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Section 1: 10-Q (10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2019
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from               to             
Commission file number: 001-32209
WELLCARE HEALTH PLANS, INC.
(Exact name of registrant as specified in its charter)
Delaware
 
47-0937650
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)

8735 Henderson Road, Renaissance One
Tampa, Florida                           33634
(Address of Principal Executive Offices)
 
(Zip Code)

(813) 290-6200
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $0.01 par value
WCG
New York Stock Exchange

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  No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes  No 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer Accelerated filer Non-accelerated filer
Smaller reporting company Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the
Exchange Act.

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

As of July 26, 2019, there were 50,312,077 shares of the registrant's common stock, par value $0.01 per share, outstanding.



WELLCARE HEALTH PLANS, INC.

TABLE OF CONTENTS

 
Page
Part I — FINANCIAL INFORMATION
 
 
 
 
Item 1.
Financial Statements
 
 
 
 
 
Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2019 and 2018 (unaudited)
 
Condensed Consolidated Balance Sheets as of June 30, 2019 and December 31, 2018 (unaudited)
 
Condensed Consolidated Statements of Changes in Stockholders' Equity for the three and six months ended
June 30, 2019 and 2018 (unaudited)
 
Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2019 and 2018 (unaudited)
 
Notes to Condensed Consolidated Financial Statements (unaudited)
 
 
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
 
 
Item 4.
Controls and Procedures
 
 
 
Part II — OTHER INFORMATION
 
 
 
 
Item 1.
Legal Proceedings
 
 
 
Item 1A.
Risk Factors
 
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
 
 
Item 3.
Defaults Upon Senior Securities
 
 
 
Item 4.
Mine Safety Disclosures
 
 
 
Item 5.
Other Information
 
 
 
Item 6.
Exhibits
 
 
 
 
Signatures
 
 
 
 
Exhibit Index




Part I — FINANCIAL INFORMATION

Item 1. Financial Statements.

WELLCARE HEALTH PLANS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited) (In millions, except per share and share data) 
 
For the Three Months Ended
June 30,
 
For the Six Months Ended
June 30,
 
2019
 
2018
 
2019
 
2018
Revenues:
 
 
 
 
 
 
 
Premium
$
6,842.2

 
$
4,612.6

 
$
13,451.6

 
$
9,238.9

Products and services
126.7

 

 
242.5

 

Investment and other income
41.2

 
26.4

 
78.2

 
46.3

Total revenues
7,010.1

 
4,639.0

 
13,772.3

 
9,285.2

 
 
 
 
 
 
 
 
Expenses:
 
 
 
 
 
 
 
Medical benefits
6,027.1

 
3,866.0

 
11,858.8

 
7,828.0

Costs of products and services
123.2

 

 
235.0

 

Selling, general and administrative
486.8

 
377.9

 
990.6

 
733.8

ACA industry fee

 
79.0

 

 
160.5

Medicaid premium taxes
31.7

 
30.6

 
63.4

 
62.7

Depreciation and amortization
68.1

 
34.5

 
137.7

 
70.9

Interest
31.1

 
17.1

 
60.6

 
34.2

Total expenses
6,768.0

 
4,405.1

 
13,346.1

 
8,890.1

Income before income taxes and equity in losses of unconsolidated subsidiaries
242.1

 
233.9

 
426.2

 
395.1

Equity in earnings (losses) of unconsolidated subsidiaries
1.7

 
(4.0
)
 
2.5

 
(6.7
)
Income before income taxes
243.8

 
229.9

 
428.7

 
388.4

Income tax expense
61.0

 
78.3

 
94.5

 
135.1

Net income
$
182.8

 
$
151.6

 
$
334.2

 
$
253.3

 
 
 
 
 
 
 
 
Other comprehensive income (loss):
 
 
 
 
 
 
 
Change in net unrealized gains and losses on
available-for-sale securities, before tax
14.2

 

 
32.7

 
(10.3
)
Income tax expense (benefit) related to other
comprehensive income
3.5

 

 
8.2

 
(2.4
)
Other comprehensive income (loss), net of tax
10.7

 

 
24.5

 
(7.9
)
Comprehensive income
$
193.5

 
$
151.6

 
$
358.7

 
$
245.4

 
 
 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
 
 
Basic
$
3.63

 
$
3.39

 
$
6.66

 
$
5.67

Diluted
$
3.60

 
$
3.35

 
$
6.58

 
$
5.60

 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 
 
 
 
 
 
 
       Basic
50,307,031

 
44,759,808

 
50,203,770

 
44,682,850

       Diluted
50,811,807

 
45,282,294

 
50,827,056

 
45,239,210


See notes to unaudited condensed consolidated financial statements.

2



WELLCARE HEALTH PLANS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited) (In millions, except share data)


 
June 30,
2019
 
December 31,
2018
Assets
 
 
 
Current Assets:
 
 
 
Cash and cash equivalents
$
2,990.2

 
$
3,653.9

Short-term investments
929.3

 
830.1

Premiums receivable, net
1,286.7

 
1,223.4

Pharmacy rebates receivable, net
447.4

 
460.6

Funds receivable for the benefit of members
312.9

 
187.3

Prepaid expenses and other current assets, net
1,300.2

 
477.1

Total current assets
7,266.7

 
6,832.4

 
 
 
 
Property, equipment and capitalized software, net
472.3

 
428.2

Goodwill
2,213.8

 
2,227.7

Other intangible assets, net
959.8

 
996.2

Long-term investments
1,539.2

 
813.2

Restricted cash, cash equivalents and investments
285.0

 
234.7

Other assets
264.1

 
18.7

Assets of discontinued operations
204.6

 
213.6

Total Assets
$
13,205.5

 
$
11,764.7

 
 
 
 
Liabilities and Stockholders' Equity
 

 
 

Current Liabilities:
 

 
 

Medical benefits payable
$
3,219.8

 
$
2,897.4

Unearned premiums
32.7

 
1.4

Accounts payable and accrued expenses
1,541.3

 
964.6

Funds payable for the benefit of members
833.8

 
693.3

Other payables to government partners
302.7

 
458.9

Total current liabilities
5,930.3

 
5,015.6

 
 
 
 
Deferred income tax liability, net
139.7

 
134.2

Long-term debt, net
2,078.2

 
2,126.4

Other liabilities
249.4

 
34.9

Liabilities of discontinued operations
204.6

 
213.6

Total Liabilities
8,602.2

 
7,524.7

Commitments and contingencies (see Note 14)


 


Stockholders' Equity:
 
 
 
Preferred stock, $0.01 par value (20,000,000 authorized, no shares issued or outstanding)

 

Common stock, $0.01 par value (100,000,000 authorized, 50,311,933 and 49,993,219 shares issued and outstanding at June 30, 2019 and December 31, 2018, respectively)
0.5

 
0.5

Paid-in capital
1,985.7

 
1,981.1

Retained earnings
2,601.5

 
2,267.3

Accumulated other comprehensive income (loss)
15.6

 
(8.9
)
Total Stockholders' Equity
4,603.3

 
4,240.0

Total Liabilities and Stockholders' Equity
$
13,205.5

 
$
11,764.7

See notes to unaudited condensed consolidated financial statements.

3



WELLCARE HEALTH PLANS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited) (In millions, except share data)

 
Three Months Ended June 30, 2019 and 2018
 
Common Stock
 
Paid in Capital
 
Retained Earnings
 
Accumulated
Other
Comprehensive Income (Loss)
 
Total
Stockholders' Equity
Shares
 
Amount
Balance at April 1, 2019
50,302,215

 
$
0.5

 
$
1,967.1

 
$
2,418.7

 
$
4.9

 
$
4,391.2

Common stock issued for vested equity-compensation awards
10,599

 

 

 

 

 

Repurchase and retirement of shares to satisfy tax withholding requirements
(881
)
 

 
(0.4
)
 

 

 
(0.4
)
Stock-based compensation expense, net of forfeitures

 

 
19.0

 

 

 
19.0

Comprehensive income

 

 

 
182.8

 
10.7

 
193.5

Balance at June 30, 2019
50,311,933

 
$
0.5

 
$
1,985.7

 
$
2,601.5

 
$
15.6

 
$
4,603.3

 
 
 
 
 
 
 
 
 
 
 
 
Balance at April 1, 2018
44,753,235

 
$
0.4

 
$
583.4

 
$
1,929.2

 
$
(10.6
)
 
$
2,502.4

Common stock issued for vested stock-based compensation awards
14,704

 

 

 

 

 

Repurchase and retirement of shares to satisfy tax withholding requirements
(662
)
 

 
(0.1
)
 

 

 
(0.1
)
Stock-based compensation expense, net of forfeitures

 

 
18.0

 

 

 
18.0

Comprehensive income (loss)

 

 

 
151.6

 

 
151.6

Balance at June 30, 2018
44,767,277

 
$
0.4

 
$
601.3

 
$
2,080.8

 
$
(10.6
)
 
$
2,671.9


 
Six Months Ended June 30, 2019 and 2018
 
Common Stock
 
Paid in Capital
 
Retained Earnings
 
Accumulated
Other
Comprehensive Income (Loss)
 
Total
Stockholders' Equity
Shares
 
Amount
Balance at January 1, 2019
49,993,219

 
$
0.5

 
$
1,981.1

 
$
2,267.3

 
$
(8.9
)
 
$
4,240.0

Common stock issued for vested equity-compensation awards
462,083

 

 

 

 

 

Repurchase and retirement of shares to satisfy tax withholding requirements
(143,369
)
 

 
(37.2
)
 

 

 
(37.2
)
Stock-based compensation expense, net of forfeitures

 

 
41.8

 

 

 
41.8

Comprehensive income

 

 

 
334.2

 
24.5

 
358.7

Balance at June 30, 2019
50,311,933

 
$
0.5

 
$
1,985.7

 
$
2,601.5

 
$
15.6

 
$
4,603.3

 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2018
44,522,988

 
$
0.4

 
$
591.5

 
$
1,827.5

 
$
(2.7
)
 
$
2,416.7

Common stock issued for vested stock-based compensation awards
349,225

 

 

 

 

 

Repurchase and retirement of shares to satisfy tax withholding requirements
(104,936
)
 

 
(20.3
)
 

 

 
(20.3
)
Stock-based compensation expense, net of forfeitures

 

 
30.1

 

 

 
30.1

Comprehensive income (loss)

 

 

 
253.3

 
(7.9
)
 
245.4

Balance at June 30, 2018
44,767,277

 
$
0.4

 
$
601.3

 
$
2,080.8

 
$
(10.6
)
 
$
2,671.9


See notes to unaudited condensed consolidated financial statements.


4



WELLCARE HEALTH PLANS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in millions)


 
For the Six Months Ended
June 30,
 
2019
 
2018
Cash flows from operating activities:
 
 
 
Net income
$
334.2

 
$
253.3

Adjustments to reconcile net income to cash flows from operating activities:


 
 

Depreciation and amortization
137.7

 
70.9

Stock-based compensation expense
41.8

 
30.1

Deferred taxes, net
(1.0
)
 
(36.9
)
Other, net
19.7

 
7.7

Changes in operating accounts, net of effects from acquisitions and divestitures:


 
 

Premiums receivable, net
(71.4
)
 
(251.2
)
Pharmacy rebates receivable, net
13.2

 
(98.1
)
Medical benefits payable
322.4

 
199.1

Unearned premiums
31.3

 
514.1

Other receivables/payables to government partners
(248.8
)
 
52.3

Prepaid and other current assets
(72.3
)
 
(48.1
)
Accrued liabilities and other, net
(0.3
)
 
83.4

Net cash provided by operating activities
506.5

 
776.6

 
 
 
 
Cash flows from investing activities:
 

 
 

Purchases of investments
(2,700.4
)
 
(696.8
)
Proceeds from sales and maturities of investments
1,807.6

 
383.1

Acquisitions and acquisition-related settlements
(8.6
)
 

Additions to property, equipment and capitalized software, net
(107.5
)
 
(52.5
)
Net cash used in investing activities
(1,008.9
)
 
(366.2
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Repurchase and retirement of shares to satisfy employee tax withholding requirements
(37.2
)
 
(20.3
)
Payments on Revolving Credit Facility, net
(50.0
)
 

Funds received for the benefit of members, net
30.6

 
491.5

Other, net
8.0

 
14.8

Net cash (used in) provided by financing activities
(48.6
)
 
486.0

 
 
 
 
(Decrease) increase in cash, cash equivalents and restricted cash and cash equivalents
(551.0
)
 
896.4

Balance at beginning of period
3,716.6

 
4,263.0

Balance at end of period
$
3,165.6

 
$
5,159.4

 
 
 
 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 

 
 

  Cash paid for taxes, net of refunds
$
88.3

 
$
86.9

  Cash paid for interest
$
58.1

 
$
32.8

SUPPLEMENTAL DISCLOSURES OF NON-CASH TRANSACTIONS:
 

 
 

Non-cash additions to property, equipment, and capitalized software
$
5.5

 
$
4.9


See notes to unaudited condensed consolidated financial statements.

5



WELLCARE HEALTH PLANS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) (In millions, except member, per share and share data)


1. ORGANIZATION, BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
 
WellCare Health Plans, Inc. (the "Company," "we," "us," or "our") focuses primarily on providing government-sponsored managed care services to families, children, seniors and individuals with complex medical needs primarily through Medicaid, Medicare Advantage ("MA") and Medicare Prescription Drug Plans ("PDP"), as well as individuals in the Health Insurance Marketplace. As of June 30, 2019, we served approximately 6.3 million members nationwide. 

As of June 30, 2019, we operated Medicaid health plans, including states where we receive Medicaid premium revenues associated with dually eligible special needs plans, in Arizona, Florida, Georgia, Hawaii, Illinois, Kentucky, Michigan, Missouri, Nebraska, New Jersey, New York, South Carolina and Texas.

In addition, as of June 30, 2019, we also operated MA coordinated care plans ("CCPs") in Alabama, Arizona, Arkansas, California, Connecticut, Florida, Georgia, Hawaii, Illinois, Indiana, Kentucky, Louisiana, Maine, Michigan, Mississippi, New Jersey, New York, North Carolina, Ohio, South Carolina, Tennessee and Texas. We also offered stand-alone Medicare PDPs nationwide.

In September 2018, we completed the acquisition of Meridian Health Plan of Michigan, Inc., Meridian Health Plan of Illinois, Inc., and MeridianRx, LLC, a pharmacy benefit manager ("PBM") (collectively, "Meridian"). As a result of the acquisition, we expanded our Medicaid portfolio through the addition of Michigan; expanded our Medicaid presence in Illinois; and acquired an integrated PBM platform. Meridian also serves MA members in Illinois, Indiana, Michigan, and Ohio, as well as Health Insurance Marketplace members in Michigan.

Basis of Presentation

The accompanying unaudited condensed consolidated balance sheets and statements of comprehensive income, changes in stockholders' equity, and cash flows include our accounts and the accounts of our subsidiaries over which we have control or are the primary beneficiary. We eliminated all intercompany accounts and transactions.

The accompanying unaudited condensed consolidated interim financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America ("GAAP"). Accordingly, certain financial information and footnote disclosures normally included in financial statements prepared in accordance with GAAP, but that are not required for interim reporting purposes, have been condensed or omitted. The accompanying unaudited condensed consolidated interim financial statements should be read in conjunction with the consolidated financial statements and notes thereto, for the fiscal year ended December 31, 2018, included in our Annual Report on Form 10-K ("2018 Form 10-K"), which was filed with the U.S. Securities and Exchange Commission ("SEC") in February 2019. Results for the interim periods presented are not necessarily indicative of results that may be expected for the entire year or any other interim period.

In the opinion of management, the unaudited condensed consolidated interim financial statements reflect all normal recurring adjustments that we consider necessary for the fair presentation of our financial position, results of operations and cash flows for the interim periods presented. In accordance with GAAP, we make certain estimates and assumptions that affect the amounts reported in the condensed consolidated interim financial statements and accompanying notes. We base these estimates, including assumptions as to the annualized tax rate, on our knowledge of current events and anticipated future events and evaluate and update our assumptions and estimates on an ongoing basis; however, actual results may differ from our estimates. We evaluated all material events subsequent to the date of these unaudited condensed consolidated interim financial statements. Certain reclassifications were made to 2018 financial information to conform to the 2019 presentation.


6


Pharmacy Benefit Manager

The external revenues and costs for our PBM business are reported within "Products and Services" and "Cost of Products and Services", respectively, on the condensed consolidated statements of comprehensive income. Products and services revenues from our PBM consist of the prescription price (ingredient cost plus dispensing fee) negotiated with the retail pharmacies with which we have contracted, plus any associated administrative fees. This revenue is recognized when the claim is processed. We have the contractual obligation to pay network pharmacies for benefits provided to participating members and, therefore, act as principal in the arrangement and reflect the total prescription price as revenue, on a gross basis, in accordance with applicable accounting guidance. Costs of products and services is recognized at the time prescriptions are dispensed by pharmacies in the PBM's network to eligible members and consists primarily of ingredient costs and dispensing fees paid to retail pharmacies with which we have contracted. The overall results of our PBM business are immaterial.

Aetna Part D Membership Reinsurance

In November 2018, we completed the purchase of Aetna Inc.'s ("Aetna") entire standalone Medicare Part D prescription drug plan membership ("Aetna Part D membership"). In connection with the purchase, we also entered into an administrative services agreement and a reinsurance agreement pursuant to which Aetna provides administrative services to, and retains financial risk of, the Aetna Part D membership, effective for plan year 2019. We remain primarily liable to policyholders under this ceded insurance contract and are contingently liable for amounts recoverable from Aetna in the event that they do not meet their contractual obligations.  In the normal course, we evaluate the financial condition of our reinsurers and monitor concentrations of credit risk to minimize our exposure to significant losses from reinsurer insolvencies. As of June 30, 2019, related to the Aetna Part D membership, our condensed consolidated balance sheet included reinsured receivables of $36.4 million, primarily related to premiums receivable, and reinsured payables of $490.6 million, primarily related to pharmacy claims payables. These reinsured receivables and payables were included in prepaid expenses and other current assets, net, and accounts payable and accrued liabilities, respectively. The resulting net reinsurance recoverables of $454.2 million was included in prepaid expenses and other current assets, net on the condensed consolidated balance sheet. There were no reinsurance recoverables or reinsurance liabilities relating to the Aetna Part D membership recorded as of December 31, 2018.
 
In our condensed consolidated statement of comprehensive income, premium revenue and medical benefits were reported net of amounts ceded under this Aetna reinsurance arrangement. Premium revenue ceded relating to the Aetna Part D membership were $417.6 million and $918.6 million for the three and six months ended June 30, 2019, respectively. Additionally, member benefits expense ceded relating to the Aetna Part D membership were $301.3 million and $775.0 million for the three and six months ended June 30, 2019, respectively.

Unconsolidated Subsidiaries

We work with physicians and other health care professionals to operate Accountable Care Organizations ("ACOs") under the Medicare Shared Saving Program ("MSSP") and Next Generation ACO Models. ACOs were established by the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively, the "ACA") to reward integrated, efficient care and allow providers to share in any savings they achieve as a result of improved quality and operational efficiency.
These ACOs are generally formed as limited liability companies. The ACOs are considered variable interest entities ("VIEs") under GAAP as these entities do not have sufficient equity to finance their own operations without additional financial support. We own a majority interest in our ACOs; however, we share the power to direct the activities that most significantly affect the ACOs with health care providers that are minority owners in the ACOs. This power is shared pursuant to the structure of the management committee of each of the ACOs. Accordingly, we have determined that we are not the primary beneficiary of the ACOs; therefore, we cannot consolidate their results. We perform an ongoing qualitative assessment of our variable interests in VIEs to determine whether we have a controlling financial interest and would therefore be considered the primary beneficiary of the VIE.
We account for our participation in the ACOs using the equity method. Gains and losses are immaterial and are reported on the face of our condensed consolidated statements of comprehensive income as equity in earnings (losses) of unconsolidated subsidiaries.

7


Significant Accounting Policies
Below is a discussion of our significant accounting policies, which affected the comparability of our consolidated results of operations, financial condition or cash flows for the periods presented. Refer to Note 2 - Summary of Significant Accounting Policies to the consolidated financial statements included in our 2018 Form 10-K for a complete discussion of all of our significant accounting policies.
Premium Receivables and Unearned Premiums
We record premiums earned but not received as premiums receivable and record premiums received in advance of the period of service as unearned premiums in our condensed consolidated balance sheets. A complete discussion of premiums receivable and unearned premiums is included in Note 2 - Summary of Significant Accounting Policies to the consolidated financial statements included in our 2018 Form 10-K. The premium receivable balance at June 30, 2019 is primarily related to Medicaid contracts with our state partners of approximately $1.2 billion, as well as net risk-adjusted premiums receivable under our MA and PDP contracts of approximately $116.3 million.
Medicaid Risk-Adjusted Premiums and Retroactive Rate Changes

As discussed further in Note 2 - Summary of Significant Accounting Policies to the consolidated financial statements included in our 2018 Form 10-K, Medicaid premium rate changes are recognized in the period the change becomes effective, when the effect of the change in the rate is reasonably estimable and collection is assured. In some instances, our Medicaid premiums are subject to risk score adjustments based on the health profile of our membership. Generally, the risk score is determined by the state agency's analysis of encounter submissions of processed claims data to determine the acuity of our membership relative to the entire state's Medicaid membership. The frequency of when states adjust premiums varies, but is usually done quarterly or semi-annually on a retrospective basis. We recognize periodic changes to risk-adjusted premiums as revenue when the amounts are determinable and collection is reasonably assured. Premiums receivable in our condensed consolidated balance sheets include net risk-adjusted premiums receivable from our Medicaid state partners related to retroactive rate changes and risk score adjustments of $210.5 million and $54.4 million as of June 30, 2019 and December 31, 2018, respectively.
Medicare Part D Settlements
We receive certain Part D prospective subsidy payments from the Centers for Medicare & Medicaid Services ("CMS") for our MA and PDP members as a fixed monthly per member amount, based on the estimated costs of providing prescription drug benefits over the plan year, as reflected in our bids. A discussion of the subsidy components under Part D is included in Note 2 - Summary of Significant Accounting Policies to the consolidated financial statements included in our 2018 Form 10-K. CMS will fully reimburse these subsidies, or recoup overpaid subsidies made during the plan year, as part of its annual settlement process that typically occurs in the fourth quarter of the subsequent year and, accordingly, there is no insurance risk to us. Therefore, amounts received for these subsidies are not considered premium revenue, and are reported, net of the subsidy benefits paid, as funds receivable (payable) for the benefit of members in the condensed consolidated balance sheets. As of June 30, 2019 and December 31, 2018, our condensed consolidated balance sheets primarily include CMS Part D payables for the 2018 plan year. Our condensed consolidated balance sheet as of June 30, 2019 additionally includes a payable for the 2019 plan year. We expect to settle a majority of the 2018 net payable during the remainder of 2019.

ACA Industry Fee

The ACA imposed certain new taxes and fees, including an annual premium-based health insurance industry assessment (the "ACA industry fee") on health insurers, which began in 2014. In January 2018, Congress approved a one-year moratorium of the ACA industry fee for 2019, which also eliminated the Medicaid ACA industry fee reimbursement from our state government partners for 2019. Accordingly, we did not incur ACA industry fee expense nor recognize any Medicaid ACA industry fee reimbursement revenue for the three and six months ended June 30, 2019. We incurred $79.0 million and $160.5 million for the ACA industry fee for the three and six months ended June 30, 2018, respectively. Additionally, we recognized $62.8 million and $127.5 million of Medicaid ACA industry fee reimbursement revenue as premium revenue for the three and six months ended June 30, 2018, respectively.

Recently Adopted Accounting Standards

In June 2018, the Financial Accounting Standards Board ("FASB") issued Accounting Standard Update ("ASU") 2018-07, “Compensation-Stock Compensation (Topic 718) - Improvements to Nonemployee Share-Based Payment

8


Accounting.” This update expands the scope of Topic 718, which currently only includes share-based payments issued to employees, to include share-based payments issued to non-employees for goods and services. This guidance was effective for interim and annual periods beginning after December 15, 2018. We adopted this guidance on January 1, 2019. The adoption of this guidance did not have a material effect on our consolidated results of operations, financial condition or cash flows.

In February 2018, the FASB issued ASU 2018-02 "Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income", which allows entities to reclassify stranded tax effects resulting from the Tax Cuts and Jobs Act of 2017 from accumulated other comprehensive income to retained earnings. The guidance is effective for interim and annual periods beginning after December 15, 2018. We adopted this guidance prospectively on January 1, 2019. The adoption of this guidance did not have a material effect on our consolidated results of operations, financial condition or cash flows.

In March 2017, the FASB issued ASU No. 2017-08, "Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities". This update shortens the amortization period for the premium on certain purchased callable debt securities to the earliest call date. Previously, entities generally amortize the premium as a yield adjustment over the contractual life of the security. The new guidance does not change the accounting for purchased callable debt securities held at a discount. This guidance is effective for interim and annual periods beginning after December 15, 2018. We adopted this guidance on January 1, 2019 on a modified retrospective basis. The adoption of this guidance did not have a material effect on our consolidated results of operations, financial condition or cash flows.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)”, which for operating leases, requires a lessee to recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments in its balance sheet. This standard also requires a lessee to recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term, on a generally straight-line basis. Subsequently, in July 2018, the FASB issued ASU 2018-11, “Leases (Topic 842), Targeted Improvements” which, among other things, allows companies to elect an optional transition method to apply the new lease standard through a cumulative-effect adjustment, if any, in the period of adoption, rather than in the earliest period presented. We adopted the standard on January 1, 2019 using the optional transition method. We elected the practical expedients permitted under the transition guidance, which allows us to carryforward our historical lease classifications for existing leases. Additionally, we elected the practical expedient to not separate non-lease components from the associated lease component. As part of the adoption process, we implemented a new lease accounting system. The adoption of this guidance resulted in the initial recognition of operating lease right-of-use assets of approximately $259.5 million, operating lease liabilities of approximately $277.3 million and the elimination of $17.8 million of straight-line lease liabilities, as of January 1, 2019. This guidance did not have a material effect on our consolidated results of operations or cash flows.

Accounting Standards Pending Adoption

In August 2018, the FASB issued ASU 2018-15, "Intangibles-Goodwill and Other-Internal-Use Software: Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract", which requires implementation costs incurred by customers in cloud computing arrangements (i.e., hosting arrangements) to be capitalized under the same premises of authoritative guidance for internal-use software, and deferred over the noncancellable term of the cloud computing arrangements plus any option renewal periods that are reasonably certain to be exercised by the customer or for which the exercise is controlled by the service provider. The guidance is effective for interim and annual periods beginning after December 15, 2019, with early adoption permitted. We are currently assessing the effect this guidance will have on our consolidated results of operations, financial condition or cash flows.
In June 2016, the FASB issued ASU 2016-13, "Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments," which requires entities to use a current expected credit loss model, which is a new impairment model based on expected losses rather than incurred losses. Under this model, an entity would recognize an impairment allowance equal to its current estimate of all contractual cash flows that the entity does not expect to collect from financial assets measured at amortized cost. The entity's estimate would consider relevant information about past events, current conditions, and reasonable and supportable forecasts, which will result in recognition of lifetime expected credit losses upon loan origination. ASU 2016-13 is effective for interim and annual reporting periods beginning after December 15, 2019, with early adoption permitted for annual reporting periods beginning after December 15, 2018. We are currently assessing the effect this guidance will have on our consolidated results of operations, financial condition or cash flows.


2. CENTENE PLAN OF MERGER AND ACQUISITIONS

Centene Plan of Merger

9



On March 26, 2019, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Centene Corporation ("Centene") under which Centene will acquire us for a combination of cash and stock (the "Centene Transaction"). Under the terms of the Merger Agreement, our shareholders will receive $120.00 in cash and 3.38 shares of Centene common stock for each share of our common stock. On June 24, 2019, stockholders of both companies approved all proposals regarding the Centene Transaction. Completion of the Centene Transaction remains subject to the receipt of U.S. federal antitrust clearance and certain other required regulatory approvals. The Centene Transaction is expected to close in the first half of 2020.

The Merger Agreement includes restrictions on the conduct of our business prior to completion of the Centene Transaction or termination of the Merger Agreement, generally requiring us to conduct our business in the ordinary course. However, we are subject to various specified restrictions unless we obtain Centene’s prior written consent, which may not be unreasonably withheld, delayed or conditioned, or expressly contemplated or permitted by the Merger Agreement or as required by applicable law. Among other things and in each case subject to certain exceptions, we may not:
incur additional indebtedness (excluding borrowings under our Revolving Credit Facility (as defined below) that are used to manage our ordinary course cash flow needs);
issue additional shares of our common stock, repurchase our common stock, or pay dividends;
acquire assets, securities or property, dispose of businesses or assets; or
authorize any payment of, accrual or commitment for capital expenditures in any calendar year that would exceed by more than 110% the aggregate amount of capital expenditures budgeted for such year.

Aetna Medicare Part D Asset Acquisition

As discussed in Note 1 - Organization, Basis of Presentation and Significant Accounting Policies of this 2019 Form 10-Q,
in November 2018, we completed the purchase of Aetna's Part D membership for total cash consideration of $115.8 million, including subsequent purchase price adjustments. These membership assets are recorded within other intangible assets, net in the condensed consolidated balance sheets as of June 30, 2019 and December 31, 2018, and have a weighted-average useful life of eight years beginning in 2020. Per the terms of the agreement, Aetna provides administrative services to, and retains financial risk of, the Aetna Part D membership through 2019. Therefore, the Aetna Part D membership is excluded from our membership and has had, or is expected to have, an immaterial effect on our results of operations until January 1, 2020.

Meridian Business Acquisition

On September 1, 2018 (the "Effective Date"), we acquired Meridian for an estimated purchase price of approximately $2.5 billion in cash, subject to certain purchase price adjustments, as described in the purchase agreement. The Meridian acquisition was funded through a combination of cash on hand, our Revolving Credit Facility, net proceeds from the August 2018 issuance of our 5.375% of Senior Notes due 2026 ("2026 Notes") and net proceeds from an issuance of shares of our common stock. We included the results of Meridian's operations since the Effective Date in our condensed consolidated financial statements.

The following table summarizes the estimated fair values of major classes of assets acquired and liabilities assumed at the Effective Date, based on our valuation assumptions, reconciled to the total consideration transferred.

10


Assets
(in millions)
Cash, cash equivalents and restricted cash
$
484.4

Investments, including restricted investments
180.4

Premiums receivable, net
379.6

Other current assets
139.8

Property, equipment and capitalized software, net
49.3

Goodwill
1,546.8

Other intangible assets, net
622.0

     Fair value of total assets acquired
$
3,402.3

 
 
Liabilities
 
Medical benefits payable
$
534.3

ACA Fee liability
66.5

Other liabilities
281.4

     Fair value of liabilities assumed
882.2

     Fair value of net assets acquired
$
2,520.1

 
 

The fair value results from judgments about future events, which reflect certain uncertainties and rely on estimates and assumptions. The judgments used to determine the fair value assigned to each class of assets acquired and liabilities assumed, as well as intangible asset lives, can materially affect our operating results. As of the Effective Date, the expected fair value of all current assets and liabilities approximated their historical cost. As of June 30, 2019, we have preliminarily determined the fair value of assets acquired and liabilities assumed; however, the final fair values may be subject to, (i) the final valuation of intangible assets related to memberships and trade names, (ii) the final assessment and valuation of certain other assets acquired and liabilities assumed, including premiums receivable, property, equipment and capitalized software, medical benefits payable and other liabilities and (iii) the final assessment and valuation of certain income tax amounts. The final fair values of the assets acquired and liabilities assumed is not expected to be materially different from our preliminary estimates.

Identifiable intangible assets acquired

Under the Hart-Scott-Rodino Antitrust Improvements Act and other relevant laws and regulations, there were significant limitations on our ability to obtain specific information about Meridian's intangible assets prior to completion of the acquisition in September 2018. As of June 30, 2019, certain of the more significant assumptions inherent in the development of intangible asset fair values, including the following, are preliminary.
final membership attrition rates;
final discount rates selected to measure the risks inherent in the future cash flows;
key assumptions in the valuation of the acquired technology, including, but not limited to, estimated costs associated with developers' salaries, external direct costs of materials and services; and the estimated time to replace the acquired software applications; and
working capital adjustments and the assessment of the assets' life cycle, among other key assumptions.

The following table summarizes the preliminary fair values and weighted average useful lives for identifiable intangible assets acquired in the Meridian acquisition as of the Effective Date of the acquisition. These preliminary estimates of fair value and weighted-average useful life may be different from the final acquisition accounting. The differences are not expected to be materially different from our preliminary estimates.


11


 
 
Gross Fair Value
(in millions)
 
Weighted Average
Useful Life (in years)
Membership
 
$
406.6

 
8.1
Tradenames
 
110.4

 
4.9
Provider network
 
8.3

 
15.0
Technology and other
 
96.7

 
5.8
Total
 
$
622.0

 
7.3
 
 
 
 
 

Goodwill

We recorded $1.5 billion for the valuation of goodwill for the excess of the purchase price over the estimated fair value of the net assets acquired. The assignment of goodwill to our respective segments has not been completed at this time. The recorded goodwill related to the acquisition is deductible for tax purposes.

Deferred taxes

The Meridian acquisition included taxable and nontaxable components resulting in differences in amounts recognized for GAAP and tax purposes. In both taxable and nontaxable business combinations, the amounts assigned to the individual assets acquired and liabilities assumed for financial statement purposes are often different from the amounts assigned or carried forward for tax purposes. We recorded a $32.3 million deferred tax liability based on the estimated bases differences.

Goodwill

A summary of changes in our goodwill by reportable segment is as follows for the six months ended June 30, 2019:

 
Medicaid Health Plans
 
Medicare Health Plans
 
Not assigned(1)
 
Total
Balance as of December 31, 2018
$
274.7

 
$
392.3

 
$
1,560.7

 
$
2,227.7

Acquisition related adjustments

 

 
(13.9
)
 
(13.9
)
Balance as of June 30, 2019
$
274.7

 
$
392.3

 
$
1,546.8

 
$
2,213.8

 
 
 
 
 
 
 
 
(1) Goodwill related to our September 1, 2018 Meridian acquisition is considered preliminary, pending the final allocation of the applicable purchase price. The assignment of goodwill to our respective segments has not been completed at this time.

Unaudited Pro Forma Financial Information

The results of operations and financial condition for the Meridian acquisition have been included in our condensed consolidated financial statements since the Effective Date. The unaudited pro forma financial information presented below reflects our 2018 acquisition of Meridian, assuming the acquisition occurred as of January 1, 2018. Pro forma results are not provided for the three and six months ended June 30, 2019, as Meridian's operations were included in our results of operations for this time period.

These pro forma results are based on estimates and assumptions and do not reflect any anticipated synergies, efficiencies or other cost savings that we expect to realize from the acquisition. The following unaudited pro forma results have been prepared for comparative purposes only and do not purport to be indicative of the results of operations that would have occurred had the acquisition actually consummated at January 1, 2018, or project the future results of the combined company.

12


 
 
Pro Forma - Unaudited
(in millions, except per share data)
 
Three Months ended
June 30, 2018
 
Six Months ended
June 30, 2018
Total revenues
 
$
5,793.8

 
$
11,467.4

Net income
 
$
159.5

 
$
260.4

 
 
 
 
 
Earnings per common share:
 
 
 
 
   Basic
 
$
3.19

 
$
5.22

   Diluted
 
$
3.16

 
$
5.16

 
 
 
 
 
Weighted average common shares outstanding:
 
 
 
 
       Basic
 
49,967,355

 
49,890,397

       Diluted
 
50,489,841

 
50,446,757

 
 
 
 
 


The pro forma results presented in the schedule above include adjustments related to the following purchase accounting and other acquisition-related costs:

Elimination of historical intangible asset amortization expense and addition of amortization expense based on the current preliminary values of identified intangible assets;
Elimination of interest expense associated with retired obligations and addition of interest expense based on debt incurred to finance the Meridian transaction;
Elimination of results for Meridian operations not acquired;
Elimination of transaction and integration-related costs;
Include 5,207,547 shares of our common stock issued to finance the Meridian transaction;
Adjustments to align the acquisition to our accounting policies; and
Tax effects of the adjustments noted above.

3. SEGMENT REPORTING

On a regular basis, we evaluate discrete financial information and assess the performance of our three reportable segments Medicaid Health Plans, Medicare Health Plans and Medicare PDPs, to determine the most appropriate use and allocation of Company resources.

We allocate premium revenue, medical benefits expense, Medicaid premium taxes, the 2018 ACA industry fee and goodwill to our reportable segments. We do not allocate to our reportable segments any other assets and liabilities, investment and other income, selling, general and administrative expenses ("SG&A"), depreciation and amortization, or interest expense. The Company's decision-makers primarily use premium revenue, medical benefits expense and gross margin to evaluate the performance of our reportable segments.

Our Corporate and Other category includes net investment and other income, SG&A expenses, depreciation, amortization and interest. Also included in this category are results for operating segments that are not individually reportable because they do not meet the quantitative thresholds required by generally accepted accounting principles.

13




Medicaid Health Plans

Our Medicaid Health Plans segment includes plans for beneficiaries of Temporary Assistance for Needy Families ("TANF"), Supplemental Security Income ("SSI"), Aged Blind and Disabled ("ABD"), Children's Health Insurance Program ("CHIP") and Long-Term Services and Supports ("LTSS") programs, among others. TANF generally provides assistance to low-income families with children. ABD and SSI generally provide assistance to low-income aged, blind or disabled individuals. CHIP provides assistance to qualifying families who are not eligible for Medicaid because their income exceeds the applicable income thresholds. The LTSS program is designed to help people with chronic illnesses or who have disabilities and need health and long-term care services, such as home care or adult day care, to enable them to stay in their homes and communities as long as possible.

Our Medicaid operations in Florida, Illinois and Kentucky individually account for 10% or more of our consolidated premium revenue for the three and six months ended June 30, 2019. These states and the respective Medicaid premium revenue as a percentage of total consolidated premium revenue are as follows: 
 
For the Three Months Ended
June 30,
 
For the Six Months Ended
June 30,
 
2019
 
2018
 
2019
 
2018
Florida
19%
 
13%
 
18%
 
13%
Illinois
12%
 
*
 
12%
 
*
Kentucky
10%
 
15%
 
10%
 
15%

*Our Illinois Medicaid health plan accounted for less than 10% of our consolidated premium revenue for the three and six months ended June 30, 2018.

On February 1, 2019, we began providing statewide-managed care services to children with medically complex conditions through the Children's Medical Services Managed Care Plan ("CMS Plan") contract from the Florida Department of Health. On December 1, 2018, we began providing managed care services to Medicaid-eligible beneficiaries, including Managed Medical Assistance and Long-Term Care beneficiaries in 10 of 11 regions in Florida through a new five-year contract. As part of the Medicaid Managed Care program, we are one of two managed care plans providing statewide-managed care services to beneficiaries in the Serious Mental Illness Specialty Plan.

Medicare Health Plans

Medicare is a federal program that provides eligible persons age 65 and over and some disabled persons with a variety of hospital, medical and prescription drug benefits. MA is Medicare's managed care alternative to the original Medicare program, which provides individuals standard Medicare benefits directly through CMS. Our MA CCPs generally require members to seek health care services and select a primary care physician from a network of health care providers. In addition, we offer coverage of prescription drug benefits under the Medicare Part D program as a component of most of our MA plans.

Medicare PDPs

We offer stand-alone Medicare Part D coverage to Medicare-eligible beneficiaries in our Medicare PDPs segment. The Medicare Part D prescription drug benefit is supported by risk sharing with the federal government through risk corridors designed to limit the losses and gains of the participating drug plans and by reinsurance for catastrophic drug costs. The government subsidy is based on the national weighted average monthly bid for this coverage, adjusted for risk factor payments. Additional subsidies are provided for dually-eligible beneficiaries and specified low-income beneficiaries. The Part D program offers national in-network prescription drug coverage that is subject to limitations in certain circumstances.





14



Summary of Financial Information

Reportable operating segments are defined as components of an enterprise for which discrete financial information is available and evaluated on a regular basis by the enterprise's decision-makers to determine how resources should be allocated to an individual segment and to assess performance of those segments. Accordingly, we have three reportable segments: Medicaid Health Plans, Medicare Health Plans and Medicare PDPs.

A summary of financial information for our reportable segments through the gross margin level and reconciliation to income from operations is presented in the table below.

 
Medicaid Health Plan
Medicare Health Plan
Medicare PDP
Corporate & Other
Consolidated
For the Three Months Ended June 30, 2019
(in millions)
Premium
$
4,704.8

$
1,872.8

$
259.3

$
5.3

$
6,842.2

Products and services



126.7

126.7

Total premium and products and services revenues
4,704.8

1,872.8

259.3

132.0

6,968.9



 



Medical benefits
4,268.1

1,545.5

210.6

2.9

6,027.1

Costs of products and services



123.2

123.2

ACA industry fee





Medicaid premium taxes
31.7




31.7

Total gross margin expenses
4,299.8

1,545.5

210.6

126.1

6,182.0



 



Gross margin
405.0

327.3

48.7

5.9

786.9



 



Investment and other income



41.2

41.2

Other expenses



(586.0
)
(586.0
)
Income from operations
$
405.0

$
327.3

$
48.7

$
(538.9
)
$
242.1







For the Three Months Ended June 30, 2018





Premium
$
2,866.2

$
1,546.4

$
200.0

$

$
4,612.6

Products and services





Total premium and products and services revenues
2,866.2

1,546.4

200.0


4,612.6

 
 
 
 
 
 
Medical benefits
2,438.6

1,281.9

145.5


3,866.0

Costs of products and services





ACA industry fee
47.8

26.7

4.5


79.0

Medicaid premium taxes
30.6




30.6

Total gross margin expenses
2,517.0

1,308.6

150.0


3,975.6

 
 
 
 
 
 
Gross margin (1)
349.2

237.8

50.0


637.0

 
 
 
 
 
 
Investment and other income



26.4

26.4

Other expenses (2)



(429.5
)
(429.5
)
Income from operations
$
349.2

$
237.8

$
50.0

$
(403.1
)
$
233.9



15



 
Medicaid Health Plan
Medicare Health Plan
Medicare PDP
Corporate & Other
Consolidated
For the Six Months Ended June 30, 2019
(in millions)
Premium
$
9,178.3

$
3,715.9

$
548.1

$
9.3

$
13,451.6

Products and services



242.5

242.5

Total premium and products and services revenues
9,178.3

3,715.9

548.1

251.8

13,694.1

 





Medical benefits
8,290.8

3,093.7

469.0

5.3

11,858.8

Costs of products and services



235.0

235.0

ACA industry fee





Medicaid premium taxes
63.4




63.4

Total gross margin expenses
8,354.2

3,093.7

469.0

240.3

12,157.2

 





Gross margin
824.1

622.2

79.1

11.5

1,536.9

 





Investment and other income



78.2

78.2

Other expenses



(1,188.9
)
(1,188.9
)