form10q.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
                                            

FORM 10-Q

 
(Mark One)
 
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   

For the quarterly period ended September 30, 2011
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: T 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). T 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 T 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  T

As of October 14, 2011, the registrant had 50,378,693 shares of common stock outstanding.

 
 
 
 

CENTENE CORPORATION

QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

   
PAGE
     
Part I
Financial Information
Item 1.
  
 
1
 
2
 
3
 
4
 
5
Item 2.
10
Item 3.
16
Item 4.
16
Part II
Other Information
Item 1.
17
Item 1A.
17
Item 2.
23
Item 6.
24
25

 
 
 
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;
·  
inflation;
·  
provider 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.

 
 
 
PART I

FINANCIAL INFORMATION

ITEM 1. Financial Statements.

CENTENE CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)
 
   
September 30,
2011
    
December 31,
 2010
  
ASSETS
            
Current assets:
            
Cash and cash equivalents of continuing operations
   $ 451,657     $ 433,914  
Cash and cash equivalents of discontinued operations
     —       252  
Total cash and cash equivalents
     451,657       434,166  
Premium and related receivables, net of allowance for uncollectible accounts of $592 and $17, respectively
     139,467       136,243  
Short-term investments, at fair value (amortized cost $104,914 and $21,141, respectively)
     106,344       21,346  
Other current assets
     68,908       64,154  
Current assets of discontinued operations other than cash
     —       912  
Total current assets
     766,376       656,821  
Long-term investments, at fair value (amortized cost $521,229 and $585,862, respectively)
     530,452       595,879  
Restricted deposits, at fair value (amortized cost $26,697 and $22,755, respectively)
     26,768       22,758  
Property, software and equipment, net of accumulated depreciation of $166,442 and $138,629, respectively
     345,600       326,341  
Goodwill
     281,981       278,051  
Intangible assets, net
     28,795       29,109  
Other long-term assets
     57,526       30,057  
Long-term assets of discontinued operations
     —       4,866  
Total assets
   $ 2,037,498     $ 1,943,882  
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
                
Current liabilities:
                
Medical claims liability
   $ 498,705     $ 456,765  
Accounts payable and accrued expenses
     173,708       185,218  
Unearned revenue
     54,764       117,344  
Current portion of long-term debt
     3,203       2,817  
Current liabilities of discontinued operations
     —       3,102  
Total current liabilities
     730,380       765,246  
Long-term debt
     348,093       327,824  
Other long-term liabilities
     54,926       53,378  
Long-term liabilities of discontinued operations
     —       379  
Total liabilities
     1,133,399       1,146,827  
                 
Commitments and contingencies
                
                 
Stockholders’ equity:
                
Common stock, $.001 par value; authorized 100,000,000 shares; 52,921,255 issued and 50,377,774 outstanding at September 30, 2011, and 52,172,037 issued and 49,616,824 outstanding at December 31, 2010
     53       52  
Additional paid-in capital
     411,924       384,206  
Accumulated other comprehensive income:
                
Unrealized gain on investments, net of tax
     6,478       6,424  
Retained earnings
     534,849       453,743  
Treasury stock, at cost (2,543,481 and 2,555,213 shares, respectively)
     (50,594 )     (50,486 )
Total Centene stockholders’ equity
     902,710       793,939  
Noncontrolling interest
     1,389       3,116  
Total stockholders’ equity
     904,099       797,055  
Total liabilities and stockholders’ equity
   $ 2,037,498     $ 1,943,882  
 
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 thousands, except share data)
(Unaudited)
 
 
Three Months Ended
September 30,
  
Nine Months Ended
September 30,
  
 
2011
  
2010
  
2011
    
2010
  
Revenues:
                          
Premium
$
1,239,464
  
$
1,060,559
  
$
3,640,829
    
$
3,085,802
  
Service
  
25,817
    
20,954
    
81,629
      
68,543
  
Premium and service revenues
  
1,265,281
    
1,081,513
    
3,722,458
      
3,154,345
  
Premium tax
  
36,754
    
40,348
    
110,948
      
113,009
  
Total revenues
  
1,302,035
    
1,121,861
    
3,833,406
      
3,267,354
  
Expenses:
                          
Medical costs
  
1,028,586
    
893,281
    
3,021,400
      
2,592,324
  
Cost of services
  
20,229
    
14,646
    
60,717
      
47,505
  
General and administrative expenses
  
167,668
    
132,095
    
496,674
      
401,072
  
Premium tax
  
37,005
    
41,591
    
111,668
      
114,885
  
Total operating expenses
  
1,253,488
    
1,081,613
    
3,690,459
      
3,155,786
  
Earnings from operations
  
48,547
    
40,248
    
142,947
      
111,568
  
Other income (expense):
                          
Investment and other income
  
2,697
    
713
    
9,379
      
11,912
  
Debt extinguishment costs
  
— 
    
— 
    
(8,488
) 
    
— 
  
Interest expense
  
(4,572
)
  
(4,858
)
  
(15,523
)
    
(12,540
)
Earnings from continuing operations, before income tax expense
  
46,672
    
36,103
    
128,315
      
110,940
  
Income tax expense
  
18,459
    
13,163
    
49,216
      
42,942
  
Earnings from continuing operations, net of income tax expense
  
28,213
    
22,940
    
79,099
      
67,998
  
Discontinued operations, net of income tax expense of $0, $26, $0 and $4,376, respectively
  
—  
    
260
    
—  
      
3,954
  
Net earnings
  
28,213
    
23,200
    
79,099
      
71,952
  
Noncontrolling interest (loss)
  
(774
)
  
538
    
(2,007
)
    
2,515
  
Net earnings attributable to Centene Corporation
$
28,987
  
$
22,662
  
$
81,106
    
$
69,437
  
                           
Amounts attributable to Centene Corporation common stockholders:
                          
Earnings from continuing operations, net of income tax expense
$
28,987
  
$
22,402
  
$
81,106
    
$
65,483
  
Discontinued operations, net of income tax expense
  
—  
    
260
    
—  
      
3,954
  
Net earnings
$
28,987
  
$
22,662
  
$
81,106
    
$
69,437
  
                           
Net earnings per common share attributable to Centene Corporation:
                          
Basic:
                          
Continuing operations
$
0.58
  
$
0.46
  
$
1.62
    
$
1.35
  
Discontinued operations
  
—  
    
—  
    
—  
      
0.08
  
Earnings per common share
$
0.58
  
$
0.46
  
$
1.62
    
$
1.43
  
Diluted:
                          
Continuing operations
$
0.55
  
$
0.44
  
$
1.55
    
$
1.30
  
Discontinued operations
  
—  
    
—  
    
—  
      
0.08
  
Earnings per common share
$
0.55
  
$
0.44
  
$
1.55
    
$
1.38
  
                           
Weighted average number of shares outstanding:
                          
Basic
  
50,345,512
    
49,238,406
    
50,089,845
      
48,552,135
  
Diluted
  
52,620,350
    
50,938,357
    
52,320,906
      
50,192,190
  

The accompanying notes to the consolidated financial statements are an integral part of these statements.
 
 
2
 
CENTENE CORPORATION AND SUBSIDIARIES
 
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(In thousands, except share data)
(Unaudited)
Nine Months Ended September 30, 2011

 ­
 
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, 2010
52,172,037
  
$
52
  
$
384,206
  
$
6,424 
  
$
453,743
  
2,555,213
  
$
(50,486)
  
$
3,116  
  
$
797,055
  
Comprehensive Earnings:
                                                  
Net earnings
—  
    
—  
    
—  
    
—  
    
81,106
  
—  
    
—  
    
(2,007)
    
79,099
  
Change in unrealized investment gain, net of $50 tax
—  
    
—  
    
—  
    
54
    
—  
  
—  
    
—  
    
—  
    
54
  
Total comprehensive earnings
                                              
79,153
  
Common stock issued for employee benefit plans
749,218
    
1
    
13,005
    
—  
    
—  
  
—  
    
—  
    
—  
    
13,006
  
Issuance of stock warrants
—  
    
—  
    
—  
    
—  
    
—  
  
(50,000)
    
1,172 
    
—  
    
1,172
  
Common stock repurchases
—  
    
—  
    
—  
    
—  
    
—  
  
38,268
    
(1,280)
    
—  
    
(1,280
)
Stock compensation expense
—  
    
—  
    
13,263
    
—  
    
—  
  
—  
    
—  
    
—  
    
13,263
  
Excess tax benefits from stock compensation
—  
    
—  
    
1,450
    
—  
    
—  
  
—  
    
—  
    
—  
    
1,450
  
Contribution from Noncontrolling interest
—  
    
—  
    
— 
    
—  
    
—  
  
—  
    
—  
    
569  
    
569
  
Deconsolidation of Noncontrolling interest
—  
    
—  
    
—  
    
—  
    
—  
  
—  
    
—  
    
(289) 
    
(289
)
Balance, September 30, 2011
52,921,255
  
$
53
  
$
411,924
  
$
6,478
  
$
534,849
  
2,543,481
  
$
(50,594)
  
$
1,389 
  
$
904,099
  
 
The accompanying notes to the consolidated financial statements are an integral part of this statement.

 
3

CENTENE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

 
   
Nine Months Ended September 30,
  
   
2011
    
2010
  
             
Cash flows from operating activities:
            
Net earnings
   $ 79,099     $ 71,952  
Adjustments to reconcile net earnings to net cash provided by operating activities
                
Depreciation and amortization
     43,055       38,620  
Stock compensation expense
     13,263       10,224  
Gain on sale of investments, net
     (213 )     (6,331 )
Debt extinguishment costs
     8,488       —  
Gain on sale of UHP
     —       (8,201 )
Impairment of investment
     —       5,531  
Deferred income taxes
     (223 )     7,012  
Changes in assets and liabilities
                
Premium and related receivables
     (13,306 )      (68,125 )
Other current assets
     (6,667 )     (2,932 )
Other assets
     (1,230 )     (990 )
Medical claims liabilities
     40,476       (29,304 )
Unearned revenue
     (65,183 )     (38,708 )
Accounts payable and accrued expenses
     (11,414 )      (3,174 )
Other operating activities
     3,528       (1,267 )
Net cash provided by (used in) operating activities
     89,673       (25,693 )
Cash flows from investing activities:
                
Capital expenditures
     (52,931 )     (50,353 )
Capital expenditures of Centene Center LLC
     (4,007 )     (41,607 )
Purchases of investments
     (201,145 )     (382,730 )
Proceeds from asset sales
     —       13,420  
Sales and maturities of investments
     180,124       452,128  
Investments in acquisitions, net of cash acquired
     (3,192 )     (26,847 )
Net cash used in investing activities
     (81,151 )     (35,989 )
Cash flows from financing activities:
                
Proceeds from exercise of stock options
     13,582       2,394  
Proceeds from borrowings
     419,183       53,812  
Proceeds from stock offering
     —       104,534  
Payment of long-term debt
     (415,475 )     (97,467 )
Contributions from (distributions to) noncontrolling interest
     569       (7,387 )
Excess tax benefits from stock compensation
     1,632       424  
Common stock repurchases
     (1,280 )     (714 )
Debt issue costs
     (9,242 )     —  
Net cash provided by financing activities
     8,969       55,596  
Net increase (decrease) in cash and cash equivalents
     17,491       (6,086 )
Cash and cash equivalents, beginning of period
     434,166       403,752  
Cash and cash equivalents, end of period
   $ 451,657     $ 397,666  
                 
Supplemental disclosures of cash flow information:
                
Interest paid
   $ 16,097     $ 9,501  
Income taxes paid
   $ 49,996     $ 44,407  
                 
Supplemental disclosure of non-cash investing and financing activities:
                
Contribution from noncontrolling interest
   $ —     $ 306  
Capital expenditures
   $ (4,833 )   $ 15,291  
 
The accompanying notes to the consolidated financial statements are an integral part of these statements.

 
4
 
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, 2010.  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, 2010 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 2010 amounts in the consolidated financial statements have been reclassified to conform to the 2011 presentation. These reclassifications have no effect on net earnings or stockholders’ equity as previously reported.
 
2. Acquisitions

—  
Casenet, LLC.  In December 2010, the Company acquired an additional ownership interest in Casenet, LLC for total consideration of $6,619, bringing its ownership interest to 68%.  The Company finalized the allocation of the fair value which resulted in goodwill of $8,975, other identifiable intangible assets of $3,561 and unearned revenue of $7,247.  All of the goodwill is deductible for income tax purposes.  During the third quarter of 2011, the Company increased its ownership interest in Casenet to 77% through additional investments.

—  
Citrus Health Care, Inc. In December 2010, the Company acquired certain assets in non-reform counties of Citrus Health Care, Inc., a Florida Medicaid and long term care health plan for $28,689.  The Company finalized the allocation of the fair value which resulted in goodwill of $19,069 and other identifiable intangible assets of $9,620.  All of the goodwill is deductible for income tax purposes.
 
3. Investments and Restricted Deposits

Short-term and long-term investments and restricted deposits by investment type consist of the following:

   
September 30, 2011
  
December 31, 2010
  
   
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
   $ 29,045     $ 691     $ (2 )   $ 29,734     $ 28,665     $ 510     $ (140 )   $ 29,035  
Corporate securities
     189,380       3,825       (757 )     192,448       197,577       3,124       (586 )     200,115  
Restricted certificates of deposit
     5,890       —       —       5,890       6,814       —       —       6,814  
Restricted cash equivalents
     13,488       —       —       13,488       8,814       —       —       8,814  
Municipal securities:
                                                                
General obligation
     117,544       3,167       (57 )     120,654       109,866       3,601       (6 )     113,461  
Pre-refunded
     32,682       613       —       33,295       32,442       756       —       33,198  
Revenue
     114,675       2,768       (16 )     117,427       100,198       2,781       (15 )     102,964  
Variable rate demand notes
     108,723       —       —       108,723       106,540       —       —       106,540  
Asset backed securities
     18,714       492       —       19,206       17,391       243       (43 )     17,591  
Cost method investments and equity method securities
     8,076       —       —       8,076       7,060       —       —       7,060  
Life insurance contracts
     14,623       —       —       14,623       14,391       —       —       14,391  
Total
   $ 652,840     $ 11,556     $ (832 )   $ 663,564     $ 629,758     $ 11,015     $ (790 )   $ 639,983  

The Company’s investments are classified as available-for-sale with the exception of life insurance contracts and certain cost method 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, 2011, 36% of the Company’s investments in securities recorded at fair value that carry a rating by Moody’s or S&P were rated AAA, 77% were rated AA- or higher, and 99% were rated A- or higher.  At September 30, 2011, the Company held certificates of deposit, life insurance contracts and cost and equity method invesments 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, 2011
    
December 31, 2010
  
   
Less Than 12 Months
    
12 Months or More
    
Less Than 12 Months
    
12 Months or More
  
   
Unrealized Losses
    
Fair
Value
    
Unrealized Losses
    
Fair
Value
    
Unrealized Losses
    
Fair
Value
    
Unrealized Losses
    
Fair
Value
  
U.S. Treasury securities and obligations of U.S. government corporations and agencies
   $ (2 )   $ 2,117     $ —     $ —     $ (140 )   $ 9,246     $ —     $ —  
Corporate securities
     (757 )     29,224       —       —       (586 )     40,341       —       —  
Municipal securities:
                                                                
General obligation
     (57 )     7,676       —       —       (6 )     1,131       —       —  
Revenue
     (16 )     7,039       —       —       (15 )     2,419       —       —  
Asset backed securities
     —       —       —       —       (43 )     5,276       —       —  
Total
   $ (832 )   $ 46,056     $ —     $ —     $ (790 )   $ 58,413     $ —     $ —  

As of September 30, 2011, the gross unrealized losses were generated from 25 positions out of a total of 410 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.

 
5
 
The contractual maturities of short-term and long-term investments and restricted deposits are as follows:

 
September 30, 2011
  
December 31, 2010
  
 
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
   $ 104,914     $ 106,344     $ 19,605     $ 19,606     $ 21,141     $ 21,346     $ 17,387     $ 17,392  
One year through five years
     391,281       400,055       7,092       7,162       464,270       474,255       5,368       5,366  
Five years through ten years
     35,748       35,748       —       —       39,732       39,731       —       —  
Greater than ten years
     94,200       94,649       —       —       81,860       81,893       —       —  
Total
   $ 626,143     $ 636,796     $ 26,697     $ 26,768     $ 607,003     $ 617,225     $ 22,755     $ 22,758  
 
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.

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 on investments were as follows:

   
Three Months Ended September 30,
    
Nine Months Ended September 30,
  
   
2011
    
2010
    
2011
    
2010
  
Gains
   $ 107     $ 2,310     $ 240     $ 6,027  
Losses
     (1 )     (23 )     (27 )     (268 )
Impairment of investment
     —       (5,531 )     —       (5,531 )
Net realized (losses) gains
   $ 106     $ (3,244 )   $ 213     $ 228  

Realized gains in the nine months ended September 30, 2010 included a net realized gain of $2,472 related to sales of fixed income investments and also included realized gains of $3,287 representing a distribution from the Reserve Primary fund in excess of our adjusted basis.

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.

During the quarter ended September 30, 2010, the Company determined it had an other-than-temporary impairment of a cost method investment in a start-up company that provides software to automate the clinical, administrative, and technical components of care management programs.  As a result, the Company recorded an impairment charge of $5,531, including $3,531 of convertible promissory notes.  The impairment charge is included in investment and other income for the quarter.

Investment amortization of $7,545 and $8,380 was recorded in the nine months ended September 30, 2011 and 2010, respectively.

4. 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.
 
The following table summarizes fair value measurements by level at September 30, 2011, for assets measured at fair value on a recurring basis:
  
   
Level I
    
Level II
    
Level III
    
Total
  
Assets
                        
Cash and cash equivalents
   $ 451,657     $ ―     $ ―     $ 451,657  
                                 
Investments available for sale:
                                
U.S. Treasury securities and obligations of U.S. government corporations and agencies
   $ 17,019     $ 5,325     $ ―     $ 22,344  
Corporate securities
     ―       192,448       ―       192,448  
Municipal securities:
                                
General obligation
     ―       120,654       ―       120,654  
Pre-refunded
     ―       33,295       ―       33,295  
Revenue
     ―       117,427       ―       117,427  
Variable rate demand notes
     ―       108,723       ―       108,723  
Asset backed securities
     ―       19,206       ―       19,206  
Total investments
   $ 17,019     $ 597,078     $ ―     $ 614,097  
                                 
Restricted deposits available for sale:
                                
Cash and cash equivalents
   $ 13,488     $ ―     $ ―     $ 13,488  
Certificates of deposit
     5,890       ―       ―       5,890  
U.S. Treasury securities and obligations of U.S. government corporations and agencies
     7,390       ―       ―       7,390  
Total restricted deposits
   $ 26,768     $ ―     $ ―     $ 26,768  
                                 
Interest rate swap contract
   $ ―     $ 10,489     $ ―     $ 10,489  
                                 
Total assets at fair value
   $ 495,444     $ 607,567     $ ―     $ 1,103,011  
 
 
6
 
The following table summarizes fair value measurements by level at December 31, 2010, for assets and liabilities measured at fair value on a recurring basis:
 
   
Level I
    
Level II
    
Level III
    
Total
  
Assets
                        
Cash and cash equivalents
   $ 433,914     $ ―     $ ―     $ 433,914  
                                 
Investments available for sale:
                                
U.S. Treasury securities and obligations of U.S. government corporations and agencies
   $ 14,809     $ 7,096     $ ―     $ 21,905  
Corporate securities
     ―       200,115       ―       200,115  
Municipal securities:
                                
General obligation
     ―       113,461       ―       113,461  
Pre-refunded
     ―       33,198       ―       33,198  
Revenue
     ―       102,964       ―       102,964  
Variable rate demand notes
     ―       106,540       ―       106,540  
Asset backed securities
     ―       17,591       ―       17,591  
Total investments
   $ 14,809     $ 580,965     $ ―     $ 595,774  
                                 
Restricted deposits available for sale:
                                
Cash and cash equivalents
   $ 8,814     $ ―     $ ―     $ 8,814  
Certificates of deposit
     6,814       ―       ―       6,814  
U.S. Treasury securities and obligations of U.S. government corporations and agencies
     7,130       ―       ―       7,130  
Total restricted deposits
   $ 22,758     $ ―     $ ―     $ 22,758  
                                 
Total assets at fair value
   $ 471,481     $ 580,965     $ ―     $ 1,052,446  
 
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 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 cost-method investments, which approximates fair value, was $22,699 and $21,451 as of September 30, 2011 and December 31, 2010, respectively.

5. Debt

Debt consists of the following:

   
September 30, 2011
    
December 31, 2010
  
Senior notes, at par
   $ 250,000     $ 175,000  
Unamortized discount on Senior notes
     (2,944 )      ―  
Interest rate swap fair value
     10,489       ―  
Senior notes, net
     257,545       175,000  
Revolving credit agreement
     ―       60,000  
Mortgage notes payable
     87,645       89,500  
Capital leases and other
     6,106       6,141  
     Total debt
     351,296       330,641  
Less current portion
     (3,203 )     (2,817 )
     Long-term debt
   $ 348,093     $ 327,824  

Senior Notes

In May 2011, the Company exercised its option to redeem its $175,000 7.25% Senior Notes due April 1, 2014 ($175,000 Notes).  The Company redeemed the $175,000 Notes at 103.625% and wrote off unamortized debt issuance costs, resulting in a pre-tax expense of $8,488.

In May 2011, pursuant to a shelf registration statement, 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, 2011, the unamortized debt discount was $2,944.  The indenture governing the $250,000 Notes contains non-financial and financial covenants.  Interest is paid semi-annually in June and December.  In connection with the issuance, the Company entered into an interest rate swap as discussed below.  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, 2011, the fair value of the interest rate swap increased the principal amount of the notes by $10,489.
 
Revolving Credit Agreement

In January 2011, the Company replaced its $300,000 revolving credit agreement with a new $350,000 revolving credit facility, or the revolver.  The revolver is unsecured and has a five-year maturity with 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.  There is a commitment fee on the unused portion of the agreement that ranges from 0.25% to 0.50% depending on the total debt to EBITDA ratio, as defined.  As of September 30, 2011, the Company had no borrowings outstanding under the agreement, leaving availability of $350,000.

The Company has outstanding letters of credit of $36,708 as of September 30, 2011, which are not part of the revolver.  The letters of credit bore interest at an average of 1.66% on September 30, 2011.
 
6. Interest Rate Swap

In May 2011, the Company entered into $250,000 notional amount of interest rate swap agreements (Swap Agreements) that are scheduled to expire June 1, 2017. Under the Swap Agreements, the Company receives a fixed rate of 5.75% and pays a variable rate of LIBOR plus 3.5% adjusted quarterly, which allows the Company to adjust the $250,000 Notes to a floating rate. The Company does not hold or issue any derivative instrument for trading or speculative purposes.

The interest rate swaps are formally designated and qualify as fair value hedges. The interest rate swaps are recorded at fair value in the Consolidated Balance Sheet in other assets or other liabilities.  Gains and losses due to changes in fair value of the interest rate swaps 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 Statement of Operations.

The fair value of the Swap Agreements as of September 30, 2011 was an asset of approximately $10,489, and is included in Other long-term assets in the Consolidated Balance Sheet. The fair value of the swap agreements excludes accrued interest and takes into consideration current interest rates and current likelihood of the swap counterparties’ compliance with its contractual obligations.

7. Contingencies

The Internal Revenue Service (IRS) performed an examination of the Company’s 2006 and 2007 tax returns and initially denied a $34,856 tax benefit related to the abandonment of the FirstGuard stock in 2007.  In October 2011, the Company agreed to a settlement for the open tax years of 2006 and 2007.  The settlement did not have a material impact on the consolidated financial statements.

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 individually, or in the aggregate, to have a material effect on its financial position or results of operations.

 
7
 
8. Earnings Per Share

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

   
Three Months Ended
September 30,
  
Nine Months Ended
September 30,
   
2011
  
2010
  
2011
  
2010
Net earnings attributable to Centene Corporation common stockholders:
                        
Earnings from continuing operations, net of tax
  
$
28,987
  
$
22,402
  
$
81,106
  
$
65,483
Discontinued operations, net of tax
    
―
    
260
    
―
    
3,954
Net earnings
  
$
28,987
  
$
22,662
  
$
81,106
  
$
69,437
Shares used in computing per share amounts:
                        
Weighted average number of common shares outstanding
    
50,345,512
    
49,238,406
    
50,089,845
    
48,552,135
Common stock equivalents (as determined by applying the treasury stock method)
    
2,274,838
    
1,699,951
    
2,231,061
    
1,640,055
Weighted average number of common shares and potential dilutive common shares outstanding
    
52,620,350
    
50,938,357
    
52,320,906
    
50,192,190
                         
Net earnings per share attributable to Centene Corporation common stockholders:
                        
Basic:
                        
  Continuing operations
  
$
0.58
  
$
0.46
  
$
1.62
  
$
1.35
  Discontinued operations
    
―
    
―
    
―
    
0.08
  Earnings per common share
  
$
0.58
  
$
0.46
  
$
1.62
  
$
1.43
                         
Diluted:
                        
  Continuing operations
  
$
0.55
  
$
0.44
  
$
1.55
  
$
1.30
  Discontinued operations
    
―
    
―
    
―
    
0.08
  Earnings per common share
  
$
0.55
  
$
0.44
  
$
1.55
  
$
1.38
                         
 
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.  The calculation of diluted earnings per common share for the three and nine months ended September 30, 2010 excludes the impact of 1,931,808 and 1,975,387 shares, respectively, related to anti-dilutive stock options, restricted stock and restricted stock units.
 
9. 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, long-term care programs, 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 included in the Specialty Services segment.

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  

Segment information for the three months ended September 30, 2010 follows:

 
   
Medicaid
Managed Care
    
Specialty
Services
    
Eliminations
    
Consolidated
Total
  
Premium and service revenues from external customers
   $ 934,664     $ 146,849     $ —     $ 1,081,513  
Premium and service revenues from internal customers
     15,512       124,732       (140,244 )     —  
Total premium and service revenues
   $ 950,176     $ 271,581     $ (140,244 )   $ 1,081,513  
                                 
Earnings from operations
   $ 35,702     $ 4,546     $ —     $ 40,248  

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  

Segment information for the nine months ended September 30, 2010 follows:
 
   
Medicaid
Managed Care
    
Specialty
Services
    
Eliminations
    
Consolidated
Total
  
Premium and service revenues from external customers
   $ 2,715,106     $ 439,239     $ —     $ 3,154,345  
Premium and service revenues from internal customers
     45,739       372,681       (418,420 )     —  
Total premium and service revenues
   $ 2,760,845     $ 811,920     $ (418,420 )   $ 3,154,345  
                                 
Earnings from operations
   $ 82,445     $ 29,123     $ —     $ 111,568  

 
8
 
10. Comprehensive Earnings
 
Differences between net earnings and total comprehensive earnings resulted from changes in unrealized gains on investments available for sale, as follows:

   
Three Months Ended
September 30,
    
Nine Months Ended
September 30,
  
   
2011
    
2010
    
2011
    
2010
  
Net earnings
   $ 28,213     $ 23,200     $ 79,099     $ 71,952  
                                 
Reclassification adjustment, net of tax
     195       1,516       415       1,552  
Change in unrealized gains on investments, net of tax
     (900 )     (1,255 )     (361 )     761  
Total change
     (705 )     261       54       2,313  
                                 
Comprehensive earnings
     27,508       23,461       79,153       74,265  
Comprehensive (losses) earnings attributable to the noncontrolling interests
     (774 )     538       (2,007 )     2,515  
Comprehensive earnings attributable to Centene Corporation
   $ 28,282     $ 22,923     $ 81,160     $ 71,750  
 
 
9
 
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

Our financial performance for the third quarter of 2011 is summarized as follows:

—  
Quarter-end at-risk managed care membership of 1,615,700, an increase of 141,900 members year over year.
—  
Premium and service revenues from continuing operations of $1.3 billion, representing 17.0% growth year over year.
—  
Health Benefits Ratio from continuing operations of 83.0%, compared to 84.2% in 2010.
—  
General and Administrative expense ratio from continuing operations of 13.3%, compared to 12.2% in 2010.
—  
Diluted net earnings per share from continuing operations of $0.55, compared to $0.44 in the prior year.
—  
Total operating cash flows of $36.5 million.

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

—  
Arizona. In December 2010, Cenpatico Behavioral Health of Arizona began operating under an expanded contract to manage behavioral healthcare services for an additional four counties.
 
—  
Celtic Insurance Company, Inc. In July 2010, we completed the acquisition of NovaSys Health, LLC, a third party administrator in Arkansas that complements our existing Celtic business.  In November 2010, Celtic began operating under a new contract with the Texas Department of Insurance to provide affordable health insurance plans for small businesses under the new Healthy Texas initiative.

—  
Florida.  In December 2010, we completed the conversion of members from Access Health Solutions LLC, to our subsidiary, Sunshine State Health Plan, on an at-risk basis.  Additionally, in December 2010, we completed the acquisition of Citrus Health Care, Inc., a Medicaid and long-term care health plan.

—  
Illinois.  In May 2011, our new subsidiary, IlliniCare Health Plan, began providing managed care services for older adults and adults with disabilities under the Integrated Care Program in six counties.

—  
Massachusetts.  In April 2010, we began offering an individual insurance product, under the names of Commonwealth Choice and CeltiCare Direct, for residents who do not qualify for other state funded insurance programs.

—  
Mississippi.  In January 2011, we began operating through the Mississippi Coordinated Access Network (MississippiCan) program.

—  
South Carolina. In June 2010, we completed the acquisition of Carolina Crescent Health Plan.
 
—  
Texas.  In February 2011, we began operating under an additional STAR+PLUS ABD contract in the Dallas service area.
 
We expect the following items to contribute to our future growth potential:

—  
In May 2011, Bridgeway Health Solutions, LLC announced it was awarded a contract to deliver Long-term Care services in three geographic service areas of Arizona, effective October 1, 2011.

—  
In July 2011, our subsidiary, Kentucky Spirit Health Plan, announced it was awarded a three-year contract with the Kentucky Finance and Administration Cabinet to serve Medicaid beneficiaries.  Operations are expected to commence in the fourth quarter of 2011.

—  
In July 2011, Louisiana Healthcare Connections, our joint venture subsidiary, was selected to contract with the Louisiana Department of Health and Hospitals to provide healthcare services to Medicaid enrollees participating in the Medicaid Coordinated Care Network project in all three of the state’s geographical services areas.  Services for these members are expected to begin in the first quarter of 2012, with a three-phase membership roll-out ending in the second quarter of 2012.

—  
In August 2011, Superior HealthPlan, Inc. announced it was awarded renewed and expanded contracts by the Texas Health and Human Services Commission.  The contracts expand Superior’s STAR, STAR+PLUS and CHIP product offerings to include the new 10 county Hidalgo Service Area (STAR and STAR+PLUS), Medicaid RSA West Texas, Medicaid RSA Central Texas, Medicaid RSA North-East Texas and Lubbock (STAR+PLUS).  All of the service areas and products will now include the management of the pharmacy benefit for Superior’s members.  In addition, the state has added inpatient facility services to the managed care structure for the STAR+PLUS program.  Operations in the expanded areas are expected to commence late in the first quarter of 2012.
 
—  
In October 2011, Buckeye Community Health Plan began operating under an amended contract with the Ohio Department of Job and Family Services.  The amended contract includes the management of the pharmacy benefit for Buckeye’s members.
 
In 2010, we filed a legal challenge to the State of Wisconsin’s decision on the southeast region reprocurement.  In September 2011, the Wisconsin Court of Appeals denied our appeal. 

 MEMBERSHIP

From September 30, 2010 to September 30, 2011, we increased our at-risk managed care membership by 141,900, or 9.6%.  The following table sets forth our membership by state for our managed care organizations:

   
September 30,
    
December 31,
  
   
2011
    
2010
    
2010
  
Arizona
     22,800       22,300       22,400  
Florida
     188,600       116,300       194,900  
Georgia
     298,000       300,900       305,800  
Illinois
     13,600       ―       ―  
Indiana
     205,300       213,300       215,800  
Massachusetts
     34,700       34,400       36,200  
Mississippi
     30,600       ―       ―  
Ohio
     162,200       161,800       160,100  
South Carolina
     86,500       90,600       90,300  
Texas
     494,500       428,100       433,100  
Wisconsin
     78,900       106,100       74,900  
Total at-risk membership
     1,615,700       1,473,800       1,533,500  
Non-risk membership
     10,600       35,900       4,200  
Total
     1,626,300       1,509,700       1,537,700  

 
10
 
The following table sets forth our membership by line of business:

   
September 30,
    
December 31,
  
   
2011
    
2010
    
2010
  
Medicaid
     1,189,900       1,122,800       1,177,100  
CHIP & Foster Care
     210,600       219,100       210,500  
ABD & Medicare
     171,700       94,500       104,600  
Hybrid Programs
     38,400       34,400       36,200  
Long-term Care
     5,100       3,000       5,100  
Total at-risk membership
     1,615,700       1,473,800       1,533,500  
Non-risk membership
     10,600       35,900       4,200  
Total
     1,626,300       1,509,700       1,537,700  
 
The following table provides supplemental information of other membership categories:

   
September 30,
    
December 31,
  
   
2011
    
2010
    
2010
  
Cenpatico Behavioral Health:
                  
Arizona
     175,500       121,300       174,600  
Kansas
     45,600       39,800       39,200  

 
RESULTS OF CONTINUING 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, 2011 and 2010, 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 is as follows ($ in millions):

   
Three Months Ended September 30,
    
Nine months Ended September 30,
  
   
2011
    
2010
    
% Change
2010-2011
    
2011
    
2010
    
% Change
2010-2011
  
Premium
   $ 1,239.5     $ 1,060.6       16.9 %   $ 3,640.8     $ 3,085.8       18.0 %
Service
     25.8       21.0       23.2 %     81.6       68.5       19.1 %
Total premium and service revenues
     1,265.3       1,081.6       17.0 %     3,722.4       3,154.3       18.0 %
Premium tax
     36.8       40.3       (8.9 )%     111.0       113.0       (1.8 )%
Total revenues
     1,302.1