Edgar Filing: CENTENE CORP

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

____________________________________________

FORM 10-Q

____________________________________________

(Mark One)



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

For the quarterly period ended March 31, 2018



[ ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

____________________________________________

Commission file number: 001-31826

____________________________________________

CENTENE CORPORATION

(Exact name of registrant as specified in its charter)



Delaware	42-1406317
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification Number)

7700 Forsyth Boulevard
St. Louis, Missouri	63105
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code: (314) 725-4477

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: x Yes o No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “small reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer x	Accelerated filer	o
Non-accelerated filer o (do not check if a smaller reporting company)	Smaller reporting company	o
	Emerging growth company	o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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

As of April 13, 2018, the registrant had 178,533,259 shares of common stock outstanding.

CENTENE CORPORATION

QUARTERLY REPORT ON FORM 10-Q

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		PAGE

	Part I
	Financial Information
Item 1.	Financial Statements	1
	Consolidated Balance Sheets as of March 31, 2018 (unaudited) and December 31, 2017	1
	Consolidated Statements of Operations for the Three Months Ended March 31, 2018 and 2017 (unaudited)	2
	Consolidated Statements of Comprehensive Earnings for the Three Months Ended March 31, 2018 and 2017 (unaudited)	3
	Consolidated Statement of Stockholders' Equity for the Three Months Ended March 31, 2018 (unaudited)	4
	Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2018 and 2017 (unaudited)	5
	Notes to the Consolidated Financial Statements (unaudited)	6
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	32
Item 4.	Controls and Procedures	32
	Part II
	Other Information
Item 1.	Legal Proceedings	33
Item 1A.	Risk Factors	33
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	51
Item 6.	Exhibits	52
Signatures		53

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CAUTIONARY STATEMENT ON FORWARD-LOOKING STATEMENTS

All statements, other than statements of current or historical fact, contained in this filing are forward-looking statements. We intend such forward-looking statements to be covered by the safe-harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and we are including this statement for purposes of complying with these safe-harbor provisions. We have attempted to identify these statements by terminology including “believe,” “anticipate,” “plan,” “expect,” “estimate,” “intend,” “seek,” “target,” “goal,” “may,” “will,” “would,” “could,” “should,” “can,” “continue” and other similar words or expressions (and the negative thereof) in connection with, among other things, any discussion of future operating or financial performance. In particular, these statements include without limitation statements about our market opportunity, growth strategy, competition, expected activities and future acquisitions, including our proposed acquisition of New York State Catholic Health Plan, Inc., d/b/a Fidelis Care New York (Fidelis Care) (Proposed Fidelis Acquisition or Fidelis Care Transaction), investments and the adequacy of our available cash resources. These statements may be found in the various sections of this filing, such as Part I, Item 2. “Management's Discussion and Analysis of Financial Condition and Results of Operations,” Part II, Item 1. “Legal Proceedings,” and Part II, Item 1A. “Risk Factors.” Readers are cautioned that matters subject to forward-looking statements involve known and unknown risks and uncertainties, including economic, regulatory, competitive and other factors that may cause our or our industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions.

All forward-looking statements included in this filing are based on information available to us on the date of this filing. Except as may be otherwise required by law, we undertake no obligation to update or revise the forward-looking statements included in this filing, whether as a result of new information, future events or otherwise, after the date of this filing. You should not place undue reliance on any forward-looking statements, as actual results may differ materially from projections, estimates, or other forward-looking statements due to a variety of important factors, including but not limited to:


•	our ability to accurately predict and effectively manage health benefits and other operating expenses and reserves;


•	competition;


•	membership and revenue declines or unexpected trends;


•	changes in healthcare practices, new technologies, and advances in medicine;


•	increased healthcare costs;


•	changes in economic, political or market conditions;


•	changes in federal or state laws or regulations, including changes with respect to income tax reform or government healthcare programs as well as changes with respect to the Patient Protection and Affordable Care Act and the Health Care and Education Affordability Reconciliation Act and any regulations enacted thereunder that may result from changing political conditions;


•	rate cuts or other payment reductions or delays by governmental payors and other risks and uncertainties affecting our government businesses;


•	our ability to adequately price products on federally facilitated and state based Health Insurance Marketplaces;


•	tax matters;


•	disasters or major epidemics;


•	the outcome of legal and regulatory proceedings;


•	changes in expected contract start dates;


•	provider, state, federal and other contract changes and timing of regulatory approval of contracts;


•	the expiration, suspension, or termination of our or Fidelis Care's contracts with federal or state governments (including but not limited to Medicaid, Medicare, TRICARE or other customers);


•	the difficulty of predicting the timing or outcome of pending or future litigation or government investigations;


•	challenges to our or Fidelis Care's contract awards;


•	cyber-attacks or other privacy or data security incidents;

•

the possibility that the expected synergies and value creation from acquired businesses, including, without limitation, the acquisition (Health Net Acquisition) of Health Net, Inc. (Health Net), and the Proposed Fidelis Acquisition, will not be realized, or will not be realized within the expected time period, including, but not limited to, as a result of any failure to obtain any regulatory, governmental or third party consents or approvals in connection with the Proposed Fidelis Acquisition (including any such approvals under the New York Non-For-Profit Corporation Law) or any conditions, terms, obligations or restrictions imposed in connection with the receipt of such consents or approvals;


•	the exertion of management’s time and our resources, and other expenses incurred and business changes required in connection with complying with the undertakings in connection with any regulatory, governmental or third party consents or approvals for the Health Net Acquisition or the Proposed Fidelis Acquisition;

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•	disruption caused by significant completed and pending acquisitions, including the Health Net Acquisition and the Proposed Fidelis Acquisition, making it more difficult to maintain business and operational relationships;


•	the risk that unexpected costs will be incurred in connection with the completion and/or integration of acquisition transactions, including among others, the Health Net Acquisition and the Proposed Fidelis Acquisition;


•	changes in expected closing dates, estimated purchase price and accretion for acquisitions;


•	the risk that acquired businesses and pending acquisitions, including Health Net and Fidelis Care, will not be integrated successfully;


•	the risk that the conditions to the completion of the Proposed Fidelis Acquisition may not be satisfied or completed on a timely basis, or at all;

•

failure to obtain or receive any required regulatory approvals, consents or clearances for the Proposed Fidelis Acquisition, and the risk that, even if so obtained or received, regulatory authorities impose conditions on the completion of the transaction that could require the exertion of management's time and our resources, or otherwise have an adverse effect on Centene or the completion of the Proposed Fidelis Acquisition;


•	business uncertainties and contractual restrictions while the Proposed Fidelis Acquisition is pending, which could adversely affect our business and operations;


•	change of control provisions or other provisions in certain agreements to which Fidelis Care is a party, which may be triggered by the completion of the Proposed Fidelis Acquisition;


•	loss of management personnel and other key employees due to uncertainties associated with the Proposed Fidelis Acquisition;


•	the risk that, following completion of the Proposed Fidelis Acquisition, the combined company may not be able to effectively manage its expanded operations;


•	restrictions and limitations that may stem from the financing arrangements that the combined company will enter into in connection with the Proposed Fidelis Acquisition;


•	our ability to achieve improvement in the Centers for Medicare and Medicaid Services (CMS) Star ratings and maintain or achieve improvement in other quality scores in each case that can impact revenue and future growth;


•	availability of debt and equity financing, on terms that are favorable to us;


•	inflation; and


•	foreign currency fluctuations.

This list of important factors is not intended to be exhaustive. We discuss certain of these matters more fully, as well as certain other risk factors that may affect our business operations, financial condition and results of operations, in our filings with the Securities and Exchange Commission, including our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. Item 1A. “Risk Factors” of Part II of this filing contains a further discussion of these and other important factors that could cause actual results to differ from expectations. Due to these important factors and risks, we cannot give assurances with respect to our future performance, including without limitation our ability to maintain adequate premium levels or our ability to control our future medical and selling, general and administrative costs.

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Non-GAAP Financial Presentation

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

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



	Three Months Ended March 31,
	2018			2017

GAAP net earnings	$	340		$	139
Amortization of acquired intangible assets	39			40
Acquisition related expenses	21			5
Penn Treaty assessment expense	—			47
Income tax effects of adjustments⁽¹⁾	(14		)	(34		)
Adjusted net earnings	$	386		$	197

GAAP diluted earnings per share (EPS)	$	1.91		$	0.79
Amortization of acquired intangible assets ⁽²⁾	0.17			0.14
Acquisition related expenses ⁽³⁾	0.09			0.02
Penn Treaty assessment expense ⁽⁴⁾	—			0.17
Adjusted Diluted EPS	$	2.17		$	1.12


(1)	The income tax effects of adjustments are based on the effective income tax rates applicable to adjusted (non-GAAP) results.


(2)	The amortization of acquired intangible assets per diluted share are net of an income tax benefit of $0.05 and $0.09 for the three months ended March 31, 2018 and 2017, respectively.


(3)	Acquisition related expenses per diluted share are net of an income tax benefit of $0.03 and $0.01 for the three months ended March 31, 2018 and 2017, respectively.


(4)	The Penn Treaty assessment expense per diluted share is net of an income tax benefit of $0.09 for the three months ended March 31, 2017.



	Three Months Ended March 31,
	2018		2017

GAAP selling, general and administrative expenses	$	1,316	$	1,091
Acquisition related expenses	21		5
Penn Treaty assessment expense	—		47
Adjusted selling, general and administrative expenses	$	1,295	$	1,039

iii

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PART I

FINANCIAL INFORMATION

ITEM 1. Financial Statements.

CENTENE CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In millions, except shares in thousands and per share data in dollars)



	March 31, 2018			December 31, 2017
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	5,668		$	4,072
Premium and trade receivables	3,648			3,413
Short-term investments	507			531
Other current assets	1,153			687
Total current assets	10,976			8,703
Long-term investments	5,535			5,312
Restricted deposits	140			135
Property, software and equipment, net	1,250			1,104
Goodwill	5,295			4,749
Intangible assets, net	1,519			1,398
Other long-term assets	455			454
Total assets	$	25,170		$	21,855

LIABILITIES, REDEEMABLE NONCONTROLLING INTERESTS AND STOCKHOLDERS’ EQUITY
Current liabilities:
Medical claims liability	$	4,771		$	4,286
Accounts payable and accrued expenses	4,962			4,165
Return of premium payable	515			549
Unearned revenue	638			328
Current portion of long-term debt	4			4
Total current liabilities	10,890			9,332
Long-term debt	5,172			4,695
Other long-term liabilities	1,520			952
Total liabilities	17,582			14,979
Commitments and contingencies
Redeemable noncontrolling interests	8			12
Stockholders’ equity:
Preferred stock, $0.001 par value; authorized 10,000 shares; no shares issued or outstanding at March 31, 2018 and December 31, 2017	—			—
Common stock, $0.001 par value; authorized 400,000 shares; 180,643 issued and 176,795 outstanding at March 31, 2018, and 180,379 issued and 173,437 outstanding at December 31, 2017	—			—
Additional paid-in capital	4,592			4,349
Accumulated other comprehensive (loss)	(54		)	(3		)
Retained earnings	3,104			2,748
Treasury stock, at cost (3,848 and 6,942 shares, respectively)	(139		)	(244		)
Total Centene stockholders’ equity	7,503			6,850
Noncontrolling interest	77			14
Total stockholders’ equity	7,580			6,864
Total liabilities, redeemable noncontrolling interests and stockholders’ equity	$	25,170		$	21,855

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

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CENTENE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(In millions, except per share data in dollars)

(Unaudited)



	Three Months Ended March 31,
	2018			2017
Revenues:
Premium	$	11,903		$	10,638
Service	653			527
Premium and service revenues	12,556			11,165
Premium tax and health insurer fee	638			559
Total revenues	13,194			11,724
Expenses:
Medical costs	10,039			9,322
Cost of services	543			441
Selling, general and administrative expenses	1,316			1,091
Amortization of acquired intangible assets	39			40
Premium tax expense	546			590
Health insurer fee expense	171			—
Total operating expenses	12,654			11,484
Earnings from operations	540			240
Other income (expense):
Investment and other income	41			41
Interest expense	(68		)	(62		)
Earnings from operations, before income tax expense	513			219
Income tax expense	175			87
Net earnings	338			132
Loss attributable to noncontrolling interests	2			7
Net earnings attributable to Centene Corporation	$	340		$	139

Net earnings per common share attributable to Centene Corporation:
Basic earnings per common share	$	1.95		$	0.81
Diluted earnings per common share	$	1.91		$	0.79

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

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CENTENE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS

(In millions)

(Unaudited)



	Three Months Ended March 31,
	2018			2017
Net earnings	$	338		$	132
Reclassification adjustment, net of tax	—			—
Change in unrealized gain (loss) on investments, net of tax	(52		)	14
Foreign currency translation adjustments	1			1
Other comprehensive earnings (loss)	(51		)	15
Comprehensive earnings	287			147
Comprehensive loss attributable to noncontrolling interests	2			7
Comprehensive earnings attributable to Centene Corporation	$	289		$	154

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

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CENTENE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(In millions, except shares in thousands and per share data in dollars)

(Unaudited)

Three Months Ended March 31, 2018



	Centene Stockholders’ Equity
	Common Stock											Treasury Stock
	$.001 Par Value Shares	Amt		Additional Paid-in Capital			Accumulated Other Comprehensive Loss			Retained Earnings		$.001 Par Value Shares		Amt			Non- controlling Interest		Total
Balance, December 31, 2017	180,379	$	—	$	4,349		$	(3	)	$	2,748	6,942		$	(244	)	$	14	$	6,864
Comprehensive Earnings:
Net earnings	—	—		—			—			340		—		—			1		341
Other comprehensive loss, net of ($16) tax	—	—		—			(51		)	—		—		—			—		(51		)
Common stock issued for acquisitions	—	—		210			—			—		(3,176	)	114			—		324
Common stock issued for employee benefit plans	264	—		4			—			—		—		—			—		4
Common stock repurchases	—	—		—			—			—		82		(9		)	—		(9		)
Stock compensation expense	—	—		33			—			—		—		—			—		33
Cumulative-effect of adopting new accounting guidance	—	—		—			—			16		—		—			—		16
Purchase of noncontrolling interest	—	—		(4		)	—			—		—		—			—		(4		)
Acquisition resulting in noncontrolling interest	—	—		—			—			—		—		—			62		62
Balance, March 31, 2018	180,643	$	—	$	4,592		$	(54	)	$	3,104	3,848		$	(139	)	$	77	$	7,580

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

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CENTENE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In millions)

(Unaudited)



	Three Months Ended March 31,
	2018			2017
Cash flows from operating activities:
Net earnings	$	338		$	132
Adjustments to reconcile net earnings to net cash provided by operating activities
Depreciation and amortization	104			86
Stock compensation expense	33			32
Deferred income taxes	30			(51		)
Changes in assets and liabilities
Premium and trade receivables	(176		)	59
Other assets	51			89
Medical claims liabilities	485			358
Unearned revenue	317			320
Accounts payable and accrued expenses	157			(237		)
Other long-term liabilities	477			459
Other operating activities, net	30			1
Net cash provided by operating activities	1,846			1,248
Cash flows from investing activities:
Capital expenditures	(218		)	(83		)
Purchases of investments	(765		)	(582		)
Sales and maturities of investments	445			343
Acquisitions, net of cash acquired	(226		)	—
Other investing activities, net	—			(1		)
Net cash used in investing activities	(764		)	(323		)
Cash flows from financing activities:
Proceeds from long-term debt	2,015			560
Payments of long-term debt	(1,491		)	(560		)
Common stock repurchases	(9		)	(13		)
Other financing activities, net	(2		)	3
Net cash provided by (used in) financing activities	513			(10		)
Net increase in cash, cash equivalents and restricted cash	1,595			915
Cash, cash equivalents, and restricted cash and cash equivalents, beginning of period	4,089			3,936
Cash, cash equivalents, and restricted cash and cash equivalents, end of period	$	5,684		$	4,851
Supplemental disclosures of cash flow information:
Interest paid	$	73		$	72
Income taxes paid	$	1		$	2
Equity issued in connection with acquisitions	$	324		$	—

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

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CENTENE CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Organization and Operations

Basis of Presentation

The accompanying interim financial statements have been prepared under the presumption that users of the interim financial information have either read or have access to the audited financial statements included in the Form 10-K for the fiscal year ended December 31, 2017. The unaudited interim financial statements herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, footnote disclosures which would substantially duplicate the disclosures contained in the December 31, 2017 audited financial statements have been omitted from these interim financial statements, where appropriate. In the opinion of management, these financial statements reflect all adjustments, consisting only of normal recurring adjustments, which are necessary for a fair presentation of the results of the interim periods presented.

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

Recently Adopted Accounting Guidance

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

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

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

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In May 2014, the FASB issued an ASU which supersedes existing revenue recognition standards with a single model unless those contracts are within the scope of other standards (e.g., an insurance entity's insurance contracts). Under the new standard, recognition of revenue occurs when a customer obtains control of promised goods or services in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The Company adopted the new guidance in the first quarter of 2018 using the modified retrospective approach with a cumulative-effect increase to retained earnings of $16 million. The Company also elected the practical expedient of applying the new guidance only to contracts that are not completed as of the date of initial application. The majority of the Company's revenues are derived from insurance contracts and are excluded from the new standard.

Accounting Guidance Not Yet Adopted

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

In February 2016, the FASB issued an ASU which introduces a lessee model that requires the majority of leases to be recognized on the balance sheet. The new standard also aligns many of the underlying principles of the new lessor model with those in Accounting Standards Codification 606, the FASB's new revenue recognition standard, and addresses other concerns related to the current lessee model. The standard also requires lessors to increase the transparency of their exposure to changes in value of their residual assets and how they manage that exposure. It is effective for annual and interim periods beginning after December 15, 2018. Early adoption is permitted. The initial standard required a modified retrospective transition approach, with application, including disclosures, in all comparative periods presented. In March 2018, the FASB tentatively approved an amendment to the new guidance that allows companies the option of using the effective date of the new standard as the date of initial application. The Company is currently evaluating the effect of the new lease guidance.

2. Fidelis Care Transaction

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

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3. Short-term and Long-term Investments, Restricted Deposits

Short-term and long-term investments and restricted deposits by investment type consist of the following ($ in millions):



	March 31, 2018									December 31, 2017
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	260	$	—	$	(3	)	$	257	$	311	$	—	$	(2	)	$	309
Corporate securities	2,242		5		(33		)	2,214		2,208		12		(10		)	2,210
Restricted certificates of deposit	4		—		—			4		4		—		—			4
Restricted cash equivalents	16		—		—			16		17		—		—			17
Municipal securities	2,187		3		(28		)	2,162		2,085		12		(10		)	2,087
Asset-backed securities	492		1		(3		)	490		437		1		(1		)	437
Residential mortgage-backed securities	345		—		(10		)	335		337		1		(6		)	332
Commercial mortgage-backed securities	287		—		(6		)	281		272		1		(2		)	271
Fair value and equity method investments	290		—		—			290		176		—		—			176
Life insurance contracts	133		—		—			133		135		—		—			135
Total	$	6,256	$	9	$	(83	)	$	6,182	$	5,982	$	27	$	(31	)	$	5,978

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The Company’s investments are debt securities classified as available-for-sale with the exception of life insurance contracts and certain equity method investments. The Company’s investment policies are designed to provide liquidity, preserve capital and maximize total return on invested assets with the focus on high credit quality securities. The Company limits the size of investment in any single issuer other than U.S. treasury securities and obligations of U.S. government corporations and agencies. As of March 31, 2018, 96% of the Company’s investments in rated securities carry an investment grade rating by nationally recognized statistical rating organizations. At March 31, 2018, the Company held certificates of deposit, life insurance contracts and fair value and equity method investments which did not carry a credit rating.

The Company's residential mortgage-backed securities are primarily issued by the Federal National Mortgage Association, Government National Mortgage Association or Federal Home Loan Mortgage Corporation, which carry implicit or explicit guarantees of the U.S. government. The Company's commercial mortgage-backed securities are primarily senior tranches with a weighted average rating of AA+ and a weighted average duration of 3.9 years at March 31, 2018.

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

The fair value of available-for-sale debt securities with gross unrealized losses by investment type and length of time that individual securities have been in a continuous unrealized loss position were as follows ($ in millions):



	March 31, 2018										December 31, 2017
	Less Than 12 Months					12 Months or More					Less Than 12 Months					12 Months or More
	Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	(2	)	$	171	$	(1	)	$	85	$	(1	)	$	222	$	(1	)	$	79
Corporate securities	(26		)	1,598		(7		)	185		(6		)	1,044		(4		)	185
Municipal securities	(22		)	1,467		(6		)	171		(7		)	943		(3		)	175
Asset-backed securities	(2		)	310		(1		)	27		(1		)	228		—			28
Residential mortgage-backed securities	(3		)	159		(7		)	161		(1		)	109		(5		)	171
Commercial mortgage-backed securities	(4		)	172		(2		)	50		(1		)	112		(1		)	51
Total	$	(59	)	$	3,877	$	(24	)	$	679	$	(17	)	$	2,658	$	(14	)	$	689

As of March 31, 2018, the gross unrealized losses were generated from 2,714 positions out of a total of 3,564 positions. The change in fair value of fixed income securities is primarily a result of movement in interest rates subsequent to the purchase of the security.

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

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



	March 31, 2018								December 31, 2017
	Investments				Restricted Deposits				Investments				Restricted Deposits
	Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value
One year or less	$	432	$	430	$	45	$	45	$	474	$	474	$	48	$	47
One year through five years	2,439		2,411		96		95		2,424		2,420		88		88
Five years through ten years	1,920		1,894		—		—		1,773		1,779		—		—
Greater than ten years	200		201		—		—		129		130		—		—
Asset-backed securities	1,124		1,106		—		—		1,046		1,040		—		—
Total	$	6,115	$	6,042	$	141	$	140	$	5,846	$	5,843	$	136	$	135

Actual maturities may differ from contractual maturities due to call or prepayment options. Fair value and equity method investments and life insurance contracts are included in the five years through ten years category. The Company has an option to redeem at amortized cost substantially all of the securities included in the greater than ten years category listed above.

The Company continuously monitors investments for other-than-temporary impairment. Certain investments have experienced a decline in fair value due to changes in credit quality, market interest rates and/or general economic conditions. The Company recognizes an impairment loss for fair value and equity method investments when evidence demonstrates that it is other-than-temporarily impaired. Evidence of a loss in value that is other-than-temporary may include the absence of an ability to recover the carrying amount of the investment or the inability of the investee to sustain a level of earnings that would justify the carrying amount of the investment.

4. Fair Value Measurements

Assets and liabilities recorded at fair value in the Consolidated Balance Sheets are categorized based upon observable or unobservable inputs used to estimate fair value. Level inputs are as follows:



Level Input:		Input Definition:
Level I		Inputs are unadjusted, quoted prices for identical assets or liabilities in active markets at the measurement date.

Level II		Inputs other than quoted prices included in Level I that are observable for the asset or liability through corroboration with market data at the measurement date.

Level III		Unobservable inputs that reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date.

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The following table summarizes fair value measurements by level at March 31, 2018, for assets and liabilities measured at fair value on a recurring basis ($ in millions):



	Level I		Level II		Level III		Total
Assets
Cash and cash equivalents	$	5,668	$	—	$	—	$	5,668
Investments available for sale:
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	137	$	—	$	—	$	137
Corporate securities	—		2,214		—		2,214
Municipal securities	—		2,162		—		2,162
Asset-backed securities	—		490		—		490
Residential mortgage-backed securities	—		335		—		335
Commercial mortgage-backed securities	—		281		—		281
Total investments	$	137	$	5,482	$	—	$	5,619
Restricted deposits available for sale:
Cash and cash equivalents	$	16	$	—	$	—	$	16
Certificates of deposit	4		—		—		4
U.S. Treasury securities and obligations of U.S. government corporations and agencies	120		—		—		120
Total restricted deposits	$	140	$	—	$	—	$	140
Other long-term assets: Interest rate swap agreements	$	—	$	—	$	—	$	—
Total assets at fair value	$	5,945	$	5,482	$	—	$	11,427
Liabilities
Other long-term liabilities:
Interest rate swap agreements	$	—	$	120	$	—	$	120
Total liabilities at fair value	$	—	$	120	$	—	$	120

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The following table summarizes fair value measurements by level at December 31, 2017, for assets and liabilities measured at fair value on a recurring basis ($ in millions):



	Level I		Level II		Level III		Total
Assets
Cash and cash equivalents	$	4,072	$	—	$	—	$	4,072
Investments available for sale:
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	195	$	—	$	—	$	195
Corporate securities	—		2,210		—		2,210
Municipal securities	—		2,087		—		2,087
Asset-backed securities	—		437		—		437
Residential mortgage-backed securities	—		332		—		332
Commercial mortgage-backed securities	—		271		—		271
Total investments	$	195	$	5,337	$	—	$	5,532
Restricted deposits available for sale:
Cash and cash equivalents	$	17	$	—	$	—	$	17
Certificates of deposit	4		—		—		4
U.S. Treasury securities and obligations of U.S. government corporations and agencies	114		—		—		114
Total restricted deposits	$	135	$	—	$	—	$	135
Other long-term assets:
Interest rate swap agreements	$	—	$	1	$	—	$	1
Total assets at fair value	$	4,402	$	5,338	$	—	$	9,740
Liabilities
Other long-term liabilities:
Interest rate swap agreements	$	—	$	72	$	—	$	72
Total liabilities at fair value	$	—	$	72	$	—	$	72

The Company periodically transfers U.S. Treasury securities and obligations of U.S. government corporations and agencies between Level I and Level II fair value measurements dependent upon the level of trading activity for the specific securities at the measurement date. The Company’s policy regarding the timing of transfers between Level I and Level II is to measure and record the transfers at the end of the reporting period. At March 31, 2018, there were no transfers from Level I to Level II and no transfers from Level II to Level I. The Company utilizes matrix pricing services to estimate fair value for securities which are not actively traded on the measurement date. The Company designates these securities as Level II fair value measurements. The aggregate carrying amount of the Company’s life insurance contracts and other non-majority owned investments, which approximates fair value, was $423 million and $311 million as of March 31, 2018 and December 31, 2017, respectively.

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5. Medical Claims Liability

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



	Three Months Ended March 31,
	2018			2017
Balance, January 1	$	4,286		$	3,929
Less: Reinsurance recoverable	18			5
Balance, January 1, net	4,268			3,924
Acquisitions	—			—
Incurred related to:
Current year	10,302			9,557
Prior years	(263		)	(235		)
Total incurred	10,039			9,322
Paid related to:
Current year	6,579			5,973
Prior years	2,970			2,991
Total paid	9,549			8,964
Balance at March 31, net	4,758			4,282
Plus: Reinsurance recoverable	13			8
Balance, March 31	$	4,771		$	4,290

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

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

6. Affordable Care Act

The Affordable Care Act (ACA) established risk spreading premium stabilization programs effective January 1, 2014. These programs, commonly referred to as the “three Rs,” include a permanent risk adjustment program, a transitional reinsurance program, and a temporary risk corridor program. Additionally, the ACA established a minimum annual medical loss ratio (MLR) and cost sharing reductions. Each of the three R programs are taken into consideration to determine if the Company’s estimated annual medical costs are less than the minimum loss ratio and require an adjustment to Premium revenue to meet the minimum MLR.

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The Company's net receivables (payables) for each of these programs are as follows ($ in millions):



	March 31, 2018			December 31, 2017
Risk adjustment	$	(1,131	)	$	(677	)
Reinsurance	1			15
Risk corridor	5			6
Minimum MLR	(44		)	(22		)
Cost sharing reductions	(71		)	(96		)

7. Debt

Debt consists of the following ($ in millions):



	March 31, 2018			December 31, 2017
$1,400 million 5.625% Senior notes, due February 15, 2021	$	1,400		$	1,400
$1,000 million 4.75% Senior notes, due May 15, 2022	1,006			1,006
$1,000 million 6.125% Senior notes, due February 15, 2024	1,000			1,000
$1,200 million 4.75% Senior notes, due January 15, 2025	1,200			1,200
Fair value of interest rate swap agreements	(120		)	(71		)
Total senior notes	4,486			4,535
Revolving credit agreement	675			150
Mortgage notes payable	60			61
Capital leases and other	17			18
Debt issuance costs	(62		)	(65		)
Total debt	5,176			4,699
Less current portion	(4		)	(4		)
Long-term debt	$	5,172		$	4,695

Senior Notes

The indentures governing the senior notes listed in the table above contain restrictive covenants of Centene Corporation. At March 31, 2018, the Company was in compliance with all covenants.

Interest Rate Swaps

The Company uses interest rate swap agreements to convert a portion of its interest rate exposure from fixed rates to floating rates to more closely align interest expense with interest income received on its cash equivalent and variable rate investment balances. The following is a summary of the notional amounts of the Company's interest rate swap agreements as of March 31, 2018:



Expiration Date	Notional Amount
February 15, 2021	$	600
May 15, 2022	500
February 15, 2024	1,000
January 15, 2025	600
Total	$	2,700

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

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The swap agreements are formally designated and qualify as fair value hedges. Gains and losses due to changes in fair value of the interest rate swap agreements completely offset changes in the fair value of the hedged portion of the underlying debt. Therefore, no gain or loss has been recognized due to hedge ineffectiveness. Offsetting changes in fair value of both the interest rate swaps and the hedged portion of the underlying debt both were recognized in interest expense in the Consolidated Statements of Operations. The Company does not hold or issue any derivative instrument for trading or speculative purposes.

Revolving Credit Agreement

The Company has an unsecured $1,500 million revolving credit facility. The agreement has a maturity date of December 14, 2022. Borrowings under the agreement bear interest based upon LIBOR rates, the Federal Funds Rate or the Prime Rate. As of March 31, 2018, the Company had $675 million of borrowings outstanding under the agreement with a weighted average interest rate of 5.00%, and the Company was in compliance with all covenants.

The revolving credit facility contains non-financial and financial covenants, including requirements of minimum fixed charge coverage ratios and maximum debt-to-EBITDA ratios. The Company is required to not exceed a maximum debt-to-EBITDA ratio of 3.5 to 1.0. As of March 31, 2018, there were no limitations on the availability under the revolving credit agreement as a result of the debt-to-EBITDA ratio.

Mortgage Notes Payable

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

Letters of Credit & Surety Bonds

The Company had outstanding letters of credit of $76 million as of March 31, 2018, which were not part of the revolving credit facility. The Company also had letters of credit for $47 million (valued at March 31, 2018 conversion rate), or €38 million, representing its proportional share of the letters of credit issued to support Ribera Salud’s outstanding debt, which are a part of the revolving credit facility. Collectively, the letters of credit bore interest at 1.31% as of March 31, 2018. The Company had outstanding surety bonds of $404 million as of March 31, 2018.

Construction Loan

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

8. Stockholders' Equity

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

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

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9. Earnings Per Share

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



	Three Months Ended March 31,
	2018		2017

Earnings attributable to Centene Corporation	$	340	$	139

Shares used in computing per share amounts:
Weighted average number of common shares outstanding	173,921		172,074
Common stock equivalents (as determined by applying the treasury stock method)	3,769		3,762
Weighted average number of common shares and potential dilutive common shares outstanding	177,690		175,836

Net earnings per common share attributable to Centene Corporation:
Basic earnings per common share	$	1.95	$	0.81
Diluted earnings per common share	$	1.91	$	0.79

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

10. Segment Information

Centene operates in two segments: Managed Care and Specialty Services. The Managed Care segment consists of Centene’s health plans including all of the functions needed to operate them. The Specialty Services segment consists of Centene’s specialty companies offering auxiliary healthcare services and products.

Segment information for the three months ended March 31, 2018, follows ($ in millions):



	Managed Care		Specialty Services		Eliminations			Consolidated Total
Total revenues from external customers	$	12,449	$	745	$	—		$	13,194
Total revenues from internal customers	25		2,231		(2,256		)	—
Total revenues	$	12,474	$	2,976	$	(2,256	)	$	13,194
Earnings from operations	$	470	$	70	$	—		$	540

Segment information for the three months ended March 31, 2017, follows ($ in millions):



	Managed Care		Specialty Services		Eliminations			Consolidated Total
Total revenues from external customers	$	11,115	$	609	$	—		$	11,724
Total revenues from internal customers	11		2,333		(2,344		)	—
Total revenues	$	11,126	$	2,942	$	(2,344	)	$	11,724
Earnings from operations	$	187	$	53	$	—		$	240

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11. Contingencies

Overview

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

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

California

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

Federal Securities Class Action

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

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

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

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

Medicare Parts C and D Matter

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

Veterans Administrative Matter

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

Ambetter Class Action

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

Miscellaneous Proceedings

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

•

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


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

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•

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

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

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

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

EXECUTIVE OVERVIEW

General

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

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

Fidelis Care Transaction

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

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

Acquisitions and Investments

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

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

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First Quarter 2018 Highlights

Our financial performance for the first quarter of 2018 is summarized as follows:


•	Managed care membership of 12.8 million, an increase of 684,000 members, or 6% year-over-year.


•	Total revenues of $13.2 billion, representing 13% growth year-over-year.


•	Health benefits ratio of 84.3%, compared to 87.6% in 2017.


•	SG&A expense ratio of 10.5% for the first quarter of 2018, compared to 9.8% for the first quarter of 2017.


•	Adjusted SG&A expense ratio of 10.3% for the first quarter of 2018, compared to 9.3% for the first quarter of 2017.


•	Operating cash flows of $1,846 million.


•	Diluted earnings per share (EPS) for the first quarter of 2018 of $1.91, compared to $0.79 for the first quarter of 2017.


•	Adjusted Diluted EPS for the first quarter of 2018 of $2.17, compared to $1.12 for the first quarter of 2017.

Adjusted Diluted EPS is highlighted below and additional detail is provided above under the heading "Non-GAAP Financial Presentation":



	Three Months Ended March 31,
	2018		2017
GAAP diluted EPS	$	1.91	$	0.79
Amortization of acquired intangible assets	0.17		0.14
Acquisition related expenses	0.09		0.02
Penn Treaty assessment expense	—		0.17
Adjusted Diluted EPS	$	2.17	$	1.12

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


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


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


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


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

•

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


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


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


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

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


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


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

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


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


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

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


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


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


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


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


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

•

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

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


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


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

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

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

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

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

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

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MEMBERSHIP

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



	March 31, 2018	December 31, 2017	March 31, 2017
Arizona	639,800	640,500	684,300
Arkansas	92,300	85,700	98,100
California	2,903,600	2,877,800	2,980,100
Florida	1,090,600	848,800	872,000
Georgia	581,500	483,600	568,300
Illinois	238,400	239,500	253,800
Indiana	317,400	304,500	335,800
Kansas	151,500	129,100	133,100
Louisiana	485,900	485,500	484,100
Massachusetts	8,900	43,000	44,200
Michigan	2,800	2,500	2,100
Minnesota	9,400	9,400	9,500
Mississippi	347,600	329,900	349,500
Missouri	329,900	269,400	106,100
Nebraska	81,500	79,700	79,200
Nevada	74,600	34,900	—
New Hampshire	82,900	74,800	77,800
New Mexico	7,200	7,100	7,100
Ohio	352,800	332,700	328,900
Oregon	199,300	205,200	211,900
Pennsylvania	22,400	—	—
South Carolina	119,300	117,800	121,900
Tennessee	22,000	22,200	21,900
Texas	1,260,100	1,233,500	1,243,900
Vermont	1,600	1,600	1,600
Washington	260,800	237,800	254,400
Wisconsin	74,900	70,200	71,700
Total at-risk membership	9,759,000	9,166,700	9,341,300
TRICARE eligibles	2,851,500	2,824,100	2,804,100
Non-risk membership	218,900	216,300	—
Total	12,829,400	12,207,100	12,145,400

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



	March 31, 2018	December 31, 2017	March 31, 2017
Medicaid:
TANF, CHIP & Foster Care	5,776,600	5,807,300	5,714,100
ABD & LTSS	866,000	846,200	825,600
Behavioral Health	454,500	463,700	466,900
Commercial	2,161,200	1,558,300	1,864,700
Medicare & MMP ⁽¹⁾	343,400	333,700	328,100
Correctional	157,300	157,500	141,900
Total at-risk membership	9,759,000	9,166,700	9,341,300
TRICARE eligibles	2,851,500	2,824,100	2,804,100
Non-risk membership	218,900	216,300	—
Total	12,829,400	12,207,100	12,145,400

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

The following table sets forth additional membership statistics, which are included in the membership information above:



	March 31, 2018	December 31, 2017	March 31, 2017
Dual-eligible⁽²⁾	438,200	474,500	458,700
Health Insurance Marketplace	1,603,800	959,600	1,188,700
Medicaid Expansion	1,057,400	1,091,500	1,091,300

(2) Membership includes dual-eligible ABD & LTC and dual-eligible Medicare membership in the table above.

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RESULTS OF OPERATIONS

The following discussion and analysis is based on our Consolidated Statements of Operations, which reflect our results of operations for the three months ended March 31, 2018 and 2017, prepared in accordance with generally accepted accounting principles in the United States.

Summarized comparative financial data for the three months ended March 31, 2018 and 2017 is as follows ($ in millions, except per share data in dollars):



	Three Months Ended March 31,
	2018			2017			% Change 2017-2018
Premium	$	11,903		$	10,638		12	%
Service	653			527			24	%
Premium and service revenues	12,556			11,165			12	%
Premium tax and health insurer fee	638			559			14	%
Total revenues	13,194			11,724			13	%
Medical costs	10,039			9,322			8	%
Cost of services	543			441			23	%
Selling, general and administrative expenses	1,316			1,091			21	%
Amortization of acquired intangible assets	39			40			(3	)%
Premium tax expense	546			590			(7	)%
Health insurer fee expense	171			—			100	%
Earnings from operations	540			240			125	%
Investment and other income (expense), net	(27		)	(21		)	(29	)%
Earnings from operations, before income tax expense	513			219			134	%
Income tax expense	175			87			101	%
Net earnings	338