidelis Acquisition;
the risk that, following completion of the Proposed Fidelis Acquisition, the combined company may not be able to effectively manage its expanded operations;
restrictions and limitations that may stem from the financing arrangements that the combined company will enter into in connection with the Proposed Fidelis Acquisition;
our ability to achieve improvement in the Centers for Medicare and Medicaid Services (CMS) Star ratings and maintain or achieve improvement in other quality scores in each case that can impact revenue and future growth;
availability of debt and equity financing, on terms that are favorable to us;
inflation; and
foreign currency fluctuations.

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 report 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 and selling, general and administrative costs.




ii


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 amortization of acquired intangible assets, acquisition related expenses, as well as other items, allows investors to develop a more meaningful understanding of the Company's performance over time. The tables below provide reconciliations of non-GAAP items ($ in millions, except per share data):

 
Three Months Ended
March 31,
 
2018
 
2017
 
 
 
 
GAAP net earnings
$
340

 
$
139

Amortization of acquired intangible assets
39

 
40

Acquisition related expenses
21

 
5

Penn Treaty assessment expense

 
47

Income tax effects of adjustments (1)
(14
)
 
(34
)
Adjusted net earnings
$
386

 
$
197

 
 
 
 
GAAP diluted earnings per share (EPS)
$
1.91

 
$
0.79

Amortization of acquired intangible assets (2)
0.17

 
0.14

Acquisition related expenses (3)
0.09

 
0.02

Penn Treaty assessment expense (4)

 
0.17

Adjusted Diluted EPS
$
2.17

 
$
1.12

(1)
The income tax effects of adjustments are based on the effective income tax rates applicable to adjusted (non-GAAP) results.
(2)
The amortization of acquired intangible assets per diluted share are net of an income tax benefit of $0.05 and $0.09 for the three months ended March 31, 2018 and 2017, respectively.
(3)
Acquisition related expenses per diluted share are net of an income tax benefit of $0.03 and $0.01 for the three months ended March 31, 2018 and 2017, respectively.
(4)
The Penn Treaty assessment expense per diluted share is net of an income tax benefit of $0.09 for the three months ended March 31, 2017.
 
Three Months Ended
March 31,
 
2018
 
2017
 
 
 
 
GAAP selling, general and administrative expenses
$
1,316

 
$
1,091

Acquisition related expenses
21

 
5

Penn Treaty assessment expense

 
47

Adjusted selling, general and administrative expenses
$
1,295

 
$
1,039


iii


PART I
FINANCIAL INFORMATION

ITEM 1. Financial Statements.
CENTENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In millions, except shares in thousands and per share data in dollars)
 
March 31, 2018
 
December 31, 2017
 
(Unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
5,668


$
4,072

Premium and trade receivables
3,648


3,413

Short-term investments
507


531

Other current assets
1,153


687

Total current assets
10,976


8,703

Long-term investments
5,535


5,312

Restricted deposits
140


135

Property, software and equipment, net
1,250


1,104

Goodwill
5,295


4,749

Intangible assets, net
1,519


1,398

Other long-term assets
455


454

Total assets
$
25,170


$
21,855

 





LIABILITIES, REDEEMABLE NONCONTROLLING INTERESTS AND STOCKHOLDERS’ EQUITY


 

Current liabilities:
 


 

Medical claims liability
$
4,771


$
4,286

Accounts payable and accrued expenses
4,962


4,165

Return of premium payable
515

 
549

Unearned revenue
638


328

Current portion of long-term debt
4


4

Total current liabilities
10,890


9,332

Long-term debt
5,172


4,695

Other long-term liabilities
1,520


952

Total liabilities
17,582


14,979

Commitments and contingencies





Redeemable noncontrolling interests
8


12

Stockholders’ equity:
 


 

Preferred stock, $0.001 par value; authorized 10,000 shares; no shares issued or outstanding at March 31, 2018 and December 31, 2017



Common stock, $0.001 par value; authorized 400,000 shares; 180,643 issued and 176,795 outstanding at March 31, 2018, and 180,379 issued and 173,437 outstanding at December 31, 2017



Additional paid-in capital
4,592


4,349

Accumulated other comprehensive (loss)
(54
)

(3
)
Retained earnings
3,104


2,748

Treasury stock, at cost (3,848 and 6,942 shares, respectively)
(139
)

(244
)
Total Centene stockholders’ equity
7,503


6,850

Noncontrolling interest
77


14

Total stockholders’ equity
7,580


6,864

Total liabilities, redeemable noncontrolling interests and stockholders’ equity
$
25,170


$
21,855

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 per share data in dollars)
(Unaudited)
 
Three Months Ended March 31,
 
2018

2017
Revenues:



Premium
$
11,903


$
10,638

Service
653


527

Premium and service revenues
12,556


11,165

Premium tax and health insurer fee
638


559

Total revenues
13,194


11,724

Expenses:



Medical costs
10,039


9,322

Cost of services
543


441

Selling, general and administrative expenses
1,316


1,091

Amortization of acquired intangible assets
39


40

Premium tax expense
546


590

Health insurer fee expense
171



Total operating expenses
12,654


11,484

Earnings from operations
540


240

Other income (expense):



Investment and other income
41


41

Interest expense
(68
)

(62
)
Earnings from operations, before income tax expense
513


219

Income tax expense
175


87

Net earnings
338


132

Loss attributable to noncontrolling interests
2


7

Net earnings attributable to Centene Corporation
$
340


$
139





Net earnings per common share attributable to Centene Corporation:
Basic earnings per common share
$
1.95


$
0.81

Diluted earnings per common share
$
1.91


$
0.79





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 March 31,
 
2018
 
2017
Net earnings
$
338

 
$
132

Reclassification adjustment, net of tax

 

Change in unrealized gain (loss) on investments, net of tax
(52
)
 
14

Foreign currency translation adjustments
1

 
1

Other comprehensive earnings (loss)
(51
)
 
15

Comprehensive earnings
287

 
147

Comprehensive loss attributable to noncontrolling interests
2

 
7

Comprehensive earnings attributable to Centene Corporation
$
289

 
$
154


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 shares in thousands and per share data in dollars)
(Unaudited)

Three Months Ended March 31, 2018

 
Centene Stockholders’ Equity
 
 
 
 
 
Common Stock
 
 
 
 
 
 
 
Treasury Stock
 
 
 
 
 
$.001 Par
Value
Shares
 
Amt
 
Additional
Paid-in
Capital
 
Accumulated
Other
Comprehensive
Loss
 
Retained
Earnings
 
$.001 Par
Value
Shares
 
Amt
 
Non-
controlling
Interest
 
Total
Balance, December 31, 2017
180,379

 
$

 
$
4,349

 
$
(3
)
 
$
2,748

 
6,942

 
$
(244
)
 
$
14

 
$
6,864

Comprehensive Earnings:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net earnings

 

 

 

 
340

 

 

 
1

 
341

Other comprehensive loss, net of ($16) tax

 

 

 
(51
)
 

 

 

 

 
(51
)
Common stock issued for acquisitions

 

 
210

 

 

 
(3,176
)
 
114

 

 
324

Common stock issued for employee benefit plans
264

 

 
4

 

 

 

 

 

 
4

Common stock repurchases

 

 

 

 

 
82

 
(9
)
 

 
(9
)
Stock compensation expense

 

 
33

 

 

 

 

 

 
33

Cumulative-effect of adopting new accounting guidance

 

 

 

 
16

 

 

 

 
16

Purchase of noncontrolling interest

 

 
(4
)
 

 

 

 

 

 
(4
)
Acquisition resulting in noncontrolling interest

 

 

 

 

 

 

 
62

 
62

Balance, March 31, 2018
180,643

 
$

 
$
4,592

 
$
(54
)
 
$
3,104

 
3,848

 
$
(139
)
 
$
77

 
$
7,580

 
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)
 
Three Months Ended March 31,
 
2018

2017
Cash flows from operating activities:
 

 
Net earnings
$
338


$
132

Adjustments to reconcile net earnings to net cash provided by operating activities
Depreciation and amortization
104


86

Stock compensation expense
33


32

Deferred income taxes
30


(51
)
Changes in assets and liabilities
 


 

Premium and trade receivables
(176
)

59

Other assets
51


89

Medical claims liabilities
485


358

Unearned revenue
317


320

Accounts payable and accrued expenses
157


(237
)
Other long-term liabilities
477


459

Other operating activities, net
30


1

Net cash provided by operating activities
1,846


1,248

Cash flows from investing activities:
 


 

Capital expenditures
(218
)

(83
)
Purchases of investments
(765
)

(582
)
Sales and maturities of investments
445


343

Acquisitions, net of cash acquired
(226
)


Other investing activities, net


(1
)
Net cash used in investing activities
(764
)

(323
)
Cash flows from financing activities:
 


 

Proceeds from long-term debt
2,015


560

Payments of long-term debt
(1,491
)

(560
)
Common stock repurchases
(9
)

(13
)
Other financing activities, net
(2
)

3

Net cash provided by (used in) financing activities
513


(10
)
Net increase in cash, cash equivalents and restricted cash
1,595


915

Cash, cash equivalents, and restricted cash and cash equivalents, beginning of period
4,089


3,936

Cash, cash equivalents, and restricted cash and cash equivalents, end of period
$
5,684


$
4,851

Supplemental disclosures of cash flow information:
 


 

Interest paid
$
73


$
72

Income taxes paid
$
1


$
2

Equity issued in connection with acquisitions
$
324


$


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
(Unaudited)
   
1. Organization and Operations

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, 2017. 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, 2017 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 amounts in the consolidated financial statements and notes to the consolidated financial statements have been reclassified to conform to the 2018 presentation. These reclassifications have no effect on net earnings or stockholders' equity as previously reported.
 
Recently Adopted Accounting Guidance

In February 2018, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) which allows a reclassification from accumulated other comprehensive income (OCI) to retained earnings for stranded tax effects resulting from the Tax Cuts and Job Acts (TCJA). Consequently, the amendments eliminate the stranded tax effects resulting from the TCJA and will improve the usefulness of information reported to financial statement users. However, because the amendments only relate to the reclassification of the income tax effects of the TCJA, the underlying guidance that requires that the effect of a change in tax laws or rates be included in income from continuing operations is not affected. The amendments in this ASU also require certain disclosures about stranded tax effects. The Company adopted the new guidance in the first quarter of 2018 and elected to reclassify stranded tax effects as a result of the TCJA related to unrealized gains and losses on investments and defined benefit plan obligations. The Company uses the individual security approach to release income tax effects from accumulated OCI. The new guidance did not have a material impact on the Company's consolidated financial position, results of operations or cash flows.

In November 2016, the FASB issued an ASU clarifying the classification and presentation of changes in restricted cash on the statement of cash flows. The amendments in this ASU require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and restricted cash. Therefore, amounts generally described as restricted cash should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The Company adopted the new guidance in the first quarter of 2018. The new guidance did not have a material impact on the Company's consolidated financial position, results of operations or cash flows. Cash, cash equivalents, and restricted cash and cash equivalents reported on the Consolidated Statements of Cash Flows includes restricted cash and cash equivalents of $6 million, $12 million, $17 million, and $16 million as of December 31, 2016, March 31, 2017, December 31, 2017 and March 31, 2018, respectively, as well as previously reported cash and cash equivalents.

In March 2016, the FASB issued an ASU which requires entities to measure equity investments at fair value and recognize any change in fair value in net income. The standard does not apply to accounting methods that result in consolidation of the investee and those accounted for under the equity method. The standard also requires entities to record changes in instrument-specific credit risk for financial liabilities measured under the fair value option in other comprehensive income. Companies are required to record a cumulative-effect adjustment to the statement of financial position as of the beginning of the fiscal year in which the guidance is adopted, with the exception of amendments related to equity investments without readily determinable fair values, which will be applied prospectively to all investments that exist as of the date of adoption. The Company adopted the new guidance in the first quarter of 2018. The new guidance did not have a material impact on the Company's consolidated financial position, results of operations or cash flows.


6


In May 2014, the FASB issued an 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. The Company adopted the new guidance in the first quarter of 2018 using the modified retrospective approach with a cumulative-effect increase to retained earnings of $16 million. The Company also elected the practical expedient of applying the new guidance only to contracts that are not completed as of the date of initial application. The majority of the Company's revenues are derived from insurance contracts and are excluded from the new standard.

Accounting Guidance Not Yet Adopted

In February 2018, the FASB issued an ASU which makes technical corrections and clarifications to certain aspects of the new guidance on recognizing and measuring financial instruments. The amendment clarifies, among other things, that entities will use a prospective transition approach only for equity securities they elect to measure using the new measurement alternative. The amendments are effective for annual periods beginning in 2018 and interim periods beginning in the third quarter of 2018. The new guidance is not expected to have a material impact on the Company's consolidated financial position, results of operations or cash flows.

In February 2016, the FASB issued an 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 initial standard required a modified retrospective transition approach, with application, including disclosures, in all comparative periods presented. In March 2018, the FASB tentatively approved an amendment to the new guidance that allows companies the option of using the effective date of the new standard as the date of initial application. The Company is currently evaluating the effect of the new lease guidance.

2. Fidelis Care Transaction

In September 2017, the Company signed a definitive agreement under which Fidelis Care will become the Company's health plan in New York State. Under the terms of the agreement, the Company will acquire substantially all of the assets of Fidelis Care for $3.75 billion, subject to certain adjustments.


7


3. 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):
 
March 31, 2018
 
December 31, 2017
 
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
$
260

 
$

 
$
(3
)
 
$
257

 
$
311

 
$

 
$
(2
)
 
$
309

Corporate securities
2,242

 
5

 
(33
)
 
2,214

 
2,208

 
12

 
(10
)
 
2,210

Restricted certificates of deposit
4

 

 

 
4

 
4

 

 

 
4

Restricted cash equivalents
16

 

 

 
16

 
17

 

 

 
17

Municipal securities
2,187

 
3

 
(28
)
 
2,162

 
2,085

 
12

 
(10
)
 
2,087

Asset-backed securities
492

 
1

 
(3
)
 
490

 
437

 
1

 
(1
)
 
437

Residential mortgage-backed securities
345

 

 
(10
)
 
335

 
337

 
1

 
(6
)
 
332

Commercial mortgage-backed securities
287

 

 
(6
)
 
281

 
272

 
1

 
(2
)
 
271

Fair value and equity method investments
290

 

 

 
290

 
176

 

 

 
176

Life insurance contracts
133

 

 

 
133

 
135

 

 

 
135

Total
$
6,256

 
$
9

 
$
(83
)
 
$
6,182

 
$
5,982

 
$
27

 
$
(31
)
 
$
5,978



8


The Company’s investments are debt securities classified as available-for-sale with the exception of life insurance contracts and certain 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 March 31, 2018, 96% of the Company’s investments in rated securities carry an investment grade rating by nationally recognized statistical rating organizations. At March 31, 2018, the Company held certificates of deposit, life insurance contracts and fair value 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 3.9 years at March 31, 2018.

In March 2018, the Company completed a 25% investment in RxAdvance, a full-service pharmacy benefit manager. The investment is accounted for using the equity method of accounting.

The fair value of available-for-sale debt securities 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):
 
March 31, 2018
 
December 31, 2017
 
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
$
(2
)
 
$
171

 
$
(1
)
 
$
85

 
$
(1
)
 
$
222

 
$
(1
)
 
$
79

Corporate securities
(26
)
 
1,598

 
(7
)
 
185

 
(6
)
 
1,044

 
(4
)
 
185

Municipal securities
(22
)
 
1,467

 
(6
)
 
171

 
(7
)
 
943

 
(3
)
 
175

Asset-backed securities
(2
)
 
310

 
(1
)
 
27

 
(1
)
 
228

 

 
28

Residential mortgage-backed securities
(3
)
 
159

 
(7
)
 
161

 
(1
)
 
109

 
(5
)
 
171

Commercial mortgage-backed securities
(4
)
 
172

 
(2
)
 
50

 
(1
)
 
112

 
(1
)
 
51

Total
$
(59
)
 
$
3,877

 
$
(24
)
 
$
679

 
$
(17
)
 
$
2,658

 
$
(14
)
 
$
689


As of March 31, 2018, the gross unrealized losses were generated from 2,714 positions out of a total of 3,564 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.


9


The contractual maturities of short-term and long-term investments and restricted deposits are as follows ($ in millions):
 
March 31, 2018
 
December 31, 2017
 
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
$
432

 
$
430

 
$
45

 
$
45

 
$
474

 
$
474

 
$
48

 
$
47

One year through five years
2,439

 
2,411

 
96

 
95

 
2,424

 
2,420

 
88

 
88

Five years through ten years
1,920

 
1,894

 

 

 
1,773

 
1,779

 

 

Greater than ten years
200

 
201

 

 

 
129

 
130

 

 

Asset-backed securities
1,124

 
1,106

 

 

 
1,046

 
1,040

 

 

Total
$
6,115

 
$
6,042

 
$
141

 
$
140

 
$
5,846

 
$
5,843

 
$
136

 
$
135

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

4. 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.

10


 
The following table summarizes fair value measurements by level at March 31, 2018, 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
$
5,668

 
$

 
$

 
$
5,668

Investments available for sale:
 

 
 

 
 

 
 

U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
137

 
$

 
$

 
$
137

Corporate securities

 
2,214

 

 
2,214

Municipal securities

 
2,162

 

 
2,162

Asset-backed securities

 
490

 

 
490

Residential mortgage-backed securities

 
335

 

 
335

Commercial mortgage-backed securities

 
281

 

 
281

Total investments
$
137

 
$
5,482

 
$

 
$
5,619

Restricted deposits available for sale:
 

 
 

 
 

 
 

Cash and cash equivalents
$
16

 
$

 
$

 
$
16

Certificates of deposit
4

 

 

 
4

U.S. Treasury securities and obligations of U.S. government corporations and agencies
120

 

 

 
120

Total restricted deposits
$
140

 
$

 
$

 
$
140

Other long-term assets: Interest rate swap agreements
$

 
$

 
$

 
$

Total assets at fair value
$
5,945

 
$
5,482

 
$

 
$
11,427

Liabilities
 
 
 
 
 
 
 
Other long-term liabilities:
 
 
 
 
 
 
 
Interest rate swap agreements
$

 
$
120

 
$

 
$
120

Total liabilities at fair value
$

 
$
120

 
$

 
$
120



























11



The following table summarizes fair value measurements by level at December 31, 2017, 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
$
4,072

 
$

 
$

 
$
4,072

Investments available for sale:
 

 
 

 
 

 
 

U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
195

 
$

 
$

 
$
195

Corporate securities

 
2,210

 

 
2,210

Municipal securities

 
2,087

 

 
2,087

Asset-backed securities

 
437

 

 
437

Residential mortgage-backed securities

 
332

 

 
332

Commercial mortgage-backed securities

 
271

 

 
271

Total investments
$
195

 
$
5,337

 
$

 
$
5,532

Restricted deposits available for sale:
 

 
 

 
 

 
 

Cash and cash equivalents
$
17

 
$

 
$

 
$
17

Certificates of deposit
4

 

 

 
4

U.S. Treasury securities and obligations of U.S. government corporations and agencies
114

 

 

 
114

Total restricted deposits
$
135

 
$

 
$

 
$
135

Other long-term assets:
 
 
 
 
 
 
 
Interest rate swap agreements
$

 
$
1

 
$

 
$
1

Total assets at fair value
$
4,402

 
$
5,338

 
$

 
$
9,740

Liabilities
 
 
 
 
 
 
 
Other long-term liabilities:
 
 
 
 
 
 
 
Interest rate swap agreements
$

 
$
72

 
$

 
$
72

Total liabilities at fair value
$

 
$
72

 
$

 
$
72

 
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 March 31, 2018, there were no transfers from Level I to Level II and no 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 $423 million and $311 million as of March 31, 2018 and December 31, 2017, respectively.


12


5. Medical Claims Liability

The following table summarizes the change in medical claims liability ($ in millions):

 
 
Three Months Ended March 31,
 
 
2018
 
2017
Balance, January 1
 
$
4,286

 
$
3,929

Less: Reinsurance recoverable
 
18

 
5

Balance, January 1, net
 
4,268

 
3,924

Acquisitions
 

 

Incurred related to:
 
 
 
 
          Current year
 
10,302

 
9,557

          Prior years
 
(263
)
 
(235
)
         Total incurred
 
10,039

 
9,322

Paid related to:
 
 
 
 
          Current year
 
6,579

 
5,973

          Prior years
 
2,970

 
2,991

         Total paid
 
9,549

 
8,964

Balance at March 31, net
 
4,758

 
4,282

Plus: Reinsurance recoverable
 
13

 
8

Balance, March 31
 
$
4,771

 
$
4,290


Reinsurance recoverables related to medical claims are included in premium and related receivables. Changes in estimates of incurred claims for prior years are primarily attributable to reserving under moderately adverse conditions. Additionally, as a result of development within "Incurred related to: Prior years" due to minimum HBR and other return of premium programs, we recorded $13 million and $3 million as a reduction to premium revenues in the three months ended March 31, 2018 and 2017, respectively.

Incurred but not reported (IBNR) plus expected development on reported claims as of March 31, 2018 was $3,688 million. Total IBNR plus expected development on reported claims represents estimates for claims incurred but not reported, development on reported claims, and estimates for the costs necessary to process unpaid claims at the end of each period. We estimate our liability using actuarial methods that are commonly used by health insurance actuaries and meet Actuarial Standards of Practice. These actuarial methods consider factors such as historical data for payment patterns, cost trends, product mix, seasonality, utilization of healthcare services and other relevant factors.
 
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 (MLR) and cost sharing reductions. 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 MLR.




13


The Company's net receivables (payables) for each of these programs are as follows ($ in millions):
 
March 31, 2018
 
December 31, 2017
Risk adjustment
$
(1,131
)
 
$
(677
)
Reinsurance
1

 
15

Risk corridor
5

 
6

Minimum MLR
(44
)
 
(22
)
Cost sharing reductions
(71
)
 
(96
)
                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
7. Debt
 
Debt consists of the following ($ in millions):
 
March 31, 2018
 
December 31, 2017
$1,400 million 5.625% Senior notes, due February 15, 2021
$
1,400

 
$
1,400

$1,000 million 4.75% Senior notes, due May 15, 2022
1,006

 
1,006

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

 
1,000

$1,200 million 4.75% Senior notes, due January 15, 2025
1,200

 
1,200

Fair value of interest rate swap agreements
(120
)
 
(71
)
Total senior notes
4,486

 
4,535

Revolving credit agreement
675

 
150

Mortgage notes payable
60

 
61

Capital leases and other
17

 
18

Debt issuance costs
(62
)
 
(65
)
Total debt
5,176

 
4,699

Less current portion
(4
)
 
(4
)
 Long-term debt
$
5,172

 
$
4,695


Senior Notes

The indentures governing the senior notes listed in the table above contain restrictive covenants of Centene Corporation. At March 31, 2018, 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 following is a summary of the notional amounts of the Company's interest rate swap agreements as of March 31, 2018:

Expiration Date
 
Notional Amount
February 15, 2021
 
$
600

May 15, 2022
 
500

February 15, 2024
 
1,000

January 15, 2025
 
600

Total
 
$
2,700


The fair value of the swap agreements shown above are recorded in other long-term assets and other long-term liabilities, respectively in the Consolidated Balance Sheets. Under the swap agreements, the Company receives a fixed rate of interest and pays an average variable rate of either the three or one month LIBOR plus 3.61% adjusted monthly or quarterly, based on the terms of the individual swap agreements. At March 31, 2018, the weighted average rate was 5.44%.


14


The swap agreements are formally designated and qualify as fair value hedges. 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

The Company has an unsecured $1,500 million revolving credit facility. The agreement has a maturity date of December 14, 2022. Borrowings under the agreement bear interest based upon LIBOR rates, the Federal Funds Rate or the Prime Rate. As of March 31, 2018, the Company had $675 million of borrowings outstanding under the agreement with a weighted average interest rate of 5.00%, 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. As of March 31, 2018, there were no limitations on the availability under the revolving credit agreement as a result of the debt-to-EBITDA ratio.

Mortgage Notes Payable

The Company has a non-recourse mortgage note of $60 million at March 31, 2018 collateralized by its corporate headquarters building. The mortgage note is due January 1, 2021 and bears a 5.14% interest rate. The collateralized property had a net book value of $170 million at March 31, 2018.

Letters of Credit & Surety Bonds

The Company had outstanding letters of credit of $76 million as of March 31, 2018, which were not part of the revolving credit facility. The Company also had letters of credit for $47 million (valued at March 31, 2018 conversion rate), or €38 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 1.31% as of March 31, 2018. The Company had outstanding surety bonds of $404 million as of March 31, 2018.

Construction Loan

The Company has a $200 million non-recourse construction loan to fund the expansion of the Company's corporate headquarters. The loan bears interest based on the one month LIBOR plus 2.70% and matures in April 2021 with an optional one-year extension. The agreement contains financial and non-financial covenants aligning with the Company's revolving credit agreement. The Company has guaranteed completion of the construction project associated with the loan. As of March 31, 2018, the Company had no borrowings outstanding under the loan.

8. Stockholders' Equity
 
In March 2018, the Company acquired CMG and issued 1,449 thousand shares of Centene common stock to the selling shareholders, with a fair value of $149 million.

In March 2018, the Company acquired an additional 61% of Interpreta and issued 1,727 thousand shares of Centene common stock to the selling shareholders, with a fair value of $175 million.
 

15


9. Earnings Per Share

The following table sets forth the calculation of basic and diluted net earnings per common share ($ in millions, except shares in thousands and per share data in dollars):
 
Three Months Ended March 31,
 
2018
 
2017
 
 
 
 
Earnings attributable to Centene Corporation
$
340

 
$
139

 
 
 
 
Shares used in computing per share amounts:
 
 
 
Weighted average number of common shares outstanding
173,921

 
172,074

Common stock equivalents (as determined by applying the treasury stock method)
3,769

 
3,762

Weighted average number of common shares and potential dilutive common shares outstanding
177,690

 
175,836

 
 
 
 
Net earnings per common share attributable to Centene Corporation:
Basic earnings per common share
$
1.95

 
$
0.81

Diluted earnings per common share
$
1.91

 
$
0.79


The calculation of diluted earnings per common share for the three months ended March 31, 2018 and 2017 excludes the impact of 5 thousand and 55 thousand shares, respectively, related to anti-dilutive stock options, restricted stock and restricted stock units.

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. The Specialty Services segment consists of Centene’s specialty companies offering auxiliary healthcare services and products.

Segment information for the three months ended March 31, 2018, follows ($ in millions):
 
Managed Care
 
Specialty
Services
 
Eliminations
 
Consolidated
Total
Total revenues from external customers
$
12,449

 
$
745

 
$

 
$
13,194

Total revenues from internal customers
25

 
2,231

 
(2,256
)
 

Total revenues
$
12,474

 
$
2,976

 
$
(2,256
)
 
$
13,194

Earnings from operations
$
470

 
$
70

 
$

 
$
540


Segment information for the three months ended March 31, 2017, follows ($ in millions):
 
Managed Care
 
Specialty
Services
 
Eliminations
 
Consolidated
Total
Total revenues from external customers
$
11,115

 
$
609

 
$

 
$
11,724

Total revenues from internal customers
11

 
2,333

 
(2,344
)
 

Total revenues
$
11,126

 
$
2,942

 
$
(2,344
)
 
$
11,724

Earnings from operations
$
187

 
$
53

 
$

 
$
240



16


11. Contingencies

Overview

The Company records reserves and accrues costs for certain legal proceedings and regulatory matters to the extent that it determines an unfavorable outcome is probable and the amount of the loss can be reasonably estimated. While such reserves and accrued costs reflect the Company's best estimate of the probable loss for such matters, the recorded amounts may differ materially from the actual amount of any such losses. In some cases, no estimate of the possible loss or range of loss in excess of amounts accrued, if any, can be made because of the inherently unpredictable nature of legal and regulatory proceedings, which may be exacerbated by various factors, including but not limited to, they may involve indeterminate claims for monetary damages or may involve fines, penalties or punitive damages; present novel legal theories or legal uncertainties; involve disputed facts; represent a shift in regulatory policy; involve a large number of parties, claimants or regulatory bodies; are in the early stages of the proceedings; involve a number of separate proceedings and/or a wide range of potential outcomes; or result in a change of business practices.

As of the date of this report, amounts accrued for legal proceedings and regulatory matters were not material. However, it is possible that in a particular quarter or annual period the Company’s financial condition, results of operations, cash flow and/or liquidity could be materially adversely affected by an ultimate unfavorable resolution of or development in legal and/or regulatory proceedings, including as described below. Except for the proceedings discussed below, the Company believes that the ultimate outcome of any of the regulatory and legal proceedings that are currently pending against it should not have a material adverse effect on financial condition, results of operations, cash flow or liquidity.

California

On October 20, 2015, the Company's California subsidiary, Health Net of California, Inc. (Health Net California), was named as a defendant in a California taxpayer action filed in Los Angeles County Superior Court, captioned as Michael D. Myers v. State Board of Equalization, Dave Jones, Insurance Commissioner of the State of California, Betty T. Yee, Controller of the State of California, et al., Los Angeles Superior Court Case No. BS158655. This action is brought under a California statute that permits an individual taxpayer to sue a governmental agency when the taxpayer believes the agency has failed to enforce governing law. Plaintiff contends that Health Net California, a California licensed Health Care Service Plan (HCSP), is an “insurer” for purposes of taxation despite acknowledging it is not an “insurer” under regulatory law. Under California law, “insurers” must pay a gross premiums tax (GPT), calculated as 2.35% on gross premiums. As a licensed HCSP, Health Net California has paid the California Corporate Franchise Tax (CFT), the tax generally paid by California businesses. Plaintiff contends that Health Net California must pay the GPT rather than the CFT. Plaintiff seeks a writ of mandate directing the California taxing agencies to collect the GPT, and seeks an order requiring Health Net California to pay GPT, interest and penalties for a period dating to eight years prior to the October 2015 filing of the complaint. This lawsuit is being coordinated with similar lawsuits filed against other entities. In September 2017, the Company filed a demurrer seeking to dismiss the complaint, and a motion to strike the allegations seeking retroactive relief. In March 2018, the Court overruled the Company's demurrer, denied the motion to strike, and set a status conference for May 2018. The Company intends to vigorously defend itself against these claims; however, this matter is subject to many uncertainties, and an adverse outcome in this matter could potentially have a materially adverse impact on our financial position, results of operations and cash flows.

Federal Securities Class Action

On November 14, 2016, a putative federal securities class action, Israel Sanchez v. Centene Corp., et al., was filed against the Company and certain of its executives in the U.S. District Court for the Central District of California. In March 2017, the court entered an order transferring the matter to the U.S. District Court for the Eastern District of Missouri. The plaintiffs in the lawsuit allege that the Company's accounting and related disclosures for certain liabilities acquired in the acquisition of Health Net violated federal securities laws. In July 2017, the lead plaintiff filed a Consolidated Class Action Complaint. The Company filed a motion to dismiss this complaint in September 2017. In February 2018, the Court held a hearing on the motion to dismiss but has not yet issued a ruling.

The Company denies any wrongdoing and is vigorously defending itself against these claims. Nevertheless, this matter is subject to many uncertainties and the Company cannot predict how long this litigation will last or what the ultimate outcome will be, and an adverse outcome in this matter could potentially have a materially adverse impact on our financial position and results of operations.


17


Additionally, on January 24, 2018, a separate derivative action was filed by plaintiff Harkesh Parekh on behalf of Centene Corporation against the Company and certain of its officers and directors in the United States District Court for the Eastern District of Missouri. Plaintiff purports to bring suit derivatively on behalf of the Company against certain officers and directors for violation of securities laws, breach of fiduciary duty, waste of corporate assets and unjust enrichment. The derivative complaint repeats many of the allegations in the federal securities class action described above and asserts that defendants made inaccurate or misleading statements, and/or failed to correct the alleged misstatements.

A second shareholder derivative action was filed on March 9, 2018, by plaintiffs Laura Wood and Peoria Police Pension Fund on behalf of Centene Corporation against the Company and certain of its officers and directors in the United States District Court for the Eastern District of Missouri. This second derivative complaint repeats many of the allegations in the securities class action and the first derivative suit. The derivative suits are expected to be consolidated and a lead plaintiff appointed for the litigation.

Medicare Parts C and D Matter

In December 2016, a Civil Investigative Demand (CID) was issued to Health Net by the United States Department of Justice regarding Health Net’s submission of risk adjustment claims to CMS under Parts C and D of Medicare. The CID may be related to a federal qui tam lawsuit filed under seal in 2011 naming more than a dozen health insurers including Health Net. The lawsuit was unsealed in February 2017 when the Department of Justice intervened in the case with respect to one of the insurers (not Health Net). In subsequent pleadings, both the Department of Justice and the Relator excluded Health Net from the lawsuit. The Company is complying with the CID and will vigorously defend any lawsuits. At this point, it is not possible to determine what level of liability, if any, the Company may face as a result of this matter.

Veterans Administrative Matter

In October 2017, a CID was issued to Health Net Federal Services, LLC (HNFS) by the United States Department of Justice. The CID seeks documents and interrogatory responses concerning whether HNFS submitted, or caused to be submitted, excessive, duplicative or otherwise improper claims to the U.S. Department of Veterans Affairs under a contract to arrange health care services for veterans. The contract began in late 2014. In 2016, modifications to the contract were made to allow for possible duplicate billings with a reconciliation period at the end of the contract term. The Company is complying with the CID and believes it has been meeting its contractual obligations. At this point, it is not possible to determine what level of liability, if any, the Company may face as a result of this matter.

Ambetter Class Action

On January 11, 2018, a putative class action lawsuit was filed by Cynthia Harvey and Steven A. Milman against the Company and certain subsidiaries in the U.S. District Court for the Eastern District of Washington. The complaint alleges that the Company failed to meet federal and state requirements for provider networks and directories with regard to its Ambetter policies, denied coverage and/or refused to pay for covered benefits, and failed to address grievances adequately, causing some members to incur unexpected costs. In March 2018, the Company filed separate motions to dismiss each defendant. The Company intends to vigorously defend itself against these claims. Nevertheless, this matter is subject to many uncertainties and the Company cannot predict how long this litigation will last or what the ultimate outcome will be, and an adverse outcome in this matter could potentially have a materially adverse impact on our financial position and results of operations.

Miscellaneous Proceedings

Excluding the matters discussed above, the Company is also routinely subjected to legal and regulatory proceedings in the normal course of business. These matters can include, without limitation:

periodic compliance and other reviews and investigations by various federal and state regulatory agencies with respect to requirements applicable to the Company's business, including, without limitation, those related to payment of out-of-network claims, submissions to CMS for risk adjustment payments or the False Claims Act, pre-authorization penalties, timely review of grievances and appeals, timely and accurate payment of claims, and the Health Insurance Portability and Accountability Act of 1996;

litigation arising out of general business activities, such as tax matters, disputes related to healthcare benefits coverage or reimbursement, putative securities class actions and medical malpractice, privacy, real estate, intellectual property and employment-related claims;


18


disputes regarding reinsurance arrangements, claims arising out of the acquisition or divestiture of various assets, class actions and claims relating to the performance of contractual and non-contractual obligations to providers, members, employer groups and others, including, but not limited to, the alleged failure to properly pay claims and challenges to the manner in which the Company processes claims, and claims alleging that the Company has engaged in unfair business practices.

Among other things, these matters may result in awards of damages, fines or penalties, which could be substantial, and/or could require changes to the Company’s business. The Company intends to vigorously defend itself against the miscellaneous legal and regulatory proceedings to which it is currently a party; however, these proceedings are subject to many uncertainties. In some of the cases pending against the Company, substantial non-economic or punitive damages are being sought.

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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.

EXECUTIVE OVERVIEW

General

We are a diversified, multi-national healthcare enterprise that provides services to government sponsored and commercial healthcare programs, focusing on under-insured and uninsured individuals. We provide member-focused services through locally based staff by assisting in accessing care, coordinating referrals to related health and social services and addressing member concerns and questions.

Results of operations depend on our ability to manage expenses associated with health benefits (including estimated costs incurred) and selling, general and administrative (SG&A) costs. We measure operating performance based upon two key ratios. The health benefits ratio (HBR) represents medical costs as a percentage of premium revenues, excluding premium tax and health insurer fee revenues that are separately billed, and reflects the direct relationship between the premium received and the medical services provided. The SG&A expense ratio represents SG&A costs as a percentage of premium and service revenues, excluding premium tax and health insurer fee revenues that are separately billed.

Fidelis Care Transaction

In September 2017, we signed a definitive agreement under which New York State Catholic Health Plan, Inc., d/b/a Fidelis Care New York (Fidelis Care) (Proposed Fidelis Acquisition or Fidelis Care Transaction) will become the Company's health plan in New York State upon closing. Under the terms of the agreement, we will acquire substantially all of the assets of Fidelis Care for $3.75 billion, subject to certain adjustments. This transaction is expected to close on or about July 1, 2018. In April 2018, we received regulatory approvals for the Fidelis Care Transaction from the New York Department of Health and the New York Department of Financial Services. The Proposed Fidelis Acquisition remains subject to regulatory approval from the New York Attorney General and certain closing conditions. Subject to market conditions, we expect to fund the transaction with approximately $2.3 billion of new equity, including share consideration, and approximately $1.6 billion of new long-term debt.

As part of the regulatory approval process, it is expected that we will enter into certain undertakings with the New York State Department of Health. The undertakings are anticipated to contain various commitments by Centene that will be effective upon completion of the Fidelis Care Transaction. It is expected that one of the undertakings, among others, will include a $340 million contribution by Centene to the State of New York to be paid over a five-year period for initiatives consistent with our mission of providing high quality healthcare to vulnerable populations within New York State. Upon the closing of the Fidelis Care Transaction, the present value of the $340 million contribution to the State of New York, estimated to be approximately $325 million, will be expensed in SG&A.

Acquisitions and Investments

We continued to execute on our growth strategy through acquisitions and investments in the first quarter of 2018. We acquired 100% of Community Medical Holdings Corp., d/b/a Community Medical Group (CMG), an at-risk primary care provider serving approximately 70,000 Medicaid, Medicare Advantage, and Health Insurance Marketplace patients in Miami-Dade County, Florida. CMG has a multi-payor strategy and serves our Florida health plan members. The acquisition increases Centene's scale and capabilities and creates a vertical integration opportunity with providers. We also acquired an additional 61% ownership in Interpreta Holdings, Inc. (Interpreta), a clinical and genomics data analytics business, bringing our total ownership to 80%. Finally, we made a 25% equity method investment in RxAdvance (RxA), a full-service pharmacy benefit manager (PBM) with a best-in-class technology platform. Both the Interpreta and RxA transactions reflect our commitment to technological innovation and providing comprehensive and integrated specialty services.

In the second quarter of 2018, we acquired 100% of MHM Services Inc. (MHM), a provider of behavioral health, medical and dental services to correctional facilities, state hospitals, courts, juvenile facilities and community clinics. Under the terms of the agreement, Centene also acquired the remaining 49% ownership of Centurion, the correctional healthcare services joint venture between Centene and MHM, expanding our national footprint in the correctional healthcare sector.

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First Quarter 2018 Highlights

Our financial performance for the first quarter of 2018 is summarized as follows:
Managed care membership of 12.8 million, an increase of 684,000 members, or 6% year-over-year.
Total revenues of $13.2 billion, representing 13% growth year-over-year.
Health benefits ratio of 84.3%, compared to 87.6% in 2017.
SG&A expense ratio of 10.5% for the first quarter of 2018, compared to 9.8% for the first quarter of 2017.
Adjusted SG&A expense ratio of 10.3% for the first quarter of 2018, compared to 9.3% for the first quarter of 2017.
Operating cash flows of $1,846 million.
Diluted earnings per share (EPS) for the first quarter of 2018 of $1.91, compared to $0.79 for the first quarter of 2017.
Adjusted Diluted EPS for the first quarter of 2018 of $2.17, compared to $1.12 for the first quarter of 2017.
Adjusted Diluted EPS is highlighted below and additional detail is provided above under the heading "Non-GAAP Financial Presentation":
 
Three Months Ended March 31,
 
2018
 
2017
GAAP diluted EPS
$
1.91

 
$
0.79

Amortization of acquired intangible assets
0.17

 
0.14

Acquisition related expenses
0.09

 
0.02

Penn Treaty assessment expense

 
0.17

Adjusted Diluted EPS
$
2.17

 
$
1.12

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

Arkansas. In February 2018, our Arkansas subsidiary, Arkansas Total Care began managing a Medicaid special needs population comprised of people with high behavioral health needs and individuals with developmental/intellectual disabilities. Arkansas Total Care will assume full-risk on this population beginning in January 2019.

Correctional. In June 2017, Centurion began operating under an expanded contract to provide correctional healthcare services for the Florida Department of Corrections in South Florida.

Health Insurance Marketplace. In January 2018, we expanded our offerings in the 2018 Health Insurance Marketplace. We entered Kansas, Missouri and Nevada, and expanded our footprint in the following six existing markets: Florida, Georgia, Indiana, Ohio, Texas, and Washington.

Health Net Federal Services. In January 2018, our subsidiary, Health Net Federal Services, began operating under the TRICARE West Region contract to provide administrative services to Military Health System eligible beneficiaries.

Illinois. In January 2018, our Illinois subsidiary, IlliniCare Health, began operating under a state-wide contract for the Medicaid Managed Care Program. Implementation dates varied by region and was fully implemented statewide in April 2018. The new contract will include children who are in need through the Department of Children and Family Services (DCFS)/Youth in Care by the Illinois Department of Healthcare and Family Services (HFS) and Foster Care. These additional products are expected to be implemented in the fourth quarter of 2018.

Maryland. In July 2017, our specialty solutions subsidiary, Envolve, Inc., began providing health plan management services for Medicaid operations in Maryland.

Medicare. In January 2018, we expanded our offerings in Medicare. We entered Arkansas, Indiana, Kansas, Louisiana, Missouri, Pennsylvania, South Carolina, and Washington and expanded our footprint in Ohio.

Missouri. In May 2017, our Missouri subsidiary, Home State Health, began providing managed care services to MO HealthNet Managed Care beneficiaries under an expanded statewide contract.

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Nevada. In July 2017, our Nevada subsidiary, SilverSummit Healthplan, began serving Medicaid recipients enrolled in Nevada's Medicaid managed care program.

Pennsylvania. In January 2018, our Pennsylvania subsidiary, Pennsylvania Health & Wellness, began serving enrollees in the Community HealthChoices program. Contract commencement dates vary by zone and will be fully implemented statewide by January 2020.

Washington. In January 2018, our Washington subsidiary, Coordinated Care of Washington, began providing managed care services to Apple Health's Fully Integrated Managed Care (FIMC) beneficiaries in the North Central Region.

The growth items listed above are partially offset by the following items:

We were successful in reprocuring our contract in Georgia. However, the Medicaid program was expanded to include additional insurers, which has reduced our market share. In addition, we are no longer serving LTSS members in Arizona or Medicaid members in Massachusetts.

Beginning in January 2018, the State of California no longer includes costs for in-home support services (IHSS) in its Medicaid contracts.

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

We expect to realize the full year benefit in 2018 of business commenced during 2017 in Florida, Maryland, Missouri and Nevada, as discussed above.

In April 2018, we received regulatory approvals from the New York Department of Health and the New York Department of Financial Services for the Proposed Fidelis Acquisition. The Proposed Fidelis Acquisition remains subject to regulatory approval from the New York Attorney General and certain closing conditions.

In April 2018, we completed the acquisition of MHM, a national provider of healthcare and staffing services to correctional systems and other government agencies. Under the terms of the agreement, Centene also acquired the remaining 49% ownership of Centurion, the correctional healthcare services joint venture between Centene and MHM.

In March 2018, we acquired an additional 61% ownership in Interpreta, a clinical and genomics data analytics business, bringing our total ownership to 80%.

In March 2018, we completed the acquisition of CMG, an at-risk primary care provider serving approximately 70,000 Medicaid, Medicare Advantage, and Health Insurance Marketplace patients in Miami-Dade County, Florida.

In March 2018, we made a 25% equity method investment in RxAdvance, a full-service PBM, and expect to use its platform to improve health outcomes and reduce avoidable drug-impacted medical and administrative costs. This partnership includes both a customer relationship and a strategic investment in RxAdvance. As part of the initial transaction, Centene has certain rights to expand its equity investment in the future.

In March 2018, our Arizona subsidiary, Health Net Access, was selected to provide physical and behavioral health care services through the Arizona Health Care Cost Containment System Complete Care program in the Central region and the Southern region. Pending regulatory approval and successful completion of readiness review, the three-year agreement, with the possibility of two two-year extensions, is expected to commence on October 1, 2018.

In January 2018, our New Mexico subsidiary, Western Sky Community Care, was awarded a statewide contract in New Mexico for the Centennial Care 2.0 Program. The new contract is expected to commence membership operations in January 2019.

In August 2017, Centurion was recommended for a contract award by the Tennessee Department of Correction to continue providing inmate health services. This contract is expected to commence in the third quarter of 2018.


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In June 2017, our Mississippi subsidiary, Magnolia Health, was selected by the Mississippi Division of Medicaid to continue serving Medicaid recipients enrolled in the Mississippi Coordinated Access Network (MississippiCAN). Pending regulatory approval, the new three-year agreement, which also includes the option of two one-year extensions, is expected to commence in October 2018.

In January 2017, we signed a joint venture agreement with the North Carolina Medical Society, working in conjunction with the North Carolina Community Health Center Association, to collaborate on a patient-focused approach to Medicaid under the reform plan enacted in the State of North Carolina. The newly created health plan, Carolina Complete Health, was created to establish, organize and operate a physician-led health plan to provide Medicaid managed care services in North Carolina.

The future growth items listed above are partially offset by the following items:

Effective July 2018, we will no longer be serving correctional healthcare members in Massachusetts. Effective October 2018, we will no longer be serving veterans under the PC3 program. In the first quarter of 2018, Health Net of Arizona, Inc. notified the Arizona Department of Insurance of its decision to discontinue and non-renew all of its Employer Group plans for small and large business groups in Arizona beginning January 1, 2019. The effective date of coverage termination for existing groups is dependent on remaining renewals, however coverage will no longer be provided to any group policyholders and/ or members after December 31, 2019.

In October 2017, the Centers for Medicare and Medicaid Services (CMS) published updated Medicare Star quality ratings for the 2018 rating year. The 2018 rating year will affect quality bonus payments for Medicare Advantage plans in 2019. One of Health Net of California, Inc.'s Medicare Advantage plans (H0562) moved to a 3.5 Star rating from a 4.0 Star rating for the 2018 rating year, which lowered our overall 2018 parent Star rating to 3.5 Stars. Our commitment to quality remains as strong as ever. We are working to evaluate and mitigate the potential impact on our revenue in 2019 as a result of the lowered 2018 rating and working to implement year-over-year quality improvements. We continue to work towards improving our star ratings and make efforts to return to at least a 4.0 Star parent rating in future periods.


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MEMBERSHIP

From March 31, 2017 to March 31, 2018, we increased our managed care membership by 684,000, or 6%. The following table sets forth the Company's membership by state:
 
March 31,
2018
 
December 31,
2017
 
March 31,
2017
Arizona
639,800

 
640,500

 
684,300

Arkansas
92,300

 
85,700

 
98,100

California
2,903,600

 
2,877,800

 
2,980,100

Florida
1,090,600

 
848,800

 
872,000

Georgia
581,500

 
483,600

 
568,300

Illinois
238,400

 
239,500

 
253,800

Indiana
317,400

 
304,500

 
335,800

Kansas
151,500

 
129,100

 
133,100

Louisiana
485,900

 
485,500

 
484,100

Massachusetts
8,900

 
43,000

 
44,200

Michigan
2,800

 
2,500

 
2,100

Minnesota
9,400

 
9,400

 
9,500

Mississippi
347,600

 
329,900

 
349,500

Missouri
329,900

 
269,400

 
106,100

Nebraska
81,500

 
79,700

 
79,200

Nevada
74,600

 
34,900

 

New Hampshire
82,900

 
74,800

 
77,800

New Mexico
7,200

 
7,100

 
7,100

Ohio
352,800

 
332,700

 
328,900

Oregon
199,300

 
205,200

 
211,900

Pennsylvania
22,400

 

 

South Carolina
119,300

 
117,800

 
121,900

Tennessee
22,000

 
22,200

 
21,900

Texas
1,260,100

 
1,233,500

 
1,243,900

Vermont
1,600

 
1,600

 
1,600

Washington
260,800

 
237,800

 
254,400

Wisconsin
74,900

 
70,200

 
71,700

Total at-risk membership
9,759,000

 
9,166,700

 
9,341,300

TRICARE eligibles
2,851,500

 
2,824,100

 
2,804,100

Non-risk membership
218,900

 
216,300

 

Total
12,829,400

 
12,207,100

 
12,145,400



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The following table sets forth our membership by line of business:
 
March 31,
2018
 
December 31,
2017
 
March 31,
2017
Medicaid:
 
 
 
 
 
TANF, CHIP & Foster Care
5,776,600

 
5,807,300

 
5,714,100

ABD & LTSS
866,000

 
846,200

 
825,600

Behavioral Health
454,500

 
463,700

 
466,900

Commercial
2,161,200

 
1,558,300

 
1,864,700

Medicare & MMP (1)
343,400

 
333,700

 
328,100

Correctional
157,300

 
157,500

 
141,900

Total at-risk membership
9,759,000

 
9,166,700

 
9,341,300

TRICARE eligibles
2,851,500

 
2,824,100

 
2,804,100

Non-risk membership
218,900

 
216,300

 

Total
12,829,400

 
12,207,100

 
12,145,400

 
 
 
 
 
 
(1) Membership includes Medicare Advantage, Medicare Supplement, Special Needs Plans, and Medicare-Medicaid Plans.

The following table sets forth additional membership statistics, which are included in the membership information above:
 
March 31,
2018
 
December 31,
2017
 
March 31,
2017
Dual-eligible (2)
438,200

 
474,500

 
458,700

Health Insurance Marketplace
1,603,800

 
959,600

 
1,188,700

Medicaid Expansion
1,057,400

 
1,091,500

 
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