Magellan Health, Inc.
MAGELLAN HEALTH INC (Form: 10-Q, Received: 07/29/2016 11:51:10)

Table of Contents

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549



FORM 10-Q

(Mark One)    

ý

 

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

For the Quarterly Period Ended June 30, 2016

Or

o

 

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

For the transition period from                to              

Commission File No. 1-6639

MAGELLAN HEALTH, INC.
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of
incorporation or organization)
  58-1076937
(IRS Employer
Identification No.)

4800 N. Scottsdale Rd, Suite 4400
Scottsdale, Arizona

(Address of principal executive offices)

 

85251
(Zip code)

(602) 572-6050
(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 twelve 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  ý     No  o

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

        Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ý   Accelerated filer o   Non-accelerated filer o
(Do not check if a
smaller reporting company)
  Smaller reporting company o

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

        The number of shares of the registrant's Ordinary Common Stock outstanding as of June 30, 2016 was 24,581,451.

   


Table of Contents


FORM 10-Q

MAGELLAN HEALTH, INC. AND SUBSIDIARIES
INDEX

 
   
  Page No.  

 

PART I—Financial Information:

       

Item 1:

 

Financial Statements

    2  

 

Consolidated Balance Sheets—December 31, 2015 and June 30, 2016

    2  

 

Consolidated Statements of Income—For the Three and Six Months Ended June 30, 2015 and 2016

    3  

 

Consolidated Statements of Comprehensive Income—For the Three and Six Months Ended June 30, 2015 and 2016

    4  

 

Consolidated Statements of Cash Flows—For the Six Months Ended June 30, 2015 and 2016

    5  

 

Notes to Consolidated Financial Statements

    6  

Item 2:

 

Management's Discussion and Analysis of Financial Condition and Results of Operations

    33  

Item 3:

 

Quantitative and Qualitative Disclosures about Market Risk

    47  

Item 4:

 

Controls and Procedures

    47  

 

PART II—Other Information:

       

Item 1:

 

Legal Proceedings

    48  

Item 1A:

 

Risk Factors

    48  

Item 2:

 

Unregistered Sales of Equity Securities and Use of Proceeds

    48  

Item 3:

 

Defaults Upon Senior Securities

    49  

Item 4:

 

Mine Safety Disclosures

    49  

Item 5:

 

Other Information

    49  

Item 6:

 

Exhibits

    49  

Signatures

    50  

1


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PART I—FINANCIAL INFORMATION

Item 1.    Financial Statements.

        


MAGELLAN HEALTH, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)

 
  December 31,
2015
  June 30, 2016
(unaudited)
 

ASSETS

             

Current Assets:

             

Cash and cash equivalents

  $ 115,432   $ 198,656  

Restricted cash

    133,597     80,642  

Accounts receivable, less allowance for doubtful accounts of $3,246 and $3,384 at December 31, 2015 and June 30, 2016, respectively

    428,644     506,980  

Short-term investments (restricted investments of $277,556 and $246,968 at December 31, 2015 and June 30, 2016, respectively)

    322,339     284,604  

Pharmaceutical inventory

    50,749     62,995  

Other current assets (restricted deposits of $27,752 and $32,125 at December 31, 2015 and June 30, 2016, respectively)

    46,921     75,808  

Total Current Assets

    1,097,682     1,209,685  

Property and equipment, net

    174,745     173,933  

Restricted long-term investments

    3,826     3,054  

Deferred income taxes

    26,836     25,364  

Other long-term assets

    11,207     38,736  

Goodwill

    621,390     634,613  

Other intangible assets, net

    133,374     116,012  

Total Assets

  $ 2,069,060   $ 2,201,397  

LIABILITIES, REDEEMABLE NON-CONTROLLING INTEREST AND STOCKHOLDERS' EQUITY

             

Current Liabilities:

             

Accounts payable

  $ 86,484   $ 71,440  

Accrued liabilities

    139,726     171,102  

Short-term contingent consideration

    91,623     594  

Medical claims payable

    250,449     216,793  

Other medical liabilities

    136,939     136,637  

Current maturities of long-term debt and capital lease obligations

    19,014     50,516  

Total Current Liabilities

    724,235     647,082  

Long-term debt and capital lease obligations

    238,295     426,175  

Tax contingencies

    12,677     13,681  

Long-term contingent consideration

    803     3,214  

Deferred credits and other long-term liabilities

    20,930     21,975  

Total Liabilities

    996,940     1,112,127  

Redeemable non-controlling interest

    5,937     4,368  

Preferred stock, par value $.01 per share

   
 
   
 
 

Authorized—10,000 shares at December 31, 2015 and June 30, 2016—Issued and outstanding—none

         

Ordinary common stock, par value $.01 per share

             

Authorized—100,000 shares at December 31, 2015 and June 30, 2016—Issued and outstanding—51,340 shares and 24,692 shares at December 31, 2015, respectively, and 51,605 and 24,581 shares at June 30, 2016, respectively

    513     516  

Multi-Vote common stock, par value $.01 per share

             

Authorized—40,000 shares at December 31, 2015 and June 30, 2016—Issued and outstanding—none

         

Other Stockholders' Equity:

             

Additional paid-in capital

    1,124,013     1,150,756  

Retained earnings

    1,211,310     1,228,505  

Accumulated other comprehensive loss

    (262 )   (26 )

Ordinary common stock in treasury, at cost, 26,648 shares and 27,024 shares at December 31, 2015 and June 30, 2016, respectively

    (1,269,391 )   (1,294,849 )

Total Stockholders' Equity

    1,066,183     1,084,902  

Total Liabilities, Redeemable Non-Controlling Interest and Stockholders' Equity

  $ 2,069,060   $ 2,201,397  

   

See accompanying notes to consolidated financial statements.

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MAGELLAN HEALTH, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(In thousands, except per share amounts)

 
  Three Months Ended
June 30,
  Six Months Ended
June 30,
 
 
  2015   2016   2015   2016  

Net revenue:

                         

Managed care and other

  $ 776,240   $ 699,861   $ 1,524,890   $ 1,376,322  

PBM and dispensing

    381,367     464,484     613,685     905,045  

Total net revenue

    1,157,607     1,164,345     2,138,575     2,281,367  

Cost and expenses:

                         

Cost of care

    568,288     472,529     1,090,616     930,160  

Cost of goods sold

    361,409     436,930     579,616     852,389  

Direct service costs and other operating expenses(1)(2)(3)

    191,455     214,077     395,905     406,533  

Depreciation and amortization

    25,022     25,580     48,518     50,587  

Interest expense

    1,653     1,994     3,279     3,742  

Interest income

    (500 )   (692 )   (966 )   (1,375 )

Total costs and expenses

    1,147,327     1,150,418     2,116,968     2,242,036  

Income before income taxes

    10,280     13,927     21,607     39,331  

Provision for income taxes

    5,987     12,615     10,120     24,628  

Net income

    4,293     1,312     11,487     14,703  

Less: net (loss) income attributable to non-controlling interest

    (350 )   (2,646 )   (444 )   (2,492 )

Net income attributable to Magellan Health, Inc. 

  $ 4,643   $ 3,958   $ 11,931   $ 17,195  

Net income per common share attributable to Magellan Health, Inc.:

                         

Basic (See Note B)

  $ 0.18   $ 0.17   $ 0.47   $ 0.73  

Diluted (See Note B)

  $ 0.17   $ 0.16   $ 0.45   $ 0.70  

(1)
Includes stock compensation expense of $13,795 and $9,510 for the three months ended June 30, 2015 and 2016, respectively, and $27,696 and $18,397 for the six months ended June 30, 2015 and 2016, respectively.

(2)
Includes changes in fair value of contingent consideration of $2,567 and $463 for the three months ended June 30, 2015 and 2016, respectively, and $17,536 and $197 for the six months ended June 30, 2015 and 2016, respectively.

(3)
Includes impairment of intangible assets of $4,800 for the three and six months ended June 30, 2016.

   

See accompanying notes to consolidated financial statements.

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MAGELLAN HEALTH, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(In thousands)

 
  Three Months
Ended
June 30,
  Six Months Ended
June 30,
 
 
  2015   2016   2015   2016  

Net income

  $ 4,293   $ 1,312   $ 11,487   $ 14,703  

Other comprehensive income:

                         

Unrealized (losses) gains on available-for-sale securities(1)

    (93 )   (2 )   (24 )   236  

Comprehensive income

    4,200     1,310     11,463     14,939  

Less: comprehensive (loss) income attributable to non-controlling interest

    (350 )   (2,646 )   (444 )   (2,492 )

Comprehensive income attributable to Magellan Health, Inc. 

  $ 4,550   $ 3,956   $ 11,907   $ 17,431  

(1)
Net of income tax (benefit) provision of $(48) and $1 for the three months ended June 30, 2015 and 2016, respectively, and $(2) and $147 for the six months ended June 30, 2015 and 2016, respectively.

   

See accompanying notes to consolidated financial statements.

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MAGELLAN HEALTH, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30,

(Unaudited)

(In thousands)

 
  2015   2016  

Cash flows from operating activities:

             

Net income

  $ 11,487   $ 14,703  

Adjustments to reconcile net income to net cash provided by operating activities:

             

Depreciation and amortization

    48,518     50,587  

Non-cash impairment of intangible asset

        4,800  

Non-cash interest expense

    197     204  

Non-cash stock compensation expense

    27,696     18,397  

Non-cash income tax (benefit) provision

    (3,323 )   1,570  

Non-cash amortization on investments

    2,966     3,147  

Cash flows from changes in assets and liabilities, net of effects from acquisitions of businesses:

             

Restricted cash

    84,004     53,528  

Accounts receivable, net

    (32,064 )   (74,430 )

Pharmaceutical inventory

    (2,919 )   (12,246 )

Other assets

    (31,551 )   (56,460 )

Accounts payable and accrued liabilities

    (72,439 )   14,050  

Medical claims payable and other medical liabilities

    45,544     (34,460 )

Contingent consideration

    36,245     (50,904 )

Tax contingencies

    (578 )   647  

Deferred credits and other long-term liabilities

    (1,059 )   663  

Other

    (48 )   23  

Net cash provided by (used in) operating activities

    112,676     (66,181 )

Cash flows from investing activities:

             

Capital expenditures

    (37,653 )   (30,522 )

Acquisitions and investments in businesses, net of cash acquired

    (55,943 )   (16,050 )

Purchase of investments

    (293,348 )   (211,061 )

Maturity of investments

    215,984     246,786  

Net cash used in investing activities

    (170,960 )   (10,847 )

Cash flows from financing activities:

             

Proceeds from issuance of debt

        225,000  

Payments to acquire treasury stock

    (68,783 )   (25,458 )

Proceeds from exercise of stock options and warrants

    49,170     9,691  

Payments on long-term debt and capital lease obligations

    (8,299 )   (9,401 )

Payments on contingent consideration

    (4,439 )   (39,958 )

Tax benefit from exercise of stock options and vesting of stock awards

    3,774     472  

Other

    (616 )   (94 )

Net cash (used in) provided by financing activities

    (29,193 )   160,252  

Net (decrease) increase in cash and cash equivalents

    (87,477 )   83,224  

Cash and cash equivalents at beginning of period

    255,303     115,432  

Cash and cash equivalents at end of period

  $ 167,826   $ 198,656  

Supplemental cash flow data:

             

Non-cash investing activites:

             

Property and equipment acquired under capital leases

  $ 1,987   $ 4,010  

   

See accompanying notes to consolidated financial statements.

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MAGELLAN HEALTH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

(Unaudited)

NOTE A—General

Basis of Presentation

        The accompanying unaudited consolidated financial statements of Magellan Health, Inc., a Delaware corporation ("Magellan"), include Magellan and its subsidiaries (together with Magellan, the "Company"). The financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the Securities and Exchange Commission's (the "SEC") instructions to Form 10-Q. Accordingly, the financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring adjustments considered necessary for a fair presentation, have been included. The results of operations for the three and six months ended June 30, 2016 are not necessarily indicative of the results to be expected for the full year. All significant intercompany accounts and transactions have been eliminated in consolidation.

        These unaudited consolidated financial statements should be read in conjunction with the Company's audited consolidated financial statements for the year ended December 31, 2015 and the notes thereto, which are included in the Company's Annual Report on Form 10-K filed with the SEC on February 29, 2016.

Business Overview

        The Company is engaged in the healthcare management business, and is focused on managing the fastest growing, most complex areas of health, including special populations, complete pharmacy benefits and other specialty areas of healthcare. The Company develops innovative solutions that combine advanced analytics, agile technology and clinical excellence to drive better decision making, positively impact health outcomes and optimize the cost of care for the members we serve. The Company provides services to health plans and other managed care organizations ("MCOs"), employers, labor unions, various military and governmental agencies and third party administrators ("TPAs").

Healthcare

        Healthcare includes the Company's: (i) management of behavioral healthcare services and employee assistance program ("EAP") services, (ii) management of other specialty areas including diagnostic imaging and musculoskeletal management, and (iii) the integrated management of physical, behavioral and pharmaceutical healthcare for special populations, delivered through Magellan Complete Care ("MCC"). These special populations include individuals with serious mental illness ("SMI"), dual eligibles, long-term services and supports and other populations with unique and often complex healthcare needs.

        The Company's coordination and management of these healthcare services are provided through its comprehensive network of medical and behavioral health professionals, clinics, hospitals and ancillary service providers. This network of credentialed and privileged providers is integrated with clinical and quality improvement programs to improve access to care and enhance the healthcare experience for individuals in need of care, while at the same time making the cost of these services

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MAGELLAN HEALTH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE A—General (Continued)

more affordable for our customers. The Company generally does not directly provide or own any provider of treatment services, although it does employ licensed behavioral health counselors to deliver non-medical counseling under certain government contracts.

        The Healthcare segment's commercial division serves a variety of customers, with services, inclusive of special population management, provided under contracts with health plans and accountable care organizations for some or all of their commercial, Medicaid and Medicare members, as well as with employers. The government division contracts with local, state and federal governmental agencies to provide services to recipients under Medicaid, Medicare and other government programs.

        The Company provides its management services primarily through: (i) risk-based products, where the Company assumes all or a substantial portion of the responsibility for the cost of providing treatment services in exchange for a fixed per member per month fee and (ii) administrative services only ("ASO") products, where the Company provides services such as utilization review, claims administration and/or provider network management, but does not assume responsibility for the cost of the treatment services.

Pharmacy Management

        The Pharmacy Management segment ("Pharmacy Management") comprises products and solutions that provide clinical and financial management of pharmaceuticals paid under medical and pharmacy benefit programs. Pharmacy Management's services include: (i) pharmacy benefit management ("PBM") services; (ii) pharmacy benefit administration ("PBA") for state Medicaid and other government sponsored programs; (iii) pharmaceutical dispensing operations; (iv) clinical and formulary management programs; (v) medical pharmacy management programs; and (vi) programs for the integrated management of specialty drugs across both the medical and pharmacy benefit that treat complex conditions, regardless of site of service, method of delivery, or benefit reimbursement.

        Pharmacy Management's services are provided under contracts with health plans, employers, MCOs, state Medicaid programs, Medicare Part D and other government agencies, and encompass risk-based and fee-for-service ("FFS") arrangements. In addition, Pharmacy Management has subcontract arrangements to provide PBM services for certain Healthcare customers.

Corporate

        This segment of the Company is comprised primarily of amounts not allocated to the Healthcare and Pharmacy Management segments, including costs related to being a publicly traded company. In order to better represent the operations of the Company's segments, effective January 1, 2016, the Company began allocating operational and corporate support costs to the Healthcare and Pharmacy segments. These costs, which were historically reported in the Corporate segment, include operational support functions such as sales and marketing and information technology, as well as corporate support functions such as executive, finance and human resources. Prior period balances have been reclassified to reflect this change.

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MAGELLAN HEALTH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE A—General (Continued)

Summary of Significant Accounting Policies

Recent Accounting Pronouncements

        In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, "Revenue from Contracts with Customers (Topic 606)" ("ASU 2014-09"), which is a new comprehensive revenue recognition standard that will supersede virtually all existing revenue guidance under GAAP. In March 2016, the FASB issued ASU 2016-08, "Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)" ("ASU 2016-08"), which clarifies the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU No 2016-10, "Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing" ("ASU 2016-10"), which clarifies the performance obligations and licensing implementation guidance of ASU 2014-09. In July 2015, the FASB approved to defer the effective date of ASU 2014-09. These ASUs are effective for calendar years beginning after December 15, 2017. The Company is currently assessing the potential impact this ASU will have on the Company's consolidated results of operations, financial position and cash flows.

        In June 2014, the FASB issued ASU No. 2014-12, "Compensation—Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved After the Requisite Service Period" ("ASU 2014-12"), which revises the accounting treatment for stock compensation tied to performance targets. The amendments in this ASU are effective for calendar years beginning after December 15, 2015 and were adopted by the Company during the quarter ended March 31, 2016. The effect of this guidance was immaterial to the Company's consolidated results of operations, financial position or cash flows.

        In August 2014, the FASB issued ASU No. 2014-15, "Presentation of Financial Statements—Going Concern (Subtopic 205-40)" ("ASU 2014- 15"), which provides guidance in GAAP about management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and to provide related footnote disclosures. This amendment should reduce diversity in the timing and content of footnote disclosures. This ASU is effective for the annual period beginning after December 15, 2016 and for annual and interim reporting periods thereafter. The guidance is not expected to materially impact the Company's consolidated results of operations, financial position or cash flows.

        In February 2015, the FASB issued ASU No. 2015-02, "Amendments to the Consolidation Analysis" ("ASU 2015-02"), which amends certain requirements for determining whether a variable interest entity must be consolidated. The amendments in this ASU are effective for annual and interim reporting periods of public entities beginning after December 31, 2015 and were adopted by the Company during the quarter ended March 31, 2016. The effect of this guidance was immaterial to the Company's consolidated results of operations, financial position or cash flows.

        In April 2015, the FASB issued ASU No. 2015-05, "Intangibles—Goodwill and Other—Internal—Use Software (Subtopic 350-40): Customer's Accounting for Fees Paid in a Cloud Computing Arrangement" ("ASU 2015-05"), which provides guidance to clarify the customer's accounting for fees

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MAGELLAN HEALTH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE A—General (Continued)

paid in a cloud computing arrangement. The amendments in this ASU are effective for annual and interim reporting periods of public entities beginning after December 31, 2015 and were adopted by the Company on a prospective basis during the quarter ended March 31, 2016. The effect of this guidance was immaterial to the Company's consolidated results of operations, financial position or cash flows.

        In July 2015, the FASB issued ASU No. 2015-11, "Inventory (Topic 330): Simplifying the Measurement of Inventory" ("ASU 2015-11"). The amendment under this ASU requires that an entity measure inventory at the lower of cost or net realizable value. This guidance is effective for annual and interim reporting periods of public entities beginning after December 15, 2016. The guidance is not expected to materially impact the Company's consolidated results of operations, financial position or cash flows.

        In September 2015, the FASB issued ASU No. 2015-16, "Business Combinations (Topic 805): Simplifying the Accounting for Measurement Period Adjustments" ("ASU 2015-16"). The amendment under this ASU requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments in this ASU are effective for calendar years beginning after December 15, 2015 and were adopted by the Company during the quarter ended March 31, 2016. The effect of this guidance is immaterial to the Company's consolidated results of operations, financial position or cash flows.

        In February 2016, the FASB issued ASU No. 2016-02, "Leases" ("ASU 2016-02"). This ASU amends the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets. This guidance is effective for annual and interim reporting periods of public entities beginning after December 15, 2018, with early adoption permitted. The Company is currently assessing the potential impact this ASU will have on the Company's consolidated results of operations, financial position and cash flows.

        In March 2016, the FASB issued ASU No. 2016-09, "Compensation—Stock Compensation (Topic 718)" ("ASU 2016-09"). This ASU amends the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. This guidance is effective for annual and interim reporting period of public entities beginning after December 15, 2017, with early adoption permitted. The Company is currently assessing the potential impact this ASU will have on the Company's consolidated results of operations, financial position and cash flows.

        In June 2016, the FASB issued ASU No. 2016-13, "Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments" ("ASU 2016-13"). This ASU amends the accounting on reporting credit losses for assets held at amortized cost basis and available for sale debt securities. This guidance is effective for annual and interim periods of public entities beginning after December 15, 2019, with early adoption permitted for fiscal years beginning after December 31, 2018. The Company is currently assessing the potential impact this ASU will have on the Company's consolidated results of operation, financial positions and cash flows.

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MAGELLAN HEALTH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE A—General (Continued)

Use of Estimates

        The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Significant estimates of the Company include, among other things, accounts receivable realization, valuation allowances for deferred tax assets, valuation of goodwill and intangible assets, medical claims payable, other medical liabilities, contingent consideration, stock compensation assumptions, tax contingencies and legal liabilities. Actual results could differ from those estimates.

Managed Care and Other Revenue

        Managed Care Revenue.     Managed care revenue, inclusive of revenue from the Company's risk, EAP and ASO contracts, is recognized over the applicable coverage period on a per member basis for covered members. The Company is paid a per member fee for all enrolled members, and this fee is recorded as revenue in the month in which members are entitled to service. The Company adjusts its revenue for retroactive membership terminations, additions and other changes, when such adjustments are identified, with the exception of retroactivity that can be reasonably estimated. The impact of retroactive rate amendments is generally recorded in the accounting period that terms to the amendment are finalized, and that the amendment is executed. Any fees paid prior to the month of service are recorded as deferred revenue. Managed care revenues approximated $668.6 million and $1,314.9 million for the three and six months ended June 30, 2015, respectively and $570.8 million and $1,115.8 million for the three and six months ended June 30, 2016, respectively.

        Fee-For-Service, Fixed Fee and Cost-Plus Contracts.     The Company has certain contracts with customers under which the Company recognizes revenue as services are performed and as costs are incurred. This includes revenues received in relation to the Patient Protection and Affordable Care Act health insurer fee ("HIF fee") billed on a cost reimbursement basis. Revenues from these contracts approximated $86.7 million and $163.6 million for the three and six months ended June 30, 2015, respectively, and $102.6 million and $205.6 million for the three and six months ended June 30, 2016, respectively.

        Rebate Revenue.     The Company administers a rebate program for certain clients through which the Company coordinates the achievement, calculation and collection of rebates and administrative fees from pharmaceutical manufacturers on behalf of clients. Each period, the Company estimates the total rebates earned based on actual volumes of pharmaceutical purchases by the Company's clients, as well as historical and/or anticipated sharing percentages. The Company earns fees based upon the volume of rebates generated for its clients. The Company does not record as rebate revenue any rebates that are passed through to its clients. Total rebate revenues approximated $16.9 million and $32.8 million for the three and six months ended June 30, 2015, respectively, and $21.3 million and $41.1 million for the three and six months ended June 30, 2016, respectively.

        In relation to the Company's PBM business, the Company administers rebate programs through which it receives rebates from pharmaceutical manufacturers that are shared with its customers. The

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE A—General (Continued)

Company recognizes rebates when the Company is entitled to them and when the amounts of the rebates are determinable. The amount recorded for rebates earned by the Company from the pharmaceutical manufacturers is recorded as a reduction of cost of goods sold.

PBM and Dispensing Revenue

        Pharmacy Benefit Management Revenue.     The Company recognizes PBM revenue, which consists of a negotiated prescription price (ingredient cost plus dispensing fee), co-payments collected by the pharmacy and any associated administrative fees, when claims are adjudicated. The Company recognizes PBM revenue on a gross basis (i.e. including drug costs and co-payments) as it is acting as the principal in the arrangement and is contractually obligated to its clients and network pharmacies, which is a primary indicator of gross reporting. In addition, the Company is solely responsible for the claims adjudication process, negotiating the prescription price for the pharmacy, collection of payments from the client for drugs dispensed by the pharmacy, and managing the total prescription drug relationship with the client's members. If the Company enters into a contract where it is only an administrator, and does not assume any of the risks previously noted, revenue will be recognized on a net basis. PBM revenues approximated $330.0 million and $515.8 million for the three and six months ended June 30, 2015, respectively, and $362.0 million and $697.0 million for the three and six months ended June 30, 2016, respectively.

        Dispensing Revenue.     The Company recognizes dispensing revenue, which includes the co-payments received from members of the health plans the Company serves, when the specialty pharmaceutical drugs are shipped. At the time of shipment, the earnings process is complete; the obligation of the Company's customer to pay for the specialty pharmaceutical drugs is fixed, and, due to the nature of the product, the member may neither return the specialty pharmaceutical drugs nor receive a refund. Revenues from the dispensing of specialty pharmaceutical drugs on behalf of health plans were $51.4 million and $97.9 million for the three and six months ended June 30, 2015, respectively, and $54.4 million and $109.7 million for the three and six months ended June 30, 2016, respectively.

        Medicare Part D.     The Company is contracted with the Centers for Medicare and Medicaid Services ("CMS") as a Prescription Drug Plan ("PDP") to provide prescription drug benefits to Medicare beneficiaries. Net revenues include insurance premiums earned by the PDP, which includes a direct premium paid by CMS and a beneficiary premium paid by the PDP member. In cases of low-income members, the beneficiary premium may be subsidized by CMS. The Company recognizes insurance premium revenues on a monthly basis on a per member basis for covered members. In addition to these premiums, net revenues includes certain payments from the members based on the members' actual prescription claims, including co-payments, coverage gap benefits, deductibles and co-insurance (collectively, "Member Responsibilities"). The Company receives a prospective subsidy payment from CMS each month to subsidize a portion of the Member Responsibilities for low-income members. If the prospective subsidy differs from actual prescription claims, the difference is recorded as either a receivable or payable on the consolidated balance sheets. The Company assumes no risk for the Member Responsibilities, including the portion subsidized by CMS. The Company recognizes revenues for Member Responsibilities, including the portion subsidized by CMS, on a gross basis as claims are adjudicated. The CMS also provides an annual risk corridor adjustment which compares the

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE A—General (Continued)

Company's actual drug costs incurred to the premiums received. Based on the risk corridor adjustment, the Company may receive additional premiums from CMS or may be required to refund CMS a portion of previously received premiums. The Company calculates the risk corridor adjustment on a quarterly basis and the amount is included in net revenues with a corresponding receivable or payable on the consolidated balance sheets. Medicare Part D revenues approximated $48.1 million and $98.4 million for the three and six months ended June 30, 2016.

Significant Customers

Customers exceeding ten percent of the consolidated Company's net revenues

        The Company provides behavioral healthcare management and other related services to members in the state of Florida pursuant to contracts with the State of Florida (the "Florida Contracts"). The Company had behavioral healthcare contracts with various areas in the State of Florida (the "Florida Areas") which were part of the Florida Medicaid program. The State of Florida implemented a new system of mandated managed care through which Medicaid enrollees receive integrated healthcare services, and in 2014 phased out the behavioral healthcare programs under which the Florida Areas' contracts operated. The Company has a contract with the State of Florida to provide integrated healthcare services under the new program ("the Florida Medicaid Contract"). The Florida Medicaid Contract began on February 4, 2014 and extends through December 31, 2018, unless sooner terminated by the parties. The State of Florida has the right to terminate the Florida Medicaid Contract with cause, as defined, upon 24 hour notice and upon 30 days notice for any reason or no reason at all. The Florida Contracts generated net revenues of $218.0 million and $267.8 million for the six months ended June 30, 2015 and 2016, respectively.

        Through December 31, 2015, the Company provided behavioral healthcare management and other related services to members in the state of Iowa pursuant to contracts with the State of Iowa (the "Iowa Contracts"). The Iowa Contracts terminated on December 31, 2015. The Iowa Contracts generated net revenues of $261.9 million and $7.4 million for the six months ended June 30, 2015 and 2016, respectively.

Customers exceeding ten percent of segment net revenues

        In addition to the Florida Contracts and the Iowa Contracts previously discussed, the following customers generated in excess of ten percent of net revenues for the respective segment for the six months ended June 30, 2015 and 2016 (in thousands):

Segment
  Term Date   2015   2016  

Healthcare

                 

None

                 

Pharmacy Management

 

 

   
 
   
 
 

Customer A

  December 31, 2016   $ 158,132   $ 193,956  

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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(Unaudited)

NOTE A—General (Continued)

Concentration of Business

        The Company also has a significant concentration of business with various counties in the State of Pennsylvania (the "Pennsylvania Counties") which are part of the Pennsylvania Medicaid program, and with members under its contract with CMS. Net revenues from the Pennsylvania Counties in the aggregate totaled $186.1 million and $226.0 million for the six months ended June 30, 2015 and 2016, respectively. Net revenues from members in relation to its contract with CMS in aggregate totaled $115.5 million for the six months ended June 30, 2016, of which $98.4 million is Medicare Part D revenue.

        The Company's contracts with customers typically have terms of one to three years, and in certain cases contain renewal provisions (at the customer's option) for successive terms of between one and two years (unless terminated earlier). Substantially all of these contracts may be immediately terminated with cause and many of the Company's contracts are terminable without cause by the customer or the Company either upon the giving of requisite notice and the passage of a specified period of time (typically between 60 and 180 days) or upon the occurrence of other specified events. In addition, the Company's contracts with federal, state and local governmental agencies generally are conditioned on legislative appropriations. These contracts generally can be terminated or modified by the customer if such appropriations are not made.

Fair Value Measurements

        The Company has certain assets and liabilities that are required to be measured at fair value on a recurring basis. These assets and liabilities are to be measured using inputs from the three levels of the fair value hierarchy, which are as follows:

            Level 1—Inputs are unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

            Level 2—Inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (i.e., interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs).

            Level 3—Unobservable inputs that reflect the Company's assumptions about the assumptions that market participants would use in pricing the asset or liability. The Company develops these inputs based on the best information available, including the Company's data.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE A—General (Continued)

        In accordance with the fair value hierarchy described above, the following table shows the fair value of the Company's assets and liabilities that are required to be measured at fair value as of December 31, 2015 and June 30, 2016 (in thousands):

 
  December 31, 2015  
 
  Level 1   Level 2   Level 3   Total  

Assets

                         

Cash and cash equivalents(1)

  $   $ 6,009   $   $ 6,009  

Restricted cash(2)

        82,808         82,808  

Investments:

   
 
   
 
   
 
   
 
 

U.S. government and agency securities

    5,514             5,514  

Obligations of government-sponsored enterprises(3)

        50,525         50,525  

Corporate debt securities

        268,976         268,976  

Certificates of deposit

        1,150         1,150  

Total assets held at fair value

  $ 5,514   $ 409,468   $   $ 414,982  

Liabilities

                         

Contingent consideration

  $   $   $ 92,426   $ 92,426  

Total liabilities held at fair value

  $   $   $ 92,426   $ 92,426  

 

 
  June 30, 2016  
 
  Level 1   Level 2   Level 3   Total  

Assets

                         

Cash and cash equivalents(4)

  $   $ 65,785   $   $ 65,785  

Restricted cash(5)

        59,706         59,706  

Investments:

   
 
   
 
   
 
   
 
 

U.S. government and agency securities

    5,132             5,132  

Obligations of government-sponsored enterprises(6)

        54,708         54,708  

Corporate debt securities

        226,668         226,668  

Certificates of deposit

        1,150         1,150  

Total assets held at fair value

  $ 5,132   $ 408,017   $   $ 413,149  

Liabilities

                         

Contingent consideration

  $   $   $ 3,808   $ 3,808  

Total liabilities held at fair value

  $   $   $ 3,808   $ 3,808  

(1)
Excludes $109.4 million of cash held in bank accounts by the Company.

(2)
Excludes $50.8 million of restricted cash held in bank accounts by the Company.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE A—General (Continued)

(3)
Includes investments in notes issued by the Federal Home Loan Bank and Federal Farm Credit Banks.

(4)
Excludes $132.9 million of cash held in bank accounts by the Company.

(5)
Excludes $20.9 million of restricted cash held in bank accounts by the Company.

(6)
Includes investments in notes issued by the Federal Home Loan Bank, Federal National Mortgage Association and Federal Farm Credit Banks.

        For the six months ended June 30, 2016, the Company has not transferred any assets between fair value measurement levels.

        The carrying values of financial instruments, including accounts receivable and accounts payable, approximate their fair values due to their short-term maturities. The estimated fair value of the Company's term loans of $428.1 million as of June 30, 2016 was based on current interest rates for similar types of borrowings and is in Level 2 of the fair value hierarchy. The estimated fair values may not represent actual values of the financial instruments that could be realized as of the balance sheet date or that will be realized in the future.

        All of the Company's investments are classified as "available-for-sale" and are carried at fair value.

        The contingent consideration liability reflects the fair value of potential future payments related to the CDMI, LLC ("CDMI"), Cobalt Therapeutics, LLC ("Cobalt"), 4D Pharmacy Management Systems, Inc. ("4D") and The Management Group, LLC ("TMG") acquisitions. The CDMI purchase agreement provides for potential contingent payments up to a maximum aggregate amount of $165.0 million. The potential future payments are contingent upon CDMI meeting certain client retention, client conversion and gross profit milestones through December 31, 2016. The 4D purchase agreement provided for potential contingent payments up to a maximum aggregate amount of $30.0 million. The potential future payments were contingent upon the achievement of certain growth targets in the underlying dual eligible membership served by 4D during calendar year 2015 and the retention of certain business. The Cobalt and TMG purchase agreements also provide for potential contingent payments of up to a maximum of $6.0 million and $15.0 million, respectively.

        As of the balance sheet date, the fair value of contingent consideration is determined based on probabilities of payment, projected payment dates, discount rates, projected revenues, gross profits, client base, member engagement, and new contract execution. The projected revenues, gross profits, client base, member engagement and new contract execution are derived from the Company's latest internal operational forecasts. The Company used a probability weighted discounted cash flow method to arrive at the fair value of the contingent consideration. Changes in the operational forecasts, probabilities of payment, discount rates or projected payment dates may result in a change in the fair value measurement. Any changes in the fair value measurement are reflected as income or expense in the consolidated statements of income. As the fair value measurement for the contingent consideration is based on inputs not observed in the market, these measurements are classified as Level 3 measurements as defined by fair value measurement guidance.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE A—General (Continued)

        For CDMI, the Company estimated undiscounted future contingent payments of $90.1 million as of December 31, 2015, which the Company settled in June 2016. For 4D, the Company estimated net undiscounted future contingent payments of $1.0 million as of December 31, 2015, which the Company settled in February 2016. For Cobalt and TMG the unobservable inputs used in the fair value measurement include the discount rate, probabilities of payment and projected payment dates.

        As of June 30, 2016, the fair value of the short-term and long-term contingent consideration was $0.6 million and $3.2 million, respectively, and is included in short-term contingent consideration and long-term contingent consideration, respectively, in the consolidated balance sheets. The change in the fair value of the contingent consideration was $0.5 million and $0.2 million for the three and six months ended June 30, 2016, respectively, which was recorded as direct service costs and other operating expenses in the consolidated statements of income. The increase was mainly a result of changes in present value and the estimated undiscounted liability.

        The following table summarizes the Company's liability for contingent consideration for the six months ended (in thousands):

 
  June 30,
2016
 

Balance as of beginning of period

  $ 92,426  

Acquistion of TMG

    2,244  

Change in fair value

    197  

Net payments

    (91,059 )

Balance as of end of period

  $ 3,808  

Cash and Cash Equivalents

        Cash equivalents are short-term, highly liquid interest-bearing investments with maturity dates of three months or less when purchased, consisting primarily of money market instruments. At June 30, 2016, the Company's excess capital and undistributed earnings for the Company's regulated subsidiaries of $78.5 million are included in cash and cash equivalents.

Investments

        If a debt security is in an unrealized loss position and the Company has the intent to sell the debt security, or it is more likely than not that the Company will have to sell the debt security before recovery of its amortized cost basis, the decline in value is deemed to be other-than-temporary and is recorded to other-than-temporary impairment losses recognized in income in the consolidated statements of income. For impaired debt securities that the Company does not intend to sell or it is more likely than not that the Company will not have to sell such securities, but the Company expects that it will not fully recover the amortized cost basis, the credit component of the other- than-temporary impairment is recognized in other-than-temporary impairment losses recognized in income in the consolidated statements of income and the non-credit component of the other-than-temporary impairment is recognized in other comprehensive income.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE A—General (Continued)

        As of December 31, 2015 and June 30, 2016, there were no unrealized losses that the Company determined to be other-than-temporary. No realized gains or losses were recorded for the six months ended June 30, 2015 or 2016. The following is a summary of short-term and long-term investments at December 31, 2015 and June 30, 2016 (in thousands):

 
  December 31, 2015  
 
  Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Estimated
Fair Value
 

U.S. government and agency securities

  $ 5,524   $   $ (10 ) $ 5,514  

Obligations of government-sponsored enterprises(1)

    50,575     4     (54 )   50,525  

Corporate debt securities

    269,340         (364 )   268,976  

Certificates of deposit

    1,150             1,150  

Total investments at December 31, 2015

  $ 326,589   $ 4   $ (428 ) $ 326,165  

 

 
  June 30, 2016  
 
  Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Estimated
Fair Value
 

U.S. government and agency securities

  $ 5,126   $ 6   $   $ 5,132  

Obligations of government-sponsored enterprises(2)

    54,688     20         54,708  

Corporate debt securities

    226,735     26     (93 )   226,668  

Certificates of deposit

    1,150             1,150  

Total investments at June 30, 2016

  $ 287,699   $ 52   $ (93 ) $ 287,658  

(1)
Includes investments in notes issued by the Federal Home Loan Bank and Federal Farm Credit Banks.

(2)
Includes investments in notes issued by the Federal Home Loan Bank, Federal National Mortgage Association and Federal Farm Credit Banks.

        The maturity dates of the Company's investments as of June 30, 2016 are summarized below (in thousands):

 
  Amortized
Cost
  Estimated
Fair Value
 

2016

  $ 215,467   $ 215,426  

2017

    69,737     69,730  

2018

    2,495     2,502  

Total investments at June 30, 2016

  $ 287,699   $ 287,658  

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE A—General (Continued)

Income Taxes

        The Company's effective income tax rates were 46.8 percent and 62.6 percent for the six months ended June 30, 2015 and 2016, respectively. These rates differ from the federal statutory income tax rate primarily due to state income taxes, permanent differences between book and tax income, and changes to recorded tax contingencies and valuation allowances. The Company also accrues interest and penalties related to uncertain tax positions in its provision for income taxes. The effective income tax rate for the six months ended June 30, 2015 is lower than the effective rate for the six months ended June 30, 2016 mainly due to valuation allowance increases in 2016 with respect to losses at AlphaCare of New York, Inc. ("AlphaCare").

        The Company files a consolidated federal income tax return with most of its eighty-percent or more controlled subsidiaries. The Company files a separate consolidated federal income tax return for AlphaCare and its parent, AlphaCare Holdings, Inc. The Company and its subsidiaries also file income tax returns in various state and local jurisdictions. With few exceptions, the Company is no longer subject to state or local income tax assessments by tax authorities for years ended prior to 2012.

Net Operating Loss Carryforwards

        The Company has $2.4 million of federal net operating loss carryforwards ("NOLs") available to reduce its federal consolidated taxable income in 2016 and subsequent years. These NOLs will expire in 2018 and 2019 if not used and are subject to examination and adjustment by the Internal Revenue Service ("IRS"). AlphaCare has $37.6 million of federal NOLs available to reduce its consolidated taxable income in 2016 and subsequent years. These NOLs will expire in 2033 through 2035 if not used and are subject to examination and adjustment by the IRS. The Company and its subsidiaries also have $153.5 million of state NOLs available to reduce state taxable income at certain subsidiaries in 2016 and subsequent years. Most of these state NOLs will expire in 2017 through 2035 if not used and are subject to examination and adjustment by the respective state tax authorities.

        Deferred tax assets as of December 31, 2015 and June 30, 2016 are shown net of valuation allowances of $15.5 million and $20.2 million, respectively. These valuation allowances mostly relate to uncertainties regarding the eventual realization of the AlphaCare federal NOLs and certain state NOLs. Determination of the amount of deferred tax assets considered realizable requires significant judgment and estimation regarding the forecasts of future taxable income which are consistent with the plans and estimates the Company uses to manage the underlying businesses. Although consideration is also given to potential tax planning strategies which might be available to improve the realization of deferred tax assets, none were identified which were both prudent and reasonable. Future changes in the estimated realizable portion of deferred tax assets could materially affect the Company's financial condition and results of operations.

Health Care Reform

        The Patient Protection and the Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively, the "Health Reform Law"), imposes a mandatory annual fee on health insurers for each calendar year beginning on or after January 1, 2014. The

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE A—General (Continued)

Company has obtained rate adjustments from customers which the Company expects will cover the direct costs of these fees and the impact from non-deductibility of such fees for federal and state income tax purposes. To the extent the Company has such a customer that does not renew, there may be some impact due to taxes paid where the timing and amount of recoupment of these additional costs is uncertain. In the event the Company is unable to obtain rate adjustments to cover the financial impact of the annual fee, the fee may have a material impact on the Company. For 2015, the HIF fees were $26.5 million which has been paid. For 2016, the HIF fees are estimated to be $26.3 million, and are included in accrued liabilities in the consolidated balance sheets. Of these amounts, $6.3 million and $13.2 million was expensed in the three and six months ended June 30, 2015 and $6.1 million and $13.2 million was expensed in the three and six months ended June 30, 2016, respectively, which was included in direct service costs and other operating expenses in the consolidated statements of income. The Company recorded revenues of $10.7 million and $22.4 million in the three and six months ended June 30, 2015, respectively, and $10.1 million and $21.4 million in the three and six months ended June 30, 2016, respectively, associated with the accrual for the reimbursement of the economic impact of the HIF fees from its customers.

Stock Compensation

        At December 31, 2015 and June 30, 2016, the Company had equity-based employee incentive plans, which are described more fully in Note 6 in the Company's Annual Report on Form 10-K for the year ended December 31, 2015. The Company recorded stock compensation expense of $13.8 million and $27.7 million for the three and six months ended June 30, 2015 and $9.5 million and $18.4 million for the three and six months ended June 30, 2016, respectively. Stock compensation expense recognized in the consolidated statements of income for the six months ended June 30, 2015 and 2016 has been reduced for forfeitures, estimated at between zero and four percent for both periods.

        The weighted average grant date fair value of all stock options granted during the six months ended June 30, 2016 was $15.04 as estimated using the Black-Scholes-Merton option pricing model, which also assumed an expected volatility of 27.75 percent based on the historical volatility of the Company's stock price.

        The benefits of tax deductions in excess of recognized stock compensation expense are reported as a financing cash flow, rather than as an operating cash flow. In the six months ended June 30, 2015 and 2016, $3.8 million and $0.5 million, respectively, of benefits of such tax deductions related to stock compensation expense were realized and as such were reported as financing cash flows. For the six months ended June 30, 2015, the net change to additional paid in capital related to tax benefits (deficiencies) was $3.7 million, which includes $3.8 million of excess tax benefits offset by $(0.1) million of excess tax deficiencies. For the six months ended June 30, 2016, the net change to additional paid in capital related to tax benefits (deficiencies) was $0.3 million, which includes $0.5 million of excess tax benefits offset by $(0.2) million of excess tax deficiencies.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE A—General (Continued)

        Summarized information related to the Company's stock options for the six months ended June 30, 2016 is as follows:

 
  Options   Weighted
Average
Exercise
Price
 

Outstanding, beginning of period

    2,939,840   $ 55.13  

Granted

    445,560     64.08  

Forfeited

    (45,263 )   51.07  

Exercised

    (195,202 )   49.00  

Outstanding, end of period

    3,144,935   $ 56.84  

Vested and expected to vest at end of period

    3,111,786   $ 56.78  

Exercisable, end of period

    1,785,957   $ 53.13  

        All of the Company's options granted during the six months ended June 30, 2016 vest ratably on each anniversary date over the three years subsequent to grant and have a ten year life.

        Summarized information related to the Company's nonvested restricted stock awards ("RSAs") for the six months ended June 30, 2016 is as follows:

 
  Shares   Weighted
Average
Grant Date
Fair Value
 

Outstanding, beginning of period

    1,109,622   $ 57.88  

Awarded

    16,065     65.36  

Vested

    (20,115 )   67.12  

Forfeited

         

Outstanding, end of period

    1,105,572     57.82  

        Summarized information related to the Company's nonvested restricted stock units ("RSUs") for the six months ended June 30, 2016 is as follows:

 
  Shares   Weighted
Average
Grant Date
Fair Value
 

Outstanding, beginning of period

    231,088   $ 61.53  

Awarded

    51,521     64.87  

Vested

    (51,419 )   63.77  

Forfeited

    (13,713 )   63.59  

Outstanding, end of period

    217,477     61.66  

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE A—General (Continued)

        The vesting period for RSAs ranges from 12 months to 42 months. In general, RSUs vest ratably on each anniversary over the three years subsequent to grant. In addition, certain RSUs outstanding contain associated performance hurdle(s) that must be met in order for the awards to vest.

        Summarized information related to the Company's nonvested restricted performance stock units ("PSUs") for the six months ended June 30, 2016 is as follows:

 
  Shares   Weighted
Average
Grant Date
Fair Value
 

Outstanding, beginning of period

    36,938   $ 85.00  

Awarded

    65,067     97.60  

Vested

         

Forfeited

         

Outstanding, end of period

    102,005     93.04  

        The estimated fair value of the PSUs granted in the six months ended June 30, 2016 was $97.60, which was derived from a Monte Carlo simulation. Significant assumptions utilized in estimating the value of the awards granted include an expected dividend yield of 0%, a risk free rate of 1%, and expected volatility of 16% to 81% (average of 32%). The PSUs granted in the six months ended June 30, 2016, will entitle the grantee to receive a number of shares of the Company's common stock determined over a three-year performance period ending on December 31, 2018 and vesting on March 3, 2019, the settlement date, provided the grantee remains in the service of the Company on the settlement date. The Company expenses the cost of these awards ratably over the requisite service period. The number of shares for which the PSUs will be settled will be a percentage of shares for which the award is targeted and will depend on the Company's total shareholder return (as defined below), expressed as a percentile ranking of the Company's total shareholder return as compared to the Company's peer group (as defined below). The number of shares for which the PSUs will be settled vary from zero to 200 percent of the shares specified in the grant. Total shareholder return is determined by dividing the average share value of the Company's common stock over the 30 trading days preceding January 1, 2019 by the average share value of the Company's common stock over the 30 trading days beginning on January 1, 2016, with a deemed reinvestment of any dividends declared during the performance period. The Company's peer group includes 56 companies which comprise the S&P Health Care Services Industry Index, which was selected by the compensation committee of the Company's board of directors and includes a range of healthcare companies operating in several business segments.

Long Term Debt and Capital Lease Obligations

        On July 23, 2014, the Company entered into a $500.0 million Credit Agreement with various lenders that provides for Magellan Rx Management, Inc. (a wholly owned subsidiary of Magellan Health, Inc.) to borrow up to $250.0 million of revolving loans, with a sublimit of up to $70.0 million for the issuance of letters of credit for the account of the Company, and a term loan in an original

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE A—General (Continued)

aggregate principal amount of $250.0 million (the "2014 Credit Facility"). On December 2, 2015, the Company entered into an amendment to the 2014 Credit Facility under which Magellan Pharmacy Services, Inc. (a wholly owned subsidiary of Magellan Health, Inc.) became a party to the $500.0 million Credit Agreement as the borrower and assumed all of the obligations of Magellan Rx Management, Inc. The 2014 Credit Facility is guaranteed by substantially all of the non-regulated subsidiaries of the Company and will mature on July 23, 2019; however, the Company holds an option to extend the 2014 Credit Facility for an additional one year period.

        Under the 2014 Credit Facility, the annual interest rate on revolving and term loan borrowings is equal to (i) in the case of base rate loans, the sum of a borrowing margin of 0.50 percent plus the higher of the prime rate, one-half of one percent in excess of the overnight "federal funds" rate, or the Eurodollar rate for one month plus 1.00 percent, or (ii) in the case of Eurodollar rate loans, the sum of a borrowing margin of 1.50 percent plus the Eurodollar rate for the selected interest period based on the Company's current total leverage ratio. The Company has the option to borrow in base rate loans or Eurodollar rate loans at its discretion, with the borrowing margin for these loans adjusted from time to time based on the Company's total leverage ratio. Letters of credit issued bear interest at the rate of 1.625 percent and the commitment commission on the 2014 Credit Facility is 0.20 percent of the unused Revolving Loan Commitment, both of which are based on the Company's current total leverage ratio. These rates shall be adjusted from time to time based on the Company's total leverage ratio.

        Under the 2014 Credit Facility, on September 30, 2014, the Company completed a draw-down of the $250.0 million term loan (the "2014 Term Loan"). The borrowings will initially be maintained as a Eurodollar loan. The 2014 Term Loan is subject to certain quarterly amortization payments. As of June 30, 2016 the remaining balance on the 2014 Term Loan was $228.1 million. The 2014 Term Loan will mature on July 23, 2019. As of June 30, 2016, the 2014 Term Loan bore interest at a rate of 1.50 percent plus the London Interbank Offered Rate ("LIBOR"), which was equivalent to a total interest rate of 1.9603 percent. For the six months ended June 30, 2016, the weighted average interest rate was 1.9358 percent.

        On June 27, 2016, the Company entered into a $200.0 million Credit Agreement with various lenders that provides for a $200.0 million term loan (the "2016 Term Loan") to Magellan Pharmacy Services, Inc. (the "2016 Credit Facility"). The 2016 Credit Facility is guaranteed by substantially all of the non-regulated subsidiaries of the Company and will mature on December 29, 2017.

        Under the 2016 Credit Facility, the annual interest rate on the term loan is equal to (i) in the case of base rate loans, the sum of a borrowing margin of 0.375 percent plus the higher of the prime rate, one-half of one percent in excess of the overnight "federal funds" rate, or the Eurodollar rate for one month plus 1.00 percent, or (ii) in the case of Eurodollar rate loans, the sum of a borrowing margin of 1.375 percent plus the Eurodollar rate for the selected interest period, based on the Company's current total leverage ratio. The Company has the option to borrow in base rate loans or Eurodollar rate loans at its discretion, with the borrowing margin for these loans adjusted from time to time based on the Company's total leverage ratio.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE A—General (Continued)

        The borrowings under the 2016 Term Loan will initially be maintained as a Eurodollar loan. As of June 30, 2016 the remaining balance on the 2016 Term Loan was $200.0 million and bore interest at a rate of 1.375 percent plus the London Interbank Offered Rate ("LIBOR"), which was equivalent to a total interest rate of 1.8283 percent.

        As of June 30, 2016, the contractual maturities of the term loans under the 2014 Credit Facility and the 2016 Credit Facility were as follows: 2016—$9.4 million; 2017—$225.0 million; 2018—$25.0 million; and 2019—$168.7 million. The Company had $33.4 million and $33.7 million of letters of credit outstanding at December 31, 2015 and June 30, 2016, respectively. The Company had no revolving loan borrowings at December 31, 2015. In April 2016, due to the timing of working capital needs, the Company borrowed $25.0 million of the available revolving loans under the 2014 Credit Facility, which remains outstanding on June 30, 2016. In July 2016, due to the timing of working capital needs, the Company borrowed an additional net $25.0 million of the available revolving loans under the 2014 Credit Facility. As of July 22, 2016, there are $166.3 million of revolving loans available under the 2014 Credit Facility.

        There were $24.4 million and $25.2 million of capital lease obligations at December 31, 2015 and June 30, 2016, respectively. Included in long-term debt and capital lease obligations as of December 31, 2015 and June 30, 2016 are deferred loan issuance costs of $1.4 million and $1.6 million, respectively.

Redeemable Non-Controlling Interest

        As of June 30, 2016, the Company held an equity interest of approximately 84% in AlphaCare Holdings. The other shareholders of AlphaCare Holdings have the right to exercise put options, requiring the Company to purchase up to 50% of the remaining shares prior to January 1, 2017, provided certain membership levels are attained. After December 31, 2016, the other shareholders of AlphaCare Holdings have the right to exercise put options requiring the Company to purchase all or any portion of the remaining shares. In addition, after December 31, 2016, the Company has the right to purchase all remaining shares. Non-controlling interests with redemption features, such as put options, that are not solely within the Company's control are considered redeemable non-controlling interests. Redeemable non-controlling interest is considered to be temporary and is therefore reported in a mezzanine level between liabilities and stockholders' equity on the Company's consolidated balance sheet at the greater of the initial carrying amount adjusted for the non-controlling interest's share of net income or loss or its redemption value. The carrying value of the non-controlling interest as of December 31, 2015 and June 30, 2016 was $5.9 million and $4.4 million, respectively. The $1.5 million decrease in carrying value is a result of operating losses, partially offset by the impact of additional capital provided by the Company. The Company evaluates the redemption value on a quarterly basis. If the redemption value is greater than the carrying value, the Company adjusts the carrying amount of the non-controlling interest to equal the redemption value at the end of each reporting period. Under this method, this is viewed at the end of the reporting period as if it were also the redemption date for the non-controlling interest. The Company will reflect redemption value adjustments in the earnings per share ("EPS") calculation if redemption value is in excess of the carrying value of the non-controlling interest. As of June 30, 2016, the carrying value of the non-controlling interest exceeded the redemption value and therefore no adjustment to the carrying value was required.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE A—General (Continued)

Intangible Assets

        The Company reviews other intangible assets for impairment when events or changes in circumstances occur which may potentially impact the estimated useful life of the intangible assets. During the second quarter of 2016, the Company recognized $4.8 million in impairment charges, which are reflected in direct service costs and other operating expenses in the consolidated statements of income and reported within the Healthcare segment. The fair value of the impairment was determined using the income method, which resulted in the full impairment of the customer agreement intangible asset recorded in conjunction with the AlphaCare acquisition.

Reclassifications

        Certain prior year amounts have been reclassified to conform with the current year presentation.

        In order to better represent the operations of the Company's segments, effective January 1, 2016, the Company began allocating operational and corporate support costs to the Healthcare and Pharmacy Management segments. For comparative presentation, the Company applied the allocation methodology retrospectively and reclassified direct service costs and other between segments for the three and six months ended June 30, 2015. The impact of these reclassifications are disclosed in Note C—"Business Segment Information".

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE B—Net Income per Common Share Attributable to Magellan Health, Inc.

        The following table reconciles income attributable to common shareholders (numerator) and shares (denominator) used in the computations of net income per share attributable to common shareholders (in thousands, except per share data):

 
  Three Months Ended
June 30,
  Six Months Ended
June 30,
 
 
  2015   2016   2015   2016  

Numerator:

                         

Net income attributable to Magellan Health, Inc. 

  $ 4,643   $ 3,958   $ 11,931   $ 17,195  

Denominator:

                         

Weighted average number of common shares outstanding—basic

    25,684     23,516     25,502     23,570  

Common stock equivalents—stock options

    362     355     406     306  

Common stock equivalents—RSAs

    654     619     584     583  

Common stock equivalents—RSUs

    26     23     36     27  

Common stock equivalents—PSUs

    49     31     58     29  

Common stock equivalents—employee stock purchase plan

    1     2     2     2  

Weighted average number of common shares outstanding—diluted

    26,776     24,546     26,588     24,517  

Net income attributable to Magellan Health, Inc. per common share—basic

  $ 0.18   $ 0.17   $ 0.47   $ 0.73  

Net income attributable to Magellan Health, Inc. per common share—diluted

  $ 0.17   $ 0.16   $ 0.45   $ 0.70  

        The weighted average number of common shares outstanding for the six months ended June 30, 2015 and 2016 were calculated using outstanding shares of the Company's common stock. Common stock equivalents included in the calculation of diluted weighted average common shares outstanding for the six months ended June 30, 2015 and 2016 represent stock options to purchase shares of the Company's common stock, RSAs, RSUs, PSUs and stock purchased under the Employee Stock Purchase Plan.

        The Company had additional potential dilutive securities outstanding representing 0.8 million and 0.9 million options for the three and six months ended June 30, 2015, respectively, and 1.2 million and 1.1 million options for the three and six months ended June 30, 2016, respectively, that were not included in the computation of dilutive securities because they were anti-dilutive for the period. Had these shares not been anti-dilutive, all of these shares would not have been included in the net income attributable to common shareholder per common share calculation as the Company uses the treasury stock method of calculating diluted shares.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE C—Business Segment Information

        The accounting policies of the Company's segments are the same as those described in Note A—"General." The Company evaluates performance of its segments based on profit or loss from operations before stock compensation expense, depreciation and amortization, interest expense, interest and other income, changes in the fair value of contingent consideration recorded in relation to acquisitions, gain on sale of assets, special charges or benefits, and income taxes ("Segment Profit"). Management uses Segment Profit information for internal reporting and control purposes and considers it important in making decisions regarding the allocation of capital and other resources, risk assessment and employee compensation, among other matters. Healthcare subcontracts with Pharmacy Management to provide pharmacy benefits management services for certain of Healthcare's customers. In addition, Pharmacy Management provides pharmacy benefits management for the Company's employees covered under its medical plan. As such, revenue, cost of goods sold and direct service costs and other related to these arrangements are eliminated. The Company's segments are defined in Note A—"General".

        The following tables summarize, for the periods indicated, operating results by business segment (in thousands):

 
  Healthcare   Pharmacy
Management
  Corporate
and
Elimination
  Consolidated  

Three Months Ended June 30, 2015

                         

Managed care and other revenue

  $ 722,471   $ 53,782   $ (13 ) $ 776,240  

PBM and dispensing revenue

        408,924     (27,557 )   381,367  

Cost of care

    (568,288 )           (568,288 )

Cost of goods sold

        (387,828 )   26,419     (361,409 )

Direct service costs and other(3)

    (124,779 )   (61,038 )   (5,638 )   (191,455 )

Stock compensation expense(1)(3)

    1,784     10,339     1,672     13,795  

Changes in fair value of contingent consideration(1)

    71     2,496         2,567  

Less: non-controlling interest segment profit (loss)(2)

    (273 )       (77 )   (350 )

Segment profit (loss)

  $ 31,532   $ 26,675   $ (5,040 ) $ 53,167  

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE C—Business Segment Information (Continued)


 
  Healthcare   Pharmacy
Management
  Corporate
and
Elimination
  Consolidated  

Three Months Ended June 30, 2016

                         

Managed care and other revenue

  $ 637,970   $ 61,975   $ (84 ) $ 699,861  

PBM and dispensing revenue

        495,399     (30,915 )   464,484  

Cost of care

    (472,529 )           (472,529 )

Cost of goods sold

        (466,637 )   29,707     (436,930 )

Direct service costs and other(3)

    (139,965 )   (64,086 )   (10,026 )   (214,077 )

Stock compensation expense(1)(3)

    2,451     5,548     1,511     9,510  

Changes in fair value of contingent consideration(1)

    390     73         463  

Impairment of intangible assets(1)

    4,800             4,800  

Less: non-controlling interest segment profit (loss)(2)

    (1,305 )       (7 )   (1,312 )

Segment profit (loss)

  $ 34,422   $ 32,272   $ (9,800 ) $ 56,894  

 

 
  Healthcare   Pharmacy
Management
  Corporate
and
Elimination
  Consolidated  

Six Months Ended June 30, 2015

                         

Managed care and other revenue

  $ 1,422,064   $ 102,850   $ (24 ) $ 1,524,890  

PBM and dispensing revenue

        667,717     (54,032 )   613,685  

Cost of care

    (1,090,621 )   5         (1,090,616 )

Cost of goods sold

        (631,366 )   51,750     (579,616 )

Direct service costs and other(3)

    (253,247 )   (129,271 )   (13,387 )   (395,905 )

Stock compensation expense(1)(3)

    4,972     19,744     2,980     27,696  

Changes in fair value of contingent consideration(1)

    171     17,365         17,536  

Less: non-controlling interest segment profit (loss)(2)

    (393 )       (51 )   (444 )

Segment profit (loss)

  $ 83,732   $ 47,044   $ (12,662 ) $ 118,114  

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE C—Business Segment Information (Continued)


 
  Healthcare   Pharmacy
Management
  Corporate
and
Elimination
  Consolidated  

Six Months Ended June 30, 2016

                         

Managed care and other revenue

  $ 1,256,898   $ 119,552   $ (128 ) $ 1,376,322  

PBM and dispensing revenue

        965,633     (60,588 )   905,045  

Cost of care

    (930,160 )           (930,160 )

Cost of goods sold

        (910,586 )   58,197     (852,389 )

Direct service costs and other(3)

    (265,582 )   (124,927 )   (16,024 )   (406,533 )

Stock compensation expense(1)(3)

    4,470     10,970     2,957     18,397  

Changes in fair value of contingent consideration(1)

    70     127         197  

Impairment of intangible assets(1)

    4,800             4,800  

Less: non-controlling interest segment profit (loss)(2)

    (1,136 )       (11 )   (1,147 )

Segment profit (loss)

  $ 71,632   $ 60,769   $ (15,575 ) $ 116,826  

(1)
Stock compensation expense, changes in the fair value of contingent consideration recorded in relation to the acquisitions, and impairment of intangible assets are included in direct service costs and other operating expenses; however, these amounts are excluded from the computation of Segment Profit.

(2)
The non-controlling portion of AlphaCare's segment profit (loss) is excluded from the computation of Segment Profit.

(3)
Effective January 1, 2016, the Company implemented changes related to the allocation of Corporate operational and support functions. These changes were applied retrospectively. The following tables summarize, for the periods indicated, the changes by business segment (in thousands):

 
  Healthcare   Pharmacy
Management
  Corporate
and
Elimination
  Consolidated  

Three Months Ended June 30, 2015

                         

Segment profit (loss) before Corporate allocations

  $ 47,522   $ 30,960   $ (25,315 ) $ 53,167  

Allocated Corporate costs

    (17,280 )   (4,608 )   21,888      

Allocated Corporate stock compensation expense

    1,290     323     (1,613 )    

Segment profit (loss)

  $ 31,532   $ 26,675   $ (5,040 ) $ 53,167  

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE C—Business Segment Information (Continued)


 
  Healthcare   Pharmacy
Management
  Corporate
and
Elimination
  Consolidated  

Three Months Ended June 30, 2016

                         

Segment profit (loss) before Corporate allocations

  $ 50,719   $ 36,256   $ (30,081 ) $ 56,894  

Allocated Corporate costs

    (17,661 )   (4,325 )   21,986      

Allocated Corporate stock compensation expense

    1,364     341     (1,705 )    

Segment profit (loss)

  $ 34,422   $ 32,272   $ (9,800 ) $ 56,894  

 

 
  Healthcare   Pharmacy
Management
  Corporate
and
Elimination
  Consolidated  

Six Months Ended June 30, 2015

                         

Segment profit (loss) before Corporate allocations

  $ 115,470   $ 55,465   $ (52,821 ) $ 118,114  

Allocated Corporate costs

    (35,227 )   (9,293 )   44,520      

Allocated Corporate stock compensation expense

    3,489     872     (4,361 )    

Segment profit (loss)

  $ 83,732   $ 47,044   $ (12,662 ) $ 118,114  

 

 
  Healthcare   Pharmacy
Management
  Corporate
and
Elimination
  Consolidated  

Six Months Ended June 30, 2016

                         

Segment profit (loss) before Corporate allocations

  $ 104,246   $ 68,963   $ (56,383 ) $ 116,826  

Allocated Corporate costs

    (35,302 )   (8,866 )   44,168      

Allocated Corporate stock compensation expense

    2,688     672     (3,360 )    

Segment profit (loss)

  $ 71,632   $ 60,769   $ (15,575 ) $ 116,826  

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE C—Business Segment Information (Continued)

        The following table reconciles Segment Profit to income before income taxes (in thousands):

 
  Three Months Ended
June 30,
  Six Months Ended
June 30,
 
 
  2015   2016   2015   2016  

Segment profit

  $ 53,167   $ 56,894   $ 118,114   $ 116,826  

Stock compensation expense

    (13,795 )   (9,510 )   (27,696 )   (18,397 )

Changes in fair value of contingent consideration

    (2,567 )   (463 )   (17,536 )   (197 )

Impairment of intangible assets

        (4,800 )       (4,800 )

Non-controlling interest segment profit (loss)

    (350 )   (1,312 )   (444 )   (1,147 )

Depreciation and amortization

    (25,022 )   (25,580 )   (48,518 )   (50,587 )

Interest expense

    (1,653 )   (1,994 )   (3,279 )   (3,742 )

Interest income

    500     692     966     1,375  

Income before income taxes

  $ 10,280   $ 13,927   $ 21,607   $ 39,331  

NOTE D—Commitments and Contingencies

Legal

        The Company's operating activities entail significant risks of liability. From time to time, the Company is subject to various actions and claims arising from the acts or omissions of its employees, network providers or other parties. In the normal course of business, the Company receives reports relating to deaths and other serious incidents involving patients whose care is being managed by the Company. Such incidents occasionally give rise to malpractice, professional negligence and other related actions and claims against the Company or its network providers. Many of these actions and claims received by the Company seek substantial damages and therefore require the Company to incur significant fees and costs related to their defense.

        The Company is also subject to or party to certain class actions and other litigation and claims relating to its operations or business practices. In the opinion of management, the Company has recorded reserves that are adequate to cover litigation, claims or assessments that have been or may be asserted against the Company, and for which the outcome is probable and reasonably estimable. Management believes that the resolution of such litigation and claims will not have a material adverse effect on the Company's financial condition or results of operations; however, there can be no assurance in this regard.

Stock Repurchases

        On October 22, 2014 the Company's board of directors approved a new stock repurchase plan which authorized the Company to purchase up to $200 million of its outstanding common stock through October 22, 2016. Stock repurchases under the program may be purchased from time to time in open market transactions (including blocks) or in privately negotiated transactions. The timing of repurchases and the actual amount purchased will depend on a variety of factors including the market price of the Company's shares, general market and economic conditions, and other corporate

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2016

(Unaudited)

NOTE D—Commitments and Contingencies (Continued)

considerations. Repurchases may be made pursuant to plans intended to comply with Rule 10b5-1 under the Securities Exchange Act of 1934, which could allow the Company to purchase its shares during periods when it otherwise might be prevented from doing so under insider trading laws or because of self-imposed trading blackout periods. Repurchases are expected to be funded from working capital and anticipated cash from operations. The repurchase authorization does not require the purchase of a specific number of shares and is subject to suspension or termination by the Company's board of directors at any time.

        Pursuant to this program, the Company made open market purchases as follows (aggregate cost excludes broker commissions and is reflected in millions):

Period
  Total Number
of Shares
Purchased
  Average
Price Paid
per Share
  Aggregate
Cost
 

November 24, 2014 - December 31, 2014

    232,170   $ 60.65   $ 14.1  

January 1, 2015 - October 21, 2015

    3,153,156     58.96     185.9  

    3,385,326         $ 200.0  

        On October 26, 2015, the Company's board of directors approved a stock repurchase plan which authorized the Company to purchase up to $200 million of its outstanding common stock through October 26, 2017. Pursuant to this program, the Company made purchases as follows (aggregate cost excludes broker commissions and is reflected in millions):

Period
  Total Number
of Shares
Purchased
  Average
Price Paid
per Share
  Aggregate
Cost
 

October 26, 2015 - December 31, 2015

    345,044   $ 53.46   $ 18.4  

January 1, 2016 - June 30, 2016

    375,507     67.78     25.5  

    720,551         $ 43.9  

        The Company made no repurchases from July 1, 2016 through July 22, 2016.

NOTE E—Acquisitions

        Pursuant to the February 9, 2016 purchase agreement (the "TMG Agreement") with TMG, on February 29, 2016 the Company acquired all of the outstanding equity interests of TMG. TMG is a company with 30 years of expertise in community-based long-term care services and supports. As consideration for the transaction, the Company paid a base price of $15.0 million in cash, subject to working capital adjustments. In addition to the base purchase price, the TMG agreement provides for potential contingent payments up to a maximum aggregate of $15.0 million. The potential future payments are contingent upon the Company being awarded additional managed long-term services and supports contracts. The Company reports the results of operations of TMG within its Healthcare segment. The Company's estimated fair values of TMG's assets acquired and liabilities assumed at the date of acquisition are determined based on certain valuations and analyses that have yet to be

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JUNE 30, 2016

(Unaudited)

NOTE E—Acquisitions (Continued)

finalized, and accordingly, the assets acquired and liabilities assumed are subject to adjustment once the analyses are completed. The Company will make appropriate adjustments to the purchase price allocations prior to the completion of the measurement period as required.

NOTE F—Subsequent Events

        Pursuant to the May 15, 2016 share purchase agreement (the "AFSC Agreement") with Armed Forces Services Corporation ("AFSC"), on July 1, 2016 the Company acquired all of the outstanding equity interests of AFSC. AFSC has extensive experience providing and managing behavioral health and specialty services to various agencies of the federal government, including all five branches of the U.S. Armed Forces.

        Under the terms of the AFSC Agreement, the base purchase price is $117.5 million plus potential contingent payments up to a maximum aggregate amount of $10.0 million. The contingent payments are based on the retention of certain core business of AFSC. Certain key members of AFSC's management, who are also shareholders, will reinvest a portion of their proceeds in Magellan restricted common stock. The stock is subject to vesting over a two-year period.

        The Company will report the results of operation of AFSC within the Healthcare segment.

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Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations.

        The following discussion and analysis of the financial condition and results of operations of Magellan and its subsidiaries should be read together with the Consolidated Financial Statements and the notes to the Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q and the Company's Annual Report on Form 10-K for the year ended December 31, 2015, which was filed with the SEC on February 29, 2016.

Forward-Looking Statements

        This Form 10-Q includes "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Although the Company believes that its plans, intentions and expectations as reflected in such forward-looking statements are reasonable, it can give no assurance that such plans, intentions or expectations will be achieved. Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements. Important factors currently known to management that could cause actual results to differ materially from those in forward-looking statements include:

    the Company's inability to renegotiate or extend expiring customer contracts, or the termination of customer contracts;

    the Company's inability to integrate acquisitions in a timely and effective manner;

    changes in business practices of the industry, including the possibility that certain of the Company's managed care customers could seek to provide managed healthcare services directly to their subscribers, instead of contracting with the Company for such services, particularly as a result of further consolidation in the managed care industry and especially regarding managed healthcare customers that have already done so with a portion of their membership;

    the impact of changes in the contracting model for Medicaid contracts, including certain changes in the contracting model used by states for managed healthcare services contracts relating to Medicaid lives;

    the Company's ability to accurately predict and control healthcare costs, and to properly price the Company's services;

    the Company's ability to accurately underwrite and control healthcare costs associated with its expansion into clinically integrated management of special populations eligible for Medicaid and Medicare, including individuals with serious mental illness and other unique high-cost populations;

    the Company's ability to maintain or secure cost-effective healthcare provider contracts;

    the Company's ability to maintain relationships with key pharmacy providers, vendors and manufacturers;

    fluctuation in quarterly operating results due to seasonal and other factors;

    the Company's dependence on government spending for managed healthcare, including changes in federal, state and local healthcare policies;

    restrictive covenants in the Company's debt instruments;

    present or future state regulations and contractual requirements that the Company provide financial assurance of its ability to meet its obligations;

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    the impact of the competitive environment in the managed healthcare services industry which may limit the Company's ability to maintain or obtain contracts, as well as its ability to maintain or increase its rates;

    the impact of healthcare reform legislation;

    the Mental Health and Substance Abuse Benefit Parity Law and Regulations;

    government regulation;

    the Company's participation in Medicare Part D is subject to government regulation;

    the unauthorized disclosure of sensitive or confidential member or other information;

    a breach or failure in the Company's operational security systems or infrastructure, or those of third parties with which we do business;

    the possible impact of additional regulatory scrutiny and liability associated with the Company's Pharmacy Management segment;

    the inability to realize the value of goodwill and intangible assets;

    pending or future actions or claims for professional liability;

    claims brought against the Company that either exceed the scope of the Company's liability coverage or result in denial of coverage;

    class action suits and other legal proceedings;

    negative publicity;

    the impact of governmental investigations;

    the impact of varying economic and market conditions on the Company's investment portfolio;

    the state of the national economy and adverse changes in economic conditions; and

    the impact to contingent consideration as a result of changes in operational forecasts and probabilities of payment.

        Further discussion of factors currently known to management that could cause actual results to differ materially from those in forward-looking statements is set forth under the heading "Risk Factors" in Item 1A of Magellan's Annual Report on Form 10-K for the year ended December 31, 2015. When used in this Quarterly Report on Form 10-Q, the words "estimate," "anticipate," "expect," "believe," "should," and similar expressions are intended to be forward-looking statements. Magellan undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time, except as required by law.

Business Overview

        The Company is engaged in the healthcare management business, and is focused on managing the fastest growing, most complex areas of health, including special populations, complete pharmacy benefits and other specialty areas of healthcare. The Company develops innovative solutions that combine advanced analytics, agile technology and clinical excellence to drive better decision making, positively impact health outcomes and optimize the cost of care for the members we serve. The Company provides services to health plans and other MCOs, employers, labor unions, various military and governmental agencies and TPAs. The Company's business is divided into three segments, based on the services it provides and/or the customers it serves. See Note A—"General" for more information on the Company's business segments.

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        The following tables summarize, for the periods indicated, revenues and covered lives for Healthcare by product classification and customer type (in thousands):

 
  Covered lives as of
June 30, 2016
 
 
  Risk-based   ASO  

Commercial

             

Behavioral(1)

    13,528     10,110  

Specialty

    8,189     16,582  

Government(2)

    4,229     1,030  

 

 
  Revenue for six months
ended June 30, 2016
 
 
  Risk-based   ASO   Total  

Commercial

                   

Behavioral(1)

  $ 164,907   $ 59,735   $ 224,642  

Specialty

    254,611     32,771     287,382  

Government(2)

    702,359     42,515     744,874  

Total

  $ 1,121,877   $ 135,021   $ 1,256,898  

(1)
Includes revenues of $25.6 million from EAP services provided on a risk basis to health plans and employers with 11.0 million covered lives.

(2)
Includes revenues of $77.5 million from EAP services provided on a risk basis to federal governmental entities with 3.5 million covered lives.

        During six months ended June 30, 2016, Pharmacy Management paid 12.5 million adjusted commercial network claims in its PBM business, 37.3 million adjusted PBA claims and 0.1 million specialty dispensing claims. Adjusted claim totals apply a multiple of three for each 90-day and traditional mail claim. As of June 30, 2016, Pharmacy Management had a generic dispensing rate of 84.9 percent within its commercial PBM business and served 1.7 million commercial PBM members, 12.4 million members in its medical pharmacy management programs, and 25 states and the District of Columbia in its PBA business.

Critical Accounting Policies and Estimates

        The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Significant estimates of the Company include, among other things, accounts receivable realization, valuation allowances for deferred tax assets, valuation of goodwill and intangible assets, medical claims payable, other medical liabilities, stock compensation assumptions, tax contingencies, legal liabilities and contingent consideration payable. Actual results could differ from those estimates. Except as noted below, the Company's critical accounting policies are summarized in the Company's Annual Report on Form 10-K, filed with the SEC on February 29, 2016.

Results of Operations

        The accounting policies of the Company's segments are the same as those described in Note A—"General." The Company evaluates performance of its segments based on Segment Profit. Management uses Segment Profit information for internal reporting and control purposes and considers

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it important in making decisions regarding the allocation of capital and other resources, risk assessment and employee compensation, among other matters. Healthcare subcontracts with Pharmacy Management to provide pharmacy benefits management services for certain of Healthcare's customers. In addition, Pharmacy Management provides pharmacy benefits management for the Company's employees covered under its medical plan. As such, revenue, cost of goods sold and direct service costs and other related to these arrangements are eliminated. The Company's segments are defined in Note A—"General".

        The following tables summarize, for the periods indicated, operating results by business segment (in thousands):

 
  Healthcare   Pharmacy
Management
  Corporate and
Elimination
  Consolidated  

Three Months Ended June 30, 2015

                         

Managed care and other revenue

  $ 722,471   $ 53,782   $ (13 ) $ 776,240  

PBM and dispensing revenue

        408,924     (27,557 )   381,367  

Cost of care

    (568,288 )           (568,288 )

Cost of goods sold

        (387,828 )   26,419     (361,409 )

Direct service costs and other(3)

    (124,779 )   (61,038 )   (5,638 )   (191,455 )

Stock compensation expense(1)(3)

    1,784     10,339     1,672     13,795  

Changes in fair value of contingent consideration(1)

    71     2,496         2,567  

Less: non-controlling interest segment profit (loss)(2)

    (273 )       (77 )   (350 )

Segment profit (loss)

  $ 31,532   $ 26,675   $ (5,040 ) $ 53,167  

 

 
  Healthcare   Pharmacy
Management
  Corporate and
Elimination
  Consolidated  

Three Months Ended June 30, 2016

                         

Managed care and other revenue

  $ 637,970   $ 61,975   $ (84 ) $ 699,861  

PBM and dispensing revenue

        495,399     (30,915 )   464,484  

Cost of care

    (472,529 )           (472,529 )

Cost of goods sold

        (466,637 )   29,707     (436,930 )

Direct service costs and other(3)

    (139,965 )   (64,086 )   (10,026 )   (214,077 )

Stock compensation expense(1)(3)

    2,451     5,548     1,511     9,510  

Changes in fair value of contingent consideration(1)

    390     73         463  

Impairment of intangible assets(1)

    4,800             4,800  

Less: non-controlling interest segment profit (loss)(2)

    (1,305 )       (7 )   (1,312 )

Segment profit (loss)

  $ 34,422   $ 32,272   $ (9,800 ) $ 56,894  

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  Healthcare   Pharmacy
Management
  Corporate and
Elimination
  Consolidated  

Six Months Ended June 30, 2015

                         

Managed care and other revenue

  $ 1,422,064   $ 102,850   $ (24 ) $ 1,524,890  

PBM and dispensing revenue

        667,717     (54,032 )   613,685  

Cost of care

    (1,090,621 )   5         (1,090,616 )

Cost of goods sold

        (631,366 )   51,750     (579,616 )

Direct service costs and other(3)

    (253,247 )   (129,271 )   (13,387 )   (395,905 )

Stock compensation expense(1)(3)

    4,972     19,744     2,980     27,696  

Changes in fair value of contingent consideration(1)

    171     17,365         17,536  

Less: non-controlling interest segment profit (loss)(2)

    (393 )       (51 )   (444 )

Segment profit (loss)

  $ 83,732   $ 47,044   $ (12,662 ) $ 118,114  

 

 
  Healthcare   Pharmacy
Management
  Corporate and
Elimination
  Consolidated  

Six Months Ended June 30, 2016

                         

Managed care and other revenue

  $ 1,256,898   $ 119,552   $ (128 ) $ 1,376,322  

PBM and dispensing revenue

        965,633     (60,588 )   905,045  

Cost of care

    (930,160 )           (930,160 )

Cost of goods sold

        (910,586 )   58,197     (852,389 )

Direct service costs and other(3)

    (265,582 )   (124,927 )   (16,024 )   (406,533 )

Stock compensation expense(1)(3)

    4,470     10,970     2,957     18,397  

Changes in fair value of contingent consideration(1)

    70     127         197  

Impairment of intangible assets(1)

    4,800             4,800  

Less: non-controlling interest segment profit (loss)(2)

    (1,136 )       (11 )   (1,147 )

Segment profit (loss)

  $ 71,632   $ 60,769   $ (15,575 ) $ 116,826  

(1)
Stock compensation expense, changes in the fair value of contingent consideration recorded in relation to the acquisitions, and impairment of intangible assets are included in direct service costs and other operating expenses; however, these amounts are excluded from the computation of Segment Profit.

(2)
The non-controlling portion of AlphaCare's segment profit (loss) is excluded from the computation of Segment Profit.

(3)
Effective January 1, 2016, the Company implemented changes related to the allocation of Corporate operational and support functions. These changes were applied retrospectively. The

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    following tables summarize, for the periods indicated, the changes by business segment (in thousands):

 
  Healthcare   Pharmacy
Management
  Corporate and
Elimination
  Consolidated  

Three Months Ended June 30, 2015

                         

Segment profit (loss) before Corporate allocations

  $ 47,522   $ 30,960   $ (25,315 ) $ 53,167  

Allocated Corporate costs

    (17,280 )   (4,608 )   21,888      

Allocated Corporate stock compensation expense

    1,290     323     (1,613 )    

Segment profit (loss)

  $ 31,532   $ 26,675   $ (5,040 ) $ 53,167  

 

 
  Healthcare   Pharmacy
Management
  Corporate and
Elimination
  Consolidated  

Three Months Ended June 30, 2016

                         

Segment profit (loss) before Corporate allocations

  $ 50,719   $ 36,256   $ (30,081 ) $ 56,894  

Allocated Corporate costs

    (17,661 )   (4,325 )   21,986      

Allocated Corporate stock compensation expense

    1,364     341     (1,705 )    

Segment profit (loss)

  $ 34,422   $ 32,272   $ (9,800 ) $ 56,894  

 

 
  Healthcare   Pharmacy
Management
  Corporate and
Elimination
  Consolidated  

Six Months Ended June 30, 2015

                         

Segment profit (loss) before Corporate allocations

  $ 115,470   $ 55,465   $ (52,821 ) $ 118,114  

Allocated Corporate costs

    (35,227 )   (9,293 )   44,520      

Allocated Corporate stock compensation expense

    3,489     872     (4,361 )    

Segment profit (loss)

  $ 83,732   $ 47,044   $ (12,662 ) $ 118,114