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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to ___________
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Commission file number 000-33395
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CENTENE CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 04-1406317
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
7711 CARONDELET AVENUE, SUITE 800
ST. LOUIS, MISSOURI 63105
(Address of Principal Executive Offices) (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: Yes [X] No [ ]
As of October 18, 2002, the registrant had 10,769,199 shares of common
stock, $.001 par value per share, outstanding.
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CENTENE CORPORATION
QUARTERLY REPORT ON FORM 10-Q
INDEX
PAGE
----
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements..........................................................................3
Consolidated Balance Sheets as of September 30, 2002 (unaudited) and December 31, 2001........3
Consolidated Statements of Earnings for the Three Months Ended September 30, 2002 and
2001 (unaudited) and the Nine Months Ended September 30, 2002 (unaudited) and 2001.......4
Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 2002 (unaudited) and 2001..................................................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...................................22
Item 4. Controls and Procedures......................................................................22
PART II
OTHER INFORMATION
Item 1. Legal Proceedings............................................................................23
Item 2. Changes in Securities and Use of Proceeds....................................................23
Item 3. Defaults Upon Senior Securities..............................................................23
Item 4. Submission of Matters to a Vote of Security Holders..........................................23
Item 5. Other Information............................................................................23
Item 6. Exhibits and Reports on Form 8-K.............................................................23
SIGNATURES..............................................................................................24
CERTIFICATIONS..........................................................................................25
2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
CENTENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------ -----------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ..................................................... $ 56,066 $ 88,867
Premium and related receivables, net of allowances of $591 and $3,879,
respectively ................................................................ 8,250 7,032
Short-term investments, at fair value (amortized cost $9,890 and $1,166,
respectively) ............................................................... 9,834 1,169
Deferred income taxes ......................................................... 2,589 2,515
Other current assets .......................................................... 3,202 2,464
-------- --------
Total current assets ........................................................ 79,941 102,047
LONG-TERM INVESTMENTS, at fair value (amortized cost $75,440 and $22,127,
respectively) ................................................................. 76,974 22,339
PROPERTY AND EQUIPMENT, net ...................................................... 5,600 3,796
INTANGIBLE ASSETS, net ........................................................... 3,217 2,396
DEFERRED INCOME TAXES ............................................................ -- 788
OTHER ASSETS ..................................................................... 5,034 --
-------- --------
Total assets ................................................................ $170,766 $131,366
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Medical claims liabilities .................................................... $ 65,194 $ 59,565
Unearned capitation premium ................................................... 897 --
Accounts payable and accrued expenses ......................................... 5,235 7,712
-------- --------
Total current liabilities ................................................... 71,326 67,277
OTHER LIABILITIES ................................................................ 4,546 --
-------- --------
Total liabilities ........................................................... 75,872 67,277
-------- --------
STOCKHOLDERS' EQUITY:
Common stock, $.001 par value; authorized 40,000,000 shares; 10,767,407 and
10,085,112 shares issued and outstanding, respectively ...................... 11 10
Additional paid-in capital .................................................... 72,058 60,857
Net unrealized gain on investments, net of tax ................................ 931 135
Retained earnings ............................................................. 21,894 3,087
-------- --------
Total stockholders' equity .................................................. 94,894 64,089
-------- --------
Total liabilities and stockholders' equity .................................. $170,766 $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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
2002 2001 2002 2001
------------ ----------- ------------ -----------
(UNAUDITED) (UNAUDITED)
REVENUES:
Premiums .............................................. $ 116,289 $ 85,313 $ 319,441 $ 235,995
Administrative services fees .......................... 109 101 320 283
------------ ----------- ------------ -----------
Total revenues ...................................... 116,398 85,414 319,761 236,278
------------ ----------- ------------ -----------
EXPENSES:
Medical services costs ................................ 95,644 70,473 262,697 195,512
General and administrative expenses ................... 12,726 9,586 35,056 27,992
------------ ----------- ------------ -----------
Total operating expenses ............................ 108,370 80,059 297,753 223,504
------------ ----------- ------------ -----------
Earnings from operations ............................ 8,028 5,355 22,008 12,774
OTHER INCOME (EXPENSE):
Investment and other income, net ...................... 6,768 909 8,659 2,806
Interest expense ...................................... (16) (89) (27) (285)
------------ ----------- ------------ -----------
Earnings before income taxes ........................ 14,780 6,175 30,640 15,295
INCOME TAX EXPENSE ....................................... 5,507 2,612 11,833 6,320
------------ ----------- ------------ -----------
Net earnings ........................................ 9,273 3,563 18,807 8,975
ACCRETION OF REDEEMABLE PREFERRED STOCK .................. -- (123) -- (369)
------------ ----------- ------------ -----------
Net earnings attributable to common stockholders .... $ 9,273 $ 3,440 $ 18,807 $ 8,606
============ =========== ============ ===========
EARNINGS PER COMMON SHARE, BASIC:
Net earnings per common share ......................... $ 0.87 $ 3.78 $ 1.81 $ 9.47
EARNINGS PER COMMON SHARE, DILUTED:
Net earnings per common share ......................... $ 0.78 $ 0.45 $ 1.63 $ 1.15
SHARES USED IN COMPUTING PER SHARE AMOUNTS:
Basic ................................................. 10,694,797 908,939 10,372,053 908,918
Diluted ............................................... 11,833,381 7,862,779 11,565,345 7,787,653
The accompanying notes are an integral part of these statements.
4
CENTENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------
2002 2001
--------- --------
(UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings ................................................................. $ 18,807 $ 8,975
Adjustments to reconcile net earnings to net cash provided by operating
activities --
Depreciation and amortization ............................................ 1,534 1,274
Stock compensation expense ............................................... 264 6
Gain on sale of investments .............................................. (632) (72)
Changes in assets and liabilities --
(Increase) decrease in premium and related receivables ..................... (1,218) 8,285
(Increase) decrease in other current assets ................................ (663) 810
Decrease in deferred income taxes .......................................... 248 338
Decrease in other assets ................................................... 171 --
Increase in medical claims liabilities ..................................... 5,629 13,100
(Decrease) increase in accounts payable and accrued expenses ............... (2,247) 6,850
Increase in unearned capitation premium .................................... 897 --
Decrease in other liabilities .............................................. (659) --
--------- --------
Net cash provided by operating activities ................................ 22,131 39,566
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment ........................................... (3,110) (2,540)
Purchase of investments ...................................................... (155,690) (17,459)
Sales and maturities of investments .......................................... 96,975 16,148
Contract acquisitions ........................................................ (570) (1,250)
Investment in subsidiary ..................................................... (3,193) 7,995
--------- --------
Net cash (used in) provided by investing activities ...................... (65,588) 2,894
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock ................................... 10,317 17
Proceeds from exercise of stock options ...................................... 339 --
Purchase/redemption of stock ................................................. -- (102)
--------- --------
Net cash provided by (used in) financing activities ...................... 10,656 (85)
--------- --------
Net (decrease) increase in cash and cash equivalents ..................... (32,801) 42,375
--------- --------
CASH AND CASH EQUIVALENTS, beginning of period .................................. 88,867 19,023
--------- --------
CASH AND CASH EQUIVALENTS, end of period ........................................ $ 56,066 $ 61,398
========= ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid ................................................................ $ 11 $ 817
Income taxes paid ............................................................ $ 11,878 $ 2,107
The Company purchased all of the capital stock of Bankers Reserve for $3,527
(Note 6). 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 THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS 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 the State Children's Health Insurance
Program (SCHIP). 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. INVESTMENT AND OTHER INCOME
During July 2002, Centene received a one-time dividend of $5,055 from United
SPC, a captive insurance company in which Centene maintained an investment. The
dividend related to underwriting gains on certain underlying books of business
assumed by United SPC.
4. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible
Assets," which requires that goodwill and intangible assets with indefinite
useful lives no longer be amortized, but instead be 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
September 30, 2001, this adjustment would have added $108 in net earnings, or
$0.01 per diluted share and $0.12 per basic share. For the nine months ended
September 30, 2001, this adjustment would have added $353 in net earnings, or
$0.05 per diluted share and $0.39 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.
In May 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4,
44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections as of
April 2002." As a result of the rescission of SFAS No. 4, gains and losses
related to the extinguishment of debt should be classified as extraordinary only
if they meet the criteria outlined under APB Opinion No. 30, "Reporting the
Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." SFAS No. 64, "Extinguishments of Debt Made to Satisfy
Sinking-Fund Requirements," was an amendment to SFAS No. 4 and is no longer
necessary. SFAS No. 44, "Accounting for Intangible Assets of Motor Carriers,"
defined accounting requirements for the effects of the transition to the Motor
Carrier Act of 1980. The transitions are
6
CENTENE CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
complete and SFAS No. 44 is no longer necessary. SFAS No. 145 amends SFAS No.
13, "Accounting for Leases," requiring that any capital lease that is modified
resulting in an operating lease should be accounted for under the sale-leaseback
provisions of SFAS No. 98 or SFAS No. 28, as applicable. SFAS No. 145 is
effective for fiscal years beginning after May 15, 2002. The adoption of the
provisions of SFAS No. 145 is not expected to have a material impact on the
Company's results of operations, financial position or cash flows.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which requires that a liability for a cost
associated with an exit or disposal activity be recognized when the liability is
incurred. This statement nullifies Emerging Issues Task Force Issue No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring),"
which required that a liability for an exit cost be recognized upon the entity's
commitment to an exit plan. SFAS No. 146 is effective for exit or disposal
activities that are initiated after December 31, 2002. The adoption of the
provisions of SFAS No. 146 is not expected to 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:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- --------------------------
2002 2001 2002 2001
----------- ---------- ----------- -----------
Net earnings .............................................. $ 9,273 $ 3,563 $ 18,807 $ 8,975
Accretion of redeemable preferred stock ................... -- (123) -- (369)
----------- ---------- ----------- -----------
Net earnings attributable to common stockholders .......... $ 9,273 $ 3,440 $ 18,807 $ 8,606
=========== ========== =========== ===========
Shares used in computing per share amounts:
Weighted average number of common shares outstanding ... 10,694,797 908,939 10,372,053 908,918
Dilutive effect of stock options and warrants (as
determined by applying the treasury stock
method) and convertible preferred stock .............. 1,138,584 6,953,840 1,193,292 6,878,735
----------- ---------- ----------- -----------
Weighted average number of common shares and
potential dilutive common shares outstanding ......... 11,833,381 7,862,779 11,565,345 7,787,653
=========== ========== =========== ===========
Earnings per common share, basic:
Net earnings per common share .......................... $ 0.87 $ 3.78 $ 1.81 $ 9.47
Earnings per common share, diluted:
Net earnings per common share .......................... $ 0.78 $ 0.45 $ 1.63 $ 1.15
6. 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
$3,527. 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 nine-month period ended September
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
ten years. In addition, as part of the Bankers Reserve
7
CENTENE CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
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 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.
7. CONTRACT ACQUISITIONS
During August 2002, Superior HealthPlan, Inc. (Superior), a wholly owned Texas
corporation, purchased the rights to Texas Universities Health Plan, Inc.'s
SCHIP contracts with the State of Texas in three service areas. The transition
of these contracts will occur September through November 2002 and will allow
Superior to serve approximately 26,000 additional members in the state.
As a result of the above transaction, $570 was recorded as an intangible asset
related to purchased contract rights. Centene is amortizing the contract rights
on a straight-line basis over five years, the period expected to be benefited.
8. PENDING ACQUISITIONS
In August 2002, Centene and University of Medicine and Dentistry of New Jersey
(UMDNJ) entered into an agreement for Centene to acquire UMDNJ's University
Health Plans, Inc. (UHP). UHP is a managed health plan serving approximately
50,000 Medicaid members in 15 counties throughout New Jersey. Under the terms of
the agreement, Centene will purchase 80% of the outstanding capital stock of UHP
for $10,000 in cash, with UMDNJ continuing to own 20% of UHP's stock. Centene
would have an option to purchase the remaining UHP stock within nine months of
closing for approximately $2,500 in cash. If Centene did not exercise the
option, Centene would acquire the remaining UHP stock at the third anniversary
of closing for an appraised value of that stock, payable at Centene's option in
cash or Centene common stock. The acquisition is subject to regulatory approvals
and other closing conditions.
9 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. On September 4, 2002,
the parties negotiated a release and settlement agreement, which is currently
awaiting court approval. The agreement requires no payment by either party, but
does allow for future agreements by which Centene may provide administrative
services for a fee. All receivable balances from Maxicare were previously fully
reserved and, therefore, written off.
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 State Children's Health Insurance Program or SCHIP. We have health
plans in Wisconsin, Indiana and Texas.
In August 2002, we purchased the rights to Texas Universities Health Plan,
Inc.'s SCHIP contracts with the State of Texas in three service areas. The
transition of these contracts will occur September through November 2002 and
will allow Superior to serve approximately 26,000 additional members in the
state. In addition, Centene and University of Medicine and Dentistry of New
Jersey, or UMDNJ, entered into an agreement for Centene to acquire UMDNJ's
University Health Plans, Inc., or UHP. UHP is a managed health plan serving
approximately 50,000 Medicaid members in 15 counties throughout New Jersey.
Under the terms of the agreement, Centene will purchase 80% of the outstanding
capital stock of UHP for $10.0 million in cash, with UMDNJ continuing to own 20%
of UHP's stock. Centene would have an option to purchase the remaining UHP stock
within nine months of closing for approximately $2.5 million in cash. If Centene
did not exercise the option, Centene would acquire the remaining UHP stock at
the third year anniversary of closing for an appraised value of that stock,
payable at Centene's option in cash or Centene common stock. The acquisition is
expected to close in the fourth quarter 2002, but is subject to regulatory
approvals and other closing conditions.
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
September 30, 2001 to September 30, 2002, our membership grew 31.7% 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:
SEPTEMBER 30,
---------------------
2002 2001
------- -------
Wisconsin................................ 126,800 108,100
Indiana.................................. 101,500 61,800
Texas.................................... 67,800 54,900
------- -------
Total................................. 296,100 224,800
======= =======
The following table depicts membership by line of business:
SEPTEMBER 30,
---------------------
2002 2001
------- -------
Medicaid................................ 266,700 204,500
SCHIP................................... 29,400 20,300
------- -------
Total................................ 296,100 224,800
======= =======
9
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 consider the costs to process medical claims, and estimates of
amounts to cover uncertainties related to fluctuations in physician billing
patterns, membership 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 actuarially 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2002 2001 2002 2001
---- ---- ---- ----
Health benefits ratio........... 82.2% 82.6% 82.2% 82.8%
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2002 2001 2002 2001
---- ---- ---- ----
General and administrative
expenses ratio............... 10.9% 11.2% 11.0% 11.8%
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 reflects the non-use fee on our revolving line of
credit facility. In 2001, interest expense reflected interest paid on
our subordinated notes, which we repaid in full in December 2001.
10
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 2001
Revenues
Premiums for the nine months ended September 30, 2002 increased $83.4
million, or 35.4%, to $319.4 million from $236.0 million for the comparable
period 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 nine months ended September 30, 2002
increased $37,000, or 13.1%, to $320,000 from $283,000 for the comparable period
in 2001. This increase resulted from increases in our non-risk SSI membership.
Operating Expenses
Medical services costs for the nine months ended September 30, 2002
increased $67.2 million, or 34.4%, to $262.7 million from $195.5 million for the
comparable period in 2001. This increase reflected the growth in our membership.
General and administrative expenses for the nine months ended September 30,
2002 increased $7.1 million, or 25.2%, to $35.1 million from $28.0 million for
the comparable period 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 nine months ended September 30, 2002 increased $6.1
million, or 242%, to $8.6 million from $2.5 million for the comparable period in
2001. This reflected a one-time dividend of $5.1 million from a captive
insurance company in which we maintained an investment.
Income Tax Expense
For the nine months ended September 30, 2002, we recorded income tax
expense of $11.8 million based on a 38.6% effective tax rate. For the nine
months ended September 30, 2001, we recorded income tax expense of $6.3 million
based on an effective tax rate of 41.3%. Our effective tax rate decreased period
over period primarily due to our investment in tax-advantaged securities and our
implementation of state tax savings strategies during the period ended September
30, 2002.
THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 2001
Revenues
Premiums for the three months ended September 30, 2002 increased $31.0
million, or 36.3%, to $116.3 million from $85.3 million for the comparable
period 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 September 30, 2002
increased $8,000, or 7.9%, to $109,000 from $101,000 for the comparable period
in 2001. This increase resulted from increases in our non-risk SSI membership.
Operating Expenses
Medical services costs for the three months ended September 30, 2002
increased $25.2 million, or 35.7%, to $95.6 million from $70.5 million for the
comparable period in 2001. This increase primarily reflected the growth in our
membership.
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General and administrative expenses for the three months ended September
30, 2002 increased $3.1 million, or 32.8%, to $12.7 million from $9.6 million
for the comparable period 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 September 30, 2002 increased $5.9
million, or 723%, to $6.8 million from $820,000 for the comparable period in
2001. This reflected a one-time dividend of $5.1 million from a captive
insurance company in which we maintained an investment.
Income Tax Expense
For the three months ended September 30, 2002, we recorded income tax
expense of $5.5 million based on a 37.3% effective tax rate. For the three
months ended September 30, 2001, we recorded income tax expense of $2.6 million
based on an effective tax rate of 42.3%. Our effective tax rate decreased period
over period due to our investment in tax advantaged securities and our
implementation of state tax savings strategies during the third quarter ended
September 30, 2002.
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 750,000 additional shares; 679,505 from selling stockholders
and 70,495 shares from us. We received net proceeds totaling $10.3 million from
the follow-on offering.
Our operating activities provided cash of $22.1 million for the nine months
ended September 30, 2002 compared to $39.6 million for the nine months ended
September 30, 2001. The decrease in cash provided in the nine months ended
September 30, 2002 compared to the nine months ended September 30, 2001 was due
to the timing of capitation receipts and membership increases. While membership
increased in both periods, the nine months ended September 20, 2002 had the
benefit of improved claims processing efficiencies implemented during 2002.
Our investing activities used cash of $65.6 million for 2002 and provided
cash of $2.9 million for the comparable period in 2001. The increase in the use
of cash in the nine months ended September 30, 2002 compared to the nine months
ended September 30, 2001 was due to the purchase of short-term and long-term
investments. Our investment policies are designed to provide liquidity, preserve
capital and maximize total return on invested assets. As such, as of September
30, 2002, our investment portfolio consisted primarily of municipal bonds with a
weighted average duration of 3.9 years. Cash is invested in investment vehicles
such as 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 7.2% for the nine months ended September 30, 2002.
Our financing activities provided cash of $10.7 million for the nine months
ended September 30, 2002 and used $85,000 for the nine months ended September
30, 2001. During the nine months ended September 30, 2002, financing cash flows
primarily consisted of our net proceeds from the follow-on public offering.
Our capital expenditures consist primarily of new software, software and
hardware upgrades, and furniture, equipment and leasehold improvements related
to office and market expansions. We purchased $3.1 million of capital assets
during the nine months ended September 30, 2002, and we anticipate spending $1.1
million for additional capital expenditures during the remainder of 2002.
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Our principal contractual obligations at September 30, 2002 consisted of
obligations under operating leases. The significant annual noncancelable lease
payments are as follows (in thousands):
PAYMENTS DUE
------------
September 30, through December 31, 2002........ $ 662
2003........................................... 2,785
2004........................................... 2,672
2005........................................... 2,576
2006........................................... 2,205
Thereafter..................................... 8,141
---------
$ 19,041
=========
During the third quarter 2002, we entered into a new lease agreement for a
ten-year period to support the expansion of the claims processing facility in
Farmington, Missouri. Lease payments will begin when we occupy the building,
which we anticipate will occur in the first quarter of 2003. This lease adds an
additional $274,000 to our annual contractual obligations.
At September 30, 2002, we had working capital of $8.6 million as compared
to $34.8 million at December 31, 2001. Our working capital is often minimal and
sometimes 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 $65.9 million at
September 30, 2002 and $90.0 million at December 31, 2001. Long-term investments
were $77.0 million at September 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 the
filing 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 minimum
quarterly earnings before income taxes, depreciation and amortization, or
EBITDA, of $1.5 million and minimum tangible net worth of $52.2 million. 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
September 30, 2002, all covenants were met. As of October 28, 2002, no
borrowings were outstanding 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 SCHIP contract
rights and related assets to increase our membership and to expand our business
into new service areas. During August 2002, we purchased the rights to Texas
Universities Health Plan, Inc.'s SCHIP contracts with the State of Texas for
$500,000. In addition, we are currently party to a definitive agreement that
would expand our Medicaid business into New Jersey, as described above under
"Overview." 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.
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. Generally, the
amount of dividend distributions that may be paid by a regulated subsidiary
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without prior approval by state regulatory authorities is limited based on the
entity's level of statutory net income and statutory capital and surplus.
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 September 30, 2002, our subsidiaries had aggregate statutory
capital and surplus of $22.3 million, compared with the required minimum
aggregate statutory capital and surplus requirements of $11.8 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.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards, or SFAS, No. 142, "Goodwill and
Other Intangible Assets," which requires that goodwill and intangible assets
with indefinite useful lives no longer be amortized, but instead be tested at
least annually for impairment. We adopted SFAS No. 142 effective January 1,
2002. Goodwill amortization has been discontinued. For the three months ended
September 30, 2001, this adjustment would have added $108,000 in net earnings,
or $0.01 per diluted share and $0.12 per basic share. For the nine months ended
September 30, 2001, this adjustment would have added $353,000 in net earnings,
or $0.05 per diluted share and $0.39 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.
In May 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections
as of April 2002." As a result of the rescission of SFAS No. 4, gains and losses
related to the extinguishment of debt should be classified as extraordinary only
if they meet the criteria outlined under APB Opinion No. 30, "Reporting the
Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." SFAS No. 64, "Extinguishments of Debt Made to Satisfy
Sinking-Fund Requirements," was an amendment to SFAS No. 4 and is no longer
necessary. SFAS No. 44, "Accounting for Intangible Assets of Motor Carriers,"
defined accounting requirements for the effects of the transition to the Motor
Carrier Act of 1980. The transitions are complete and SFAS No. 44 is no longer
necessary. SFAS No. 145 amends SFAS No. 13, "Accounting for Leases," requiring
that any capital lease that is modified resulting in an operating lease should
be accounted for under the sale-leaseback provisions of SFAS No. 98 or SFAS No.
28, as applicable. SFAS No. 145 is effective for fiscal years beginning after
May 15, 2002. The adoption of the provisions of SFAS No. 145 is not expected to
have a material impact on the Company's results of operations, financial
position or cash flows.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which requires that a liability
for a cost associated with an exit or disposal activity be recognized when the
liability is incurred. This statement nullifies Emerging Issues Task Force Issue
No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit and Activity (including Certain Costs Incurred in a
Restructuring)," which required that a liability for an exit cost be recognized
upon the entity's commitment to an exit plan. SFAS No. 146 is effective for exit
or disposal activities that are initiated after December 31, 2002.
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The adoption of the provisions of SFAS No. 146 is not expected to have a
material impact on the Company's results of operations, financial position or
cash flows.
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 report, 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 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 SCHIP 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 SCHIP. 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;
- 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;
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- 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 recently has considered 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
SCHIP 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 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 Incur
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 were required to comply with the new regulation
by October 2002. In December 2001, however, Congress enacted the Administrative
Simplification Compliance Act, which allowed a
16
one-year extension to the October 2002 compliance date. In order to qualify for
the extension, a "compliance plan" was filed with HHS that detailed how we will
meet the extended compliance deadline of October 16, 2003. In August 1998, HHS
proposed a regulation that would require health plans 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. In August 2002, HHS issued modifications to the privacy
regulations to address implementation issues and concerns. Compliance with this
regulation will be required by April 14, 2003.
In June 2002, CMS issued a final rule amending the Medicaid regulations to
implement the managed care provisions of the Balanced Budget Act of 1997, giving
states more flexibility in their administration of Medicaid managed care
programs, providing new patient protections for Medicaid managed care enrollees
and requiring states to meet new actuarial soundness requirements. These rules
superseded earlier roles that were issued in June 2001 and amended in August
2001, but that never became effective.
The Bush Administration's issuance of new regulations, its review of the
existing rules and 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 additional benefits or
change our contract arrangements may seriously harm our operations and financial
results.
If We are Unable to Participate in SCHIP Programs Our Growth Rate may be
Limited.
SCHIP 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
SCHIP 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.
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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 nine months
ended September 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.
Failure to Accurately Predict Our Medical Expenses Could Negatively Affect
Our Reported Results.
Our medical expenses include estimates of IBNR medical expenses. 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 estimate IBNR accurately 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
18
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.
In August 2002, we entered into an agreement with UMDNJ to acquire capital
stock of UHP, a managed health plan serving approximately 50,000 Medicaid
members in 15 counties of New Jersey. The closing of this acquisition is subject
to a number of closing conditions, including our obtaining approval from
regulatory authorities in New Jersey. We have no prior experience in working
with New Jersey regulators, and we cannot assure you that we will be able to
obtain the required regulatory approvals or to satisfy the other closing
conditions to this acquisition. Even if these conditions are met, in order to
operate the acquired business successfully, we would need to integrate
effectively new personnel, provider networks and members, as well as implement
efficiently our administrative and information systems. We have not previously
operated in New Jersey, and we cannot assure you that we will succeed in
achieving operating efficiencies or in otherwise integrating and operating UHP,
if acquired, successfully.
Accordingly, we may be unable to identify, consummate and integrate future
acquisitions successfully or operate acquired businesses profitably. We also may
be unable to obtain sufficient 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,
19
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, 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 noncancelable 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.
20
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.
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.
21
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.
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 September 30, 2002, we had short-term investments of $9.8 million and
long-term investments of $77.0 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 3.9 years at September 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
September 30, 2002, the fair value of our long-term income investments would
decrease by approximately $2.3 million. Similarly, a 1% decrease in market
interest rates at September 30, 2002 would result in an increase of the fair
value of our investments of approximately $2.3 million. Declines in interest
rates over time will reduce our investment income.
ITEM 4. CONTROLS AND PROCEDURES.
(a) Evaluation of disclosure controls and procedures. Based on their
evaluations as of a date within 90 days of the filing date of this report, our
principal executive officer and principal financial officer, with the
participation of our full management team, have concluded that our disclosure
controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the
Securities Exchange Act) are effective to ensure that information required to be
disclosed by us in reports that we file or submit under the Securities Exchange
Act is recorded, processed, summarized and reported within the time periods
specified in the rules and forms of the SEC.
(b) Changes in internal controls. There were no significant changes in our
internal controls or in other factors that could significantly affect these
internal controls subsequent to the date of their most recent evaluation,
including any corrective actions with regard to significant deficiencies and
material weaknesses.
22
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. On September 4, 2002, the parties
negotiated a release and settlement agreement, which is currently awaiting court
approval. The agreement requires no payment by either party, but does allow for
future agreements by which Centene may provide administrative services for a
fee. All receivable balances from Maxicare were previously fully reserved and,
therefore, written off.
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.
None.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.1 Stock Purchase Agreement dated as of August 2, 2002 among
University Health Plans, Inc., University of Medicine and
Dentistry of New Jersey and Centene Corporation
10.2 Executive Employment Agreement dated as of July 1, 2002 by
and between Centene Corporation and Carol E. Goldman
(b) Reports on Form 8-K.
On August 30, 2002, we filed a current report on Form 8-K with respect to
our adoption of a Shareholder Rights Plan.
23
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 as of October 28, 2002.
CENTENE CORPORATION
By: /s/ Michael F. Neidorff
--------------------------------------
Michael F. Neidorff
President and Chief Executive Officer
(principal executive officer)
By: /s/ Karey L. Witty
--------------------------------------
Karey L. Witty
Senior Vice President, Chief Financial
Officer and Treasurer (principal
financial and accounting officer)
24
CERTIFICATIONS
I, Michael F. Neidorff, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Centene Corporation;
2. based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of Centene Corporation as of, and for, the periods presented in this
quarterly report;
4. Karey L. Witty, the Senior Vice President, Chief Financial Officer and
Treasurer of Centene Corporation, and I:
- are responsible for establishing and maintaining disclosure controls
and procedures (as defined for purposes of Rule 13a-14 under the
Securities Exchange Act of 1934, as amended) for Centene Corporation;
- have designed such disclosure controls and procedures to ensure that
material information is made known to us, particularly during the
period in which this quarterly report was prepared;
- have evaluated the effectiveness of the disclosure controls and
procedures of Centene Corporation as of a date within 90 days prior to
the filing date of this quarterly report; and
- have presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on the
required evaluation as of that date;
5. Mr. Witty and I have disclosed to the auditors of Centene Corporation and
to the audit committee of the board of directors of Centene Corporation:
- all significant deficiencies in the design or operation of internal
controls that could adversely affect the ability of Centene
Corporation to record, process, summarize and report financial data
and have identified for such auditors any material weaknesses in
internal controls; and
- any fraud, whether or not material, that involves management or other
employees who have a significant role in the internal controls of
Centene Corporation; and
6. Mr. Witty and I have indicated in this quarterly report whether or not
there were significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent to the date of
their evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: October 28, 2002
/s/ Michael F. Neidorff
-------------------------------------
Michael F. Neidorff
President and Chief Executive Officer
(principal executive officer)
25
I, Karey L. Witty, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Centene Corporation;
2. based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of Centene Corporation as of, and for, the periods presented in this
quarterly report;
4. Michael F. Neidorff, the President and Chief Executive Officer of Centene
Corporation, and I:
- are responsible for establishing and maintaining disclosure controls
and procedures (as defined for purposes of Rule 13a-14 under the
Securities Exchange Act of 1934, as amended) for Centene Corporation;
- have designed such disclosure controls and procedures to ensure that
material information is made known to us, particularly during the
period in which this quarterly report was prepared;
- have evaluated the effectiveness of the disclosure controls and
procedures of Centene Corporation as of a date within 90 days prior to
the filing date of this quarterly report; and
- have presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on the
required evaluation as of that date;
5. Mr. Neidorff and I have disclosed to the auditors of Centene Corporation
and to the audit committee of the board of directors of Centene
Corporation:
- all significant deficiencies in the design or operation of internal
controls that could adversely affect the ability of Centene
Corporation to record, process, summarize and report financial data
and have identified for such auditors any material weaknesses in
internal controls; and
- any fraud, whether or not material, that involves management or other
employees who have a significant role in the internal controls of
Centene Corporation; and
6. Mr. Neidorff and I have indicated in this quarterly report whether or not
there were significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent to the date of
our evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: October 28, 2002 /s/ Karey L. Witty
--------------------------------------------
Karey L. Witty Senior Vice President,
Chief Financial Officer and Treasurer
(principal financial and accounting officer)
26