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

For the quarterly period ended September 30, 2012
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 ¨ 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 ¨ 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 ¨ Non-accelerated filer ¨ (do not check if a smaller reporting company) Smaller reporting company ¨

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

As of October 12, 2012, the registrant had 51,633,824 shares of common stock outstanding.




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

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


Table of Contents

CAUTIONARY STATEMENT ON FORWARD-LOOKING STATEMENTS

All statements, other than statements of current or historical fact, contained in this filing are forward-looking statements.  We have attempted to identify these statements by terminology including “believe,” “anticipate,” “plan,” “expect,” “estimate,” “intend,” “seek,” “target,” “goal,” “may,” “will,” “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,” 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:

our ability to accurately predict and effectively manage health benefits and other operating expenses;
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;
inflation;
provider and state contract changes;
new technologies;
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 Medicaid managed care contracts by state governments;
availability of debt and equity financing, on terms that are favorable to us; and
general economic and market conditions.

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



Table of Contents

PART I
FINANCIAL INFORMATION

ITEM 1. Financial Statements.
CENTENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)

 
September 30,
2012
 
December 31,
2011
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
796,621

 
$
573,698

Premium and related receivables
316,123

 
157,450

Short-term investments
139,920

 
130,499

Other current assets
123,841

 
78,363

Total current assets
1,376,505

 
940,010

Long-term investments
559,714

 
506,140

Restricted deposits
33,509

 
26,818

Property, software and equipment, net
381,781

 
349,622

Goodwill
256,288

 
281,981

Intangible assets, net
21,375

 
27,430

Other long-term assets
61,764

 
58,335

Total assets
$
2,690,936

 
$
2,190,336

LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

Current liabilities:
 

 
 

Medical claims liability
$
919,032

 
$
607,985

Premium deficiency reserve
63,000

 

Accounts payable and accrued expenses
162,778

 
216,504

Unearned revenue
131,967

 
9,890

Current portion of long-term debt
3,337

 
3,234

Total current liabilities
1,280,114

 
837,613

Long-term debt
391,973

 
348,344

Other long-term liabilities
61,785

 
67,960

Total liabilities
1,733,872

 
1,253,917

Commitments and contingencies


 


Stockholders’ equity:
 

 
 

Common stock, $.001 par value; authorized 100,000,000 shares; 54,405,296 issued and 51,632,704 outstanding at September 30, 2012, and 53,586,726 issued and 50,864,618 outstanding at December 31, 2011
54

 
54

Additional paid-in capital
458,741

 
421,981

Accumulated other comprehensive income:
 
 
 
Unrealized gain on investments, net of tax
6,702

 
5,761

Retained earnings
557,759

 
564,961

Treasury stock, at cost (2,772,592 and 2,722,108 shares, respectively)
(59,277
)
 
(57,123
)
Total Centene stockholders’ equity
963,979

 
935,634

Noncontrolling interest
(6,915
)
 
785

Total stockholders’ equity
957,064

 
936,419

Total liabilities and stockholders’ equity
$
2,690,936

 
$
2,190,336


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

1

Table of Contents

CENTENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share data)
(Unaudited)

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Revenues:
 
 
 
 
 
 
 
Premium
$
2,184,061

 
$
1,239,464

 
$
5,853,469

 
$
3,640,829

Service
28,403

 
25,817

 
84,062

 
81,629

Premium and service revenues
2,212,464

 
1,265,281

 
5,937,531

 
3,722,458

Premium tax
235,657

 
36,754

 
333,484

 
110,948

Total revenues
2,448,121

 
1,302,035

 
6,271,015

 
3,833,406

Expenses:
 
 
 
 
 
 
 
Medical costs
2,036,999

 
1,053,320

 
5,370,080

 
3,091,007

Cost of services
21,744

 
20,229

 
66,897

 
60,717

General and administrative expenses
181,073

 
142,934

 
512,322

 
427,067

Premium tax expense
235,946

 
37,005

 
333,872

 
111,668

Impairment loss

 

 
28,033

 

Total operating expenses
2,475,762

 
1,253,488

 
6,311,204

 
3,690,459

Earnings (loss) from operations
(27,641
)
 
48,547

 
(40,189
)
 
142,947

Other income (expense):
 
 
 
 
 
 
 
Investment and other income
23,244

 
2,697

 
32,580

 
9,379

Debt extinguishment costs

 

 

 
(8,488
)
Interest expense
(4,855
)
 
(4,572
)
 
(14,393
)
 
(15,523
)
Earnings (loss) from operations, before income tax expense
(9,252
)
 
46,672

 
(22,002
)
 
128,315

Income tax expense (benefit)
(9,547
)
 
18,459

 
(6,068
)
 
49,216

Net earnings (loss)
295

 
28,213

 
(15,934
)
 
79,099

Noncontrolling interest
(3,524
)
 
(774
)
 
(8,732
)
 
(2,007
)
Net earnings (loss) attributable to Centene Corporation
$
3,819

 
$
28,987

 
$
(7,202
)
 
$
81,106

 
 
 
 
 
 
 
 
Net earnings (loss) per common share attributable to Centene Corporation:
Basic earnings (loss) per common share
$
0.07

 
$
0.58

 
$
(0.14
)
 
$
1.62

Diluted earnings (loss) per common share
$
0.07

 
$
0.55

 
$
(0.14
)
 
$
1.55

 
 
 
 
 
 
 
 
Weighted average number of common shares outstanding:
 
 
 
 
 
 
 
Basic
51,584,860

 
50,345,512

 
51,393,345

 
50,089,845

Diluted
53,806,197

 
52,620,350

 
51,393,345

 
52,320,906


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

2

Table of Contents

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

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Net earnings (loss)
$
295

 
$
28,213

 
$
(15,934
)
 
$
79,099

Reclassification adjustment, net of tax
1,023

 
195

 
1,495

 
415

Change in unrealized gains on investments, net of tax
(163
)
 
(900
)
 
(554
)
 
(361
)
Other comprehensive earnings (loss)
860

 
(705
)
 
941

 
54

Comprehensive earnings (loss)
1,155

 
27,508

 
(14,993
)
 
79,153

Comprehensive earnings (loss) attributable to the noncontrolling interest
(3,524
)
 
(774
)
 
(8,732
)
 
(2,007
)
Comprehensive earnings (loss) attributable to Centene Corporation
$
4,679

 
$
28,282

 
$
(6,261
)
 
$
81,160


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


3

Table of Contents

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

Nine Months Ended September 30, 2012
 
Centene Stockholders’ Equity
 
 
 
 
 
Common Stock
 
 
 
 
 
 
 
Treasury Stock
 
 
 
 
 
$.001 Par
Value
Shares
 
Amt
 
Additional
Paid-in
Capital
 
Accumulated
Other
Comprehensive
Income
 
Retained
Earnings
 
$.001 Par
Value
Shares
 
Amt
 
Non
controlling
Interest
 
Total
Balance, December 31, 2011
53,586,726

 
$
54

 
$
421,981

 
$
5,761

 
$
564,961

 
2,722,108

 
$
(57,123
)
 
$
785

 
$
936,419

Comprehensive Earnings:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net earnings (loss)

 

 

 

 
(7,202
)
 

 

 
(8,732
)
 
(15,934
)
Change in unrealized investment gain, net of $623 tax

 

 

 
941

 

 

 

 

 
941

Total comprehensive earnings (loss)
 
 
 
 
 
 
 
 
 

 
 
 
 
 
 
 
(14,993
)
Common stock issued for employee benefit plans
818,570

 

 
12,297

 

 

 

 

 

 
12,297

Common stock repurchases

 

 

 

 

 
50,484

 
(2,154
)
 

 
(2,154
)
Stock compensation expense

 

 
18,417

 

 

 

 

 

 
18,417

Excess tax benefits from stock compensation

 

 
6,046

 

 

 

 

 

 
6,046

Contribution from noncontrolling interest

 

 

 

 

 

 

 
1,032

 
1,032

Balance, September 30, 2012
54,405,296

 
$
54

 
$
458,741

 
$
6,702

 
$
557,759

 
2,772,592

 
$
(59,277
)
 
$
(6,915
)
 
$
957,064

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



4

Table of Contents

CENTENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Nine Months Ended September 30,
 
2012
 
2011
Cash flows from operating activities:
 
 
 
Net earnings (loss)
$
(15,934
)
 
$
79,099

Adjustments to reconcile net earnings (loss) to net cash provided by operating activities
 

 
 

Depreciation and amortization
49,892

 
43,055

Stock compensation expense
18,417

 
13,263

Impairment loss
28,033

 

Gain on sale of investment in convertible note
(17,880
)
 

Gain on sale of investments, net
(1,460
)
 
(213
)
Debt extinguishment costs

 
8,488

Deferred income taxes
(19,318
)
 
(223
)
Changes in assets and liabilities
 

 
 

Premium and related receivables
(139,414
)
 
(13,306
)
Other current assets
(23,487
)
 
(6,667
)
Other assets
1,918

 
(1,230
)
Medical claims liabilities
374,046

 
40,476

Unearned revenue
122,077

 
(65,183
)
Accounts payable and accrued expenses
(59,872
)
 
(11,414
)
Other operating activities
(9,736
)
 
3,528

Net cash provided by operating activities
307,282

 
89,673

Cash flows from investing activities:
 

 
 

Capital expenditures
(70,601
)
 
(56,938
)
Purchases of investments
(501,958
)
 
(201,145
)
Sales and maturities of investments
434,009

 
180,124

Investments in acquisitions, net of cash acquired

 
(3,192
)
Net cash used in investing activities
(138,550
)
 
(81,151
)
Cash flows from financing activities:
 

 
 

Proceeds from exercise of stock options
11,686

 
13,582

Proceeds from borrowings
215,000

 
419,183

Payment of long-term debt
(177,422
)
 
(415,475
)
Excess tax benefits from stock compensation
6,049

 
1,632

Common stock repurchases
(2,154
)
 
(1,280
)
Contribution from noncontrolling interest
1,032

 
569

Debt issue costs

 
(9,242
)
Net cash provided by financing activities
54,191

 
8,969

Net increase in cash and cash equivalents
222,923

 
17,491

Cash and cash equivalents, beginning of period
573,698

 
434,166

Cash and cash equivalents, end of period
$
796,621

 
$
451,657

Supplemental disclosures of cash flow information:
 

 
 

Interest paid
$
12,127

 
$
16,097

Income taxes paid
$
34,001

 
$
49,996

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

5

Table of Contents

CENTENE CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
(Unaudited)

1. 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, 2011.  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, 2011 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 2011 amounts in the consolidated financial statements have been reclassified to conform to the 2012 presentation. These reclassifications have no effect on net earnings or stockholders’ equity as previously reported.
 
The Company reclassified certain Medical Costs and General & Administrative Expenses beginning with its financial results for the year ended December 31, 2011, as well as prior periods to conform to the current presentation, to more closely align to the National Association of Insurance Commissioners definition.  For the three months ended September 30, 2011, the net impact of the reclassification increased Medical Costs and decreased General & Administrative Expense by $24,734. For the nine months ended September 30, 2011, the net impact of the reclassification increased Medical Costs and decreased General & Administrative Expense by $69,607.

2. Short-term and Long-term Investments and Restricted Deposits

Short-term and long-term investments and restricted deposits by investment type consist of the following:
 
September 30, 2012
 
December 31, 2011
 
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
$
60,177

 
$
760

 
$
(6
)
 
$
60,931

 
$
29,014

 
$
638

 
$
(13
)
 
$
29,639

Corporate securities
257,161

 
5,844

 
(6
)
 
262,999

 
186,018

 
3,762

 
(751
)
 
189,029

Restricted certificates of deposit
5,891

 

 

 
5,891

 
5,890

 

 

 
5,890

Restricted cash equivalents
13,150

 

 

 
13,150

 
13,775

 

 

 
13,775

Municipal securities:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

General obligation
91,259

 
1,649

 

 
92,908

 
126,806

 
2,828

 
(26
)
 
129,608

Pre-refunded
16,529

 
130

 

 
16,659

 
33,247

 
465

 

 
33,712

Revenue
85,281

 
1,804

 
(25
)
 
87,060

 
118,507

 
2,387

 
(34
)
 
120,860

Variable rate demand notes
92,225

 

 

 
92,225

 
64,658

 

 

 
64,658

Asset backed securities
74,126

 
1,294

 

 
75,420

 
51,779

 
430

 
(17
)
 
52,192

Cost and equity method investments
10,958

 

 

 
10,958

 
9,395

 

 

 
9,395

Life insurance contracts
14,942

 

 

 
14,942

 
14,699

 

 

 
14,699

Total
$
721,699

 
$
11,481

 
$
(37
)
 
$
733,143

 
$
653,788

 
$
10,510

 
$
(841
)
 
$
663,457



6

Table of Contents

The Company’s investments are classified as available-for-sale with the exception of life insurance contracts and certain cost and equity method investments.  The Company’s investment policies are designed to provide liquidity, preserve capital and maximize total return on invested assets with the focus on high credit quality securities.  The Company limits the size of investment in any single issuer other than U.S. treasury securities and obligations of U.S. government corporations and agencies.  As of September 30, 2012, 38% of the Company’s investments in securities recorded at fair value that carry a rating by Moody’s or S&P were rated AAA, 68% were rated AA- or higher, and 99% were rated A- or higher.  At September 30, 2012, the Company held certificates of deposit, life insurance contracts and cost and equity method investments which did not carry a credit rating.

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:
 
September 30, 2012
 
December 31, 2011
 
Less Than 12 Months
 
12 Months or More
 
Less Than 12 Months
 
12 Months or More
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
 
Fair
Value
U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
(4
)
 
$
1,196

 
$
(2
)
 
$
202

 
$
(13
)
 
$
2,184

 
$

 
$

Corporate securities
(6
)
 
5,295

 

 

 
(751
)
 
23,040

 

 

Municipal securities:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

General obligation

 

 

 

 
(26
)
 
3,710

 

 

Revenue
(25
)
 
1,825

 

 

 
(34
)
 
12,597

 

 

Asset backed securities

 

 

 

 
(17
)
 
20,417

 

 

Total
$
(35
)
 
$
8,316

 
$
(2
)
 
$
202

 
$
(841
)
 
$
61,948

 
$

 
$


As of September 30, 2012, the gross unrealized losses were generated from 8 positions out of a total of 376 positions.  The decline 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:
 
September 30, 2012
 
December 31, 2011
 
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
$
138,508

 
$
139,920

 
$
33,108

 
$
33,151

 
$
129,232

 
$
130,499

 
$
19,666

 
$
19,666

One year through five years
423,533

 
432,717

 
358

 
358

 
406,140

 
413,953

 
7,085

 
7,152

Five years through ten years
37,331

 
37,444

 

 

 
34,945

 
34,961

 

 

Greater than ten years
88,860

 
89,553

 

 

 
56,720

 
57,226

 

 

Total
$
688,232

 
$
699,634

 
$
33,466

 
$
33,509

 
$
627,037

 
$
636,639

 
$
26,751

 
$
26,818

 
Actual maturities may differ from contractual maturities due to call or prepayment options.  Asset backed securities are included in the one year through five years category, while equity securities 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.


7

Table of Contents

Realized gains and losses are determined on the basis of specific identification or a first-in, first-out methodology, if specific identification is not practicable.  The Company’s gross recorded realized gains and losses were as follows:

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
Gains
$
1,475

 
$
107

 
$
1,483

 
$
240

Losses
(12
)
 
(1
)
 
(23
)
 
(27
)
Net realized gains
$
1,463

 
$
106

 
$
1,460

 
$
213


During the third quarter of 2012, the company recognized $1,463 in net gains primarily as a result of the liquidation of $75,468 of investments held by the Georgia health plan in order to meet short-term liquidity needs due to the delays in premium receipts.

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.

Investment amortization of $8,676 and $7,545 was recorded in the nine months ended September 30, 2012 and 2011, respectively.

3. Fair Value Measurements

Assets and liabilities recorded at fair value in the consolidated balance sheets are categorized based upon the extent to which the fair value estimates are based upon observable or unobservable inputs.  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.
 

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Table of Contents

The following table summarizes fair value measurements by level at September 30, 2012, for assets and liabilities measured at fair value on a recurring basis:  
 
Level I
 
Level II
 
Level III
 
Total
Assets
 
 
 
 
 
 
 
Cash and cash equivalents
$
796,621

 

 

 
$
796,621

Investments available for sale:
 

 
 

 
 

 
 

U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
34,409

 
$
12,054

 

 
$
46,463

Corporate securities

 
262,999

 

 
262,999

Municipal securities:
 

 
 

 
 

 
 
General obligation

 
92,908

 

 
92,908

Pre-refunded

 
16,659

 

 
16,659

Revenue

 
87,060

 

 
87,060

Variable rate demand notes

 
92,225

 

 
92,225

Asset backed securities

 
75,420

 

 
75,420

Total investments
$
34,409

 
$
639,325

 

 
$
673,734

Restricted deposits available for sale:
 

 
 

 
 

 
 

Cash and cash equivalents
$
13,150

 

 

 
$
13,150

Certificates of deposit
5,891

 

 

 
5,891

U.S. Treasury securities and obligations of U.S. government corporations and agencies
13,958

 
$
510

 

 
14,468

Total restricted deposits
$
32,999

 
$
510

 

 
$
33,509

Other long-term assets: Interest rate swap contract

 
$
17,196

 

 
$
17,196

Total assets at fair value
$
864,029

 
$
657,031

 

 
$
1,521,060


The following table summarizes fair value measurements by level at December 31, 2011, for assets and liabilities measured at fair value on a recurring basis: 
 
Level I
 
Level II
 
Level III
 
Total
Assets
 
 
 
 
 
 
 
Cash and cash equivalents
$
573,698

 

 

 
$
573,698

Investments available for sale:
 

 
 

 
 

 
 

U.S. Treasury securities and obligations of U.S. government corporations and agencies
$
17,091

 
$
5,395

 

 
$
22,486

Corporate securities

 
189,029

 

 
189,029

Municipal securities:
 

 
 

 
 

 
 
General obligation

 
129,608

 

 
129,608

Pre-refunded

 
33,712

 

 
33,712

Revenue

 
120,860

 

 
120,860

Variable rate demand notes

 
64,658

 

 
64,658

Asset backed securities

 
52,192

 

 
52,192

Total investments
$
17,091

 
$
595,454

 

 
$
612,545

Restricted deposits available for sale:
 

 
 

 
 

 
 

Cash and cash equivalents
$
13,775

 

 

 
$
13,775

Certificates of deposit
5,890

 

 

 
5,890

U.S. Treasury securities and obligations of U.S. government corporations and agencies
7,153

 

 

 
7,153

Total restricted deposits
$
26,818

 

 

 
$
26,818

Other long-term assets: Interest rate swap contract

 
$
11,431

 

 
$
11,431

Total assets at fair value
$
617,607

 
$
606,885

 

 
$
1,224,492

 

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Table of Contents

The Company periodically transfers U.S. Treasury securities and obligations of U.S. government corporations and agencies between Level I and Level II fair value measurements dependent upon the level of trading activity for the specific securities at the measurement date.  The Company’s policy regarding the timing of transfers between Level I and Level II is to measure and record the transfers at the end of the reporting period.  At September 30, 2012, there were $1,818 of transfers from Level I to Level II and $3,612 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 $25,900 and $24,094 as of September 30, 2012 and December 31, 2011, respectively.

4. Notes Receivable

Between July 2008 and October 2011, the Company made an investment of $30,000 in secured notes receivable to a third party as part of an investment in certain Medicaid and Medicare related businesses. The notes included a feature to convert the note balance into an equity ownership in the underlying businesses.
In September 2012, the Company executed an agreement with the borrower whereby the borrower agreed to pay the Company total consideration of $50,000 for retirement of the outstanding notes and equity ownership conversion feature. Under the terms of the agreement, the borrower agreed to pay the Company $30,000 by December 1, 2012, $10,000 by September 30, 2013 and $10,000 by September 30, 2014. All outstanding balances are secured by liens on certain underlying businesses as well as guaranteed personally by the principal owner of the businesses. The $10,000 notes to be paid on or before September 30, 2013 and September 30, 2014 are non-interest bearing and, as a result, total consideration has been discounted by $2,120 to reflect imputation of interest. As a result, during the third quarter of 2012, the Company recorded a pre-tax gain of $17,880 in other income representing the fair value of the total consideration in excess of the carrying value of the loans on the Company's balance sheet.

5. Premium Deficiency Reserve

The Company periodically reviews actual and anticipated experience compared to the assumptions used to establish medical costs. The Company establishes premium deficiency reserves if actual and anticipated experience indicates that existing policy liabilities together with the present value of future gross premiums will not be sufficient to cover the present value of future benefits, settlement and maintenance costs.

In October 2012, the Company notified the Kentucky Cabinet for Health and Family Services that it is exercising a contractual right that it believes allows Kentucky Spirit to terminate its Medicaid managed care contract with the Commonwealth of Kentucky effective July 5, 2013. As a result, the Company recorded a premium deficiency reserve included in Medical costs expense of $63,000 for its Kentucky contract in the quarter ended September 30, 2012. The premium deficiency reserve encompasses the contract period from October 1, 2012 through July 5, 2013.

6. Debt
 
Debt consists of the following:
 
September 30, 2012
 
December 31, 2011
Senior notes, at par
$
250,000

 
$
250,000

Unamortized discount on Senior notes
(2,425
)
 
(2,814
)
Interest rate swap fair value
17,196

 
11,431

Senior notes, net
264,771

 
258,617

Revolving credit agreement
40,000

 

Mortgage notes payable
84,810

 
86,948

Capital leases and other
5,729

 
6,013

Total debt
395,310

 
351,578

Less current portion
(3,337
)
 
(3,234
)
 Long-term debt
$
391,973

 
$
348,344



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Table of Contents

Senior Notes

In May 2011, the Company issued non-callable $250,000 5.75% Senior Notes due June 1, 2017 ($250,000 Notes) at a discount to yield 6%.  At September 30, 2012, the unamortized debt discount was $2,425.  In connection with the issuance, the Company entered into an interest rate swap.  Gains and losses due to changes in the fair value of the interest rate swap completely offset changes in the fair value of the hedged portion of the underlying debt and are recorded as an adjustment to the $250,000 Notes.  At September 30, 2012, the fair value of the interest rate swap increased the fair value of the notes by $17,196.  At September 30, 2012, the variable interest rate of the swap was 3.92%.

Revolving Credit Agreement

The Company has a $350,000 revolving credit facility due in January 2016.  The revolver is unsecured and has  non-financial and financial covenants, including requirements of minimum fixed charge coverage ratios, maximum debt to EBITDA ratios and minimum net worth.  Borrowings under the revolver bear interest based upon LIBOR rates, the Federal funds rate, or the prime rate.  As of September 30, 2012, the Company had $40,000 in borrowings outstanding under the agreement, leaving availability of $310,000.

The Company has outstanding letters of credit of $35,631 as of September 30, 2012, which are not part of the revolver.  The letters of credit bore interest at 1.03% as of September 30, 2012.

7. Impairment Loss

During the second quarter of 2012, the Company's subsidiary, Celtic Insurance Company, experienced a high level of medical costs for individual health policies, especially for recently issued policies related to members converted from another insurer throughout the first quarter of 2012. Additionally, in June 2012, the U.S. Supreme Court upheld the constitutionality of the Patient Protection and Affordable Care Act. The Affordable Care Act, among other things, limits the profitability of the individual health insurance business because of minimum medical loss ratios, guaranteed issue policies, and increased competition in the exchange market. As a result of these factors, the Company's expectations for future growth and profitability are lower than previous estimates. The Company conducted an impairment analysis of the identifiable intangible assets and goodwill of the Celtic reporting unit, which encompasses Celtic Insurance Company, CeltiCare Health Plan of Massachusetts, Inc., and Novasys Health, Inc. For the purpose of testing goodwill, the fair value of the Celtic reporting unit was determined using discounted expected cash flows. For the purpose of testing the customer relationship intangible, the fair value was determined using the discounted expected cash flows. The impairment analysis resulted in goodwill and intangible asset impairments of $28,033, recorded as impairment loss in the consolidated statement of operations. The impaired identifiable intangible assets of $2,340 and goodwill of $25,693 were reported under the Specialty Services segment, of which $26,589 of the impairment loss is not deductible for income tax purposes.

8. Income Tax

During the third quarter of 2012, the Company recorded a tax benefit resulting from the clarification by a state taxing authority regarding a state income tax calculation.  Accordingly, during the third quarter of 2012, the Company reversed the reserve associated with the uncertain tax position and recognized a net tax benefit of $4,569.


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Table of Contents

9. Earnings (Loss) Per Share

The following table sets forth the calculation of basic and diluted net earnings (loss) per common share:

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
Net earnings (loss) attributable to Centene Corporation
$
3,819

 
$
28,987

 
$
(7,202
)
 
$
81,106

 
 
 
 
 
 
 
 
Shares used in computing per share amounts:
 

 
 

 
 
 
 
Weighted average number of common shares outstanding
51,584,860

 
50,345,512

 
51,393,345

 
50,089,845

Common stock equivalents (as determined by applying the treasury stock method)
2,221,337

 
2,274,838

 

 
2,231,061

Weighted average number of common shares and potential dilutive common shares outstanding
53,806,197

 
52,620,350

 
51,393,345

 
52,320,906

 
 
 
 
 
 
 
 
Net earnings (loss) per share attributable to Centene Corporation:
 
 
 
 
 
 
 
Basic earnings (loss) per common share
$
0.07

 
$
0.58

 
$
(0.14
)
 
$
1.62

Diluted earnings (loss) per common share
$
0.07

 
$
0.55

 
$
(0.14
)
 
$
1.55


The calculation of diluted earnings (loss) per common share for the three and nine months ended September 30, 2012 excludes the impact of 44,642 and 4,638,757 shares (before application of the treasury stock method), respectively, related to anti-dilutive stock options, restricted stock and restricted stock units. The calculation of diluted earnings per common share for the three and nine months ended September 30, 2011 excludes the impact of 69,359 and 97,004 shares, respectively, related to anti-dilutive stock options, restricted stock and restricted stock units.

10. Segment Information

Centene operates in two segments: Medicaid Managed Care and Specialty Services.  The Medicaid 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 products for behavioral health, care management software, health insurance exchanges, individual health insurance, life and health management, managed vision, telehealth services, and pharmacy benefits management.  The health plans in Arizona, operated by our long-term care company, and Massachusetts, operated by our individual health insurance provider, are also included in the Specialty Services segment.
 
Segment information for the three months ended September 30, 2012, follows:
 
Medicaid
Managed Care
 
Specialty
Services
 
Eliminations
 
Consolidated
Total
Premium and service revenues from external customers
$
1,994,867

 
$
217,597

 
$

 
$
2,212,464

Premium and service revenues from internal customers
25,138

 
442,387

 
(467,525
)
 

Total premium and service revenues
$
2,020,005

 
$
659,984

 
$
(467,525
)
 
$
2,212,464

Earnings (loss) from operations
$
(55,363
)
 
$
27,722

 
$

 
$
(27,641
)

Segment information for the three months ended September 30, 2011, follows:
 
Medicaid
Managed Care
 
Specialty
Services
 
Eliminations
 
Consolidated
Total
Premium and service revenues from external customers
$
1,080,038

 
$
185,243

 
$

 
$
1,265,281

Premium and service revenues from internal customers
16,976

 
171,358

 
(188,334
)
 

Total premium and service revenues
$
1,097,014

 
$
356,601

 
$
(188,334
)
 
$
1,265,281

Earnings from operations
$
38,387

 
$
10,160

 
$

 
$
48,547



12

Table of Contents

Segment information for the nine months ended September 30, 2012, follows:
 
Medicaid
Managed Care
 
Specialty
Services
 
Eliminations
 
Consolidated
Total
Premium and service revenues from external customers
$
5,293,736

 
$
643,795

 
$

 
$
5,937,531

Premium and service revenues from internal customers
62,751

 
1,206,293

 
(1,269,044
)
 

Total premium and service revenues
$
5,356,487

 
$
1,850,088

 
$
(1,269,044
)
 
$
5,937,531

Earnings (loss) from operations
$
(69,846
)
 
$
29,657

 
$

 
$
(40,189
)

Segment information for the nine months ended September 30, 2011, follows:
 
Medicaid
Managed Care
 
Specialty
Services
 
Eliminations
 
Consolidated
Total
Premium and service revenues from external customers
$
3,179,601

 
$
542,857

 
$

 
$
3,722,458

Premium and service revenues from internal customers
50,020

 
495,829

 
(545,849
)
 

Total premium and service revenues
$
3,229,621

 
$
1,038,686

 
$
(545,849
)
 
$
3,722,458

Earnings from operations
$
109,004

 
$
33,943

 
$

 
$
142,947


11. Contingencies
In June 2012, a class action lawsuit was filed against the Company and certain of its officers in the United States District Court for the Eastern District of Missouri.  The lawsuit alleged, on behalf of purchasers of the Company's securities from February 7, 2012 through June 8, 2012, that the Company and certain of its officers violated federal securities laws by making false or misleading statements principally concerning the Company's fiscal 2012 earnings guidance.  The Company believed the case was without merit. In September 2012, the plaintiff voluntarily dismissed the action without prejudice as to all claims and defendants.
In June 2012, the Company was notified by the Ohio Department of Job and Family Services (ODJFS) that Buckeye, its Ohio subsidiary, was awarded a contract to serve Medicaid members in Ohio. The award remains subject to an ongoing legal proceeding from another managed care organization that was not awarded a contract. At September 30, 2012, the Company continued to carry goodwill and intangible assets of $42,734 associated with Buckeye pending final resolution of the award.
In addition, the Company is routinely subjected to legal proceedings in the normal course of business. While the ultimate resolution of such matters is uncertain, the Company does not expect the results of any of these matters discussed above individually, or in the aggregate, to have a material effect on its financial position or results of operations.

12. Kentucky Contract Termination

In October 2012, the Company notified the Kentucky Cabinet for Health and Family Services that it is exercising a contractual right that it believes allows the Company to terminate its Medicaid managed care contract with the Commonwealth of Kentucky effective July 5, 2013. The Company has also filed a formal dispute with the Cabinet for damages incurred under the contract. In addition, the Company has filed a lawsuit in Franklin Circuit Court against the Commonwealth of Kentucky seeking declaratory relief as a result of the Commonwealth's failure to completely and accurately disclose material information.

During the fourth quarter of 2012 and during 2013, the Company expects to incur exit costs of approximately $5,000 to $7,000, consisting primarily of lease termination fees and employee retention and severance accruals. The exit costs will be recorded during the remaining period of the contract and subsequent wind down period and are not reflected in the financial results as of September 30, 2012.


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Table of Contents

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

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

OVERVIEW
During the third quarter of 2012, we recorded net earnings of $0.07 per diluted share reflecting the following:
Earnings excluding Kentucky operations
$
0.78

Loss from Kentucky operations
(0.31
)
Subtotal
0.47

Kentucky premium deficiency reserve
(0.69
)
Gains on sales of investments
0.21

Tax benefit
0.08

Net earnings per diluted share
$
0.07

During the third quarter of 2012, we recorded a $63.0 million pre-tax premium deficiency reserve for our Kentucky health plan contract covering the period from October 1, 2012 through July 5, 2013, or $0.69 per diluted share. We recorded a $17.9 million pre-tax gain on the sale of investment in a convertible note and $1.5 million in gains on the sale of investments in our Georgia health plan, or $0.21 per diluted share during the third quarter of 2012. We also recorded a $4.6 million tax benefit, or $0.08 per diluted share, associated with the clarification by a state regarding the items included in the state income tax calculation These items are discussed below under the captions "Medical Costs," "Other Income (Expense)," and "Income Tax Expense."
Key financial metrics for the third quarter of 2012 are summarized as follows:
Quarter-end at-risk managed care membership of 2,503,000, an increase of 887,300 members, or 55% year over year.
Premium and service revenues of $2.2 billion, representing 75% growth year over year.
Health Benefits Ratio of 93.3%, compared to 85.0% in 2011. Excluding the impact of our Kentucky operations, the HBR was 88.7% for the third quarter of 2012.
General and Administrative expense ratio of 8.2%, compared to 11.3% in 2011.
Operating cash flow of $317.2 million for the third quarter of 2012.

The following items contributed to our revenue and membership growth over the last year:
Arizona. In October 2011, Bridgeway Health Solutions began operating under an expanded contract to deliver long-term care services in three geographic service areas of Arizona.
Illinois. In May 2011, our subsidiary, IlliniCare Health Plan, began providing managed care services for older adults and adults with disabilities under the Integrated Care Program in six counties.
Kentucky. In November 2011, our subsidiary, Kentucky Spirit Health Plan, began providing managed care services under a contract with the Kentucky Finance and Administration Cabinet to serve Medicaid beneficiaries.
Louisiana. In February 2012, our joint venture subsidiary, Louisiana Healthcare Connections (LHC), began operating under a new contract in Louisiana to provide healthcare services to Medicaid enrollees participating in the Bayou Health program. LHC completed its three-phase membership roll-out for the three geographical service areas during the second quarter of 2012. In addition, Nurtur, our subsidiary which provides life, health and wellness programs, contracted to provide disease management services for state employees in Louisiana for the 2012 calendar year.
Missouri. In July 2012, our subsidiary, Home State Health Plan, began operating under a new contract with the Office of Administration for Missouri to serve Medicaid beneficiaries in the Eastern, Central, and Western Managed Care Regions of the state.
Ohio. In October 2011, Buckeye Community Health Plan, or Buckeye, began operating under an amended contract with the Ohio Department of Job and Family Services which includes the management of the pharmacy benefits for Buckeye's members.

14

Table of Contents

Texas. In March 2012, the Company began operating under contracts in Texas that expanded its operations through new service areas including the 10 county Hidalgo Service Area and the Medicaid Rural Service Areas of West Texas, Central Texas and North-East Texas, as well as the addition of STAR+PLUS in the Lubbock Service Area.  The expansion also added the management of outpatient pharmacy benefits in all service areas and products, as well as inpatient facility services for the STAR+PLUS program.

Washington. In July 2012, we began operating under a new contract with the Washington Health Care Authority to serve Medicaid beneficiaries in the state, initially operating as Coordinated Care. 

We expect the following items to contribute to our future growth potential:
We expect to realize the continued benefit of business commenced during 2011 in Arizona, Illinois, Louisiana, Texas and Ohio as discussed above.
In August 2012, we were notified by the Ohio Department of Job and Family Services (ODJFS) that Buckeye Community Health Plan (Buckeye), our Ohio subsidiary, was selected to serve Medicaid members in a dual-eligible demonstration program in three of Ohio's pre-determined seven regions: Northeast (Cleveland), Northwest (Toledo) and West Central (Dayton). This three-year program, which is part of the state of Ohio's Integrated Care Delivery System (ICDS) expansion, will serve those who have both Medicare and Medicaid eligibility. Enrollment is expected to begin in the second half of 2013.
In June 2012, we were notified by the ODJFS that Buckeye, our Ohio subsidiary, was selected to be awarded a new and expanded contract to serve Medicaid members in Ohio. Under the new state contract, Buckeye will operate statewide through Ohio's three newly aligned regions (West, Central/Southeast, and Northeast). The award remains subject to an ongoing legal proceeding from another managed care organization that was not awarded a contract. At September 30, 2012, we continued to carry goodwill and intangible assets of $42.7 million associated with Buckeye pending final resolution of the award. Enrollment is expected to begin in July 2013.
In June 2012, our Kansas subsidiary, Sunflower State Health Plan, was awarded a statewide contract to serve members in the state's KanCare program, which includes TANF, ABD non-duals, long-term care and CHIP beneficiaries. Operations are expected to commence in the first quarter of 2013.
In May 2012, we announced the Governor and Executive Council of New Hampshire had given approval for the Department of Health and Human Services to contract with our subsidiary, Granite State Health Plan, to serve Medicaid beneficiaries in New Hampshire. Operations are currently expected to commence in the first half of 2013.
In October 2012, we announced that our subsidiary, Kentucky Spirit Health Plan (Kentucky Spirit), notified the Cabinet for Health and Family Services that it is exercising a contractual right that it believes allows Kentucky Spirit to terminate its Medicaid managed care contract with the Commonwealth of Kentucky effective July 5, 2013. Kentucky Spirit has also filed a formal dispute with the Cabinet for damages incurred under the contract. In addition, we have filed a lawsuit in Franklin Circuit Court against the Commonwealth of Kentucky seeking declaratory relief as a result of the Commonwealth's failure to completely and accurately disclose material information.

MEMBERSHIP

From September 30, 2011 to September 30, 2012, we increased our at-risk managed care membership by 887,300, or 54.9%.  The following table sets forth our membership by state for our managed care organizations:

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Table of Contents

 
September 30,
 
December 31,
 
2012
 
2011
 
2011
Arizona
23,800

 
22,800

 
23,700

Florida
209,600

 
188,600

 
198,300

Georgia
312,400

 
298,000

 
298,200

Illinois
17,900

 
13,600

 
16,300

Indiana
205,400

 
205,300

 
206,900

Kentucky
145,400

 

 
180,700

Louisiana
167,200

 

 

Massachusetts
28,000

 
34,700

 
35,700

Mississippi
30,600

 
30,600

 
31,600

Missouri
53,900

 

 

Ohio
173,800

 
162,200

 
159,900

South Carolina
89,400

 
86,500

 
82,900

Texas
930,700

 
494,500

 
503,800

Washington
42,000

 

 

Wisconsin
72,900

 
78,900

 
78,000

Total at-risk membership
2,503,000

 
1,615,700

 
1,816,000

Non-risk membership

 
10,600

 
4,900

Total
2,503,000

 
1,626,300

 
1,820,900


The following table sets forth our membership by line of business:
 
September 30,
 
December 31,
 
2012
 
2011
 
2011
Medicaid
1,939,400

 
1,189,900
 
1,336,800

CHIP & Foster Care
229,600

 
210,600
 
213,900

ABD & Medicare
289,800

 
171,700
 
218,000

Hybrid Programs
35,700

 
38,400
 
40,500

Long-term Care
8,500

 
5,100
 
6,800

Total at-risk membership
2,503,000

 
1,615,700
 
1,816,000

Non-risk membership

 
10,600
 
4,900

Total
2,503,000

 
1,626,300
 
1,820,900

 
The following table identifies the Company's dual eligible membership by line of business. The membership tables above include these members.
 
September 30,
 
December 31,
 
2012
 
2011
 
2011
ABD
76,900

 
34,000
 
45,400
Long-term Care
7,800

 
4,700
 
6,200
Medicare
4,000

 
3,100
 
3,200
Total
88,700

 
41,800
 
54,800
The following table provides supplemental information of other membership categories:
 
September 30,
 
December 31,
 
2012
 
2011
 
2011
Cenpatico Behavioral Health:
 
 
 
 
 
Arizona
162,000

 
175,500
 
168,900
Kansas
48,500

 
45,600
 
46,200

Cenpatico Behavioral Health members in Kansas will begin receiving benefits under the previously announced statewide contract to serve members in the state's KanCare program, estimated to commence in the first quarter of 2013.


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Table of Contents

RESULTS OF OPERATIONS
The following discussion and analysis is based on our consolidated statements of operations, which reflect our results of operations for the three and nine months ended September 30, 2012 and 2011, prepared in accordance with generally accepted accounting principles in the United States. 
Summarized comparative financial data for the three and nine months ended September 30, 2012 and 2011 is as follows ($ in millions):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
% Change 2011-2012
 
2012
 
2011
 
% Change 2011-2012
Premium
$
2,184.1

 
$
1,239.5

 
76.2
 %
 
$
5,853.5

 
$
3,640.8

 
60.8
 %
Service
28.4

 
25.8

 
10.0
 %
 
84.0

 
81.6

 
3.0
 %
Premium and service revenues
2,212.5

 
1,265.3

 
74.9
 %
 
5,937.5

 
3,722.4

 
59.5
 %
Premium tax
235.6

 
36.8

 
541.2
 %
 
333.5

 
111.0

 
200.6
 %
Total revenues
2,448.1

 
1,302.1

 
88.0
 %
 
6,271.0

 
3,833.4

 
63.6
 %
Medical costs
2,037.0

 
1,053.3

 
93.4
 %
 
5,370.1

 
3,091.0

 
73.7
 %
Cost of services
21.7

 
20.2

 
7.5
 %
 
66.9

 
60.7

 
10.2
 %
General and administrative expenses
181.1

 
143.0

 
26.7
 %
 
512.3

 
427.1

 
20.0
 %
Premium tax expense
235.9

 
37.0

 
537.6
 %
 
333.9

 
111.7

 
199.0
 %
Impairment loss

 

 
 %
 
28.0

 

 
 %
Earnings from operations
(27.6
)
 
48.6

 
(156.9
)%
 
(40.2
)
 
142.9

 
(128.1
)%
Investment and other income, net
18.4

 
(2.0
)
 
(1,080.7
)%
 
18.2

 
(14.6
)
 
(224.3
)%
Earnings (loss) from operations, before income tax expense
(9.2
)
 
46.6

 
(119.8
)%
 
(22.0
)
 
128.3

 
(117.1
)%
Income tax expense (benefit)
(9.5
)
 
18.4

 
(151.7
)%
 
(6.1
)
 
49.2

 
(112.3
)%
Net earnings
0.3

 
28.2

 
(99.0
)%
 
(15.9
)
 
79.1

 
(120.1
)%
Noncontrolling interest
(3.5
)
 
(0.8
)
 
355.3
 %
 
(8.7
)
 
(2.0
)
 
335.1
 %
Net earnings (loss) attributable to Centene Corporation
$
3.8

 
$
29.0

 
(86.8
)%
 
$
(7.2
)
 
$
81.1

 
(108.9
)%
Diluted earnings (loss) per common share attributable to Centene Corporation
$
0.07

 
$
0.55

 
(87.3
)%
 
$
(0.14
)
 
$
1.55

 
(109.0
)%
Three Months Ended September 30, 2012 Compared to Three Months Ended September 30, 2011
Revenues and Revenue Recognition
Premium and service revenues increased 74.9% in the three months ended September 30, 2012 over the corresponding period in 2011 primarily as a result of the additions between years of the Texas and Arizona expansions, pharmacy carve-ins in Texas and Ohio, Kentucky, Louisiana, Missouri and Washington contracts, and membership growth.  
One of our states maintains a reconciliation process associated with membership eligibility and has continued to reconcile membership from previous periods.  The amount of any reduction to revenue related to this review is subject to consideration of rate adequacy calculations, as part of actuarially soundness standards, for the appropriate periods.  We have estimated the revenue impact related to reconciliation adjustments to the retroactive eligibility reductions due to the state and have adjusted our accrual in our consolidated financial statements.  There can be no assurance that future adjustment of amounts related to membership reconciliations will not have a material adverse effect on the Company.

Operating Expenses
Medical Costs
Results of operations depend on our ability to manage expenses associated with health benefits and to accurately estimate costs incurred. The Health Benefits Ratio, or HBR, represents medical costs as a percentage of premium revenues (excluding premium taxes) and reflects the direct relationship between the premium received and the medical services provided. The table below depicts the HBR for our membership by member category for the three months ended September 30:


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Table of Contents

 
2012
 
2011
Medicaid and CHIP
91.8
%
 
81.5
%
ABD and Medicare
97.3

 
92.0

Specialty Services
89.5

 
87.9

Total
93.3

 
85.0

The consolidated HBR for the three months ended September 30, 2012 was 93.3% compared to 85.0% in the same period in 2011.  The increase compared to last year primarily reflects the recognition of a $63.0 million premium deficiency reserve for our Kentucky contract as well as increased medical costs in Kentucky. Excluding our Kentucky health plan operations, the third quarter 2012 HBR was 88.7%.
In October 2012, we notified the Kentucky Cabinet for Health and Family Services that we are exercising a contractual right that we believe allows our Kentucky Spirit Health Plan to terminate its Medicaid managed care contract with the Commonwealth of Kentucky effective July 5, 2013. As a result, we recorded a premium deficiency reserve included in Medical costs expense of $63.0 million for the Kentucky Spirit Health Plan contract in the quarter ended September 30, 2012. This premium deficiency reserve encompasses the contract period from October 1, 2012 through July 5, 2013.
General & Administrative Expenses
General and administrative expenses, or G&A, increased by $38.1 million in the three months ended September 30, 2012, compared to the corresponding period in 2011.  This was primarily due to expenses for additional staff and facilities to support our membership growth, partially offset by a reduction in performance based compensation expense in 2012.
The consolidated G&A expense ratio for the three months ended September 30, 2012, and 2011 was 8.2%, and 11.3%, respectively.  The year over year decrease reflects the leveraging of expenses over higher revenues and a reduction in performance based compensation expense which lowered the ratio by 50 basis points.  
Other Income (Expense)
The following table summarizes the components of other income (expense) for the three months ended September 30, ($ in millions): 
 
2012
 
2011
Investment income
$
3.9

 
$
2.5

Gain on sale of investments
1.5

 
0.1

Gain on sale of investment in convertible note
17.9

 

Interest expense
(4.9
)
 
(4.6
)
Other income (expense), net
$
18.4

 
$
(2.0
)
Investment income. The increase in investment income in 2012 reflects an increase in investment balances over 2011.
Gain on sale of investments. During the third quarter of 2012, we recognized $1.5 million in net gains primarily as a result of the liquidation of $75.5 million of investments held by the Georgia health plan in order to meet short-term liquidity needs due to the delays in premium receipts.
Gain on sale of investment in convertible note. Between July 2008 and October 2011, we made an investment of $30.0 million in secured notes receivable to a third party as part of an investment in certain Medicaid and Medicare related businesses. The notes included a feature to convert the note balance into an equity ownership in the underlying businesses. In September 2012, we executed an agreement with the borrower whereby the borrower agreed to pay us total consideration of $50.0 million for retirement of the outstanding notes and equity ownership conversion feature. As a result, during the third quarter of 2012, we recorded a pre-tax gain of $17.9 million in other income representing the fair value of the total consideration in excess of the carrying value of the loans on the balance sheet.
Interest expense. Interest expense was relatively flat in 2012 compared to 2011, reflecting a consistent interest rate on our Senior Notes.
Income Tax Expense
During the three months ended September 30, 2012, we recognized a tax benefit of $9.5 million compared to tax expense of $18.5 million in the corresponding period in 2011.  During the third quarter of 2012, we recorded a tax benefit resulting from the clarification by a state taxing authority regarding a state income tax calculation.  Accordingly, during the third quarter of 2012, we reversed the reserve associated with the uncertain tax position and recognized a net tax benefit of $4.6 million, or $0.08 per share. We expect the state income tax determination to have a favorable impact of approximately $2.5 million in 2013.

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Table of Contents

Segment Results
The following table summarizes our operating results by segment for the three months ended September 30, (in millions):

 
2012
 
2011
 
% Change
2011-2012
Premium and Service Revenues
 
 
 
 
 
Medicaid Managed Care
$
2,020.0

 
$
1,097.0

 
84.1
 %
Specialty Services
660.0

 
356.6

 
85.1
 %
Eliminations
(467.5
)
 
(188.3
)
 
148.2
 %
Consolidated Total
$
2,212.5