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4-Traders Homepage  >  Shares  >  Nasdaq  >  Magellan Health Inc    MGLN

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MAGELLAN HEALTH : Management's Discussion and Analysis of Financial Condition and Results of Operations. (form 10-Q)

07/27/2015 | 11:59am US/Eastern
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, 2014, which
was filed with the SEC on February 26, 2015.

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:

º •

º the Company's inability to renegotiate or extend expiring customer

          contracts, or the termination of customer contracts;

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

        º •
        º 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;

        º •

º 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;

        º •

º the Company's ability to accurately predict and control healthcare

costs, and to properly price the Company's services;

º •

º 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;

        º •

º the Company's ability to maintain or secure cost-effective healthcare

provider contracts;

º •

º the Company's ability to maintain relationships with key pharmacy

          providers, vendors and manufacturers;

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

        º •
        º the Company's dependence on government spending for managed

healthcare, including changes in federal, state and local healthcare

          policies;

        º •
        º restrictive covenants in the Company's debt instruments;

        º •
        º 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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º •

º 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;

        º •
        º the impact of healthcare reform legislation;

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

        º •
        º government regulation;

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

        º •

º a breach or failure in the Company's operational security systems or

infrastructure, or those of third parties with which we do business;

º •

º the possible impact of additional regulatory scrutiny and liability

associated with the Company's Pharmacy Management segment;

º •

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

        º •
        º pending or future actions or claims for professional liability;

        º •

º claims brought against the Company that either exceed the scope of the

          Company's liability coverage or result in denial of coverage;

        º •
        º class action suits and other legal proceedings;

        º •
        º negative publicity;

        º •
        º the impact of governmental investigations;

        º •

º the impact of varying economic and market conditions on the Company's

investment portfolio;

º •

º the state of the national economy and adverse changes in economic

          conditions; and

        º •
        º 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, 2014. 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 meeting needs in areas of healthcare that are fast growing, highly complex
and high cost, with an emphasis on special population management. The Company
provides services to health plans and other MCOs, employers, labor unions,
various military and governmental agencies, third party administrators,
consultants and brokers. The Company's business is divided into five segments,
based on the services it provides and/or the customers that it serves. See
Note A-"General" for more information on the Company's business segments.

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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 and
legal liabilities. 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 26, 2015.

Stock Compensation


    The Company uses the Black-Scholes-Merton option pricing model to estimate
the fair value of substantially all stock options granted to employees. The fair
value of all RSUs and RSAs is determined as the fair market value of the
underlying shares on the date of the grant. The fair value of PSUs issued with
market-based conditions is calculated on the date of the grant using a Monte
Carlo simulation model. Stock compensation expense recognized in the
consolidated statements of income is based on awards ultimately expected to
vest, it has been reduced for annual estimated forfeitures of four percent. If
the actual number of forfeitures differs from those estimated, additional
adjustments to compensation expense may be required in future periods. If
vesting of an award is conditioned upon the achievement of performance goals,
compensation expense during the performance period is estimated using the most
probable outcome of the performance goals, and adjusted as the expected outcome
changes. The Company recognizes compensation costs for awards that do not
contain performance or market conditions on a straight- line basis over the
requisite service period, which is generally the vesting term of three years.
For restricted stock units that include performance conditions, stock
compensation is recognized using an accelerated method over the vesting period.
For PSUs issued with market-based conditions, stock compensation is recognized
using a straight line method over the vesting period.

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 it important in making decisions
regarding the allocation of capital and other resources, risk assessment and
employee compensation, among other matters. Public Sector subcontracts with
Pharmacy Management and Specialty Solutions to provide pharmacy benefits
management services and radiology benefits management services for certain of
Public Sector'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 care, 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".

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


                                                                          Corporate
                                  Public     Specialty     Pharmacy          and
                  Commercial      Sector     Solutions    Management     Elimination     Consolidated
Three Months
Ended June 30,
2014
Managed care
and other
revenue           $   198,025   $  319,954   $  119,326   $    44,969   $           -   $      682,274
PBM and
dispensing
revenue                     -            -            -       209,265          (3,525 )        205,740
Cost of care         (116,852 )   (275,108 )    (89,753 )          96               -         (481,617 )
Cost of goods
sold                        -            -            -      (196,080 )         3,514         (192,566 )
Direct service
costs and other       (42,530 )    (45,391 )    (17,897 )     (41,605 )       (31,611 )       (179,034 )
Stock
compensation
expense(1)                157          230          354         5,556           3,253            9,550
Less:
non-controlling
interest
segment profit
(loss)(2)                   -         (648 )          -             -               -             (648 )

Segment profit
(loss)            $    38,800   $      333   $   12,030   $    22,201   $     (28,369 ) $       44,995







                                                                            Corporate
                                    Public     Specialty     Pharmacy          and
                    Commercial      Sector     Solutions    Management     Elimination     Consolidated
Three Months
Ended June 30,
2015
Managed care and
other revenue      $    150,658   $  439,858   $  132,227   $    53,782   $        (285 ) $      776,240
PBM and
dispensing
revenue                       -            -            -       408,924         (27,557 )        381,367
Cost of care            (88,200 )   (380,580 )    (99,508 )           -               -         (568,288 )
Cost of goods
sold                          -            -            -      (387,828 )        26,419         (361,409 )
Direct service
costs and other         (37,915 )    (49,944 )    (19,913 )     (56,430 )       (27,253 )       (191,455 )
Stock
compensation
expense(1)                  233          240           21        10,016           3,285           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)             $     24,847   $    9,847   $   12,827   $    30,960   $     (25,314 ) $       53,167







                                                                          Corporate
                                  Public     Specialty     Pharmacy          and
                  Commercial      Sector     Solutions    Management     Elimination    Consolidated
Six Months
Ended June 30,
2014
Managed care
and other
revenue           $   386,916   $  817,897   $  224,760   $   100,347   $     (18,055 ) $   1,511,865
PBM and
dispensing
revenue                     -            -            -       348,889          (6,265 )       342,624
Cost of care         (228,054 )   (697,626 )   (163,405 )     (16,295 )        18,055      (1,087,325 )
Cost of goods
sold                        -            -            -      (324,111 )         6,247        (317,864 )
Direct service
costs and other       (82,806 )    (88,349 )    (33,038 )     (77,156 )       (62,407 )      (343,756 )
Stock
compensation
expense(1)                312          504          768         5,859           6,579          14,022
Less:
non-controlling
interest
segment profit
(loss)(2)                   -       (1,978 )          -             -               -          (1,978 )

Segment profit
(loss)            $    76,368   $   34,404   $   29,085   $    37,533   $     (55,846 ) $     121,544





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                                                                           Corporate
                                   Public     Specialty     Pharmacy          and
                   Commercial      Sector     Solutions    Management     Elimination    Consolidated
Six Months Ended
June 30, 2015
Managed care and
other revenue      $   303,183   $  862,835   $  256,569   $   102,850   $        (547 ) $   1,524,890
PBM and
dispensing
revenue                      -            -            -       667,717         (54,032 )       613,685
Cost of care          (170,330 )   (727,510 )   (192,781 )           5               -      (1,090,616 )
Cost of goods
sold                         -            -            -      (631,366 )        51,750        (579,616 )
Direct service
costs and other        (77,125 )   (101,331 )    (40,087 )    (119,978 )       (57,384 )      (395,905 )
Stock
compensation
expense(1)                 404          549          530        18,872           7,341          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)             $    56,303   $   34,936   $   24,231   $    55,465   $     (52,821 ) $     118,114




--------------------------------------------------------------------------------

º (1)

º Stock compensation expense, as well as changes in the fair value of

contingent consideration recorded in relation to the acquisitions, are

included in direct service costs and other operating expenses; however,

     these amounts are excluded from the computation of Segment Profit.

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

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

                                              Three Months Ended       Six Months Ended
                                                   June 30,                June 30,
                                               2014        2015        2014        2015
Segment profit                              $   44,995   $  53,167   $ 121,544   $ 118,114
Stock compensation expense                      (9,550 )   (13,795 )   (14,022 )   (27,696 )
Changes in fair value of contingent
consideration                                        -      (2,567 )         -     (17,536 )
Non-controlling interest segment profit
(loss)                                            (648 )      (350 )    (1,978 )      (444 )
Depreciation and amortization                  (22,480 )   (25,022 )   (42,709 )   (48,518 )
Interest expense                                (2,004 )    (1,653 )    (2,840 )    (3,279 )
Interest income                                    275         500         586         966

Income before income taxes                  $   10,588   $  10,280   $  60,581   $  21,607





Non-GAAP Measures

    The Company reports its financial results in accordance with GAAP, however
the Company's management also assesses business performance and makes business
decisions regarding the Company's operations using certain non-GAAP measures. In
addition to Segment Profit, as defined above, the Company also uses adjusted net
income attributable to Magellan Health, Inc. ("Adjusted Net Income") and
adjusted net income per common share attributable to Magellan Health, Inc. on a
diluted basis ("Adjusted EPS"). Adjusted Net Income and Adjusted EPS reflect
certain adjustments made for acquisitions completed after January 1, 2013 to
exclude non-cash stock compensation expense resulting from restricted stock
purchases by sellers, changes in the fair value of contingent consideration, as
well as amortization of identified acquisition intangibles. The Company believes
these non-GAAP measures provide a more useful comparison of the Company's
underlying business performance from period to period and are more
representative of the earnings capacity of the Company. Non-GAAP financial
measures we disclose, such as Segment Profit, Adjusted Net Income, and Adjusted
EPS, should not be considered a substitute for, or superior to, financial
measures determined or calculated in accordance with GAAP.

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The following table reconciles Adjusted Net Income to net income attributable to Magellan Health, Inc. (in thousands):

                                               Three Months Ended       Six Months Ended
                                                    June 30,                June 30,
                                                2014         2015       2014       2015
Adjusted Net Income                          $    11,773   $ 14,722   $ 39,078   $  39,106
Adjusted for acquisitions starting in 2013
Stock compensation relating to
acquisitions                                      (6,373 )   (8,498 )   (7,311 )   (16,836 )
Changes in fair value of contingent
consideration                                     (1,204 )   (2,567 )   (1,204 )   (17,536 )
Amortization of acquired intangibles              (3,426 )   (5,260 )   (5,059 )    (9,643 )
Tax impact                                         4,216      6,246      

5,202 16,840


Net income attributable to Magellan
Health, Inc.                                 $     4,986   $  4,643   $ 30,706   $  11,931




The following table reconciles Adjusted EPS to net income per common share attributable to Magellan Health, Inc.-diluted:

                                                Three Months Ended       Six Months Ended
                                                     June 30,                June 30,
                                                 2014         2015        2014       2015
Adjusted EPS                                  $     0.42    $   0.56   $     1.39   $  1.47
Adjusted for acquisitions starting in 2013
Stock compensation relating to acquisitions        (0.23 )     (0.32 )      (0.26 )   (0.63 )
Changes in fair value of contingent
consideration                                      (0.04 )     (0.10 )      (0.04 )   (0.66 )
Amortization of acquired intangibles               (0.12 )     (0.20 )      (0.18 )   (0.36 )
Tax impact                                          0.15        0.23        

0.19 0.63


Net income per common share attributable to
Magellan Health, Inc.-diluted                 $     0.18    $   0.17   $     1.10   $  0.45




Quarter ended June 30, 2015 ("Current Year Quarter"), compared to the quarter ended June 30, 2014 ("Prior Year Quarter")

Commercial

Net Revenue


    Net revenue related to Commercial decreased by 23.9 percent or $47.4 million
from the Prior Year Quarter to the Current Year Quarter. The decrease in revenue
is mainly due to terminated contracts of $56.6 million, program changes of
$9.5 million, and unfavorable rates changes of $2.6 million, customer
settlements in the Prior Year Quarter of $1.4 million and favorable prior period
rate, membership and other adjustments of $0.9 million in the Prior Year
Quarter. These decreases were partially offset by contracts implemented after
(or during) the Prior Year Quarter of $12.6 million, increased membership from
existing customers of $3.1 million and other net favorable increases of
$7.9 million (mainly related to higher care associated with a cost-plus
contract).

Cost of Care


    Cost of care decreased by 24.5 percent or $28.7 million from the Prior Year
Quarter to the Current Year Quarter. The decrease in cost of care is primarily
due to terminated contracts of $43.2 million, program changes of $8.5 million
and favorable medical claims development for the Prior Year Quarter which was
recorded after the Prior Year Quarter of $3.6 million. These decreases were
partially offset by new contracts implemented after (or during) the Prior Year
Quarter of $10.0 million, favorable prior period medical claims development
recorded in the Prior Year Quarter of $3.3 million,

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customer settlements in the Prior Year Quarter of $1.3 million and unfavorable
care trends and other net variances of $12.0 million. Cost of care increased as
a percentage of risk revenue (excluding EAP business) from 76.8 percent in the
Prior Year Quarter to 84.0 percent in the Current Year Quarter, mainly due to
unfavorable care trends and business mix.

Direct Service Costs

    Direct service costs decreased by 10.9 percent or $4.6 million from the
Prior Year Quarter to the Current Year Quarter primarily due to terminated
contracts, partially offset by new business and increased administrative cost.
Direct service costs increased as a percentage of revenue from 21.5 percent in
the Prior Year Quarter to 25.2 percent in the Current Year Quarter, mainly due
to the impact of terminated contracts and the program changes.

Public Sector

Net Revenue


    Net revenue related to Public Sector increased by 37.5 percent or
$119.9 million from the Prior Year Quarter to the Current Year Quarter. This
increase is primarily due to increased membership from existing customers and
favorable rate changes of $155.7 million. This increase was partially offset by
terminated contracts of $27.0 million, revenue impact of favorable prior period
medical claims development recorded in the Prior Year Quarter of $3.5 million,
revenue impact of favorable medical claims development for the Prior Year
Quarter which was recorded after the Prior Year Quarter of $3.9 million, revenue
impact of favorable prior period medical claims development recorded in the
Current Year Quarter of $1.2 million and other net decreases of $0.2 million.

Cost of Care

    Cost of care increased by 38.3 percent or $105.5 million from the Prior Year
Quarter to the Current Year Quarter. This increase is primarily due to increased
membership from existing customers and higher care associated with favorable
rate increases of $140.0 million and unfavorable care trends and other net
variance of $4.7 million. These increases were partially offset by terminated
contracts of $18.8 million, unfavorable prior period medical claims development
recorded in the Prior Year Quarter of $10.3 million, favorable medical claims
development for the Prior Year Quarter which was recorded after the Prior Year
Quarter of $5.5 million and favorable prior period medical claims development
recorded in the Current Year Quarter of $4.6 million. Cost of care decreased as
a percentage of risk revenue from 89.9 percent in the Prior Year Quarter to
89.6 percent in the Current Year Quarter mainly due to favorable care
development.

Direct Service Costs

    Direct service costs increased by 10.0 percent or $4.6 million from the
Prior Year Quarter to the Current Year Quarter, mainly due to costs to support
new business and development costs for the Magellan Complete Care product,
partially offset by terminated contracts. Direct service costs decreased as a
percentage of revenue from 14.2 percent for the Prior Year Quarter to
11.4 percent in the Current Year Quarter mainly due to increased revenue from
membership growth.

Specialty Solutions

Net Revenue

Net revenue related to Specialty Solutions increased by 10.8 percent or $12.9 million from the Prior Year Quarter to the Current Year Quarter. This increase is primarily due to new contracts implemented after (or during) the Prior Year Quarter of $15.9 million, increased membership from

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existing customers of $4.4 million, revenue for HSM acquired January 31, 2015 of
$2.7 million and other net favorable variances of $3.4 million. These increases
were partially offset by program change of $12.3 million and revenue impact of
favorable prior period medical claims development recorded in the Current Year
Quarter of $1.2 million.

Cost of Care

    Cost of care increased by 10.9 percent or $9.8 million from the Prior Year
Quarter to the Current Year Quarter. This increase is primarily attributed to
new contracts of $12.9 million, increased membership from existing customers of
$3.5 million, HSM acquired January 31, 2015 of $1.2 million, favorable prior
period development recorded in the Prior Year Quarter of $1.2 million and
unfavorable care trends and other net variance of $3.8 million. These increases
were partially offset by program changes of $11.1 million and favorable prior
period medical claims development recorded in the Current Year Quarter of
$1.7 million. Cost of care increased as a percentage of risk revenue from
82.9 percent in the Prior Year Quarter to 84.3 percent in the Current Year
Quarter mainly due to unfavorable care trends.

Direct Service Costs

    Direct service costs increased by 11.3 percent or $2.0 million from the
Prior Year Quarter to the Current Year Quarter mainly due to new business and
the acquisition of HSM. As a percentage of revenue, direct service costs in the
Current Year Quarter of 15.0 percent were consistent with the Prior Year
Quarter.

Pharmacy Management

Managed Care and Other Revenue

    Managed care and other revenue related to Pharmacy Management increased by
19.6 percent or $8.8 million from the Prior Year Quarter to the Current Year
Quarter. This increase is primarily due to increased rebate revenue of
$7.1 million and new contracts implemented after (or during) the Prior Year
Quarter of $2.1 million, partially offset by other net decreases of
$0.4 million.

PBM/Distribution Revenue


    PBM and Distribution revenue related to Pharmacy Management increased by
95.4 percent or $199.7 million from the Prior Year Quarter to the Current Year
Quarter. This increase is primarily due to revenue for 4D acquired on April 1,
2015 of $122.2 million, pharmacy MCO revenue of $32.7 million, new contracts
implemented after (or during) the Prior Year Quarter of $30.9 million and
pharmacy employer revenue of $29.9 million. These increases were partially
offset by terminated contracts of $10.9 million, net decreased dispensing
activity from existing customers of $4.1 million and other net unfavorable
variances of $1.0 million.

Cost of Goods Sold

    Cost of goods sold increased by 97.8 percent or $191.7 million from the
Prior Year Quarter to the Current Year Quarter. This increase is primarily due
to revenue for 4D acquired April 1, 2014 of $118.7 million, pharmacy MCO of
$32.5 million, new contracts implemented after the Prior Year Quarter of
$29.7 million and an increase in pharmacy employer of $26.4 million. These
increases were partially offset by terminated contracts of $10.6 million,
decreased dispensing activity from existing customers of $4.5 million and other
net favorable variances of $0.5 million. As a percentage of the portion of net
revenue that relates to PBM and dispensing activity, cost of goods sold
increased from 93.7 percent in the Prior Year Quarter to 94.7 percent the
Current Year Quarter, mainly due to business mix.

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Direct Service Costs


    Direct service costs increased by 35.6 percent or $14.8 million from the
Prior Year Quarter to the Current Year Quarter. This increase mainly relates to
increased stock compensation expense of $4.5 million, and changes in the fair
value of contingent consideration related to the CDMI acquisition of
$2.5 million, in addition to additional cost from the acquisition of 4D and
implementation costs and ongoing costs to support new business. As a percentage
of revenue, direct service costs decreased from 16.4 percent in the Prior Year
Quarter to 12.2 percent in the Current Year Quarter, mainly due to the increase
in revenue from business growth and acquisition activity.

Corporate and Elimination


    Net expenses related to Corporate, which includes eliminations, decreased by
9.3 percent or $2.9 million, primarily due to lower benefit and project costs.
As a percentage of revenue, corporate and elimination decreased from 3.6 percent
in the Prior Year Quarter to 2.5 percent in the Current Year Quarter, mainly due
to the increase in revenue due to acquisitions and new business.

Depreciation and Amortization

Depreciation and amortization expense increased by 11.3 percent or $2.5 million from the Prior Year Quarter to the Current Year Quarter, primarily due to asset additions after the Prior Year Quarter and acquisition activity.

Interest Expense


    Interest expense decreased by $0.4 million from the Prior Year Quarter to
the Current Year Quarter, mainly due to contingent consideration expense for
CDMI recorded in the Prior Year Quarter, partially offset by borrowings under
the 2014 Credit Facility after the Prior Year Quarter.

Interest Income


    Interest income increased by $0.2 million from the Prior Year Quarter to the
Current Year Quarter primarily due to higher yields and increase in invested
balances.

Income Taxes

    The Company's effective income tax rates were 59.1 percent and 58.2 percent
for the Prior Year Quarter and Current Year Quarter, respectively. The effective
income tax rate for the Current Year Quarter differs from the Prior Year Quarter
mainly due to more significant valuation allowances added on certain deferred
assets in the Prior Year Quarter than the Current Year Quarter.

Six months ended June 30, 2015 ("Current Year Period"), compared to the six months ended June 30, 2014 ("Prior Year Period")

Commercial

Net Revenue


    Net revenue related to Commercial decreased by 21.6 percent or $83.7 million
from the Prior Year Period to the Current Year Period. The decrease in revenue
is mainly due to terminated contracts of $112.3 million, program changes of
$18.2 million and favorable prior period rate, membership and other adjustments
of $2.4 million in the Prior Year Period. These decreases were partially offset
by contracts implemented after (or during) the Prior Year Period of
$23.6 million, increased membership from existing customers of $6.0 million and
other net favorable increases of $19.6 million (mainly related to higher care
associated with a cost-plus contract).

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Cost of Care


    Cost of care decreased by 25.3 percent or $57.7 million from the Prior Year
Period to the Current Year Period. The decrease in cost of care is primarily due
to terminated contracts of $84.5 million, program changes of $15.5 million and
favorable prior period medical claims development recorded in the Current Year
Period of $1.7 million. These decreases were partially offset by new contracts
implemented after (or during) the Prior Year Period of $18.8 million, favorable
prior period medical claims development recorded in the Prior Year Period of
$2.4 million, customer settlements in the Prior Year Period of $2.4 million and
unfavorable care trends and other net variances of $20.4 million. Cost of care
increased as a percentage of risk revenue (excluding EAP business) from
76.8 percent in the Prior Year Period to 79.9 percent in the Current Year
Period, mainly due to unfavorable care trends and business mix.

Direct Service Costs


    Direct service costs decreased by 6.9 percent or $5.7 million from the Prior
Year Period to the Current Year Period primarily due to terminated contracts.
Direct service costs increased as a percentage of revenue from 21.4 percent in
the Prior Year Period to 25.4 percent in the Current Year Period, mainly due to
the impact of terminated contracts and the program changes.

Public Sector

Net Revenue


    Net revenue related to Public Sector increased by 5.5 percent or
$44.9 million from the Prior Year Period to the Current Year Period. This
increase is primarily due to increased membership from existing customers and
favorable rate changes of $312.8 million, and an increase in net revenue
recorded for ACA fees of $8.3 million. These increases were partially offset by
terminated contracts of $260.9 million, the revenue impact of favorable medical
claims development for the Prior Year Quarter which was recorded after the Prior
Year Quarter of $6.7 million, unfavorable retroactive rate adjustments in the
Current Year Period of $3.3 million, the revenue impact of favorable prior
period medical claims development recorded in the Current Year Period of
$2.7 million and other net decreases of $2.6 million.

Cost of Care


    Cost of care increased by 4.3 percent or $29.9 million from the Prior Year
Period to the Current Year Period. This increase is primarily due to increased
membership from existing customers and higher care associated with favorable
rate changes of $283.6 million and other net unfavorable care trends and other
net variances of $1.4 million. These increases were partially offset by
terminated contracts of $220.9 million and favorable prior period medical claims
development recorded in the Current Year Period of $22.4 million, favorable
medical claims development for the Prior Year Period which was recorded after
the Prior Year Period of $10.5 million and unfavorable prior period medical
claims development recorded in the Prior Year Period of $1.3 million. Cost of
care decreased as a percentage of risk revenue from 88.3 percent in the Prior
Year Period to 87.4 percent in the Current Year Period mainly due favorable care
development.

Direct Service Costs

    Direct service costs increased by 14.7 percent or $13.0 million from the
Prior Year Period to the Current Year Period, mainly due to higher ACA fees of
$2.5 million, as well as costs to support new business and development costs for
the Magellan Complete Care product, partially offset by terminated contracts.
Direct service costs increased as a percentage of revenue from 10.8 percent for
the Prior

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Year Period to 11.7 percent in the Current Year Period mainly due to development
costs for the Magellan Complete Care product, partially offset by terminated
contracts.

Specialty Solutions

Net Revenue
    Net revenue related to Specialty Solutions increased by 14.2 percent or
$31.8 million from the Prior Year Period to the Current Year Period. This
increase is primarily due to new contracts implemented after (or during) the
Prior Year Period of $28.9 million, increased membership from existing customers
of $16.6 million, revenue for HSM acquired January 31, 2015 of $4.2 million,
favorable rates changes of $2.8 million and other favorable variances of
$2.4 million, partially offset by program changes of $23.1 million.

Cost of Care


    Cost of care increased by 18.0 percent or $29.4 million from the Prior Year
Period to the Current Year Period. This increase is primarily attributed to new
contracts of $24.0 million, increased membership from existing customers of
$12.8 million, favorable prior period development recorded in the Prior Year
Period of $2.1 million, HSM acquired January 31, 2015 of $1.7 million, and
unfavorable care trends and other net variances of $8.7 million, partially
offset by program changes of $19.9 million. Cost of care increased as a
percentage of risk revenue from 80.5 percent in the Prior Year Period to
84.4 percent in the Current Year Period mainly due to unfavorable care trends.

Direct Service Costs

    Direct service costs increased by 21.3 percent or $7.0 million from the
Prior Year Period to the Current Year Period mainly due to new business, the
acquisition of HSM and additional costs incurred for product development. Direct
service costs increased as a percentage of revenue from 14.7 percent for the
Prior Year Period to 15.6 percent in the Current Year Period mainly due to costs
for product development.

Pharmacy Management

Managed Care and Other Revenue

    Managed care and other revenue related to Pharmacy Management increased by
2.5 percent or $2.5 million from the Prior Year Period to the Current Year
Period. This increase is primarily due to revenue of $12.1 million for CDMI
which was acquired on April 1, 2014, increased rebate revenue of $7.8 million
and new contracts implemented after (or during) the Prior Year Period of
$2.9 million. These increases were partially offset by terminated contracts of
$18.1 million and other decreases of $2.2 million.

PBM/Distribution Revenue


    PBM and Distribution revenue related to Pharmacy Management increased by
91.4 percent or $318.8 million from the Prior Year Period to the Current Year
Period. This increase is primarily due to new contracts implemented after (or
during) the Prior Year Period of $135.0 million, revenue for 4D acquired on
April 1, 2015 of $122.2 million, an increase in pharmacy employer revenue of
$55.3 million and an increase in pharmacy MCO of $32.7 million. These increases
were partially offset by terminated contracts of $16.2 million, net decreased
dispensing activity from existing customers of $6.4 million and other net
unfavorable variances of $3.8 million.

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Cost of Care

Cost of care decreased by $16.3 million from the Prior Year Period to the Current Year Period due to a terminated contract.

Cost of Goods Sold

    Cost of goods sold increased by 94.8 percent or $307.3 million from the
Prior Year Period to the Current Year Period. This increase is primarily due to
new contracts implemented after the Prior Year Period of $131.3 million, 4D
acquired April 1, 2015 of $118.7 million, an increase in pharmacy employer of
$50.3 million and an increase in pharmacy MCO of $32.5 million. These increases
were partially offset by terminated contracts of $16.1 million, decreased
dispensing activity from existing customers of $6.7 million and other net
decreases of $2.7 million. As a percentage of the portion of net revenue that
relates to PBM and dispensing activity, cost of goods sold increased from
92.9 percent in the Prior Year Period to 94.4 percent the Current Year Period,
mainly due to business mix.

Direct Service Costs

    Direct service costs increased by 55.5 percent or $42.8 million from the
Prior Year Period to the Current Year Period. This increase mainly relates to
increased stock compensation expense of $13.0 million, and changes in the fair
value of contingent consideration related to the CDMI acquisition of
$17.4 million, in addition to additional cost from the acquisition of 4D and
implementation costs and ongoing costs to support new business. As a percentage
of revenue, direct service costs decreased from 17.2 percent in the Prior Year
Period to 15.6 percent in the Current Year Period, mainly due to the increase in
revenue from business growth and acquisition activity.

Corporate and Elimination


    Net expenses related to Corporate, which includes eliminations, decreased by
3.5 percent or $2.2 million, primarily due to project cost and legal fees
recorded in the Prior Year Period. As a percentage of revenue, corporate and
elimination decreased from 3.3 percent in the Prior Year Period to 2.8 percent
in the Current Year Period, mainly due to the increase in revenue due to
acquisitions and new business.

Depreciation and Amortization

Depreciation and amortization expense increased by 13.6 percent or $5.8 million from the Prior Year Period to the Current Year Period, primarily due to asset additions after the Prior Year Period and acquisition activity.

Interest Expense


    Interest expense increased by 15.5 percent or $0.4 million from the Prior
Year Period to the Current Year Period, mainly due to borrowings under the 2014
Credit Facility after the Prior Year Period partially offset by CDMI contingent
consideration recorded in the Prior Year Period.

Interest Income

Interest income by $0.4 million from the Prior Year Period to the Current Year Period, mainly due to higher yields and increase in invested balances.

Income Taxes


    The Company's effective income tax rates were 52.6 percent and 46.8 percent
for the Prior Year Period and Current Year Period, respectively. The effective
income tax rate for the Current Year Period

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differs from the Prior Year Period mainly due to more significant valuation allowances added in the prior year than the current year on certain deferred assets, and the reversal of tax contingencies in the current year from the favorable settlement of state income tax examinations.

Outlook-Results of Operations


    The Company's Segment Profit and net income are subject to significant
fluctuations from period to period. These fluctuations may result from a variety
of factors such as those set forth under Item 2-"Forward-Looking Statements" as
well as a variety of other factors including: (i) changes in utilization levels
by enrolled members of the Company's risk-based contracts, including seasonal
utilization patterns; (ii) contractual adjustments and settlements;
(iii) retrospective membership adjustments; (iv) timing of implementation of new
contracts, enrollment changes and contract terminations; (v) pricing adjustments
upon contract renewals (and price competition in general); (vi) the timing of
acquisitions; (vii) changes in estimates regarding medical costs and IBNR; and
(viii) changes in the estimates of contingent consideration.

    A portion of the Company's business is subject to rising care costs due to
an increase in the number and frequency of covered members seeking behavioral
healthcare or radiology services, higher costs per inpatient day or outpatient
visit for behavioral services, and higher costs per scan for radiology services.
Many of these factors are beyond the Company's control. Future results of
operations will be heavily dependent on management's ability to obtain customer
rate increases that are consistent with care cost increases and/or to reduce
operating expenses.

    In relation to the managed behavioral healthcare business, the Company is a
market leader in a mature market with many viable competitors. The Company is
continuing its attempts to grow its business in the managed behavioral
healthcare industry through aggressive marketing and development of new
products; however, due to the maturity of the market, the Company believes that
the ability to grow its current business lines may be limited. In addition, as
previously discussed, substantially all of the Company's Commercial segment
revenues are derived from Blue Cross Blue Shield health plans and other managed
care companies, health insurers and health plans. In the past, certain of the
managed care customers of the Company have decided not to renew all or part of
their contracts with the Company, and to instead manage the behavioral
healthcare services directly for their subscribers.

    Care Trends.  The Company expects that same-store normalized cost of care
trend for the 12 month forward outlook to be 6 to 8 percent for Commercial, 0 to
2 percent for Public Sector and 3 to 5 percent for Specialty Solutions.

    Interest Rate Risk.  Changes in interest rates affect interest income earned
on the Company's cash equivalents and investments, as well as interest expense
on variable interest rate borrowings under the Company's 2014 Credit Facility.
Based on the amount of cash equivalents and investments and the borrowing levels
under the 2014 Credit Facility as of June 30, 2015, a hypothetical 10 percent
increase or decrease in the interest rate associated with these instruments,
with all other variables held constant, would not materially affect the
Company's future earnings and cash outflows.

Historical-Liquidity and Capital Resources


    Operating Activities.  The Company reported net cash provided by operating
activities of $137.1 million and $112.7 million for the Prior Year Period and
Current Year Period, respectively. The $24.4 million decrease in operating cash
flows from the Prior Year Period to the Current Year Period is attributable to
net unfavorable working capital changes and a decrease in Segment Profit between
periods, offset by the net shift of restricted funds between cash and
investments that results in an operating cash flow change that is directly
offset by an investing cash flow change and a decrease in tax payments between
periods.

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    The net unfavorable impact of working capital changes between periods
totaled $80.8 million. For the Prior Year Period, operating cash flows were
impacted by net favorable working capital changes of $43.5 million, largely
attributable to a net decrease in restricted cash requirements associated with
the Company's regulated entities and increase in medical claims payable,
partially offset by timing of discretionary bonus activity. For the Current Year
Period, operating cash flows were impacted by net unfavorable working capital
changes of $37.3 million, which were largely attributable to timing of
discretionary bonus activity and an increase in accounts receivable, partially
offset by the collection of ACA receivables. Segment Profit for the Current Year
Period decreased $3.4 million from the Prior Year Period.

    Restricted cash of $12.3 million and $63.2 million for the Prior Year Period
and Current Year Period, respectively, were shifted to restricted investments
that increased operating cash flows. The net impact of the shift in restricted
funds between periods is an increase in operating cash flows of $50.9 million.
Tax payments for the Current Year Period totaled $31.3 million, which represents
a decrease of $8.9 million from the Prior Year Period.

    During the Current Year Period, the Company's restricted cash decreased
$84.0 million. The change in restricted cash is attributable to the net shift of
restricted cash of $63.2 million to restricted investments, net decrease in
restricted cash of $13.4 million associated with the Company's regulated
entities, and other net decreases of $7.4 million. The net change in restricted
cash for the Company's regulated entities is attributable to a net increase in
restricted cash requirements of $7.2 million that resulted in an operating cash
flow use, partially offset by a net decrease in restricted cash of $20.6 million
that is offset by changes in other assets and liabilities, primarily accounts
receivable, accrued liabilities, medical claims payable and other medical
liabilities, thus having no impact on operating cash flows.

    Investing Activities.  The Company utilized $32.0 million and $37.7 million
during the Prior Year Period and Current Year Period, respectively, for capital
expenditures. The additions related to hard assets (equipment, furniture,
leaseholds) and capitalized software for the Prior Year Period were
$10.9 million and $21.1 million, respectively, as compared to additions for the
Current Year Period related to hard assets and capitalized software of
$13.2 million and $24.5 million, respectively. During the Prior Year Period the
Company receive net cash of $34.4 million from the net maturity of
"available-for-sale" securities, with the Company using net cash of
$77.4 million during the Current Year Period for the net purchase of "available
for sale" securities. In addition, during the Prior Year Period, the Company
used net cash of $125.0 million for the acquisition of CDMI. During the Current
Year Period, the Company used net cash of $13.6 million and $42.4 million for
the acquisitions of HSM Physical Health and 4D, respectively.

    Financing Activities.  During the Prior Year Period, the Company paid
$65.3 million for the repurchase of treasury stock under the Company's share
repurchase program and paid $2.1 million on capital lease obligations. In
addition, the Company received $34.2 million from the exercise of stock options
and had other net favorable items of $1.3 million.

    During the Current Year Period, the Company paid $68.8 million for the
repurchase of treasury stock under the Company's share repurchase program,
$6.3 million on debt obligations and $2.0 million on capital lease obligations.
The Company made a contingent consideration payment totaling $5.0 million, of
which $4.4 million was related to financing activities. In addition, the Company
received $49.2 million from the exercise of stock options and had other net
favorable items of $3.1 million.

Outlook-Liquidity and Capital Resources


    Liquidity.  During the remainder of 2015, the Company expects to fund its
estimated capital expenditures of $26.3 million to $36.3 million with cash from
operations. The Company does not anticipate that it will need to draw on
additional amounts available under the 2014 Credit Facility for

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cash flow needs related to its operations, capital needs or debt service in
2015. The Company also currently expects to have adequate liquidity to satisfy
its existing financial commitments over the periods in which they will become
due. The Company may draw on the 2014 Credit Facility to fund a portion of cash
required for its acquisition activities. The Company plans to maintain its
current investment strategy of investing in a diversified, high quality, liquid
portfolio of investments and continues to closely monitor the situation in the
financial markets. The Company estimates that it has no risk of any material
permanent loss on its investment portfolio; however, there can be no assurance
that the Company will not experience any such losses in the future.

    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. For
See Note D-"Commitments and Contingencies" for more information on the Company's
share repurchase program.

Off-Balance Sheet Arrangements. As of June 30, 2015, the Company has no material off-balance sheet arrangements.


    2014 Credit Facility.  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 aggregate principal amount of
$250.0 million. The 2014 Credit Facility is guaranteed by substantially all of
the non-regulated subsidiaries of the Company and will mature on July 23, 2019,
but the Company holds an option to extend the 2014 Credit Facility for an
additional one year period. See Note A-"General" for more information on the
2014 Credit Facility.

    Restrictive Covenants in Debt Agreements.  The 2014 Credit Facility contains
covenants that potentially limit management's discretion in operating the
Company's business by, in certain circumstances, restricting or limiting the
Company's ability, among other things, to:

        º •
        º incur or guarantee additional indebtedness or issue preferred or
          redeemable stock;

        º •
        º pay dividends and make other distributions;

        º •
        º repurchase equity interests;

        º •
        º make certain advances, investments and loans;

        º •
        º enter into sale and leaseback transactions;

        º •
        º create liens;

        º •
        º sell and otherwise dispose of assets;

        º •
        º acquire or merge or consolidate with another company; and

        º •
        º enter into some types of transactions with affiliates.

    These restrictions could adversely affect the Company's ability to finance
future operations or capital needs or engage in other business activities that
may be in the Company's interest.

    The 2014 Credit Facility also requires the Company to comply with specified
financial ratios and tests. Failure to do so, unless waived by the lenders under
the 2014 Credit Facility pursuant to its terms, would result in an event of
default under the 2014 Credit Facility.

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