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CENTENE CORP filed this Form 10-Q on 04/26/2016
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10-Q

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

For the quarterly period ended March 31, 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 April 15, 2016, the registrant had 170,473,015 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 have attempted to identify these statements by terminology including “believe,” “anticipate,” “plan,” “expect,” “estimate,” “intend,” “seek,” “target,” “goal,” “may,” “will,” “would,” “could,” “should,” “can,” “continue” and other similar words or expressions in connection with, among other things, any discussion of future operating or financial performance.  In particular, these statements include statements about our market opportunity, our growth strategy, competition, expected activities and future acquisitions, investments and the adequacy of our available cash resources.  These statements may be found in the various sections of this filing, including those entitled “Management's Discussion and Analysis of Financial Condition and Results of Operations,” Part II, Item 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 and we undertake no obligation to update or revise the forward-looking statements included in this filing, whether as a result of new information, future events or otherwise, after the date of this filing.  Actual results may differ from projections or estimates due to a variety of important factors, including but not limited to:

our ability to accurately predict and effectively manage health benefits and other operating expenses and reserves;
competition;
membership and revenue projections;
timing of regulatory contract approval;
changes in healthcare practices;
changes in federal or state laws or regulations, including the Patient Protection and Affordable Care Act and the Health Care and Education Affordability Reconciliation Act and any regulations enacted thereunder;
changes in expected contract start dates;
changes in expected closing dates, estimated purchase price and accretion for acquisitions;
inflation;
foreign currency fluctuations;
provider and state contract changes;
new technologies;
advances in medicine;
reduction in provider payments by governmental payors;
major epidemics;
disasters and numerous other factors affecting the delivery and cost of healthcare;
the expiration, cancellation or suspension of our managed care contracts by federal or state governments (including but not limited to Medicaid, Medicare, and TRICARE);
the outcome of our pending legal proceedings;
availability of debt and equity financing, on terms that are favorable to us;
our ability to adequately price products on federally facilitated and state based Health Insurance Marketplaces;
changes in economic, political and market conditions;
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; and
the risk that acquired businesses will not be integrated successfully.

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

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




Other Information

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

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 which excludes Health Net acquisition related expenses and intangible amortization allows investors to understand the Company's performance more consistently. The table below provides a reconciliation of non-GAAP items ($ in millions, except share data):

 
Three Months Ended March 31,
 
2016
 
2015
 
 
 
 
GAAP general and administrative expenses
$
722

 
$
396

Health Net acquisition related expenses
189

 

General and administrative expenses, excluding Health Net acquisition related expenses
$
533

 
$
396

 
 
 
 
GAAP diluted net earnings (loss) per share
$
(0.13
)
 
$
0.52

Health Net acquisition related expenses
0.83

 

Amortization of acquired intangible assets
0.04

 
0.03

Adjusted Diluted EPS
$
0.74

 
$
0.55






PART I
FINANCIAL INFORMATION

ITEM 1. Financial Statements.
CENTENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In millions, except share data)
 
March 31, 2016
 
December 31, 2015
 
(Unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
3,436

 
$
1,760

Premium and related receivables
2,529

 
1,279

Short term investments
269

 
176

Other current assets
1,317

 
390

Total current assets
7,551

 
3,605

Long term investments
3,973

 
1,927

Restricted deposits
143

 
115

Property, software and equipment, net
580

 
518

Goodwill
4,442

 
842

Intangible assets, net
1,646

 
155

Other long term assets
317

 
177

Total assets
$
18,652

 
$
7,339

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

Current liabilities:
 

 
 

Medical claims liability
$
3,863

 
$
2,298

Accounts payable and accrued expenses
3,228

 
976

Return of premium payable
579

 
207

Unearned revenue
197

 
143

Current portion of long term debt
4

 
5

Total current liabilities
7,871

 
3,629

Long term debt
4,276

 
1,216

Other long term liabilities
1,052

 
170

Total liabilities
13,199

 
5,015

Commitments and contingencies


 


Redeemable noncontrolling interests
144

 
156

Stockholders’ equity:
 

 
 

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

 

Common stock, $0.001 par value; authorized 400,000,000 shares; 175,952,159 issued and 170,449,444 outstanding at March 31, 2016, and 126,855,477 issued and 120,342,981 outstanding at December 31, 2015

 

Additional paid-in capital
4,084

 
956

Accumulated other comprehensive earnings (loss)
10

 
(10
)
Retained earnings
1,341

 
1,358

Treasury stock, at cost (5,502,715 and 6,512,496 shares, respectively)
(138
)
 
(147
)
Total Centene stockholders’ equity
5,297

 
2,157

Noncontrolling interest
12

 
11

Total stockholders’ equity
5,309

 
2,168

Total liabilities and stockholders’ equity
$
18,652

 
$
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 March 31,
 
2016
 
2015
Revenues:
 
 
 
Premium
$
5,986

 
$
4,299

Service
425

 
462

Premium and service revenues
6,411

 
4,761

Premium tax and health insurer fee
542

 
370

Total revenues
6,953

 
5,131

Expenses:
 
 
 
Medical costs
5,311

 
3,861

Cost of services
367

 
402

General and administrative expenses
722

 
396

Amortization of acquired intangible assets
9

 
7

Premium tax expense
450

 
281

Health insurer fee expense
74

 
55

Total operating expenses
6,933

 
5,002

Earnings from operations
20

 
129

Other income (expense):
 
 
 
Investment and other income
15

 
9

Interest expense
(33
)
 
(10
)
Earnings from continuing operations, before income tax expense
2

 
128

Income tax expense
17

 
63

Earnings (loss) from continuing operations, net of income tax expense
(15
)
 
65

Discontinued operations, net of income tax
(1
)
 
(1
)
Net earnings (loss)
(16
)
 
64

(Earnings) loss attributable to noncontrolling interests
(1
)
 
(1
)
Net earnings (loss) attributable to Centene Corporation
$
(17
)
 
$
63

 
 
 
 
Amounts attributable to Centene Corporation common shareholders:
Earnings (loss) from continuing operations, net of income tax expense
$
(16
)
 
$
64

Discontinued operations, net of income tax
(1
)
 
(1
)
Net earnings (loss)
$
(17
)
 
$
63

 
 
 
 
Net earnings (loss) per common share attributable to Centene Corporation:
Basic:
 
 
 
Continuing operations
$
(0.13
)
 
$
0.54

Discontinued operations
(0.01
)
 
(0.01
)
Basic earnings (loss) per common share
$
(0.14
)
 
$
0.53

 
 
 
 
Diluted:
 
 
 
Continuing operations
$
(0.13
)
 
$
0.52

Discontinued operations
(0.01
)
 
(0.01
)
Diluted earnings (loss) per common share
$
(0.14
)
 
$
0.51

 
 
 
 
Weighted average number of common shares outstanding:
Basic
125,543,076

 
118,783,755

Diluted
125,543,076

 
122,572,366

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,
 
2016
 
2015
Net earnings (loss)
$
(16
)
 
$
64

Reclassification adjustment, net of tax
1

 

Change in unrealized gain on investments, net of tax
18

 
5

Foreign currency translation adjustments
1

 
(5
)
Other comprehensive earnings
20

 

Comprehensive earnings
4

 
64

Comprehensive (earnings) loss attributable to noncontrolling interests
(1
)
 
(1
)
Comprehensive earnings attributable to Centene Corporation
$
3

 
$
63


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)

Three Months Ended March 31, 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 (loss)

 

 

 

 
(17
)
 

 

 
1

 
(16
)
Other comprehensive earnings, net of $13 tax

 

 

 
20

 

 

 

 

 
20

Common stock issued for acquisitions
48,218,310

 

 
3,074

 

 

 
(1,375,596
)
 
31

 

 
3,105

Common stock issued for employee benefit plans
878,372

 

 
2

 

 

 

 

 

 
2

Common stock repurchases

 

 

 

 

 
365,815

 
(22
)
 

 
(22
)
Stock compensation expense

 

 
51

 

 

 

 

 

 
51

Excess tax benefits from stock compensation

 

 
1

 

 

 

 

 

 
1

Balance, March 31, 2016
175,952,159

 
$

 
$
4,084

 
$
10

 
$
1,341

 
5,502,715

 
$
(138
)
 
$
12

 
$
5,309

 
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,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net earnings (loss)
$
(16
)
 
$
64

Adjustments to reconcile net earnings (loss) to net cash provided by operating activities
Depreciation and amortization
35

 
27

Stock compensation expense
51

 
16

Deferred income taxes
(17
)
 
(6
)
Gain on contingent consideration
(1
)
 
(10
)
Changes in assets and liabilities
 

 
 

Premium and related receivables
(174
)
 
(334
)
Other current assets
(35
)
 
(3
)
Medical claims liabilities
196

 
227

Unearned revenue
(64
)
 
(51
)
Accounts payable and accrued expenses
35

 
58

Other long term liabilities
192

 
68

Other operating activities, net
(7
)
 
(11
)
Net cash provided by operating activities
195

 
45

Cash flows from investing activities:
 

 
 

Capital expenditures
(45
)
 
(27
)
Purchases of investments
(212
)
 
(307
)
Sales and maturities of investments
203

 
111

Investments in acquisitions, net of cash acquired
(782
)
 
(9
)
Other investing activities, net

 
7

Net cash used in investing activities
(836
)
 
(225
)
Cash flows from financing activities:
 

 
 

Proceeds from borrowings
3,790

 
500

Payment of long term debt
(1,388
)
 
(253
)
Common stock repurchases
(22
)
 
(4
)
Purchase of noncontrolling interest
(14
)
 

Debt issue costs
(51
)
 
(4
)
Other financing activities, net
2

 
(3
)
Net cash provided by financing activities
2,317

 
236

Net increase in cash and cash equivalents
1,676

 
56

Cash and cash equivalents, beginning of period
1,760

 
1,610

Cash and cash equivalents, end of period
$
3,436

 
$
1,666

Supplemental disclosures of cash flow information:
 

 
 

Interest paid
$
3

 
$
2

Income taxes paid
$
33

 
$
24

Equity issued in connection with acquisitions
$
3,105

 
$
13

 
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 months ended March 31, 2016 include the results of operations of Health Net from March 24, 2016 to March 31, 2016. The Health Net segment previously known as the Western Region Operations, with the exception of the pharmaceutical services subsidiaries and behavioral health subsidiaries, is included in the Managed Care segment. The portions of Health Net's Western Region Operations segment included in the Managed Care segment consists of the following Health Net operations: commercial, Medicare, Medicaid and dual eligible health plans.

The Company's Specialty Services revenue 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. The Government Contracts business includes the federal government-sponsored managed care contract with the U.S. Department of Defense (DoD) under the TRICARE program in the North Region, the 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 brings most leases 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.

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 months ended March 31, 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 the first 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.

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.


7


The Company's Medicare Advantage contracts are with the Centers for Medicare & Medicaid Services (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 contract with the DoD 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 for the TRICARE North Region, 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 $5,982 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.

The total consideration for the acquisition was $5,279 million, consisting of Centene common shares valued at $3,038 million (based on Centene's stock price of $62.70), $2,239 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 to the Health Net stockholders. The cash portion of the acquisition consideration was funded through the issuance of long-term debt as further discussed in Note 7. Debt. The Company also recognized $189 million of acquisition related costs that were recorded in general and administrative expense in the statement of operations for the three months ended March 31, 2016.


8


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 assets acquired and liabilities assumed has not yet been finalized and as a result, the 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.

Due to the timing of the acquisition date, the Company has performed limited valuation procedures, and the valuation of nearly all assets and liabilities assumed is incomplete. 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
 
$
1,422

Premium and related receivables (a)
 
1,076

Short term investments
 
40

Other current assets
 
670

Long term investments
 
1,965

Restricted deposits
 
36

Property, software and equipment, net
 
43

Intangible assets (b)
 
1,500

Other long term assets
 
203

Total assets acquired
 
6,955

 
 
 
Medical claims liability
 
1,370

Borrowings under revolving credit facility
 
285

Accounts payable and accrued expenses
 
1,928

Return of premium payable
 
375

Unearned revenue
 
117

Long term deferred tax liabilities (c)
 
415

Long term debt (d)
 
418

Other long term liabilities
 
369

Total liabilities assumed
 
5,277

 
 
 
Total identifiable net assets
 
1,678

Goodwill (e)
 
3,601

Total assets acquired and liabilities assumed
 
$
5,279


The Company has made the following preliminary fair value adjustments based on information reviewed through March 31, 2016. Significant 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 $0.

(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. As discussed above, due to the timing of the acquisition date, the Company has only performed limited valuation procedures, and the intangible valuation is incomplete. 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.

(c)
The preliminary deferred tax liabilities are presented net of $226 million of deferred tax assets.


9


(d)
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.

(e)
The acquisition resulted in $3.6 billion of goodwill related primarily to buyer specific synergies expected from the acquisition and the assembled workforce of Health Net. The 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 March 31, 2016, the Company's consolidated statements of operations includes total revenues of $354 million. It is impracticable to determine the effect on net income resulting from the Health Net acquisition for the three months ended March 31, 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 three months ended March 31, 2016 and 2015 were $10,626 million and $9,007 million, respectively. The pro forma net earnings attributable to Centene Corporation and diluted earnings per share were $39 million and $0.23, respectively for the three months ended March 31, 2015. It is impracticable for the Company to determine the pro forma earnings information for the three months ended March 31, 2016 due to the nature of obtaining that information as the Company immediately integrated Health Net into its ongoing operations. 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.

The unaudited pro forma financial information reflects the historical results of Centene and Health Net adjusted as if it 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.
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 incurred by Centene and Health Net.

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 continuing 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 three months ended March 31, 2016 were as follows ($ in millions):

10



 
 
March 31, 2016
Employee termination costs:
 
 
Charges incurred
 
$
14

Cash paid
 

Accrued employee termination costs as of March 31, 2016
 
$
14

Other restructuring costs:
 
 
Stock based compensation incurred
 
$
31

Stock based compensation settled
 
(31
)
Accrued other restructuring costs as of March 31, 2016
 

Total accrued restructuring costs as of March 31, 2016
 
$
14


The Company expects to record a total of approximately $53 million of employee termination costs and $42 million of stock based compensation in connection with the acquisition, the majority of which is expected to be incurred through 2016 and early 2017. The Company expects these costs to be allocated to the Managed Care segment.

Commitments

In connection with regulatory approval 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 others items, operational commitments around premiums, dividend restrictions, minimum RBC levels, primary offices, growth, accreditation, HEDIS scores and other quality measures, network adequacy, certifications, investments and capital expenditures. Specifically, the Company agreed to:

invest $30 million through the California Organized Investment Network over the next five years;
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 over five years to improve enrollee health outcomes, support locally-based consumer assistance programs and strengthen the health care delivery system (of which, the present value of $61 million was expensed in the three months ended March 31, 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):
 
March 31, 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
$
339

 
$
2

 
$

 
$
341

 
$
431

 
$

 
$
(2
)
 
$
429

Corporate securities
1,607

 
14

 
(3
)
 
1,618

 
859

 
2

 
(8
)
 
853

Restricted certificates of deposit
5

 

 

 
5

 
5

 

 

 
5

Restricted cash equivalents
70

 

 

 
70

 
78

 

 

 
78

Municipal securities
1,406

 
12

 
(1
)
 
1,417

 
496

 
2

 
(1
)
 
497

Asset-backed securities
273

 
1

 
(1
)
 
273

 
163

 

 
(1
)
 
162

Residential mortgage-backed securities
279

 
2

 

 
281

 
66

 
1

 

 
67

Commercial mortgage-backed securities
223

 
5

 
(5
)
 
223

 
40

 

 

 
40

Cost and equity method investments
141

 

 

 
141

 
71

 

 

 
71

Life insurance contracts
16

 

 

 
16

 
16

 

 

 
16

Total
$
4,359

 
$
36

 
$
(10
)
 
$
4,385

 
$
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 March 31, 2016, 94% of the Company’s investments in rated securities carry an investment grade rating by S&P and Moody's.  At March 31, 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 all issued by the Federal National Mortgage Association, Government National Mortgage Association or Federal Home Loan Mortgage Corporation, which carry implicit or explicit guarantees of the U.S. government. The Company's commercial mortgage-backed securities are primarily senior tranches with a weighted average rating of AA and a weighted average duration of 2.9 years at March 31, 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 to the selling stockholders, valued at $68 million. The investment will be 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):
 
March 31, 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
$

 
$
13

 
$

 
$

 
$
(2
)
 
$
294

 
$

 
$
14

Corporate securities
(2
)
 
280

 
(1
)
 
82

 
(6
)
 
561

 
(2
)
 
41

Municipal securities
(1
)
 
245

 

 
21

 
(1
)
 
208

 

 
5

Asset-backed securities
(1
)
 
118

 

 
10

 
(1
)
 
121

 

 
8

Residential mortgage-backed securities

 
11

 

 

 

 
30

 

 

Commercial mortgage-backed securities
(5
)
 
31

 

 

 

 
34

 

 

Total
$
(9
)
 
$
698

 
$
(1
)
 
$
113

 
$
(10
)
 
$
1,248

 
$
(2
)
 
$
68


As of March 31, 2016, the gross unrealized losses were generated from 503 positions out of a total of 2,274 positions.  The change in fair value of fixed income securities is a result of movement in interest rates subsequent to the purchase of the security.

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

The contractual maturities of short term and long term investments and restricted deposits are as follows ($ in millions):
 
March 31, 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
$
269

 
$
269

 
$
112

 
$
112

 
$
176

 
$
176

 
$
93

 
$
93

One year through five years
1,833

 
1,845

 
31

 
31

 
1,662

 
1,654

 
22

 
22

Five years through ten years
853

 
860

 

 

 
267

 
268

 

 

Greater than ten years
487

 
491

 

 

 
5

 
5

 

 

Asset-backed securities
775

 
777

 

 

 

 

 

 

Total
$
4,217

 
$
4,242

 
$
143

 
$
143

 
$
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 March 31, 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
$
3,436

 
$

 
$

 
$
3,436

Investments available for sale:
 

 
 

 
 

 
 

U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
257

 
$
16

 
$

 
$
273

Corporate securities

 
1,618

 

 
1,618

Municipal securities

 
1,417

 

 
1,417

Asset-backed securities

 
273

 

 
273

Residential mortgage-backed securities

 
281

 

 
281

Commercial mortgage-backed securities

 
223

 

 
223

Total investments
$
257

 
$
3,828

 
$

 
$
4,085

Restricted deposits available for sale:
 

 
 

 
 

 
 

Cash and cash equivalents
$
70

 
$

 
$

 
$
70

Certificates of deposit
5

 

 

 
5

U.S. Treasury securities and obligations of U.S. government corporations and agencies
63

 
5

 

 
68

Total restricted deposits
$
138

 
$
5

 
$

 
$
143

Other long term assets: Interest rate swap agreements
$

 
$
22

 
$

 
$
22

Total assets at fair value
$
3,831

 
$
3,855

 
$

 
$
7,686

Liabilities
 
 
 
 
 
 
 
Other long term liabilities:
 
 
 
 
 
 
 
Interest rate swap agreements
$

 
$
10

 
$

 
$
10

Total liabilities at fair value
$

 
$
10

 
$

 
$
10



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 March 31, 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 $157 million and $87 million as of March 31, 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.

The Company's receivables (payables) for each of these programs are as follows ($ in millions):
 
March 31, 2016
 
December 31, 2015
Risk adjustment
$
(335
)
 
$
(108
)
Reinsurance
173

 
24

Risk corridor
(3
)
 
(4
)
Minimum medical loss ratio
(6
)
 
(15
)


15


7. Debt
 
Debt consists of the following ($ in millions):
 
March 31, 2016
 
December 31, 2015
$425 million 5.75% Senior notes, due June 1, 2017
$
427

 
$
428

$400 million 6.375% Senior notes, due June 1, 2017
418

 

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

 

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

 
500

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

 

Fair value of interest rate swap agreements
12

 
9

Senior notes
3,757

 
937

Revolving credit agreement
515

 
225

Mortgage notes payable
66

 
67

Capital leases
5

 
6

Debt issuance costs
(63
)
 
(14
)
Total debt
4,280

 
1,221

Less current portion
(4
)
 
(5
)
 Long term debt
$
4,276

 
$
1,216


Senior Notes

In February 2016, a wholly owned unrestricted subsidiary of the Company (Escrow Issuer) issued $1,400 million of 5.625% Senior Notes ($1,400 Million Notes) at par due 2021 and $1,000 million of 6.125% Senior Notes ($1,000 Million Notes) at par due 2024. 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 aggregate principal amount of Health Net's $400 million 6.375% Senior Notes due 2017, recorded at acquisition date fair value of $418 million.

The indentures governing the $425 million notes due 2017, the $1,400 million notes due 2021, the $500 million notes due 2022, and the $1,000 million notes due 2024 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.

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 March 31, 2016, the weighted average rate was 4.41%.


16


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 March 31, 2016, the Company had $515 million of borrowings outstanding under the agreement with a weighted average interest rate of 4.25%.

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 March 31, 2016, there were no limitations on the availability under the revolving credit agreement as a result of the debt-to-EBITDA ratio.

Also, in connection with the closing of the Health Net acquisition, the Company assumed, repaid and terminated the existing Health Net revolving credit facility of $285 million upon acquisition.

Letters of Credit & Surety Bonds

The Company had outstanding letters of credit of $53 million as of March 31, 2016, which were not part of the revolving credit facility. The Company also had letters of credit for $52 million (valued at March 31, 2016 conversion rate), or €46 million, representing its proportional share of the letters of credit issued to support Ribera Salud’s outstanding debt, which are a part of the revolving credit facility. Collectively, the letters of credit bore interest at 1.51% as of March 31, 2016. The Company had outstanding surety bonds of $386 million as of March 31, 2016.

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 $2,239 million in cash in exchange for all the outstanding shares of Health Net common stock and outstanding 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.


17


9. Earnings (Loss) Per Share

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

 
Three Months Ended March 31,
 
2016
 
2015
Earnings (loss) attributable to Centene Corporation:
 
 
 
Earnings (loss) from continuing operations, net of tax
$
(16
)
 
$
64

Discontinued operations, net of tax
(1
)
 
(1
)
Net earnings (loss)
$
(17
)
 
$
63

 
 
 
 
Shares used in computing per share amounts:
 

 
 
Weighted average number of common shares outstanding
125,543,076

 
118,783,755

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

 
3,788,611

Weighted average number of common shares and potential dilutive common shares outstanding
125,543,076

 
122,572,366

 
 
 
 
Net earnings (loss) per common share attributable to Centene Corporation:
Basic:
 
 
 
Continuing operations
$
(0.13
)
 
$
0.54

Discontinued operations
(0.01
)
 
(0.01
)
Basic earnings (loss) per common share
$
(0.14
)
 
$
0.53

 
 
 
 
Diluted:
 
 
 
Continuing operations
$
(0.13
)
 
$
0.52

Discontinued operations
(0.01
)
 
(0.01
)
Diluted earnings (loss) per common share
$
(0.14
)
 
$
0.51


The calculation of diluted earnings (loss) per common share for the three months ended March 31, 2016 and 2015 excludes the impact of 6,742,714 and 26,376 shares (before application of the treasury stock method), respectively, related to anti-dilutive restricted stock and restricted stock units.


18


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 Health Net Western Region, with the exception of the pharmaceutical services subsidiaries and behavioral health subsidiaries. Health Net's Western Region operations include: 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 Government Contracts segment of Health Net as well as their pharmaceutical services and behavioral health subsidiaries, which Health Net previously included in their Western Region Operations segment. The Government Contracts business includes the Company's government-sponsored managed care 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 March 31, 2016, follows ($ in millions):
 
Managed Care
 
Specialty
Services
 
Eliminations
 
Consolidated
Total
Total revenues from external customers
$
6,355

 
$
598

 
$

 
$
6,953

Total revenues from internal customers
34

 
1,448

 
(1,482
)
 

Total revenues
$
6,389

 
$
2,046

 
$
(1,482
)
 
$
6,953

Earnings (loss) from operations
$
(22
)
 
$
42

 
$

 
$
20


Segment information for the three months ended March 31, 2015, follows ($ in millions):
 
Managed Care
 
Specialty
Services
 
Eliminations
 
Consolidated
Total
Total revenues from external customers
$
4,612

 
$
519

 
$

 
$
5,131

Total revenues from internal customers
24

 
1,075

 
(1,099
)
 

Total revenues
$
4,636

 
$
1,594

 
$
(1,099
)
 
$
5,131

Earnings from operations
$
95

 
$
34

 
$

 
$
129


As discussed in Note 3. Health Net, the assignment of goodwill to the Company's segment has not been completed at this time. The Company will update segment asset disclosures once a preliminary allocation is available.

11. Contingencies
On July 5, 2013, the Company's subsidiary, Kentucky Spirit Health Plan, Inc. (Kentucky Spirit), terminated its contract with the Commonwealth of Kentucky (the Commonwealth). Kentucky Spirit believes it had a contractual right to terminate the contract and filed a lawsuit in Franklin Circuit Court seeking a declaration of this right. The Commonwealth has alleged that Kentucky Spirit's exit constitutes a material breach of contract.  The Commonwealth seeks to recover substantial damages and to enforce its rights under Kentucky Spirit's $25 million performance bond. The Commonwealth's attorneys have asserted that the Commonwealth's expenditures due to Kentucky Spirit's departure range from $28 million to $40 million plus interest, and that the associated CMS expenditures range from $92 million to $134 million. Kentucky Spirit disputes the Commonwealth's alleged damages, and filed a lawsuit in April 2013, amended in October 2014, in Franklin Circuit Court seeking damages against the Commonwealth for losses sustained due to the Commonwealth's alleged breaches.

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


19


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

On March 9, 2015, the Secretary of the Kentucky Cabinet for Health and Family Services (CHFS) issued a determination letter finding that Kentucky Spirit owed the Commonwealth $40 million in actual damages plus prejudgment interest at 8 percent. On March 18, 2015, in a letter to the Kentucky Finance and Administration Cabinet (FAC), Kentucky Spirit contested CHFS' jurisdiction to make such a determination. The FAC did not issue a decision within the required 120 days. On August 13, 2015, Kentucky Spirit filed a declaratory judgment action against the Commonwealth in Franklin Circuit Court seeking a declaration that the Commonwealth may not purport to issue a decision against Kentucky Spirit awarding damages to itself when the matter is already before the Kentucky courts, and that the Commonwealth has waived its claims against Kentucky Spirit for damages arising out of the contract. The Commonwealth filed counterclaims seeking a Declaration of Rights and Entry of Judgment on its determination letter. On December 1, 2015 the Franklin Circuit Court consolidated this declaratory judgment action with Kentucky Spirit’s other litigation claims against the Commonwealth. On December 15, 2015, the Franklin Circuit Court denied Kentucky Spirit’s motion to dismiss the Commonwealth’s counterclaim for Declaration of Rights and Entry of Judgment. Discovery is proceeding in the consolidated litigation matters.

The resolution of the Kentucky litigation matters may result in a range of possible outcomes.  If Kentucky Spirit prevails on its claims, it would be entitled to damages.  If the Commonwealth prevails, a liability to the Commonwealth could be recorded.  The Company is unable to estimate the ultimate outcome resulting from the Kentucky litigation.  As a result, the Company has not recorded any receivable or any liability for potential damages under the contract as of March 31, 2016.  While uncertain, the ultimate resolution of the pending litigation could have a material effect on the financial position, cash flow or results of operations of the Company in the period it is resolved or becomes known.

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

20



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. The following discussion and analysis, with the exception of cash flow information, is presented in the context of continuing operations unless otherwise identified.

OVERVIEW

On March 24, 2016, we acquired all of the issued and outstanding shares of Health Net, Inc. (Health Net). Our consolidated financial statements as of and for the three months ended March 31, 2016 reflect eight days of Health Net operations.

Key financial metrics for the first quarter of 2016 are summarized as follows:
Managed care membership of 11.5 million, an increase of 7.1 million members, or 162% year over year.
Total revenues of $7.0 billion, representing 36% growth year over year.
Health Benefits Ratio of 88.7%, compared to 89.8% in 2015.
General and Administrative expense ratio of 11.3%, or 8.3% excluding Health Net acquisition related expenses for the first quarter of 2016, compared to 8.3% in the first quarter of 2015.
Operating cash flows of $195 million for the first quarter of 2016.
Loss per diluted share for the first quarter of 2016 of $(0.13), or $0.74 of Adjusted Diluted EPS when excluding Health Net acquisition related expenses and intangible amortization. In comparison, diluted EPS for the first quarter of 2015 was $0.52, or $0.55 Adjusted Diluted EPS when excluding intangible amortization. A reconciliation of GAAP net loss per diluted share to Adjusted Diluted EPS is highlighted below:
 
Three Months Ended March 31,
 
2016
 
2015
 
 
 
 
GAAP diluted net earnings (loss) per share
$
(0.13
)
 
$
0.52

Health Net acquisition related expenses
0.83

 

Amortization of acquired intangible assets
0.04

 
0.03

Adjusted Diluted EPS
$
0.74

 
$
0.55

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

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

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

Florida. In October 2015, Sunshine Health began operating under a two-year, statewide contract with the Florida Healthy Kids Corporation to manage healthcare services for children ages five through 18 in all 11 regions of Florida.

Health Insurance Marketplaces (HIM). In January 2016, we began serving members enrolled in the federally facilitated Health Insurance Marketplace in the state of New Hampshire.

21


In January 2016, we started operating under a contract with the New Hampshire Department of Health and Human Services to participate in the Medicaid expansion model that New Hampshire has adopted (referred to as the “premium assistance program”). This contract expires December 31, 2016 and may be extended for subsequent and consecutive one-year terms.

Health Net. On March 24, 2016, we acquired all of the issued and outstanding shares of Health Net for approximately $6.0 billion, including the assumption of debt. This strategic acquisition broadens our current service offerings, providing expansion in Medicaid and Medicare programs. This acquisition provides further diversification across our markets and products through the addition of government-sponsored care under federal contracts with the Department of Defense (DoD) and the U.S. Department of Veteran's Affairs (VA), as well as Medicare Advantage. Our consolidated financial statements as of and for the three months ended March 31, 2016 reflect eight days of Health Net operations.

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

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

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

In December 2015, Louisiana Healthcare Connections began operating under an expanded contract to include behavioral health benefits.

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

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

In July 2015, Magnolia Health began operating under a two-year CHIP contract with the State of Mississippi. In December 2015, Magnolia Health began operating under an expanded contract to include the inpatient benefit for Medicaid and ABD members.

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

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

Texas. In March 2015, we began operating under an expanded STAR+PLUS contract with the Texas Health and Human Services Commission (HHSC) to include nursing facility benefits.

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


22


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

We expect to realize the benefit from the Health Net acquisition completed on March 24, 2016.

We expect to realize the full year benefit in 2016 of business commenced during 2015 in Arizona, Florida, Indiana, Louisiana, Michigan, Mississippi, Oregon, South Carolina, Texas and Vermont as discussed above.

In April 2016, our Florida subsidiary, Centurion of Florida, LLC, began providing correctional healthcare services for the Florida Department of Corrections in Regions 1, 2 and 3.

In April 2016, our subsidiary, Centurion of Mississippi, LLC, was selected to provide correctional healthcare services for the MDOC. Centurion began providing healthcare services to the MDOC in July 2015 under a one-year emergency contract. The new three year contract will begin in July 2016.

In April 2016, our subsidiary, Coordinated Care of Washington, began operating as the sole contractor with the Washington State Health Care Authority to provide foster care services through the Apple Health Foster Care contract.

In April 2016, our Nebraska subsidiary, Nebraska Total Care, executed a contract with the Nebraska Department of Health and Human Services' Division of Medicaid and Long-Term Care as one of three managed care organizations to administer its new Heritage Health Program for Medicaid, ABD and CHIP enrollees. The contract is expected to commence in the first quarter of 2017, pending regulatory approval.

In January 2016, the governor of Louisiana signed an executive order to expand Medicaid coverage under the Affordable Care Act by July 1, 2016.

In October 2015, our subsidiary, Superior HealthPlan, Inc., was awarded a contract by the Texas HHSC to serve seven delivery areas for STAR Kids Medicaid recipients, more than any other successful bidder. The new contract is expected to commence in the latter part of 2016.
 
In September 2015, our subsidiary, Peach State Health Plan, was one of the Care Management Organizations selected to serve Medicaid recipients enrolled in the Georgia Families, PeachCare for Kids and Planning for Healthy Babies programs. The contract renewal is expected to commence in July 2016, pending regulatory approvals. However, the expiration date of the current contract may be extended for up to two six-month periods.


23


MEMBERSHIP

From March 31, 2015 to March 31, 2016, we increased our managed care membership by 7.1 million, or 162%.  The following table sets forth the Company's membership by state for its managed care organizations:
 
March 31, 2016
 
December 31, 2015
 
March 31, 2015
Arizona
607,000

 
440,900

 
202,200

Arkansas
50,700

 
41,900

 
43,200

California
3,125,400

 
186,000

 
171,200

Florida
660,800

 
510,400

 
463,100

Georgia
495,500

 
408,600

 
405,600

Illinois
239,100

 
207,500

 
184,800

Indiana
290,300

 
282,100

 
227,700

Kansas
141,100

 
141,000

 
143,700

Louisiana
381,200

 
381,900

 
359,500

Massachusetts
52,400

 
61,500

 
64,500

Michigan
2,600

 
4,800

 

Minnesota
9,500

 
9,600

 
9,500

Mississippi
328,300

 
302,200

 
141,900

Missouri
100,000

 
95,100

 
75,600

New Hampshire
81,500

 
71,400

 
67,500

Ohio
314,000

 
302,700

 
296,000

Oregon
209,000

 
98,700

 

South Carolina
107,700

 
104,000

 
106,000

Tennessee
20,100

 
20,000

 
20,800

Texas
1,036,700

 
983,100

 
974,900

Vermont
1,500

 
1,700

 
1,600

Washington
226,500

 
209,400

 
207,100

Wisconsin
78,400

 
77,100

 
82,100

Total at-risk membership
8,559,300

 
4,941,600

 
4,248,500

TRICARE eligibles
2,819,700

 

 

Non-risk membership
161,400

 
166,300

 
153,200

Total
11,540,400

 
5,107,900

 
4,401,700


The following table sets forth our membership by line of business:
 
March 31, 2016
 
December 31, 2015
 
March 31, 2015
Medicaid:
 
 
 
 
 
TANF, CHIP & Foster Care
5,464,200

 
3,763,400

 
3,372,200

ABD & LTC
757,600

 
478,600

 
457,500

Behavioral Health
456,500

 
456,800

 
195,100

Commercial
1,518,900

 
146,100

 
161,700

Medicare & Duals
303,100

 
37,400

 
19,400

Correctional
59,000

 
59,300

 
42,600

Total at-risk membership
8,559,300

 
4,941,600

 
4,248,500

TRICARE eligibles
2,819,700

 

 

Non-risk membership
161,400

 
166,300

 
153,200

Total
11,540,400

 
5,107,900

 
4,401,700


At March 31, 2016, the Company served 984,900 members in Medicaid expansion programs in nine states and 362,300 dual-eligible members, compared to 331,800 members in Medicaid expansion programs in seven states and 184,000 dual-eligible members at March 31, 2015, included in the table above. At March 31, 2016, the Company served 683,000 members in Health Insurance Marketplaces, compared to 161,700 at March 31, 2015.


24



RESULTS OF OPERATIONS

The following discussion and analysis is based on our consolidated statements of operations, which reflect our results of operations for the three months ended March 31, 2016 and 2015, prepared in accordance with generally accepted accounting principles in the United States. 

Summarized comparative financial data for the three months ended March 31, 2016 and 2015 is as follows ($ in millions, except per share data):
 
Three Months Ended March 31,
 
2016
 
2015
 
% Change 2015-2016
Premium
$
5,986

 
$
4,299

 
39
 %
Service
425

 
462

 
(8
)%
Premium and service revenues
6,411

 
4,761

 
35
 %
Premium tax and health insurer fee
542

 
370

 
46
 %
Total revenues
6,953

 
5,131

 
36
 %
Medical costs
5,311

 
3,861

 
38
 %
Cost of services
367

 
402

 
(9
)%
General and administrative expenses
722

 
396

 
82
 %
Amortization of acquired intangible assets
9

 
7

 
29
 %
Premium tax expense
450

 
281

 
60
 %
Health insurer fee expense
74

 
55

 
35
 %
Earnings from operations
20

 
129

 
(84
)%
Other income (expense), net
(18
)
 
(1
)
 
n.m.

Earnings from continuing operations, before income tax expense
2

 
128

 
(98
)%
Income tax expense
17

 
63

 
(73
)%
Earnings (loss) from continuing operations, net of income tax expense
(15
)
 
65

 
(123
)%
Discontinued operations, net of income tax
(1
)
 
(1
)
 
 %
Net earnings (loss)
(16
)
 
64

 
(125
)%
(Earnings) loss attributable to noncontrolling interests
(1
)
 
(1
)
 
 %
Net earnings (loss) attributable to Centene Corporation
$
(17
)
 
$