We own our corporate office headquarters building located in St. Louis, Missouri. During 2008 and 2009, our capital expenditures included costs for the construction of a new real estate development on the property adjoining our corporate office, which we believe is necessary to accommodate our growing business.
The first quarter of 2008 included $20.8 million of premium revenue for the Georgia premium rate increase related to the period from July 1, 2007 through December 31, 2007. All 2008 ratios and year over year changes discussed below are inclusive of this revenue.
Total operating cash flows of $248.2 million, or 2.9 times net earnings.
The following new contracts and acquisitions contributed to our revenue and membership growth over the last two years:
In March 2009, we completed an acquisition of certain assets in South Carolina. We now serve 48,600 at-risk members in South Carolina at December 31, 2009.
In February 2009, we began converting non-risk managed care membership in Florida from Access Health Solutions LLC, or Access, to our new subsidiary, Sunshine State Health Plan on an at-risk basis. Additionally, we also completed an acquisition of certain assets in Florida, adding to our membership. At December 31, 2009, we served 102,600 members on an at-risk basis while Access served 59,700 members on a non-risk basis. Beginning January 1, 2009, we have presented our investment in Access as a consolidated subsidiary.
Effective July 2008, we completed the acquisition of Celtic, a health insurance carrier focused on the individual health insurance market.
In November 2009, we announced we were selected to provide managed care services in Mississippi to Medicaid recipients through the Mississippi Coordinated Access Network (MississippiCan) program. We are working with the State and currently expect a 2010 start date.
Our revenue in 2010 will be adversely affected by the removal of pharmacy benefits from our contracted services (pharmacy carve-outs) in two states in 2010.
From December 31, 2007 to December 31, 2009, we increased our at-risk managed care membership by 38.1%. The following table sets forth our membership by state for our managed care organizations:
Our membership decreased in Wisconsin due to the termination of certain provider contracts.
Summarized comparative financial data for 2009, 2008 and 2007 are as follows ($ in millions):
Our health plans generate revenues primarily from premiums we receive from the states in which we operate. We receive a fixed premium per member per month pursuant to our state contracts. We generally receive premium payments during the month we provide services and recognize premium revenue during the period in which we are obligated to provide services to our members. In some instances, our base premiums are subject to an adjustment, or risk score, based on the acuity of our membership. Generally, the risk score is determined by the state analyzing encounter submissions of processed claims data to determine the acuity of our membership relative to the entire state’s Medicaid membership. Some contracts allow for additional premium associated with certain supplemental services provided such as maternity deliveries. Revenues are recorded based on membership and eligibility data provided by the states, which may be adjusted by the states for updates to this data. These eligibility adjustments have been immaterial in relation to total revenue recorded and are reflected in the period known.
Premium and service revenues increased 18.4% in 2009 over 2008 as a result of membership growth in all our states discussed under the heading “Membership”, the effect of a full year of the Celtic acquisition in July 2008, and premium rate increases. The premium rates specified in our state contracts are generally updated on an annual basis through contract amendments. In 2009, we received premium rate increases in certain markets which yielded a 2.9% composite increase across all of our markets.
Premium and service revenues increased 21.6% in 2008 over 2007 as a result of membership growth in Arizona, Indiana and Texas, the Celtic acquisition in July 2008, and premium rate increases. In 2008, we received premium rate increases in certain markets which yield a 2.7% composite increase across all of our markets.
Contract amendments related to rate increases for the Georgia health plan effective July 1, 2008 and 2009 were not fully executed until the respective fourth quarters and accordingly, the premium revenue from July 1 to September 30 was recorded in the fourth quarter in each respective year.
While we believe our IBNR estimate is appropriate, it is possible future events could require us to make significant adjustments for revisions to these estimates. Accordingly, we can not assure you that healthcare claim costs will not materially differ from our estimates.
Results of operations depend on our ability to manage expenses associated with health benefits and to accurately predict costs incurred. The health benefits ratio, or HBR, represents medical costs as a percentage of premium revenues (excluding premium taxes) and reflects the direct relationship between the premium received and the medical services provided. The table below depicts the HBR for our external membership by member category:
The consolidated HBR for the year ended December 31, 2008 was 82.5%, a decrease of 1.4% over 2007. The decrease for the year ended December 31, 2008 over 2007 is due to the effect of recording the Georgia premium rate increase for the period to July 1, 2007 to December 31, 2007 in 2008.
Cost of services expense includes the pharmaceutical costs associated with our pharmacy benefit manager’s external revenues. Cost of services also includes all direct costs to support the functions responsible for generation of our services revenues. These expenses consist of the salaries and wages of the professionals and teachers who provide the services and expenses associated with facilities and equipment used to provide services.
The G&A expense ratio represents G&A expenses as a percentage of premium and service revenues, and reflects the relationship between revenues earned and the costs necessary to earn those revenues. The consolidated G&A expense ratio for the years ended December 31, 2009, 2008 and 2007 were 13.3%, 13.6% and 14.3%, respectively. The decrease in the ratio in 2009 primarily reflects the leveraging of our expenses over higher revenues, partially offset by the effect of the acquisition of Celtic, our business expansion costs for Florida, Massachusetts and Mississippi and the consolidation of Access.
The pre-tax loss from discontinued operations was $3.6 million in 2009 and $1.0 million in 2008 compared to a pre-tax gain of $0.8 million in 2007. Legal expenses of $1.8 million and employee retention expenses of $3.6 million related to the pending sale of UHP were included in the results from discontinued operations during 2009. The 2008 results include a one-time charge of $3.7 million primarily for asset impairments and employee severance related to the sale. The assets and liabilities of the discontinued business are segregated in the consolidated balance sheet.
Earnings from operations increased 67.4% in 2009 from 2008 levels primarily due to the increase in revenue and leveraging of the segments infrastructure costs over this higher revenue base. Earnings from operations also increased due to a lower HBR.
We spent $83.1 million, $65.2 million and $53.9 million in 2009, 2008 and 2007, respectively, on capital assets consisting primarily of building construction, software and hardware upgrades, furniture, equipment, and leasehold improvements associated with office and market expansions. Exclusive of our real estate development discussed below, we anticipate spending approximately $40 million on capital expenditures in 2010 primarily associated with system enhancements and market expansions.
In June 2009, this joint venture executed a $95 million construction loan associated with the development. The construction loan is due June 1, 2011 and may be extended for two additional one year terms. The loan bears interest at the LIBOR rate plus 4% with a minimum rate of 5%. We and our development partner have each guaranteed up to $65 million associated with the construction loan. The agreement contains non-financial and financial covenants, including requirements for us to maintain a specified net worth. As of December 31, 2009, there was $32.6 million outstanding under the construction loan. Additionally, the joint venture has posted a $1.75 million letter of credit to a tenant of the development, collateralized by a portion of the entity’s cash balances.
At December 31, 2009, our debt to capital ratio, defined as total debt divided by the sum of total debt and total equity, was 33.2%, as compared to 34.6% at December 31, 2008. We utilize the debt to capital ratio as a measure, among others, of our leverage and financial flexibility.
On January 21, 2010, we completed the sale of an additional 5.75 million shares of common stock for $19.25 per share. Net proceeds from the sale of the additional shares were approximately $104.5 million. We used a portion of the net proceeds to repay the outstanding indebtedness under our $300 million revolving credit loan facility ($84.0 million as of December 31, 2009). We intend to use the remaining net proceeds for general corporate purposes, which may include the repayment of indebtedness, funding for acquisitions, capital expenditures, additions to working capital and to meet statutory capital requirements in new or existing states.
The following table summarizes future contractual obligations. These obligations contain estimates and are subject to revision under a number of circumstances. Our debt consists of borrowings from our senior notes, credit facility, mortgages, construction loan and capital leases. The purchase obligations consist primarily of software purchase and maintenance contracts. The contractual obligations and estimated period of payment over the next five years and beyond are as follows (in thousands):
Our subsidiaries are required to maintain minimum capital requirements prescribed by various regulatory authorities in each of the states in which we operate. As of December 31, 2009, our subsidiaries, including UHP, had aggregate statutory capital and surplus of $453.2 million, compared with the required minimum aggregate statutory capital and surplus requirements of $286.5 million and we estimate our Risk Based Capital, or RBC, percentage to be 347% of the Authorized Control Level.
The National Association of Insurance Commissioners has adopted rules which set minimum risk-based capital requirements for insurance companies, managed care organizations and other entities bearing risk for healthcare coverage. As of December 31, 2009, each of our health plans were in compliance with the risk-based capital requirements enacted in those states.
Effective January 1, 2009, the Company adopted new guidance related to consolidation and reporting of noncontrolling interest, which requires all entities to report noncontrolling (minority) interests in subsidiaries in the same way, that is, as equity in the consolidated financial statements. Moreover, this guidance eliminates the diversity that existed in accounting by requiring transactions between an entity and the noncontrolling interest be treated as equity transactions.
We use our judgment to determine the assumptions to be used in the calculation of the required estimates. The assumptions we consider when estimating IBNR include, without limitation, claims receipt and payment experience (and variations in that experience), changes in membership, provider billing practices, healthcare service utilization trends, cost trends, product mix, seasonality, prior authorization of medical services, benefit changes, known outbreaks of disease or increased incidence of illness such as influenza, provider contract changes, changes to Medicaid fee schedules, and the incidence of high dollar or catastrophic claims.
While we believe our estimates are appropriate, it is possible future events could require us to make significant adjustments for revisions to these estimates. For example, a 1% increase or decrease in our estimated medical claims liability would have affected net earnings by $3.0 million for the year ended December 31, 2009. The estimates are based on our historical experience, terms of existing contracts, our observance of trends in the industry, information provided by our providers and information available from other outside sources.
Medical claims are usually paid within a few months of the member receiving service from the physician or other healthcare provider. As a result, the liability generally is described as having a “short-tail,” which causes less than 5% of our medical claims liability as of the end of any given year to be outstanding the following year. We believe that substantially all the development of the estimate of medical claims liability as of December 31, 2009 will be known by the end of 2010.
Goodwill is reviewed every year during the fourth quarter for impairment. In addition, an impairment analysis of intangible assets would be performed based on other factors. These factors include significant changes in membership, state funding, medical contracts and provider networks and contracts.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Centene Corporation and subsidiaries as of December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Centene Corporation’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 21, 2010 expressed an unqualified opinion on the effectiveness of the operation of internal control over financial reporting.
Short-term investments include securities with maturities between three months and one year. Long-term investments include securities with maturities greater than one year.
Restricted deposits consist of investments required by various state statutes to be deposited or pledged to state agencies. These investments are classified as long-term, regardless of the contractual maturity date, due to the nature of the states’ requirements. The Company is required to annually adjust the amount of the deposit pledged to certain states.
Available-for-sale investments and restricted deposits: The carrying amount is stated at fair value, based on quoted market prices, where available. For securities not actively traded, fair values were estimated using values obtained from independent pricing services or quoted market prices of comparable instruments.
Property, software and equipment are stated at cost less accumulated depreciation. Capitalized software includes certain costs incurred in the development of internal-use software, including external direct costs of materials and services and payroll costs of employees devoted to specific software development. Depreciation is calculated principally by the straight-line method over estimated useful lives. Leasehold improvements are depreciated using the straight-line method over the shorter of the expected useful life or the remaining term of the lease. Property, software and equipment are depreciated over the following periods:
Premium and services revenues collected in advance are recorded as unearned revenue. For performance-based contracts the Company does not recognize revenue subject to refund until data is sufficient to measure performance. Premiums and service revenues due to the Company are recorded as premium and related receivables and are recorded net of an allowance based on historical trends and management’s judgment on the collectibility of these accounts. As the Company generally receives payments during the month in which services are provided, the allowance is typically not significant in comparison to total revenues and does not have a material impact on the presentation of the financial condition or results of operations. Activity in the allowance for uncollectible accounts for the years ended December 31, is summarized below:
Centene receives the majority of its revenues under contracts or subcontracts with state Medicaid managed care programs. The current contracts, which expire on various dates between March 31, 2010 and August 31, 2013, are expected to be renewed. States whose aggregate annual contract value exceeded 10% of annual revenues and the respective percentage of the Company’s total revenues for the years ended December 31, are as follows:
Other income (expense) consists principally of investment income, interest expense and equity method earnings from investments. Investment income is derived from the Company’s cash, cash equivalents, restricted deposits and investments. Interest expense relates to borrowings under the senior notes, credit facilities, interest on capital leases and credit facility fees.
Additional information regarding the stock option plans is included in Note 16, Stock Incentive Plans.
In April 2009, new guidance was issued related to the recognition and presentation of other-than-temporary impairments. The guidance applies to fixed maturity securities only and requires separate display of losses related to credit deterioration and losses related to other market factors. When an entity does not intend to sell the security and it is more likely than not that an entity will not have to sell the security before recovery of its cost basis, it must recognize the credit component of an other-than-temporary impairment in earnings and the remaining portion in other comprehensive income. The adoption of the guidance did not have a material effect on the Company’s financial statements.
In June 2009, new guidance was issued related to the consolidation of variable interest entities to require an analysis to determine whether a variable interest gives the Company a controlling financial interest in a variable interest entity. This guidance requires an ongoing reassessment and eliminates the quantitative approach previously required for determining whether an entity is the primary beneficiary. This guidance is effective for fiscal years beginning after November 15, 2009 and early adoption is prohibited. The Company is currently evaluating the impact of adopting this guidance on the consolidated financial statements and related disclosures.
In November 2008, the Company announced its intention to sell certain assets of its New Jersey health plan, University Health Plans, Inc, or UHP. Accordingly, the results of operations of UHP are presented as discontinued operations for all periods presented. The assets, liabilities and results of operations of UHP were classified as discontinued operations for all periods presented beginning in December 2008. UHP was previously reported in the Medicaid Managed Care segment. The Company expects the sale to be completed during the first quarter of 2010.
In 2006, FirstGuard Health Plan Kansas, Inc., or FirstGuard Kansas, a wholly owned subsidiary, received notification that its Medicaid contract scheduled to terminate December 31, 2006 would not be renewed. In 2006, the Company also evaluated its strategic alternatives for its Missouri subsidiary, FirstGuard Health Plan, Inc., or FirstGuard Missouri, and decided to divest the business. FirstGuard was previously reported in the Medicaid Managed Care segment.
The sale of the operating assets of FirstGuard Missouri was completed effective February 1, 2007, resulting in a gain on the sale of $7,472 in 2007. Goodwill associated with FirstGuard written off as part of the transaction was $5,995. In 2007, the Company abandoned the stock of FirstGuard Kansas and FirstGuard Missouri to an unrelated entity. As a result of that abandonment, the Company recognized expense of $2,298 for the write-off of the remaining assets in that entity. The Company also recognized a $34,856 tax benefit for the tax deduction associated with the basis of that stock.
In the fourth quarter of 2007, the Company abandoned its previously planned redevelopment project in Clayton, Missouri, related to a corporate office expansion. As a result, the Company conducted an impairment analysis of the related real estate and capitalized construction costs and recorded an impairment charge of $7,207. The impairment charges were recorded as General and Administrative expense under the Medicaid Managed Care segment. Also in the fourth quarter of 2007, the Company completed an organizational realignment, resulting in the elimination of approximately 35 positions. Accordingly, the Company recorded $2,185 in severance costs. This expense was recorded as General and Administrative expense under the Medicaid Managed Care segment. At December 31, 2009, the Company did not have any remaining liability for these costs.
2007 Acquisitions. The Company acquired 100% of the following entities: PhyTrust of South Carolina, LLC, effective April 20, 2007; Physician’s Choice, LLC, effective October 2007; and Work Life Innovations, effective November 30, 2007. The Company paid a total of $11,300 in cash and related transaction costs for these acquisitions. PhyTrust of South Carolina and Physician’s Choice, LLC, both with Medicaid members in South Carolina, are included in the Medicaid Managed Care segment. Work Life Innovations, a health and wellness consulting company, is included in the Specialty Services segment. For these acquisitions, goodwill of $8,343 and $2,739 was allocated to the Medicaid Managed Care segment and the Specialty Services segment, respectively, all of which is deductible for income tax purposes.
In June 2009, the Company executed an agreement as a 50% joint venture partner in a real estate development entity, Centene Center LLC, associated with the construction of a real estate development to include the Company’s corporate headquarters. Centene Center LLC is a variable interest entity, or VIE, and the Company concluded it was the primary beneficiary. Accordingly, the Company’s consolidated financial statements include the accounts of Centene Center LLC. The Company’s interest in Centene Center LLC includes an initial equity investment of $17,400. Centene Center LLC has posted a $1,750 letter of credit to a tenant of the development, collateralized by a portion of the entity’s cash balances. The assets and liabilities of Centene Center LLC as of December 31, 2009 are as follows (on a 100% basis):
The Company’s investments are classified as available for sale with the exception of life insurance contracts and certain cost method investments. The Company 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. Based on management’s intent and ability to not sell these investments prior to their anticipated recovery, no other than temporary impairment has been recorded. Investments in a gross unrealized loss position are as follows:
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.
The Company’s gross recorded realized gains and losses on investments for the years ended December 31, were as follows:
Investment and other income in the third quarter of 2008 included a loss on investments of $4,457. The loss was primarily due to investments in the Reserve Primary money market fund (Reserve Fund) whose Net Asset Value fell below $1.00 per share. Money market funds are generally recorded in Cash and cash equivalents in the Company's balance sheet, however, the investment in the Reserve Fund is recorded in Short-term investments due to the restrictions placed on redemptions imposed by the fund. As of December 31, 2009, the Company's short term investment balance includes $2,444 for the Reserve Fund.
Additional information regarding investments is included in Note 8, Fair Value Measurements.
As of December 31, 2009 and 2008, the Company had assets acquired under capital leases with a net book value of $6,411 and $6,605, respectively. Depreciation expense for the years ended December 31, 2009, 2008 and 2007 was $33,103, $28,453 and $22,647, respectively.
The Company's deferred tax assets include federal and state net operating losses, or NOLs, of which $2,543 were acquired in business combinations. Accordingly, the total and annual deduction for those NOLs is limited by tax law. The Company 's federal NOLs expire between the years 2011 and 2027 and the state NOLs expire between the years 2010 and 2027. Valuation allowances are recorded for those NOLs the Company believes are more likely than not to expire unused. During 2009 and 2008, the Company recorded valuation allowance additions in the tax provision of $1,381 and $1,829, respectively. In 2009 and 2008 the Company recorded valuation allowance reductions of $80 and $126.
The December 31, 2009 balance includes $933 (net of federal tax benefit) that would decrease income tax expense, if recognized, and the remainder would reduce deferred tax assets.
The federal income tax returns for 2006 through 2009 are open tax years. In May 2008, the Internal Revenue Service began an audit of the Company's 2006 and 2007 tax returns. As a result of this audit, the IRS has initially denied the $34,856 tax benefit the Company recognized for the abandonment of the FirstGuard stock in 2007. The Company is proceeding with the appeals process and believes that it is more likely than not that the Company's tax position will be upheld. Accordingly, the Company has not made any adjustments to the reserve for this position.
The Company files in numerous state jurisdictions with varying statutes of limitation. The unrecognized state tax benefits are related to returns open from 2004 to 2009.
As discussed in Note 2, Summary of Significant Accounting Policies, certain amounts in the consolidated financial statements have been reclassified to conform to the 2009 presentation. These reclassifications include the reclassification of certain pharmacy liabilities from accounts payable and accrued expenses to medical claims liability. This reclassification totaled $18,303, $11,323, and $10,377 as of the year ended December 31, 2009, 2008 and 2007, respectively.
The Company had reinsurance recoverables related to medical claims liability of $4,700 and $4,972 at December 31, 2009 and 2008, respectively, included in premium and related receivables.
In June 2009, the Company and its development partner executed a $95,000 construction loan associated with the construction of a real estate development to include the Company’s corporate headquarters. The construction loan is due June 1, 2011 which may be extended for two additional one year terms. The loan bears interest at the LIBOR rate plus 4% with a minimum rate of 5%. The Company and its development partner have each guaranteed up to $65,000 associated with the construction loan. The agreement contains non-financial and financial covenants, including requirements for the Company to maintain a specified net worth. As of December 31, 2009, there was $32,559 outstanding under the construction loan, bearing interest at 5.0%.
The fair value of outstanding debt was approximately $305,544 and $226,829 at December 31, 2009 and 2008, respectively.
On October 26, 2009, the Company’s Board of Directors extended the Company’s stock repurchase program. The program authorizes the repurchase of up to 4,000,000 shares of the Company’s common stock from time to time on the open market or through privately negotiated transactions. No duration has been placed on the repurchase program and the Company reserves the right to discontinue the repurchase program at any time. During the year ended December 31, 2009, the Company repurchased 332,595 shares at an aggregate cost of $6,304. During the year ended December 31, 2008, the Company repurchased 1,218,858 shares at an aggregate cost of $23,510.
Various state laws require Centene’s regulated subsidiaries to maintain minimum capital levels specified by each state and restrict the amount of dividends that may be paid without prior regulatory approval. At December 31, 2009 and 2008, Centene’s subsidiaries, including UHP, had aggregate statutory capital and surplus of $453,200 and $391,400, respectively, compared with the required minimum aggregate statutory capital and surplus of $286,500 and $241,500, respectively.
Other information pertaining to option activity during the years ended December 31, 2009, 2008 and 2007 is as follows:
The total fair value of restricted stock and restricted stock units vested during the years ended December 31, 2009, 2008 and 2007, was $17,213, $1,822 and $2,168, respectively.
Centene has a defined contribution plan which covers substantially all employees who are at least twenty-one years of age. Under the plan, eligible employees may contribute a percentage of their base salary, subject to certain limitations. Centene may elect to match a portion of the employee’s contribution. Company expense related to matching contributions to the plan was $3,499, $3,681 and $2,312 during the years ended December 31, 2009, 2008 and 2007, respectively.
Centene and its subsidiaries lease office facilities and various equipment under non-cancelable operating leases which may contain escalation provisions. The rental expense related to these leases is recorded on a straight-line basis over the lease term, including rent holidays. Tenant improvement allowances are recorded as a liability and amortized against rent expense over the term of the lease. Rent expense was $20,211, $19,561 and $15,108 for the years ended December 31, 2009, 2008 and 2007, respectively. Annual non-cancelable minimum lease payments over the next five years and thereafter are as follows:
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 including behavioral health, individual health, life and health management, long-term care, managed vision, telehealth services, pharmacy benefits management and treatment compliance functions.
Segment information as of and for the year ended December 31, 2008, follows:
Segment information as of and for the year ended December 31, 2007, follows:
(1) Includes $20.8 million pre-tax premium revenue for the Georgia premium rate increase for July 1, 2007 - December 31, 2007.
In Centene Corporation’s parent company only financial statements, Centene Corporation’s investment in subsidiaries is stated at cost plus equity in undistributed earnings of the subsidiaries. Centene Corporation’s share of net income of its unconsolidated subsidiaries is included in income using the equity method of accounting.
Certain amounts presented in the parent company only financial statements are eliminated in the consolidated financial statements of Centene Corporation. The 2007 income tax benefit reflects a $34,856 tax benefit associated with the stock abandonment discussed in Note 3, Discontinued Operations: University Health Plans and FirstGuard Health Plans.