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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 for the quarterly period ended June 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 for the transition period from ________ to _________
Commission File No. 000-33395
CENTENE CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 04-1406317
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
7711 Carondelet Avenue, Suite 800
St. Louis, Missouri
(Address of principal executive offices)
63105
(Zip Code)
314-725-4477
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
X YES NO
------ --------
As of July 19, 2002, registrant had 10,638,207 shares of common stock,
$.001 par value per share, outstanding.
CENTENE CORPORATION
Index
Page
----
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 2002 (unaudited) and
December 31, 2001................................................3
Consolidated Statements of Earnings for the
Three and Six Months Ended June 30, 2002 and 2001 (unaudited)....4
Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2002 and 2001 (unaudited)..............5
Notes to the Consolidated Financial Statements (unaudited)..........6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................9
Item 3. Quantitative and Qualitative Disclosures About Market Risk.........23
Part II. Other Information
Item 1. Legal Proceedings..................................................24
Item 2. Changes in Securities and Use of Proceeds..........................24
Item 3. Defaults Upon Senior Securities....................................24
Item 4. Submission of Matters to a Vote of Security Holders................24
Item 5. Other Information..................................................24
Item 6. Exhibits and Report on Form 8-K....................................25
2
PART I. FINANCIAL INFORMATION
-----------------------------
ITEM 1. FINANCIAL STATEMENTS
CENTENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
June 30, December 31,
2002 2001
----------- ------------
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 44,336 $ 88,867
Premium and related receivables, net of allowances of $3,164 and $3,879,
respectively 7,524 7,032
Short-term investments, at fair value (amortized cost $6,135 and $1,166,
respectively) 6,132 1,169
Deferred income taxes 3,424 2,515
Other current assets 4,215 2,464
-------- --------
Total current assets 65,631 102,047
LONG-TERM INVESTMENTS, at fair value (amortized cost $78,390 and $22,127,
respectively) 78,752 22,339
PROPERTY AND EQUIPMENT, net 5,395 3,796
INTANGIBLE ASSETS, net 2,732 2,396
DEFERRED INCOME TAXES 382 788
OTHER ASSETS 4,844 --
-------- --------
Total assets $157,736 $131,366
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Medical claims liabilities $ 63,557 $ 59,565
Accounts payable and accrued expenses 5,141 7,712
-------- --------
Total current liabilities 68,698 67,277
OTHER LIABILITIES 4,738 --
-------- --------
Total liabilities 73,436 67,277
-------- --------
STOCKHOLDERS' EQUITY:
Common stock, $.001 par value; authorized 40,000,000 shares; 10,638,207
and 10,085,112 shares issued and outstanding 11 10
Additional paid-in capital 71,443 60,857
Net unrealized gain on investments, net of tax 226 135
Retained earnings 12,620 3,087
-------- --------
Total stockholders' equity 84,300 64,089
-------- --------
Total liabilities and stockholders' equity $157,736 $131,366
======== ========
The accompanying notes are an integral part of these statements.
3
CENTENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(In thousands, except share data)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- ----------------------------
2002 2001 2002 2001
------------ ----------- ------------ -----------
(Unaudited) (Unaudited)
REVENUES:
Premiums $ 107,503 $ 80,458 $ 203,152 $ 150,682
Administrative services fees 107 102 211 182
------------ ----------- ------------ -----------
Total revenues 107,610 80,560 203,363 150,864
------------ ----------- ------------ -----------
EXPENSES:
Medical services costs 88,109 66,466 167,053 125,039
General and administrative expenses 11,783 9,581 22,330 18,406
------------ ----------- ------------ -----------
Total operating expenses 99,892 76,047 189,383 143,445
------------ ----------- ------------ -----------
Earnings from operations 7,718 4,513 13,980 7,419
OTHER INCOME (EXPENSE):
Investment and other income, net 976 931 1,891 1,897
Interest expense (11) (101) (11) (196)
------------ ----------- ------------ -----------
Earnings before income taxes 8,683 5,343 15,860 9,120
INCOME TAX EXPENSE 3,449 2,113 6,327 3,708
------------ ----------- ------------ -----------
Net earnings 5,234 3,230 9,533 5,412
ACCRETION OF REDEEMABLE PREFERED STOCK -- (123) -- (246)
------------ ----------- ------------ -----------
Net earnings attributable to common stockholders $ 5,234 $ 3,107 $ 9,533 $ 5,166
============ =========== ============ ===========
EARNINGS PER COMMON SHARE, BASIC:
Net earnings per common share $ 0.51 $ 3.41 $ 0.93 $ 5.68
EARNINGS PER COMMON SHARE, DILUTED:
Net earnings per common share $ 0.45 $ 0.42 $ 0.83 $ 0.70
SHARES USED IN COMPUTING PER SHARE AMOUNTS:
Basic 10,322,610 911,636 10,207,618 908,907
Diluted 11,546,379 7,738,742 11,435,183 7,748,825
The accompanying notes are an integral part of these statements.
4
CENTENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Six Months Ended
June 30,
-----------------------
2002 2001
-------- --------
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 9,533 $ 5,412
Adjustments to reconcile net earnings to net cash provided
by operating activities -
Depreciation and amortization 975 631
Stock compensation expense 49 6
Gain on sale of investments (307) (49)
Changes in assets and liabilities -
(Increase) decrease in premium and related receivables (492) 10,882
(Increase) decrease in other current assets (1,676) 2,104
(Increase) decrease in deferred income taxes (555) 925
Increase in other assets (106) --
Increase in medical claims liabilities 3,992 2,784
(Decrease) increase in accounts payable and accrued expenses (2,497) 5,299
-------- --------
Net cash provided by operating activities 8,916 27,994
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (2,431) (1,793)
Purchase of investments (87,328) (15,918)
Sales and maturities of investments 29,093 10,455
Contract acquisitions -- (1,000)
Investment in subsidiary (3,193) 7,701
-------- --------
Net cash used in investing activities (63,859) (555)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock 10,304 --
Proceeds from exercise of stock options 108 17
-------- --------
Net cash provided by financing activities 10,412 17
-------- --------
Net (decrease) increase in cash and cash equivalents (44,531) 27,456
-------- --------
CASH AND CASH EQUIVALENTS, beginning of period 88,867 19,023
-------- --------
CASH AND CASH EQUIVALENTS, end of period $ 44,336 $ 46,479
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid $ -- $ 439
Income taxes paid $ 9,282 $ 1,758
The Company purchased all of the capital stock of Bankers Reserve
for $3,527 (Note 3). In conjunction with the acquisition, liabilities were
assumed as follows:
Fair value of assets acquired $ 8,719
Cash paid for the capital stock (3,527)
---------
Liabilities assumed $ 5,192
========
The accompanying notes are an integral part of these statements.
5
CENTENE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share data)
1. Organization
Centene Corporation (Centene or the Company) provides managed care programs and
related services to individuals receiving benefits under Medicaid, including
Supplemental Security Income (SSI), and Children's Health Insurance Program
(CHIP). Centene operates under its own state licenses in Wisconsin, Indiana and
Texas, and contracts with other managed care organizations to provide risk and
nonrisk management services.
2. Basis of Presentation
The unaudited financial statements herein have been prepared by the Company
pursuant to the rules and regulations of the Securities and Exchange Commission.
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 for the latest fiscal year ended
December 31, 2001. Accordingly, footnote disclosures which would substantially
duplicate the disclosures contained in the December 31, 2001 audited financial
statements have been omitted from these interim financial statements. 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.
3. Acquisition of Bankers Reserve
On March 14, 2002, the Company completed an acquisition of Bankers Reserve Life
Insurance Company of Wisconsin (Bankers Reserve) for a cash purchase price of
$3,500. The Company accounted for this acquisition under the purchase method of
accounting and accordingly, the consolidated results of operations include the
results of the acquired Bankers Reserve business from the date of acquisition.
The Company has excluded pro forma disclosures related to the impact of Bankers
Reserve on the results of operations for the six-month period ended June 30,
2002, as well as the comparable period in the preceding year. Such disclosures
have been excluded as there are no significant continuing operations as of the
date of acquisition, outside of the run-off of Separate Account activity.
The Company allocated the purchase price to net tangible and identifiable
intangible assets based on their fair value. Centene allocated $479 to
identifiable intangible assets, representing the value assigned to acquired
licenses, which are being amortized on a straight-line basis over a period of 10
years. In addition, as part of the Bankers Reserve acquisition, $5,200 of
Separate Account assets and $5,200 of Separate Account liabilities were acquired
and recorded in Other Assets and Other Liabilities. The separate account
balances are being liquidated and paid to individual insureds as the annuities
mature.
Centene plans to use Bankers Reserve as a reinsurance company for its existing
managed care Medicaid entities. It is not currently anticipated that Bankers
Reserve would be used to offer reinsurance to unaffiliated entities.
6
CENTENE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands, except share data)
4. Recently Issued Accounting Pronouncements
In July 2001, SFAS No. 142, "Goodwill and Other Intangible Assets," was issued
which requires that goodwill and intangible assets with indefinite useful lives
no longer be amortized, but instead tested at least annually for impairment. The
Company has adopted SFAS No. 142 effective January 1, 2002. Goodwill
amortization has been discontinued. For the three months ended June 30, 2001,
this adjustment would have added $122 in net earnings, or $0.02 per diluted
share and $0.13 per basic share. For the six months ended June 30, 2001, this
adjustment would have added $245 in net earnings, or $0.03 per diluted share and
$0.27 per basic share. The Company reviews goodwill and other long-lived assets
annually for impairment and recognizes impairment losses if expected
undiscounted future cash flows of the related assets are less than their
carrying value. An impairment loss represents the amount by which the carrying
value of an asset exceeds the fair value of the asset. The Company did not
recognize any impairment losses for the periods presented.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS No. 144 provides updated guidance
concerning the recognition and measurement of an impairment loss for certain
types of long-lived assets. It also expands the scope of a discontinued
operation to include a component of an entity. SFAS No. 144 is effective for
financial statements issued for fiscal years beginning after December 15, 2001,
and interim periods within those years. The adoption of the provisions of SFAS
No. 144 did not have a material impact on the Company's results of operations,
financial position or cash flows.
5. Earnings Per Share
The following table sets forth the calculation of basic and diluted net earnings
per common share for the three months ended June 30:
2002 2001
----------- -----------
Net earnings $ 5,234 $ 3,230
Accretion of redeemable preferred stock -- (123)
----------- -----------
Net earnings attributable to
common stockholders $ 5,234 $ 3,107
=========== ===========
Shares used in computing per share amounts:
Weighted average number of common shares
outstanding 10,322,610 911,636
Dilutive effect of stock options and warrants
(as determined by applying the treasury
stock method) and convertible preferred stock 1,223,769 6,827,106
----------- -----------
Weighted average number of common
shares and potential dilutive common
shares outstanding 11,546,379 7,738,742
=========== ===========
EARNINGS PER COMMON SHARE, BASIC:
Net earnings per common share $ 0.51 $ 3.41
EARNINGS PER COMMON SHARE, DILUTED:
Net earnings per common share $ 0.45 $ 0.42
7
CENTENE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(In thousands, except share data)
The following table sets forth the calculation of basic and diluted net earnings
per common share for the six months ended June 30:
2002 2001
----------- -----------
Net earnings $ 9,533 $ 5,412
Accretion of redeemable preferred stock -- (246)
----------- -----------
Net earnings attributable to
common stockholders $ 9,533 $ 5,166
=========== ===========
Shares used in computing per share amounts:
Weighted average number of common shares
outstanding 10,207,618 908,907
Dilutive effect of stock options and warrants (as
determined by applying the treasury stock method)
and convertible preferred stock 1,227,565 6,839,918
----------- -----------
Weighted average number of common shares and
potential dilutive common shares outstanding 11,435,183 7,748,825
=========== ===========
EARNINGS PER COMMON SHARE, BASIC:
Net earnings per common share $ 0.93 $ 5.68
EARNINGS PER COMMON SHARE, DILUTED:
Net earnings per common share $ 0.83 $ 0.70
6. Legal Proceedings
From 1998 to 2000, Centene provided Medicaid services in certain regions of
Indiana as subcontractor with Maxicare, Indiana, Inc. In June 2001, the
Insurance Commissioner of the Indiana Department of Insurance declared
Maxicare insolvent and ordered Maxicare into liquidation. In September
2001, Centene filed an adversary proceeding in Marion County Circuit Court
against Maxicare and the Indiana Insurance Commissioner seeking declaratory
and injunctive relief and the turnover of funds. This proceeding is based
on Centene's belief that the State of Indiana's proposed liquidation plan
for Maxicare does not adequately address Centene's claims for approximately
$4,700 that Centene believes is owed to it by Maxicare. Maxicare and the
Indiana Insurance Commissioner subsequently filed a counterclaim suit
against Centene seeking, among other things, to avoid any claims Centene
has for funds held by Maxicare and to recover payments previously made to
Centene by Maxicare in the amount of approximately $2,000, on the grounds
those payments constituted preferential transfers. A bench trial is
scheduled for July 26, 2002.
7. Subsequent Event
During July 2002, the Board of Directors of United SPC, a captive insurance
company in which Centene maintained an investment, declared a one-time
dividend of $5,055. The dividend, which was received on July 18, 2002,
related to underwriting gains on certain underlying books of business
assumed by United SPC.
8
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 appearing elsewhere in this report and in our
annual report for the year ended December 31, 2001. The discussion contains
forward-looking statements that involve known and unknown risks and
uncertainties, including those set forth below under "Factors that may Affect
Future Results and the Trading Price of Our Common Stock." Our results of
operations and projections of future earnings depend in large part on accurately
predicting and effectively managing health benefits and other operating
expenses.
OVERVIEW
We provide managed care programs and related services to individuals
receiving benefits under Medicaid, including Supplemental Security Income or
SSI, and the Children's Health Insurance Program or CHIP. We have health plans
in Wisconsin, Indiana and Texas.
On June 20, 2002, we announced that our subsidiary Superior HealthPlan had
signed a definitive agreement with Texas Universities Health Plan to purchase
the CHIP contract in the San Antonio, El Paso, and Amarillo and Lubbock, Texas
service areas covering 26,000 children's lives. The agreement is subject to the
approval of the state regulators.
REVENUES
We generate revenues primarily from premiums we receive from the states in
which we operate to provide health benefits to our members. We receive a fixed
premium per member per month pursuant to our state contracts. We generally
receive premiums in advance of providing services and recognize premium revenue
during the period in which we are obligated to provide services to our members.
We also generate administrative services fees for providing services to SSI
members on a non-risk basis.
The primary driver of our increasing revenues has been membership growth.
We have increased our membership through internal growth and acquisitions. From
June 30, 2001 to June 30, 2002, our membership grew 30.7% as a result of
additions to our provider networks and growth in the number of Medicaid
beneficiaries. The following table sets forth our membership by state:
JUNE 30,
---------------------
2002 2001
------- -------
Wisconsin ...... 123,900 103,000
Indiana ........ 92,800 54,600
Texas .......... 61,900 55,600
------- -------
Total ..... 278,600 213,200
======= =======
The following table depicts membership by line of business:
JUNE 30,
---------------------
2002 2001
------- -------
Medicaid ....... 254,700 194,800
CHIP ........... 23,900 18,400
------- -------
Total ..... 278,600 213,200
======= =======
OPERATING EXPENSES
Our operating expenses include medical services costs and general and
administrative expenses.
Our medical services costs include payments to physicians, hospitals, and
other providers for healthcare and specialty product claims. Medical service
costs also include estimates of medical expenses incurred but not yet reported,
or IBNR. Monthly, we estimate our IBNR based on a number of factors, including
inpatient hospital utilization data and prior claims experience. As part of this
review, we also
9
consider the costs to process medical claims, and estimates of amounts to cover
uncertainties related to fluctuations in physician billing patterns, membership,
products and inpatient hospital trends. These estimates are adjusted as more
information becomes available. We utilize the services of independent actuarial
consultants who are contracted to review our estimates quarterly. While we
believe that our process for estimating IBNR is actuarily sound, we cannot
assure you that healthcare claim costs will not exceed our estimates.
Our results of operations depend on our ability to manage expenses related
to health benefits and to accurately predict costs incurred. The table below
depicts our health benefits ratio, which represents medical services costs as a
percentage of premium revenues and reflects the direct relationship between the
premium received and the medical services provided. Our stabilization of the
ratio primarily reflects improved provider contract terms and premium rate
increases in our markets served.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ----------------
2002 2001 2002 2001
---- ---- ---- ----
Health benefits ratio 82.0% 82.6% 82.2% 83.0%
----- ----- ----- -----
Our general and administrative expenses primarily reflect wages and
benefits and other administrative costs related to our employee base, including
those fees incurred to provide services to our members. Some of these services
are provided locally, while others are delivered to our health plans from a
centralized location. This approach provides the opportunity to control both
direct and indirect costs. The major centralized functions are claims
processing, information systems, finance, medical management support and
administration. The following table sets forth the general and administrative
expense ratio, which represents general and administrative expenses as a percent
of total revenues and reflects the relationship between revenues earned and the
costs necessary to drive those revenues. The improvement in the ratio reflects
growth in membership and revenues combined with leveraging our overall
infrastructure.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ----------------
2002 2001 2002 2001
---- ---- ---- ----
General and administrative expenses ratio 10.9% 11.9% 11.0% 12.2%
OTHER INCOME
Other income consists principally of investment and other income and
interest expense.
- Investment income is derived from our cash, cash equivalents and
investments. Information about our investments is presented below
under "Liquidity and Capital Resources."
- Interest expense primarily reflected interest paid on our subordinated
notes, which we repaid in full in December 2001.
10
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO SIX MONTHS ENDED JUNE 30, 2001
Revenues
Premiums for the six months ended June 30, 2002 increased $52.5 million, or
34.8%, to $203.2 million from $150.7 million in 2001. This increase was due to
increases in membership in each of our markets and an increase in premium rates.
Administrative services fees for the six months ended June 30, 2002
increased $29,000 or 15.9% to $211,00 from $182,000 in 2001 as a result of
increases in our SSI membership.
Operating Expenses
Medical services costs for the six months ended June 30, 2002 increased
$42.0 million or 33.6%, to $167.0 million from $125.0 million in 2001. This
increase primarily reflected the growth in our membership.
General and administrative expenses for the six months ended June 30, 2002
increased $3.9 million, or 21.3%, to $22.3 million from $18.4 million in 2001.
This increase reflected a higher level of wages and related expenses for
additional staff to support our membership growth.
Other Income
Other income for the six months ended June 30, 2002 increased $179,000, or
10.5%, to $1.9 million from $1.7 million in 2001. This primarily reflected a
decrease in interest expense resulting from our repayment of subordinated notes
in December 2001. In addition, our annualized rate of return on investments for
the six months ended June 30, 2002 was 3.1%, as compared with 3.4% for the six
months ended June 30, 2001.
Income Tax Expense
For the six months ended June 30, 2002, we recorded income tax expense of
$6.3 million based on a 39.9% effective tax rate. For the six months ended June
30, 2001, we recorded income tax expense of $3.7 million based on an effective
tax rate of 40.7%.
THREE MONTHS ENDED JUNE 30, 2002 COMPARED TO THREE MONTHS ENDED JUNE 30, 2001
Revenues
Premiums for the three months ended June 30, 2002 increased $27.0 million,
or 33.6%, to $107.5 million from $80.5 million in 2001. This increase was due to
increases in membership in each of our markets and an increase in premium rates.
Administrative services fees for the three months ended June 30, 2002
increased $5,000 or 4.9% to $107,000 from $102,000 in 2001 as a result of
increases in our SSI membership.
11
Operating Expenses
Medical services costs for the three months ended June 30, 2002 increased
$21.6 million or 32.6%, to $88.1 million from $66.5 million in 2001. This
increase primarily reflected the growth in our membership.
General and administrative expenses for the three months ended June 30,
2002 increased $2.2 million, or 23.0%, to $11.8 million from $9.6 million in
2001. This increase reflected a higher level of wages and related expenses for
additional staff to support our membership growth.
Other Income
Other income for the three months ended June 30, 2002 increased $135,000,
or 16.3%, to $965,000 from $830,000 in 2001. This primarily reflected a decrease
in interest expense resulting from our repayment of subordinated notes in
December 2001.
Income Tax Expense
For the three months ended June 30, 2002, we recorded income tax expense of
$3.4 million based on a 39.7% effective tax rate. For the three months ended
June 30, 2001, we recorded income tax expense of $2.1 million based on an
effective tax rate of 39.5%.
LIQUIDITY AND CAPITAL RESOURCES
On May 22, 2002, we closed our follow-on public offering of 5,000,000
shares of common stock at $24.75 per share. Of the 5,000,000 shares, 4,600,000
shares were offered by selling stockholders and 400,000 by us. On June 5, 2002,
the underwriters of our follow-on public offering exercised their over-allotment
option to purchase 679,505 additional shares from selling stockholders and
70,495 additional shares from us. We received net proceeds totaling $10.3
million from the two closings for the follow-on offering.
Our operating activities provided cash of $8.9 million for the six months
ended June 30, 2002 compared to $28.0 million for the six months ended June 30,
2001. The decrease in cash provided in the six months ended June 30, 2002
compared to the six months ended June 30, 2001 was due to the timing of
capitation payments and vendor payments.
Our investing activities used cash of $63.9 million for 2002 and $555,000
in 2001. Our investment policies are designed to provide liquidity, preserve
capital and maximize total return on invested assets. As such, as of June 30,
2002, our investment portfolio consisted primarily of municipal bonds with an
average duration of three months. Cash is invested in investment vehicles such
as municipal bonds, commercial paper, U.S. government-backed agencies and U.S.
Treasury instruments. The average portfolio return was 5.6% for the year ended
December 31, 2001 and 3.1% for the six months ended June 30, 2002.
Our financing activities provided cash of $10.4 million for the six months
ended June 30, 2002 and $17,000 for the six months ended June 30, 2001. During
the six months ended June 30, 2002, financing cash flows primarily consisted of
the net proceeds from the issuance of common stock through the follow-on public
offering.
12
In 2002, we anticipate purchasing $3.6 million of new software, software
and hardware upgrades, and furniture, equipment and leasehold improvements
related to office and market expansions. We have purchased $2.4 million in
capital assets during the six months ended June 30, 2002.
Our principal contractual obligations at June 30, 2002 consisted of obligations
under operating leases. The significant annual noncancelable lease payments are
as follows (in thousands):
Payments Due
------------
July 1, 2002 through December 31, 2002............... $ 1,121
2003................................................. 2,149
2004................................................. 2,112
2005................................................. 2,070
2006................................................. 1,788
Thereafter........................................... 5,836
-----------
$ 15,076
===========
No significant new obligations were incurred during the six months ended
June 30, 2002.
At June 30, 2002, we had working capital of $(3.1) million as compared to
$34.8 million at December 31, 2001. Our working capital is often negative due to
our efforts to increase investment returns through purchases of long-term
investments, which have maturities of greater than one year. Our investment
policies are also designed to provide liquidity and preserve capital. We manage
our short-term and long-term investments to ensure that a sufficient portion is
held in investments that are highly liquid and can be sold to fund working
capital as needed.
Cash, cash equivalents and short-term investments were $50.5 million at
June 30, 2002 and $90.0 million at December 31, 2001. Long-term investments were
$78.8 million at June 30, 2002 and $22.3 million at December 31, 2001. Based on
our operating plan, we expect that our available cash, cash equivalents and
investments, and cash from our operations will be sufficient to finance our
operations and capital expenditures for at least 12 months from the date of this
report.
On May 1, 2002, we obtained a $25 million revolving line of credit facility
from a financial institution. The line of credit has a term of one year and
interest rates based on prime, floating and LIBOR rates. We have granted to the
financial institution a security interest in the common stock of our
subsidiaries. The facility includes financial covenants requiring a minimum
quarterly EBITDA of $1.5 million and minimum tangible net worth of $52.2
million. As of June 30, 2002, all covenants have been met. We are required to
obtain the lender's consent if any proposed acquisition would result in
violation of one of the covenants contained in the line of credit. As of July
24, 2002, we have borrowed no funds under the line of credit facility.
In addition, we have raised capital from time to time to fund planned
geographic and product expansion, necessary regulatory reserves, and
acquisitions of healthcare contracts. We may use our existing funds, including
proceeds from our two public offerings, to acquire Medicaid and CHIP contract
rights and related assets to increase our membership and to expand our business
into new service areas. We are currently party to a definitive agreement that
would expand our CHIP program in Texas. This proposed acquisition is subject to
regulatory approval and other conditions, and there can be no assurance that we
will complete the acquisition or any future proposed acquisition.
13
REGULATORY CAPITAL AND DIVIDEND RESTRICTIONS
Our operations are conducted through our subsidiaries. As managed care
organizations, our subsidiaries are subject to state regulations that, among
other things, may require the maintenance of minimum levels of statutory
capital, as defined by each state, and restrict the timing, payment and amount
of dividends and other distributions that may be paid to us.
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 June 30, 2002, our subsidiaries had aggregate statutory capital
and surplus of $19.9 million, compared with the required minimum aggregate
statutory capital and surplus requirements of $10.8 million.
In 1998, the National Association of Insurance Commissioners adopted
guidelines, which, to the extent that they have been implemented by the states,
set new minimum capitalization requirements for insurance companies, managed
care organizations and other entities bearing risk for healthcare coverage.
Risk-based capital rules for managed care organizations, which may vary from
state to state, are currently being considered for adoption. Wisconsin and Texas
adopted various forms of the rules as of December 31, 1999. The managed care
organization rules, if adopted by Indiana in their proposed form, may increase
the minimum capital required for our subsidiary.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, SFAS No. 142, "Goodwill and Other Intangible Assets," was
issued which requires that goodwill and intangible assets with indefinite useful
lives no longer be amortized, but instead tested at least annually for
impairment. We have adopted SFAS No. 142 effective January 1, 2002. Goodwill
amortization has been discontinued. For the three months ended June 30, 2001,
this adjustment would have added $122,000 in net earnings, or $0.02 per diluted
share and $0.13 per basic share. For the six months ended June 30, 2001, this
adjustment would have added $245,000 in net earnings, or $0.03 per diluted share
and $0.27 per basic share. We review goodwill and other long-lived assets
annually for impairment. We recognize impairment losses if expected undiscounted
future cash flows of the related assets are less than their carrying value. An
impairment loss represents the amount by which the carrying value of an asset
exceeds the fair value of the asset. We did not recognize any impairment losses
for the periods presented.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 provides updated
guidance concerning the recognition and measurement of an impairment loss for
certain types of long-lived assets. It also expands the scope of a discontinued
operation to include a component of an entity. SFAS No. 144 is effective for
financial statements issued for fiscal years beginning after December 15, 2001,
and interim periods within those years. The adoption of the provisions of SFAS
No. 144 did not have a material impact on our results of operations, financial
position or cash flows.
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FACTORS THAT MAY AFFECT FUTURE RESULTS AND THE TRADING PRICE OF OUR COMMON STOCK
You should carefully consider the risks described below before making an
investment decision. The trading price of our common stock could decline due to
any of these risks, in which case you could lose all or part of your investment.
You should also refer to the other information in this prospectus, including our
consolidated financial statements and related notes. The risks and uncertainties
described below are those that we currently believe may materially affect our
company. Additional risks and uncertainties that we are unaware of or that we
currently deem immaterial also may become important factors that affect our
company.
RISKS RELATED TO BEING A REGULATED ENTITY
Reductions in Medicaid Funding Could Substantially Reduce Our Profitability.
Nearly all of our revenues come from Medicaid premiums. The base premium
rate paid by each state differs, depending on a combination of factors such as
defined upper payment limits, a member's health status, age, gender, county or
region, benefit mix and member eligibility categories. Future levels of Medicaid
premium rates may be affected by continued government efforts to contain medical
costs and may further be affected by state and federal budgetary constraints.
Changes to Medicaid programs could reduce the number of persons enrolled or
eligible, reduce the amount of reimbursement or payment levels, or increase our
administrative or healthcare costs under those programs. States periodically
consider reducing or reallocating the amount of money they spend for Medicaid.
We believe that additional reductions in Medicaid payments could substantially
reduce our profitability. Further, our contracts with the states are subject to
cancellation by the state after a short notice period in the event of
unavailability of state funds.
If Our Medicaid and CHIP Contracts are Terminated or are not Renewed, Our
Business will Suffer.
We provide managed care programs and selected services to individuals
receiving benefits under Medicaid, including SSI and CHIP. We provide those
healthcare services under five contracts with regulatory entities in the areas
in which we operate. The contracts expire on various dates between December 31,
2002 and December 31, 2003. Our contracts with the states of Indiana and
Wisconsin accounted for 73% of our revenues for the year ended December 31,
2001. Our contracts may be terminated if we fail to perform up to the standards
set by state regulatory agencies. In addition, the Indiana contract under which
we operate can be terminated by the state without cause. Our contracts are
generally intended to run for two years and may be extended for one or two
additional years if the state or its contractor elects to do so. When our
contracts expire, they may be opened for bidding by competing healthcare
providers. There is no guarantee that our contracts will be renewed or extended.
If any of our contracts are terminated, not renewed, or renewed on less
favorable terms, our business will suffer, and our operating results may be
materially affected.
Changes in Government Regulations Designed to Protect Providers and Members
Rather than Our Stockholders Could Force Us to Change How We Operate and
Could Harm Our Business.
Our business is extensively regulated by the states in which we operate and
by the federal government. The applicable laws and regulations are subject to
frequent change and generally are intended to benefit and protect health plan
providers and members rather than stockholders. Changes in existing laws and
rules, the enactment of new laws and rules, or changing interpretations of these
laws and rules could, among other things:
- force us to restructure our relationships with providers within our
network;
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- require us to implement additional or different programs and systems;
- mandate minimum medical expense levels as a percentage of premium
revenues;
- restrict revenue and enrollment growth;
- require us to develop plans to guard against the financial insolvency
of our providers;
- increase our healthcare and administrative costs;
- impose additional capital and reserve requirements; and
- increase or change our liability to members in the event of
malpractice by our providers.
For example, Congress currently is considering various forms of patient
protection legislation commonly known as Patients' Bills of Rights. We cannot
predict the impact of this legislation, if adopted, on our business.
Regulations may Decrease the Profitability of Our Health Plans.
Our Texas plans are required to pay a rebate to the state in the event
profits exceed established levels. This regulatory requirement, changes in this
requirement or the adoption of similar requirements by our other regulators may
limit our ability to increase our overall profits as a percentage of revenues.
The State of Texas has implemented and is enforcing a penalty provision for
failure to pay claims in a timely manner. Failure to meet this requirement can
result in financial fines and penalties. In addition, states may attempt to
reduce their contract premium rates if regulators perceive our medical loss
ratio as too low. Any of these regulatory actions could harm our operating
results.
Also, on January 18, 2002, the federal Centers for Medicare and Medicaid
Services, or CMS, published a final rule that removed an exception contained in
the federal Medicaid reimbursement regulations permitting states to reimburse
non-state government-owned or operated hospitals for inpatient and outpatient
hospital services at amounts up to 150 percent of a reasonable estimate of the
amount that would be paid for the services furnished by these hospitals under
Medicare payment principles. This development in federal law could decrease the
profitability of our health plans.
Failure to Comply with Government Regulations Could Subject Us to Civil and
Criminal Penalties.
Federal and state governments have enacted fraud and abuse laws and other
laws to protect patients' privacy and access to healthcare. Violation of these
and other laws or regulations governing our operations or the operations of our
providers could result in the imposition of civil or criminal penalties, the
cancellation of our contracts to provide services, the suspension or revocation
of our licenses or our exclusion from participating in the Medicaid, SSI and
CHIP programs. Because of these potential sanctions, we seek to monitor our
compliance and that of our providers with federal and state fraud and abuse and
other healthcare laws on an ongoing basis. These penalties or exclusions, were
they to occur as the result of our actions or omissions, or our inability to
monitor the compliance of our providers, would negatively impact our ability to
operate our business. For example, failure to pay our providers promptly could
result in the imposition of fines and other penalties. In some states, we may be
subject to regulation by more than one governmental authority, which may impose
overlapping or inconsistent regulations.
The Health Insurance Portability and Accountability Act of 1996, or HIPAA,
broadened the scope of fraud and abuse laws applicable to healthcare companies.
HIPAA created civil penalties for, among other things, billing for medically
unnecessary goods or services. HIPAA established new enforcement mechanisms to
combat fraud and abuse, including a whistle blower program. Further, HIPAA
imposes
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civil and, in some instances, criminal penalties for failure to comply with
specific standards relating to the privacy, security and electronic transmission
of individually-identifiable health information. Congress may enact additional
legislation to increase penalties and to create a private right of action under
HIPAA, which would entitle patients to seek monetary damages for violations of
the privacy rules.
Compliance with New Government Regulations may Require Us to Make Significant
Expenditures.
In August 2000, the Department of Health and Human Services, or HHS, issued
a new regulation under HIPAA requiring the use of uniform electronic data
transmission standards for healthcare claims and payment transactions submitted
or received electronically. We are required to comply with the new regulation by
October 2002, or submit a "compliance plan" with HHS on or before October 15,
2002, that details how we will meet the extended compliance deadline of October
16, 2003. In addition, Texas has indicated that it may impose an earlier
compliance deadline. In August 1998, HHS proposed a regulation that would
require healthcare participants to implement organizational and technical
practices to protect the security of electronically maintained or transmitted
health-related information. In December 2000, HHS issued a new regulation
mandating heightened privacy and confidentiality protections under HIPAA that
became effective on April 14, 2001. Compliance with this regulation will be
required by April 14, 2003.
In January 2001, CMS (then the Health Care Financing Administration)
published new regulations regarding Medicaid managed care. CMS subsequently
delayed the effective date of these regulations until August 16, 2002. In August
2001, CMS proposed new regulations that would modify the January regulations. If
adopted, these regulations would implement the requirements of the Balanced
Budget Act of 1997 that are intended to give states more flexibility in their
administration of Medicaid managed care programs, provide new patient
protections for Medicaid managed care enrollees and require states to meet new
actuarial soundness requirements.
The Bush Administration's issuance of new regulations, its review of the
existing HIPAA rules and other newly published regulations, the states' ability
to promulgate stricter rules, and uncertainty regarding many aspects of the
regulations may make compliance with the relatively new regulatory landscape
difficult. Our existing programs and systems would not enable us to comply in
all respects with these new regulations. In order to comply with the regulatory
requirements, we will be required to employ additional or different programs and
systems, the costs of which are unknown to us at this time. Further, compliance
with these regulations would require changes to many of the procedures we
currently use to conduct our business, which may lead to additional costs that
we have not yet identified. We do not know whether, or the extent to which, we
will be able to recover our costs of complying with these new regulations from
the states. The new regulations and the related compliance costs could have a
material adverse effect on our business.
Changes in Healthcare Law may Reduce Our Profitability.
Numerous proposals relating to changes in healthcare law have been
introduced, some of which have been passed by Congress and the states in which
we operate or may operate in the future. Changes in applicable laws and
regulations are continually being considered, and interpretations of existing
laws and rules may also change from time to time. We are unable to predict what
regulatory changes may occur or what effect any particular change may have on
our business. These changes could reduce the number of persons enrolled or
eligible for Medicaid and reduce the reimbursement or payment levels for medical
services. More generally, we are unable to predict whether new laws or proposals
will favor or hinder the growth of managed healthcare.
We cannot predict the outcome of these legislative or regulatory proposals
or the effect that they will have on us. Legislation or regulations that require
us to change our current manner of operation, provide
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additional benefits or change our contract arrangements may seriously harm our
operations and financial results.
If We are Unable to Participate in CHIP Programs Our Growth Rate may be
Limited.
CHIP is a relatively new federal initiative designed to provide coverage
for low-income children not otherwise covered by Medicaid or other insurance
programs. The programs vary significantly from state to state. Participation in
CHIP programs is an important part of our growth strategy. If states do not
allow us to participate or if we fail to win bids to participate, our growth
strategy may be materially and adversely affected.
If State Regulators do not Approve Payments of Dividends and Distributions by
Our Subsidiaries to Us, We may not Have Sufficient Funds to Implement Our
Business Strategy.
We principally operate through our health plan subsidiaries. If funds
normally available to us become limited in the future, we may need to rely on
dividends and distributions from our subsidiaries to fund our operations. These
subsidiaries are subject to regulations that limit the amount of dividends and
distributions that can be paid to us without prior approval of, or notification
to, state regulators. If these regulators were to deny our subsidiaries' request
to pay dividends to us, the funds available to our company as a whole would be
limited, which could harm our ability to implement our business strategy.
RISKS RELATED TO OUR BUSINESS
Receipt of Inadequate Premiums Would Negatively Affect Our Revenues and
Profitability.
Nearly all of our revenues are generated by premiums consisting of fixed
monthly payments per member. These premiums are fixed by contract, and we are
obligated during the contract periods to provide healthcare services as
established by the state governments. We use a large portion of our revenues to
pay the costs of healthcare services delivered to our customers. If premiums do
not increase when expenses related to medical services rise, our earnings would
be affected negatively. In addition, our actual medical services costs may
exceed our estimates, which would cause our health benefits ratio, or our
expenses related to medical services as a percentage of premium revenues, to
increase and our profits to decline. In addition, it is possible for a state to
increase the rates payable to the hospitals without granting a corresponding
increase in premiums to us. If this were to occur in one or more of the states
in which we operate, our profitability would be harmed.
Failure to Effectively Manage Our Medical Costs or Related Administrative
Costs Would Reduce Our Profitability.
Our profitability depends, to a significant degree, on our ability to
predict and effectively manage expenses related to health benefits. We have less
control over the costs related to medical services than we do over our general
and administrative expenses. Historically, our health benefits ratio has
fluctuated. For example, our health benefits ratio was 82.2% for the six months
ended June 30, 2002, 83.0% for 2001 and 84.3% for 2000, but was 88.9% for 1999
and 88.4% for 1998. Because of the narrow margins of our health plan business,
relatively small changes in our health benefits ratio can create significant
changes in our financial results. Changes in healthcare regulations and
practices, the level of use of healthcare services, hospital costs,
pharmaceutical costs, major epidemics, new medical technologies and other
external factors, including general economic conditions such as inflation
levels, are beyond our control and could reduce our ability to predict and
effectively control the costs of providing health benefits. We may not be able
to manage costs effectively in the future. If our costs related to health
benefits increase, our profits could be reduced or we may not remain profitable.
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Failure to Accurately Predict Our Medical Expenses Could Negatively Affect
Our Reported Results.
Our medical expenses include estimates of medical expenses incurred but not
yet reported, or IBNR. We estimate our IBNR medical expenses monthly based on a
number of factors. Adjustments, if necessary, are made to medical expenses in
the period during which the actual claim costs are ultimately determined or when
criteria used to estimate IBNR change. We cannot be sure that our IBNR estimates
are adequate or that adjustments to those estimates will not harm our results of
operations. From time to time in the past, our actual results have varied from
our estimates, particularly in times of significant changes in the number of our
members. Our failure to accurately estimate IBNR may also affect our ability to
take timely corrective actions, further harming our results.
Difficulties in Executing Our Acquisition Strategy Could Adversely Affect Our
Business.
Historically, the acquisition of Medicaid contract rights and related
assets of other health plans, both in our existing service areas and in new
markets, has accounted for a significant amount of our growth. For example, our
acquisition of contract rights from Humana in February 2001 accounted for 88.0%
of the increase in our net premium revenues for 2001 compared to 2000. Many of
the other potential purchasers of Medicaid assets have greater financial
resources than we have. In addition, many of the sellers are interested either
in (1) selling, along with their Medicaid assets, other assets in which we do
not have an interest or (2) selling their companies, including their
liabilities, as opposed to the assets of their ongoing businesses.
We generally are required to obtain regulatory approval from one or more
state agencies when making acquisitions. In the case of an acquisition of a
business located in a state in which we do not currently operate, we would be
required to obtain the necessary licenses to operate in that state. In addition,
even if we already operate in a state in which we acquire a new business, we
would be required to obtain additional regulatory approval if the acquisition
would result in our operating in an area of the state in which we did not
operate previously and we could be required to renegotiate provider contracts of
the acquired business. We cannot assure you that we would be able to comply with
these regulatory requirements for an acquisition in a timely manner, or at all.
In deciding whether to approve a proposed acquisition, state regulators may
consider a number of factors outside our control, including giving preference to
competing offers made by locally owned entities or by not-for-profit entities.
Furthermore, we are party to a revolving line of credit facility that prohibits
some acquisitions without the consent of our bank lender.
In addition to the difficulties we may face in identifying and consummating
acquisitions, we will also be required to integrate and consolidate any acquired
business or assets with our existing operations. This may include the
integration of:
- additional personnel who are not familiar with our operations and
corporate culture;
- existing provider networks, which may operate on different terms than
our existing networks;
- existing members, who may decide to switch to another healthcare plan;
and
- disparate administrative, accounting and finance, and information
systems.
For example, in the Humana acquisition, the configuration of new provider
contracts temporarily extended our claims payment process.
Accordingly, we may be unable to successfully identify, consummate and
integrate future acquisitions or operate acquired businesses profitably. We also
may be unable to obtain sufficient
19
additional capital resources for future acquisitions. If we are unable to
effectively execute our acquisition strategy, our future growth will suffer and
our results of operations could be harmed.
Failure to Achieve Timely Profitability in Any Business Would Negatively
Affect Our Results of Operations.
Start-up costs associated with a new business can be substantial. For
example, in order to obtain a certificate of authority in most jurisdictions, we
must first establish a provider network, have systems in place and demonstrate
our ability to obtain a state contract and process claims. If we were
unsuccessful in obtaining the necessary license, winning the bid to provide
service or attracting members in numbers sufficient to cover our costs, any new
business of ours would fail. We also could be obligated by the state to continue
to provide services for some period of time without sufficient revenue to cover
our ongoing costs or recover start-up costs. In addition, we may not be able to
effectively commercialize any new programs or services we seek to market to
third parties. The expenses associated with starting up a new business could
have a significant impact on our results of operations if we are unable to
achieve profitable operations in a timely fashion.
We Derive All of Our Revenues from Operations in Three States, and Our
Operating Results Would be Materially Affected by a Decrease in Revenues or
Profitability in Any One of Those States.
Operations in Wisconsin, Indiana and Texas account for all of our revenues.
If we were unable to continue to operate in each of those states or if our
current operations in any portion of one of those states were significantly
curtailed, our revenues would decrease materially. In the first half of 2001,
our membership in Indiana declined by approximately 46,000 due to a
subcontracting provider organization terminating a percent-of-premium
arrangement. In 2000, we reduced our service area in Wisconsin from 36 to 18
counties. In 1999 and 2000, we terminated our services to most of the southern
counties of Indiana. Our reliance on operations in a limited number of states
could cause our revenue and profitability to change suddenly and unexpectedly,
depending on legislative actions, economic conditions and similar factors in
those states. Our inability to continue to operate in any of the states in which
we operate would harm our business.
Competition may Limit Our Ability to Increase Penetration of the Markets that
We Serve.
We compete for members principally on the basis of size and quality of
provider network, benefits provided and quality of service. We compete with
numerous types of competitors, including other health plans and traditional
state Medicaid programs that reimburse providers as care is provided. Subject to
limited exceptions by federally approved state applications, the federal
government requires that there be choices for Medicaid recipients among managed
care programs. Voluntary programs and mandated competition may limit our ability
to increase our market share.
Some of the health plans with which we compete have greater financial and
other resources and offer a broader scope of products than we do. In addition,
significant merger and acquisition activity has occurred in the managed care
industry, as well as in industries that act as suppliers to us, such as the
hospital, physician, pharmaceutical, medical device and health information
systems industries. To the extent that competition intensifies in any market
that we serve, our ability to retain or increase members and providers, or
maintain or increase our revenue growth, pricing flexibility and control over
medical cost trends may be adversely affected.
In addition, in order to increase our membership in the markets we
currently serve, we believe that we must continue to develop and implement
community-specific products, alliances with key providers and localized outreach
and educational programs. If we are unable to develop and implement these
initiatives,
20
or if our competitors are more successful than we are in doing so, we may not be
able to further penetrate our existing markets.
If We are Unable to Maintain Satisfactory Relationships with Our Provider
Networks, Our Profitability will be Harmed.
Our profitability depends, in large part, upon our ability to contract
favorably with hospitals, physicians and other healthcare providers. Our
provider arrangements with our primary care physicians, specialists and
hospitals generally may be cancelled by either party without cause upon 90 to
120 days' prior written notice. We cannot assure you that we will be able to
continue to renew our existing contracts or enter into new contracts enabling us
to service our members profitably.
From time to time providers assert or threaten to assert claims seeking to
terminate noncancellable agreements due to alleged actions or inactions by us.
Even if these allegations represent attempts to avoid or renegotiate contractual
terms that have become economically disadvantageous to the providers, it is
possible that in the future a provider may pursue such a claim successfully.
Regardless of whether any claims brought against us are successful or have
merit, they will still be time-consuming and costly and could distract our
management's attention. As a result, we may incur significant expenses and may
be unable to operate our business effectively.
We will be required to establish acceptable provider networks prior to
entering new markets. We may be unable to enter into agreements with providers
in new markets on a timely basis or under favorable terms.
If we are unable to retain our current provider contracts or enter into new
provider contracts timely or on favorable terms, our profitability will be
harmed.
We may be Unable to Attract and Retain Key Personnel.
We are highly dependent on our ability to attract and retain qualified
personnel to operate and expand our Medicaid managed care business. If we lose
one or more members of our senior management team, including our chief executive
officer, Michael F. Neidorff, who has been instrumental in developing our
mission and forging our business relationships, our business and operating
results could be harmed. We do not have an employment agreement with Mr.
Neidorff, and we cannot assure you that we will be able to retain his services.
Our ability to replace any departed members of our senior management or other
key employees may be difficult and may take an extended period of time because
of the limited number of individuals in the Medicaid managed care industry with
the breadth of skills and experience required to operate and expand successfully
a business such as ours. Competition to hire from this limited pool is intense,
and we may be unable to hire, train, retain or motivate these personnel.
Negative Publicity Regarding the Managed Care Industry may Harm Our Business
and Operating Results.
Recently, the managed care industry has received negative publicity. This
publicity has led to increased legislation, regulation, review of industry
practices and private litigation in the commercial sector. These factors may
adversely affect our ability to market our services, require us to change our
services, and increase the regulatory burdens under which we operate. Any of
these factors may increase the costs of doing business and adversely affect our
operating results.
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Claims Relating to Medical Malpractice Could Cause Us to Incur Significant
Expenses.
Our providers and employees involved in medical care decisions may be
subject to medical malpractice claims. In addition, some states, including
Texas, have adopted legislation that permits managed care organizations to be
held liable for negligent treatment decisions or benefits coverage
determinations. Claims of this nature, if successful, could result in
substantial damage awards against us and our providers that could exceed the
limits of any applicable insurance coverage. Therefore, successful malpractice
or tort claims asserted against us, our providers or our employees could
adversely affect our financial condition and profitability. Even if any claims
brought against us are unsuccessful or without merit, they would still be
time-consuming and costly and could distract our management's attention. As a
result, we may incur significant expenses and may be unable to operate our
business effectively.
Growth in the Number of Medicaid-Eligible Persons During Economic Downturns
Could Cause Our Operating Results and Stock Prices to Suffer if State and
Federal Budgets Decrease or do not Increase.
Less favorable economic conditions may cause our membership to increase as
more people become eligible to receive Medicaid benefits. During such economic
downturns, however, state and federal budgets could decrease, causing states to
attempt to cut healthcare programs, benefits and rates. In particular, the
terrorist acts of September 11, 2001 created an uncertain economic environment
that has continued to date, and we cannot predict the impact of these events,
other acts of terrorism or related military action on federal or state funding
of healthcare programs or on the size of the Medicaid-eligible population. If
federal funding were decreased or unchanged while our membership was increasing,
our results of operations would suffer.
Growth in the Number of Medicaid-Eligible Persons may be Countercyclical,
Which Could Cause Our Operating Results to Suffer When General Economic
Conditions are Improving.
Historically, the number of persons eligible to receive Medicaid benefits
has increased more rapidly during periods of rising unemployment, corresponding
to less favorable general economic conditions. Conversely, this number may grow
more slowly or even decline if economic conditions improve. Therefore,
improvements in general economic conditions may cause our membership levels to
decrease, thereby causing our operating results to suffer, which could lead to
decreases in our stock price during periods in which stock prices in general are
increasing.
We Intend to Expand Primarily into Markets Where Medicaid Recipients are
Required to Enroll in Managed Care Plans.
We expect to continue to focus our business in states in which Medicaid
enrollment in managed care is mandatory. Currently, approximately two-thirds of
the states require health plan enrollment for Medicaid eligible participants in
all or a portion of their counties. The programs are voluntary in other states.
Because we concentrate on markets with mandatory enrollment, we expect the
geographic expansion of our business to be limited to those states.
If We are Unable to Integrate and Manage Our Information Systems Effectively,
Our Operations Could be Disrupted.
Our operations depend significantly on effective information systems. The
information gathered and processed by our information systems assists us in,
among other things, monitoring utilization and other cost factors, processing
provider claims, and providing data to our regulators. Our providers also depend
upon our information systems for membership verifications, claims status and
other information.
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Our information systems and applications require continual maintenance,
upgrading and enhancement to meet our operational needs. Moreover, our
acquisition activity requires frequent transitions to or from, and the
integration of, various information systems. We regularly upgrade and expand our
information systems capabilities. If we experience difficulties with the
transition to or from information systems or are unable to properly maintain or
expand our information systems, we could suffer, among other things, from
operational disruptions, loss of existing members and difficulty in attracting
new members, regulatory problems and increases in administrative expenses. In
addition, our ability to integrate and manage our information systems may be
impaired as the result of events outside our control, including acts of nature,
such as earthquakes or fires, or acts of terrorists.
We may not be Able to Obtain and Maintain Adequate Insurance.
We maintain liability insurance, subject to limits and deductibles, for
claims that could result from providing or failing to provide managed care and
related services. These claims could be substantial. We believe that our present
insurance coverage and reserves are adequate to cover currently estimated
exposures. We cannot assure you that we will be able to obtain adequate
insurance coverage in the future at acceptable costs or that we will not incur
significant liabilities in excess of policy limits.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of June 30, 2002, we had short-term investments of $6.1 million and
long-term investments of $78.8 million. The short-term investments primarily
consist of securities with original maturities between three and twelve months.
The long-term investments consist of municipal bonds and have original
maturities greater than one year. The majority of our investments are highly
liquid, with a weighted average duration of three months at June 30, 2002. Our
investments are subject to interest rate risk and will decrease in value if
market rates increase. We have the ability to hold the short-term investments to
maturity, and as a result, we would not expect the value of these investments to
decline significantly as a result of a sudden change in market interest rates.
Assuming a hypothetical and immediate 1% increase in market interest rates at
June 30, 2002, the fair value of our long-term income investments would decrease
by approximately $834,000. Similarly, a 1% decrease in market interest rates at
June 30, 2002 would result in an increase of the fair value of our investments
of approximately $834,000. Declines in interest rates over time will reduce our
investment income.
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PART II. OTHER INFORMATION
--------------------------
ITEM 1. LEGAL PROCEEDINGS
From 1998 to 2000, we provided Medicaid services in certain regions of
Indiana as subcontractor with Maxicare, Indiana, Inc. In June 2001, the
Insurance Commissioner of the Indiana Department of Insurance declared Maxicare
insolvent and ordered Maxicare into liquidation. In September 2001, we filed an
adversary proceeding in Marion County Circuit Court against Maxicare and the
Indiana Insurance Commissioner seeking declaratory and injunctive relief and the
turnover of funds. This proceeding is based on our belief that the State of
Indiana's proposed liquidation plan for Maxicare does not adequately address our
claims for approximately $4.7 million that we believe is owed to us by Maxicare.
Maxicare and the Indiana Insurance Commissioner subsequently filed a
counterclaim suit against us seeking, among other things, to avoid any claims we
have for funds held by Maxicare and to recover payments previously made to us by
Maxicare in the amount of approximately $2.0 million, on the grounds those
payments constituted preferential transfers. A bench trial is scheduled for July
26, 2002.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held our annual meeting of stockholders on June 3, 2002. At the meeting,
Samuel E. Bradt and Michael F. Neidorff were reelected as Class I directors. The
vote with respect to each nominee is set forth below:
Total Vote for Total Vote Withheld
Each Director From Each Director
-------------- -------------------
Mr. Bradt 7,743,809 92,297
Mr. Neidorff 7,579,134 256,972
Additional directors of the company whose terms of office continued after
the meeting are Edward L. Cahill, Howard E. Cox, Jr., Robert K. Ditmore, Claire
W. Johnson and Richard P. Wiederhold.
Our stockholders approved our 2002 Employee Stock Purchase Plan authorizing
the issuance of up to 300,000 shares of common stock for purchase by eligible
employees at a discounted price. The plan was approved by a vote of 7,821,856
shares for, 14,250 shares against and -0- shares abstaining.
ITEM 5. OTHER INFORMATION
None.
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ITEM 6. EXHIBITS AND REPORT ON FORM 8-K
(a) Exhibits
The following exhibits are incorporated by reference from our Amendment No.
2 to Form S-1 filed with the SEC on May 14, 2002
10.1 Loan Agreement between Centene Corporation and LaSalle Bank
National Association, dated May 1, 2002
10.1a Revolving Note between Centene Corporation and LaSalle Bank
National Association, dated May 1, 2002
10.1b Stock Pledge Agreement between Centene Corporation and LaSalle
Bank National Association, dated May 1, 2002
(b) Report on Form 8-K
On June 20, 2002 we filed a current report on Form 8-K with respect to our
engagement of PricewaterhouseCoopers LLP as our independent accountants
succeeding Arthur Andersen LLP.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: July 24, 2002
CENTENE CORPORATION
By: /s/ Michael F. Neidorff
---------------------------------------
MICHAEL F. NEIDORFF
President and Chief Executive Officer
By: /s/ Karey L. Witty
---------------------------------------
KAREY L. WITTY
Senior Vice President, Chief Financial
Officer, Secretary and Treasurer
26