Centene Corporation Quarterly report pursuant to Section 13 or 15(d)

Quarterly report pursuant to Section 13 or 15(d)

Health Net

Health Net

3 Months Ended

Mar. 31, 2016

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.

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.


(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):



	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.