UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM ~~10‑Q~~10-Q

(Mark One)
☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended ~~September 30, 2017~~March 31, 2019
Or
☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to

Commission File 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 ☒ No ☐

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 ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non‑accelerated filer, smaller reporting company, or an emerging growth company. See ~~definition~~the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b‑2 of the Exchange Act. (Check one):


Large accelerated filer ☒	Accelerated filer ☐	~~Non‑accelerated~~Non-accelerated filer ☐ (Do not check if a smaller reporting company)
Smaller reporting company ☐			Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange

Act. ☐

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

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, par value $0.01 per share	MGLN	The NASDAQ Global Market

The number of shares of ~~the registrant’s Ordinary Common Stock~~Magellan Health Inc.’s common stock outstanding as of ~~September 30, 2017~~March 31, 2019 was ~~24,042,290.~~24,032,629.

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, ~~2016~~2018 and ~~September 30, 2017~~March 31, 2019	2
	Consolidated Statements of ~~Income—For~~Comprehensive Income —For the Three ~~and Nine~~ Months Ended ~~September 30, 2016~~March 31, 2018 and ~~2017~~2019	3
	Consolidated Statements ~~of Comprehensive Income—~~Changes in Stockholders’ Equity—For the Three ~~and Nine~~ Months Ended ~~September 30, 2016~~March 31, 2018 and ~~2017~~2019	4
	Consolidated Statements of Cash Flows—For the ~~Nine~~Three Months Ended ~~September 30, 2016~~March 31, 2018 and ~~2017~~2019	5
	Notes to Consolidated Financial Statements	6
Item 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations	2728
Item 3:	Quantitative and Qualitative Disclosures about Market Risk	39
Item 4:	Controls and Procedures	39
	PART II — Other Information:
Item 1:	Legal Proceedings	4039
Item 1A:	Risk Factors	4039
Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds	40
Item 3:	Defaults Upon Senior Securities	40
Item 4:	Mine Safety Disclosures	40
Item 5:	Other Information	4140
Item 6:	Exhibits	4140
Exhibit Index		4241
Signatures		4342

Table of Contents

PART ~~I��~~I—FINANCIAL INFORMATION

Item 1. Financial Statements.

MAGELLAN HEALTH, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)


			September 30,				March 31,
	December 31,		2017		December 31,		2019
	2016			(Unaudited)	2018		(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents ($81,776 and $98,277 restricted at December 31, 2016 and September 30, 2017, respectively)	$	304,508	$	504,764
Accounts receivable, less allowance of $5,644 and $8,657 at December 31, 2016 and September 30, 2017, respectively		606,764		622,431
Short-term investments ($227,795 and $238,869 restricted at December 31, 2016 and September 30, 2017, respectively)		297,493		312,902
Cash and cash equivalents ($160,967 and $65,944 restricted at December 31, 2018 and March 31, 2019, respectively)					$	272,308	$	233,401
Accounts receivable, net						756,059		779,863
Short-term investments ($363,840 and $385,571 restricted at December 31, 2018 and March 31, 2019, respectively)						382,582		412,732
Pharmaceutical inventory		58,995		48,941		40,818		47,151
Other current assets ($38,785 and $23,140 restricted at December 31, 2016 and September 30, 2017, respectively)		51,507		52,896
Other current assets ($43,401 and $45,006 restricted at December 31, 2018 and March 31, 2019, respectively)						95,400		99,908
Total Current Assets		1,319,267		1,541,934		1,547,167		1,573,055
Property and equipment, net		172,524		161,437		150,748		149,520
Long-term investments ($6,306 and $10,575 restricted at December 31, 2016 and September 30, 2017, respectively)		7,760		10,575
Long-term investments ($2,854 and $17,331 restricted at December 31, 2018 and March 31, 2019, respectively)						3,161		17,639
Deferred income taxes		3,125		5,249		3,411		3,581
Other long-term assets		12,725		40,621		24,530		90,997
Goodwill		742,054		745,947		1,018,156		1,018,156
Other intangible assets, net		186,232		156,351		231,883		218,209
Total Assets	$	2,443,687	$	2,662,114	$	2,979,056	$	3,071,157
LIABILITIES, REDEEMABLE NON-CONTROLLING INTEREST AND STOCKHOLDERS’ EQUITY
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable	$	95,635	$	66,530	$	72,077	$	75,041
Accrued liabilities		202,176		173,701		231,356		260,954
Short-term contingent consideration		9,354		8,875		8,000		—
Medical claims payable		184,136		213,692		393,547		399,055
Other medical liabilities		197,856		193,881		169,639		183,802
Current debt and capital lease obligations		403,693		19,231
Current debt, finance lease and deferred financing obligations						24,274		25,006
Total Current Liabilities		1,092,850		675,910		898,893		943,858
Long-term debt and capital lease obligations		214,686		745,543
Long-term debt, finance lease and deferred financing obligations						728,608		722,925
Deferred income taxes						11,167		11,105
Tax contingencies		13,981		14,348		16,478		16,589
Long-term contingent consideration		1,799		615		2,124		2,268
Deferred credits and other long-term liabilities		15,882		18,290		36,483		81,022
Total Liabilities		1,339,198		1,454,706		1,693,753		1,777,767
Redeemable non-controlling interest		4,770		4,704
Preferred stock, par value $.01 per share
Authorized—10,000 shares at December 31, 2016 and September 30, 2017-Issued and outstanding-none		—		—
Ordinary common stock, par value $.01 per share
Authorized—100,000 shares at December 31, 2016 and September 30, 2017-Issued and outstanding-51,993 and 23,517 shares at December 31, 2016, respectively, and 52,723 and 24,042 shares at September 30, 2017, respectively		520		527
Authorized—10,000 shares at December 31, 2018 and March 31, 2019-Issued and outstanding-none						—		—
Common stock, par value $.01 per share
Authorized—100,000 shares at December 31, 2018 and March 31, 2019-Issued and outstanding-53,536 and 23,935 shares at December 31, 2018, respectively, and 53,695 and 24,033 shares at March 31, 2019, respectively						535		537
Other Stockholders’ Equity:
Additional paid-in capital		1,186,283		1,248,993		1,326,645		1,337,849
Retained earnings		1,289,288		1,344,986		1,419,449		1,419,735
Accumulated other comprehensive loss		(175)		(148)		(324)		(4)
Treasury stock, at cost, 28,476 and 28,681 shares at December 31, 2016 and September 30, 2017, respectively		(1,376,197)		(1,391,654)
Treasury stock, at cost, 29,601 and 29,662 shares at December 31, 2018 and March 31, 2019, respectively						(1,461,002)		(1,464,727)
Total Stockholders’ Equity		1,099,719		1,202,704		1,285,303		1,293,390
Total Liabilities, Redeemable Non-Controlling Interest and Stockholders’ Equity	$	2,443,687	$	2,662,114
Total Liabilities and Stockholders’ Equity					$	2,979,056	$	3,071,157

See accompanying notes to consolidated financial statements.

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MAGELLAN HEALTH, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(In thousands, except per share amounts)


	Three Months Ended				Nine Months Ended				Three Months Ended
	September 30,				September 30,				March 31,
	2016		2017		2016		2017		2018		2019
Net revenue:
Managed care and other	$	751,589	$	834,358	$	2,127,911	$	2,385,397	$	1,219,763	$	1,223,979
PBM and dispensing		540,543		585,048		1,445,588		1,758,771
PBM										585,314		515,510
Total net revenue		1,292,132		1,419,406		3,573,499		4,144,168		1,805,077		1,739,489
Costs and expenses:
Cost of care		480,243		569,306		1,410,403		1,634,624		928,661		941,961
Cost of goods sold		509,673		543,682		1,362,062		1,648,670		559,665		489,793
Direct service costs and other operating expenses ~~(3)~~(2)		229,094		227,372		635,627		680,230		269,077		271,924
Depreciation and amortization		26,885		28,189		77,472		82,896		30,407		30,708
Interest expense		3,038		7,663		6,780		16,711		8,366		9,107
Interest and other income		(741)		(1,781)		(2,116)		(3,801)		(2,476)		(4,974)
Total costs and expenses		1,248,192		1,374,431		3,490,228		4,059,330		1,793,700		1,738,519
Income before income taxes		43,940		44,975		83,271		84,838		11,377		970
Provision for income taxes		18,631		11,739		43,259		29,206
(Benefit) provision for income taxes										(75)		539
Net income		25,309		33,236		40,012		55,632	$	11,452	$	431
Less: net (loss) income attributable to non-controlling interest		(200)		785		(2,692)		(66)
Net income attributable to Magellan	$	25,509	$	32,451	$	42,704	$	55,698
Net income attributable to Magellan per common share:
Net income per common share:
Basic (See Note B)	$	1.11	$	1.39	$	1.83	$	2.41	$	0.47	$	0.02
Diluted (See Note B)	$	1.06	$	1.32	$	1.75	$	2.30	$	0.45	$	0.02
Other comprehensive income
Unrealized (losses) gains on available-for-sale securities(3)										(319)		320
Comprehensive income									$	11,133	$	751

(1)

Includes stock compensation expense of ~~$9,176~~$7,646 and ~~$10,323~~$9,607 for the three months ended ~~September 30, 2016~~March 31, 2018 and ~~2017,~~2019, respectively ~~and $27,573 and $31,834 for the nine months ended September 30, 2016 and 2017, respectively.~~.

(2)

Includes changes in fair value of contingent consideration of ~~$313~~$233 and ~~$(834)~~$144 for the three months ended ~~September 30, 2016~~March 31, 2018 and ~~2017, respectively, and $510 and $(631) for the nine months ended September 30, 2016 and 2017,~~2019, respectively.

(3)

~~Includes impairment~~Net of ~~intangible assets~~income tax (benefit) expense of $0$(101) and ~~$4,800~~$100 for the three ~~and nine~~ months ended ~~September 30, 2016,~~March 31, 2018 and 2019, respectively.

See accompanying notes to consolidated financial statements.

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MAGELLAN HEALTH, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF ~~COMPREHENSIVE INCOME~~CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

(In thousands)

Three Months Ended

Nine Months Ended

September 30,

September 30,


2016

2017

2016

2017
Net income

$
25,309

$
33,236

$
40,012

$
55,632
Other comprehensive income:

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

(127)

26

109

27
Comprehensive income

25,182

33,262

40,121

55,659
Less: comprehensive (loss) income attributable to non-controlling interest

(200)

785

(2,692)

(66)
Comprehensive income attributable to Magellan

$
25,382

$
32,477

$
42,813

$
55,725


												Accumulated
				Common Stock				Additional				Other		Total
	Common Stock				In Treasury			Paid in		Retained		Comprehensive		Stockholders’
	Shares	Amount		Shares		Amount		Capital		Earnings		Income		Equity
Balance at December 31, 2017	52,973	$	530		(28,771)	$	(1,397,962)	$	1,274,811	$	1,399,495	$	(380)	$	1,276,494
Stock compensation expense	—		—		—		—		7,646		—		—		7,646
Exercise of stock options	300		3		—		—		17,131		—		—		17,134
Issuance of equity	125		1		—		—		(3,052)		—		—		(3,051)
Repurchase of stock	—		—		—		—		—		—		—		—
Net income	—		—		—		—		—		11,452		—		11,452
Other comprehensive (loss)—other	—		—		—		—		—		—		(319)		(319)
Adoption of ASC 606	—		—		—		—		—		(4,227)		—		(4,227)
Balance at March 31, 2018	53,398	$	534		(28,771)	$	(1,397,962)	$	1,296,536	$	1,406,720	$	(699)	$	1,305,129


Balance at December 31, 2018	53,536	$	535		(29,601)	$	(1,461,002)	$	1,326,645	$	1,419,449	$	(324)	$	1,285,303
Stock compensation expense	—		—		—		—		9,607		—		—		9,607
Exercise of stock options	41		1		—		—		2,044		—		—		2,045
Issuance of equity	118		1		—		—		(447)		—		—		(446)
Repurchase of stock	—		—		(61)		(3,725)		—		—		—		(3,725)
Net income	—		—		—		—		—		431		—		431
Other comprehensive income—other	—		—		—		—		—		—		320		320
Adoption of ASC 842	—		—		—		—		—		(145)		—		(145)
Balance at March 31, 2019	53,695	$	537		(29,662)	$	(1,464,727)	$	1,337,849	$	1,419,735	$	(4)	$	1,293,390

~~(1)~~

Net of income tax (benefit) provision of $(78) and $16 for the three months ended September 30, 2016 and 2017, respectively, and $68 and $18 for the nine months ended September 30, 2016 and 2017, respectively.

See accompanying notes to consolidated financial statements.

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MAGELLAN HEALTH, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE ~~NINE~~THREE MONTHS ENDED ~~SEPTEMBER 30,~~MARCH 31,

(Unaudited)

(In thousands)


	2016		2017		2018		2019
Cash flows from operating activities:
Net income	$	40,012	$	55,632	$	11,452	$	431
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization		77,472		82,896		30,407		30,708
Non-cash impairment of intangible assets		4,800		—
Non-cash interest expense		385		3,120		307		326
Non-cash stock compensation expense		27,573		31,834		7,646		9,607
Non-cash income tax provision (benefit)		2,998		(2,160)		62		(250)
Non-cash amortization on investments		4,224		3,052		809		(192)
Changes in assets and liabilities, net of effects from acquisitions of businesses:
Accounts receivable, net		(31,926)		(13,539)		(87,178)		(23,804)
Pharmaceutical inventory		(10,425)		9,609		3,067		(6,333)
Other assets		(72,374)		(15,481)		(37,914)		(10,835)
Accounts payable and accrued liabilities		23,870		(70,006)		26,529		20,399
Medical claims payable and other medical liabilities		(18,017)		25,578		107,569		19,671
Contingent consideration		(50,591)		(631)		233		(1,609)
Tax contingencies		(111)		158		448		83
Deferred credits and other long-term liabilities		(5,393)		2,408		17,685		(2,889)
Other		(57)		210		(90)		111
Net cash (used in) provided by operating activities		(7,560)		112,680
Net cash provided by operating activities						81,032		35,424
Cash flows from investing activities:
Capital expenditures		(44,345)		(42,703)		(19,502)		(12,642)
Acquisitions and investments in businesses, net of cash acquired		(126,931)		(3,200)		—		(320)
Purchase of investments		(365,521)		(341,280)
Maturity of investments		373,694		320,045
Purchases of investments						(142,886)		(172,766)
Proceeds from maturities and sales of investments						118,999		128,748
Net cash used in investing activities		(163,103)		(67,138)		(43,389)		(56,980)
Cash flows from financing activities:
Proceeds from issuance of debt		290,000		949,239
Payments to acquire treasury stock		(106,806)		(15,457)		—		(4,124)
Proceeds from exercise of stock options and warrants		10,933		28,328
Payments on debt and capital lease obligations		(13,569)		(798,359)
Proceeds from exercise of stock options						16,897		2,045
Payments on debt, finance lease and deferred financing obligations						(55,895)		(7,323)
Payments on contingent consideration		(40,559)		(1,032)		—		(6,247)
Other		1,274		(8,005)		(3,051)		(1,702)
Net cash provided by financing activities		141,273		154,714
Net (decrease) increase in cash and cash equivalents		(29,390)		200,256
Net cash used in financing activities						(42,049)		(17,351)
Net decrease in cash and cash equivalents						(4,406)		(38,907)
Cash and cash equivalents at beginning of period		249,029		304,508		398,732		272,308
Cash and cash equivalents at end of period	$	219,639	$	504,764	$	394,326	$	233,401

Supplemental cash flow data:
Non-cash investing activities:
Property and equipment acquired under capital leases	$	4,193	$	2,418
Assets acquired under finance leases and deferred financing					$	51	$	3,302

See accompanying notes to consolidated financial statements.

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MAGELLAN HEALTH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

~~September 30, 2017~~March 31, 2019

(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 nine~~ months ended ~~September 30, 2017~~March 31, 2019 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, ~~2016~~2018 and the notes thereto, which are included in the Company’s Annual Report on Form 10-K filed with the SEC on February ~~24, 2017.~~28, 2019.

Business Overview

The Company is ~~engaged in~~a leader within the healthcare management business, and is focused on ~~managing~~delivering innovative specialty solutions for the fastest growing, most complex areas of health, including special populations, complete pharmacy benefits, and other specialty carve-out areas of healthcare. The Company develops innovative solutions that combine advanced analytics, agile technology and clinical excellence to drive better decision making, positively impact members’ health outcomes and optimize the cost of care for the ~~members it serves.~~customers 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”). Magellan operates three segments: Healthcare, Pharmacy Management and Corporate.

Healthcare

~~The~~During the third quarter of 2018, the Company re-evaluated how it was managing the Healthcare business segment ~~(“Healthcare”) includes~~and decided a reorganization was necessary to effectively manage the ~~Company’s: (i) management~~business going forward. As a result of ~~behavioral healthcare services~~this business reorganization, the Company concluded that changes to Healthcare’s reporting units were warranted. Healthcare now consists of two reporting units – Behavioral & Specialty Health 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”). Effective August 1, 2018, the Company evaluated the impact of the reorganization on its previously identified reporting units. The Company allocated goodwill to the new reporting units using a relative fair value approach. In addition, the Company completed an assessment of any potential goodwill impairment for all reporting units immediately prior to and immediately after the reallocation and determined that no impairment existed.

The Behavioral & Specialty Health reporting unit’s customers include health plans, accountable care organizations (“ACOs”), employers, the United States military and various federal government agencies for whom Magellan provides carve-out management services for behavioral health, employee assistance plans (“EAP”) and other areas of specialty healthcare including diagnostic imaging, musculoskeletal management, cardiac and physical medicine. These management services can be applied broadly across commercial, Medicaid and Medicare populations, or on a more targeted basis for our health plans and ACO customers. The Behavioral & Specialty Health unit also includes Magellan’s carve-out behavioral health contracts with various state Medicaid agencies.

The MCC reporting unit contracts with state Medicaid agencies and the Centers for Medicare and Medicaid Services (“CMS”) to manage care for beneficiaries under various Medicaid and Medicare programs. MCC manages a wide range of services from total medical cost to carve out long-term support services. MCC largely focuses on managing care for special populations ~~include~~including individuals with serious mental illness (“SMI”), dual eligibles, ~~long‑term services~~aged, blind and ~~supports~~disabled (“ABD”) and other populations with unique and often complex healthcare needs.

~~The Company’s~~

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MAGELLAN HEALTH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

March 31, 2019

(Unaudited)

Magellan’s coordination and management of these healthcare and long-term support services are provided through its comprehensive network of medical and behavioral health professionals, clinics, hospitals, skilled nursing facilities, home care agencies 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 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 Healthcare 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~~PMPM fee, ~~and~~or (ii) administrative services only (“ASO”) products, where the Company provides

~~Table of Contents~~

~~MAGELLAN HEALTH, INC. AND SUBSIDIARIES~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~September 30, 2017~~

~~(Unaudited)~~

services such as utilization review, claims administration and/or provider network management, but does not assume full responsibility for the cost of the treatment ~~services.~~services, in exchange for an administrative fee and, in some instances, a gain share.

Pharmacy Management

The Pharmacy Management segment (“Pharmacy Management”) ~~comprises~~is comprised of products and solutions that provide clinical and financial management of pharmaceuticals paid under both the medical and the pharmacy ~~benefit programs.~~benefit. Pharmacy Management’s services include: (i) pharmacy benefit management (“PBM”) ~~services;~~services, including pharmaceutical dispensing operations; (ii) pharmacy benefit administration (“PBA”) for state Medicaid and other government sponsored programs; (iii) ~~pharmaceutical dispensing operations; (iv)~~ clinical and formulary management programs; ~~(v)~~(iv) medical pharmacy management programs; and ~~(vi)~~(v) 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~~These services are ~~provided under contracts with~~available individually, in combination, or in a fully integrated manner. The Company markets its pharmacy management services to health plans, employers, ~~MCOs,~~third party administrators, managed care organizations, state ~~Medicaid programs,~~governments, Medicare Part D, and other government agencies, exchanges, brokers and ~~encompass~~consultants. In addition, the Company will continue to upsell its pharmacy products to its existing customers and market its pharmacy solutions to the Healthcare customer base.

Pharmacy Management contracts with its customers for services using risk‑based, ~~and fee‑for‑service (“FFS”)~~gain share or ASO arrangements. In addition, Pharmacy Management ~~has subcontract arrangements~~provides services to ~~provide PBM services~~the Healthcare segment for ~~certain Healthcare customers.~~its MCC business.

Corporate

This segment of the Company is comprised primarily of amounts not allocated to the Healthcare and Pharmacy Management segments that are largely associated with costs related to being a publicly traded company.

~~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 deferred the effective date of ASU 2014-09. In December 2016, the FASB issued ASU No. 2016-20, “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers” (“ASU 2016-20”), which amends various aspects of ASU 2014-09. The amendments in these ASUs are effective for annual and interim reporting periods of public entities beginning after December 15, 2017. The Company intends to adopt the new standard on a modified retrospective basis. The Company has completed preliminary reviews of each revenue stream and is assessing the impact of adoption under ASU 606. Within the PBM and dispensing revenue streams, exclusive of Medicare Part D, the Company has substantially completed its review under the new standard and determined that ASU 606 will not have a material impact on the Company’s consolidated results of operations, financial position and cash flows. Within the managed care and other revenue streams, the Company continues to assess the potential impact, but has identified an impact related to the recognition of Health Insurer Fee (HIF) revenue under ASC 606. Although the income tax effect has not been quantified, the Company has determined, based on its preliminary assessment, that up to $40.0million of HIF revenue will be recognized as a revenue cumulative effect adjustment upon adoption of the new standard. Under ASC 605, HIF revenue is recognized as the health insurer fee is being expensed. Under ASC 606, HIF revenue will represent a form of variable consideration that is included in the transaction price for the managed care service to the extent it is not constrained. As such, HIF revenue included within the transaction price will be recognized as the managed care service is provided, which is the year prior to the fee being accrued and expensed. At this time, the Company has not identified a material impact of adoption for other revenue streams. However, the Company has also not completed its review of the impact on interim reporting.

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~~In July 2015, the FASB issued ASU No. 2015‑11, “Inventory (Topic 330): Simplifying the Measurement~~Summary 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 and was adopted by the Company in the quarter ended March 31, 2017. The effect of this guidance was immaterial to the Company’s consolidated results of operations, financial position and cash flows.Significant Accounting Policies

Recent Accounting Pronouncements

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~~The FASB also issued various ASUs which subsequently amended ASU 2016-02. These amendments and ASU 2016-02, collectively known as Accounting Standard Codification 842 (“ASC 842”), are effective for annual and interim reporting periods of public entities beginning after December 15, ~~2018, with early adoption permitted.~~2018. The Company ~~is currently assessing~~adopted ASC 842 on a modified retrospective basis on January 1, 2019. The Company applied the ~~impact~~transition method which does not require adjustments to comparative periods nor requires modified disclosures in those comparative periods. In addition, the Company elected the package of practical expedients, the practical expedient which permits combining lease and non-lease components (which was applicable to our real estate leases) and the short-term lease practical expedient. The Company implemented new leasing software capable of producing the data to prepare the required accounting and disclosures prescribed by ASC 842. Adoption of ASC 842 resulted in the recognition of right-of-use (“ROU”) assets and lease liabilities of $59.8 million and $67.9 million, respectively as of January 1, 2019. The difference between the right-of-use asset and lease liability was recorded as an adjustment to retained earnings. The adoption ~~but believes the effect~~ of ~~this ASU will~~ASC 842 did not have a material ~~effect on the Company’s consolidated balance sheets. The Company is currently assessing the potential~~ impact ~~this ASU will have~~ on the Company’s consolidated results of operations ~~financial position and~~or cash flows.

The cumulative effect of the change to our consolidated January 1, 2019 balance sheet for the adoption of ASC 842 was as follows (in thousands):


	Balance at December 31, 2018		Adjustments Due to ASC 842		Balance at January 1, 2019
Assets
Deferred income taxes	$	3,411	$	52	$	3,463
Other long-term assets		24,530		59,820		84,350
Total Assets		2,979,056		59,872		3,038,928

Liabilities and Stockholders' Equity
Accrued liabilities		231,356		13,018		244,374
Total Current Liabilities		898,893		13,018		911,911
Deferred credits and other long-term liabilities		36,483		46,999		83,482
Total Liabilities		1,693,753		60,017		1,753,770
Retained earnings		1,419,449		(145)		1,419,304
Total Stockholders' Equity		1,285,303		(145)		1,285,158
Total Liabilities and Stockholders' Equity		2,979,056		59,872		3,038,928

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The impact of the adoption of ASC 842 on our consolidated balance sheet as of March 31, 2019 was as follows (in thousands):


	As Reported		Adjustments		Balance Without ASC 842 Adoption
Assets
Other long-term assets	$	90,997	$	(56,008)	$	34,989
Total Assets		3,071,157		(56,008)		3,015,149

Liabilities and Stockholders' Equity
Accrued liabilities		260,954		(12,555)		248,399
Total Current Liabilities		943,858		(12,555)		931,303
Deferred credits and other long-term liabilities		81,022		(43,613)		37,409
Total Liabilities		1,777,767		(56,168)		1,721,599
Retained earnings		1,419,735		160		1,419,895
Total Stockholders' Equity		1,293,390		160		1,293,550
Total Liabilities and Stockholders' Equity		3,071,157		(56,008)		3,015,149

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 position and cash flows.

In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments” (“ASU 2016-15”). This ASU makes eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows. This guidance is effective for annual and interim periods 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 operation, financial positions and cash flows.

In October 2016, the FASB issued ASU 2016-16, “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory” (“ASU 2016-16”). The amendments in this ASU require that entities recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. This guidance is effective for annual and interim periods 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 operation, financial positions and cash flows.

In December 2016, the FASB issued ASU 2016-19, “Technical Corrections and Improvements” (“ASU 2016-19”). The amendments in this ASU cover a wide range of Topics in the Accounting Standard Codification, including internal use software covered under Subtopic 350-40. This guidance is effective for annual and interim periods of public entities beginning after December 15, 2016 and was adopted by the Company in the quarter ended March 31, 2017. The effect of this guidance was immaterial to the Company’s consolidated results of operations, financial position and cash flows.

In January 2017, the FASB issued ASU No. 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business” (“ASU 2017-01”). The amendments in this ASU clarify whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. This guidance is effective for annual and interim periods 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 January 2017, the FASB issued ASU No. 2017-04, “Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment” (“ASU 2017-04”). The amendments in this ASU eliminate the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge. This guidance is effective for annual and interim periods of public entities beginning after December 15, 2019, with early adoption

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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 ~~May~~February 2018, the FASB issued ASU 2018-02, “Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income” (“ASU 2018-02”), which was issued to address the income tax accounting treatment of the stranded tax effects within other comprehensive income due to the prohibition of backward tracing due to an income tax rate change that was initially recorded in other comprehensive income. This issue came about from the enactment of the Tax Cuts and Jobs Act on December 22, 2017 that changed the Company’s federal income tax rate from 35% to 21%. ASU 2018-02 changed current accounting whereby an entity may elect to reclassify the stranded tax effect from accumulated other comprehensive income to retained earnings. The amendments in this ASU are effective for interim and annual reporting periods beginning after December 15, 2018. Adoption of this ASU is to be applied either in the period of adoption or retrospectively to each period in which the effect of the change in the tax laws or rates were recognized. The Company adopted ASU 2018-02 on January 1, 2019, which had no impact on the Company.

In August 2018, the FASB issued ASU No. ~~2017-09, “Compensation-Stock Compensation (Topic 718)~~2018-15, “Intangibles-Goodwill and Other–Internal-Use Software (Subtopic 350-40): ~~Scope of Modification Accounting”~~Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract” (“ASU ~~2017-09”~~2018-15”). ~~The amendments~~This ASU aligns the requirements for capitalizing implementation costs incurred in ~~this ASU include guidance on determining which changes~~a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to ~~the terms and conditions of share-based payment awards require an entity to apply modification accounting under Topic 718.~~develop or obtain internal-use software. This guidance is effective for annual and interim periods of public entities beginning after December 15, ~~2017,~~2019, 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.

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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 can 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. In addition, the Company also makes estimates in relation to revenue recognition under ASC 606 which are explained in more detail in “Revenue Recognition” below. Actual results could differ from those estimates.

Revenue Recognition

Virtually all of the Company’s revenues are derived from business in North America. The following tables disaggregate our revenue for the three months ended March 31, 2019 by major service line, type of customer and timing of revenue recognition (in thousands):


	Three Months Ended March 31, 2019
	Healthcare		Pharmacy Management		Elimination		Total
Major Service Lines
Behavioral & Specialty Health
Risk-based, non-EAP	$	361,808	$	—	$	(78)	$	361,730
EAP risk-based		89,617		—		—		89,617
ASO		55,203		8,143		(91)		63,255
Magellan Complete Care
Risk-based, non-EAP		642,571		—		—		642,571
ASO		15,054		—		—		15,054
PBM, including dispensing		—		493,224		(41,055)		452,169
Medicare Part D		—		63,341		—		63,341
PBA		—		33,977		—		33,977
Formulary management		—		17,183		—		17,183
Other		—		592		—		592
Total net revenue	$	1,164,253	$	616,460	$	(41,224)	$	1,739,489

Type of Customer
Government	$	888,492	$	203,271	$	—	$	1,091,763
Non-government		275,761		413,189		(41,224)		647,726
Total net revenue	$	1,164,253	$	616,460	$	(41,224)	$	1,739,489

Timing of Revenue Recognition
Transferred at a point in time	$	—	$	556,565	$	(41,055)	$	515,510
Transferred over time		1,164,253		59,895		(169)		1,223,979
Total net revenue	$	1,164,253	$	616,460	$	(41,224)	$	1,739,489

~~Managed Care and Other Revenue~~

~~Managed Care~~Per Member Per Month (“PMPM”) Revenue. ~~Managed care~~Almost all of the Healthcare revenue and a small portion of the Pharmacy Management revenue is paid on a PMPM basis. PMPM revenue is inclusive of revenue from the Company’s risk, EAP and ASO contracts ~~is recognized over~~and primarily relates to managed care contracts for services such as the ~~applicable coverage period on~~provision of behavioral healthcare, specialty healthcare, pharmacy management, or fully integrated healthcare services. PMPM contracts generally have 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,term of one year or longer, with the exception of ~~retroactivity~~government contracts where the customer can terminate with as little as 30 days’ notice for no significant penalty. All managed care contracts have a single performance obligation that can be reasonably estimated. The impact of retroactive rate amendments is generally recorded in the accounting period in which terms to the amendment are finalized. Any fees paid prior to the month of service are recorded as deferred revenue. Managed care revenues approximated $576.8 million and $1,692.6 millionconstitutes a series for the ~~three and nine months ended September 30, 2016, respectively, and $644.9 million and $1,851.2 million~~provision of managed healthcare services for a population of enrolled members for the ~~three and nine months ended September 30, 2017, 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. ~~The Consolidated Appropriations Act of 2016 imposed a one-year moratorium on the HIF fee, suspending its application for 2017.~~ Revenues from these contracts approximated $143.7 million and $349.3 million for the three and nine months ended September 30, 2016, respectively, and $156.1 million and $444.0 million for the three and nine months ended September 30, 2017, 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 $22.0 million and $63.1 million for the three and nine months ended September 30, 2016, respectively, and $21.4 million and $64.9 million for the three and nine months ended September 30, 2017, 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 Company recognizes rebates when the Company is entitled to them and when the amountsduration of the ~~rebates are determinable.~~contract. The ~~amount recorded~~transaction price for ~~rebates earned by the Company from the pharmaceutical manufacturers~~PMPM contracts is ~~recorded~~entirely variable as ~~a reduction of cost of goods sold.~~

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primarily includes PMPM fees associated with unspecified membership that fluctuates throughout the contract. In certain contracts, PMPM fees also include adjustments for things such as performance incentives, performance guarantees and risk shares. The Company generally estimates the transaction price using an expected value methodology and amounts are only included in the net transaction price to the extent that it is probable that a significant reversal of cumulative revenue will not occur once any uncertainty is resolved. The majority of the Company’s net PMPM transaction price relates specifically to its efforts to transfer the service for a distinct increment of the series (e.g. day or month) and is recognized as revenue in the month in which members are entitled to service. The remaining transaction price is recognized over the contract period (or portion of the series to which it specifically relates) based upon estimated membership as a measure of progress.

~~PBM~~Under certain government contracts, our risk scores are compared with the overall average risk scores for the relevant state and ~~Dispensing Revenue~~market pool. Generally, if our risk score is below the average risk score we are required to make a risk adjustment payment into the risk pool, and if our risk score is above the average risk score we will receive a risk adjustment payment from the risk pool. Risk adjustments can have a positive or negative retroactive impact to rates.

Pharmacy Benefit Management Revenue. The Company’s customers for PBM business, including pharmaceutical dispensing operations, are generally comprised of MCOs, employer groups and health plans. PBM relationships generally have an expected term of one year or longer. A master services arrangement (“MSA”) is executed by the Company and the customer, which outlines the terms and conditions of the PBM services to be provided. When a member in the customer’s organization submits a prescription, a claim is created which is presented for approval. The acceptance of each individual claim creates enforceable rights and obligations for each party and represents a separate contract. For each individual claim, the performance obligations are limited to the processing and adjudication of the claim, or dispensing of the products purchased. Generally, the transaction price for PBM services is explicitly listed in each contract and does not represent variable consideration. 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.~~adjudicated or the drugs are shipped. 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, controls the underlying service, 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 $413.7 million and $1,110.7 million for the three and nine months ended September 30, 2016, respectively, and $419.3 million and $1,288.2 million for the three and nine months ended September 30, 2017, respectively.

~~Dispensing Revenue.~~ ~~The Company recognizes~~For 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~~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 $57.5 million and $167.2 million for the three and nine months ended September 30, 2016, respectively, and $49.8 million and $158.2 million for the three and nine months ended September 30, 2017, respectively.

Medicare Part D.The Company is contracted with ~~the Centers for Medicare and Medicaid (“CMS”)~~CMS as a Prescription Drug Plan (“PDP”) to provide prescription drug benefits to Medicare beneficiaries. Net revenues include 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 premium revenues on a monthly basis on a per member basis~~accounting for covered members. In addition to these premiums, net revenue 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. CMS also provides an annual risk corridor adjustment which compares the 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 $76.5 million and $192.0 million~~revenue is primarily the same as that for ~~the three and nine months ended September 30, 2016, respectively, including co-payments, which are included~~PBM, as previously discussed. However, there is certain variable consideration present only in ~~PBM revenues above, of $7.2 million and $24.3 million for the three and nine months ended September 30, 2016, respectively.~~ Medicare Part D ~~revenues approximated $131.8 million and $367.9 million~~arrangements. The Company estimates the annual amount of variable consideration using a most likely amount methodology, which is allocated to each reporting period based upon actual utilization as a percentage of estimated utilization for the ~~three~~year. Amounts estimated throughout the year for interim reporting are substantially resolved and ~~nine months ended September 30, 2017, respectively, including co-payments, which~~fixed as of December 31st, the end of the plan year.

Pharmacy Benefit Administration Revenue. The Company provides Medicaid pharmacy services to states and other government sponsored programs. PBA contracts are ~~included~~generally multi-year arrangements but include language regarding early termination for convenience without material penalty provisions that results in ~~PBM revenues above, of $15.8 million~~enforceable rights and ~~$55.5 million~~obligations on a month-to-month basis. In PBA arrangements, the Company is generally paid a fixed fee per month to provide PBA services. In addition, some PBA contracts contain upfront fees that constitute a material right. For contracts without an upfront fee, there is a single performance obligation to stand ready to provide the PBA services required for the three and nine months ended September 30, 2017, respectively. As of December 31, 2016 and September 30, 2017, the Company had $117.5 million and $170.5 million, respectively, in net receivables associated with Medicare Part D from CMS and other parties related to this business.

~~Significant Customers~~

~~Customers exceeding ten percent of the consolidated Company’s net revenues~~

contracted period. The Company believes that the customer receives the PBA benefits each day from access to the claims processing activities, and has concluded that a time-based measure is appropriate for recognizing PBA revenue. For contracts with an upfront fee, the material right represents an additional performance obligation. Amounts allocated to the material right are initially recorded as a contract ~~with~~liability and recognized as revenue over the ~~State~~anticipated period of ~~Florida to provide integrated healthcare services to Medicaid enrollees in the state of Florida (“the Florida Contract”). The Florida Contract began on February 4, 2014 and extends~~

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benefit of the material right, which generally ranges from 2 to 10 years.

Formulary Management Revenue. The Company administers formulary management programs 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. Formulary management contracts generally have a term of one year or longer. All formulary management contracts have a single performance obligation that constitutes a series for the provision of rebate services for a drug, with utilization measured and settled on a quarterly basis, for the duration of the arrangement. The Company retains its administrative fee and/or a percentage of rebates that is included in its contract with the client from collecting the rebate from the manufacturer. While the administrative fee and/or the percentage of rebates retained is fixed, there is an unknown quantity of pharmaceutical purchases (utilization) during each quarter, therefore, the transaction price itself is variable. The Company uses the expected value methodology to estimate the total rebates earned each quarter based on estimated volumes of pharmaceutical purchases by the Company’s clients during the quarter, as well as historical and/or anticipated retained rebate percentages. The Company does not record as rebate revenue any rebates that are passed through to its clients.

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 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.

Government EAP Risk-Based Revenue. The Company has certain contracts with federal customers for the provision of various managed care services, which are classified as EAP risk-based business. These contracts are generally multi-year arrangements. The Company’s federal contracts are reimbursed on either a fixed fee basis or a cost reimbursement basis. The performance obligation on a fixed fee contract is to stand ready to provide the staffing required for the contracted period. For fixed fee contracts, the Company believes the invoiced amount corresponds directly with the value to the customer of the Company’s performance completed to date, therefore, the Company is utilizing the “right to invoice” practical expedient, with revenue recognition in the amount for which the Company has the right to invoice.

The performance obligation on a cost reimbursement contract is to stand ready to provide the activity or services purchased by the customer, such as the operation of a counseling services group or call center. The performance obligation represents a series for the duration of the arrangement. The reimbursement rate is fixed per the contract; however, the level of activity (e.g., number of hours, number of counselors or number of units) is variable. A majority of the Company’s cost reimbursement transaction price relates specifically to its efforts to transfer the service for a distinct increment of the series (e.g. day or month) and is recognized as revenue when the portion of the series for which it relates has been provided (i.e. as the Company provides hours, counselors or units of service).

In accordance with ASC 606-10-50-13, the Company is required to include disclosure on its remaining performance obligations as of the end of the current reporting period. Due to the nature of the contracts in the Company’s PBM and Part D business, these reporting requirements are not applicable. The majority of the Company’s remaining contracts meet certain exemptions as defined in ASC 606-10-50-14 through 606-10-50-14A, including (i) performance obligation is part of a contract that has an original expected duration of one year or less; (ii) the right to invoice practical expedient; and (iii) variable consideration related to unsatisfied performance obligations that is allocated entirely to a wholly unsatisfied promise to transfer a distinct service that forms part of a single performance obligation, and the terms of that variable consideration relate specifically to our efforts to transfer the distinct service, or to a specific outcome from transferring the distinct service. For the Company’s contracts that pertain to these exemptions: (i) the remaining performance obligations primarily relate to the provision of managed healthcare services to the customers’ membership; (ii) the estimated remaining duration of these performance obligations ranges from the remainder of the current calendar year to three years; and (iii) variable consideration for these contracts primarily includes net PMPM fees associated with unspecified membership that fluctuates throughout the contract.

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MAGELLAN HEALTH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

March 31, 2019

(Unaudited)

Accounts Receivable, Contract Assets and Contract Liabilities

Accounts receivable, contract assets and contract liabilities consisted of the following (in thousands, except percentages):


	December 31,		March 31,
	2018		2019		$ Change		% Change
Accounts receivable	$	786,395	$	797,938	$	11,543		1.5%
Contract assets		4,647		8,055		3,408		73.3%
Contract liabilities - current		16,853		8,071		(8,782)		(52.1%)
Contract liabilities - long-term		13,441		12,963		(478)		(3.6%)

Accounts receivable, which are included in accounts receivable, other current assets and other long-term assets on the consolidated balance sheets, increased by $11.5 million, mainly due to timing. Contract assets, which are included in other current assets on the consolidated balance sheets, increased by $3.4 million, mainly due to the timing of accrual of certain performance incentives. Contract liabilities – current, which are included in accrued liabilities on the consolidated balance sheets, decreased by $8.8 million, mainly due to the timing of receipts related to January 2019 revenues. Contract liabilities – long-term, which are included in deferred credits and other long-term liabilities on the consolidated balance sheets, decreased by $0.5 million, mainly due to certain balances which became current.

During the three months ended March 31, 2019, the Company recognized revenue of $12.2 million that was included in current contract liabilities at December 31, ~~2018, unless sooner terminated by~~2018. The estimated timing of recognition of amounts included in contract liabilities at March 31, 2019 are as follows: 2019—$7.1 million; 2020—$3.5 million; 2021—$3.0 million; 2022 and beyond—$7.4 million. During the ~~parties.~~ three months ended March 31, 2019, the revenue the Company recognized related to performance obligations that were satisfied, or partially satisfied, in previous periods was not material.

The ~~State~~Company’s accounts receivable consists of ~~Florida~~amounts due from customers throughout the United States. Collateral is generally not required. A majority of the Company’s contracts have payment terms in the month of service, or within a few months thereafter. The timing of payments from customers from time to time generate contract assets or contract liabilities; however, these amounts are immaterial.

Significant Customers

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

The Company has contracts with the Commonwealth of Virginia (the “Virginia Contracts”). The Company began providing Medicaid managed long-term services and supports to enrollees in the Commonwealth Coordinated Care Plus (“CCC Plus”) program on August 1, 2017. The CCC Plus contract expires annually on December 31, and automatically renews annually on January 1 for a period of five calendar years, with potential of up to five 12-month extensions. The Commonwealth of Virginia has the right to terminate the ~~Florida Contract~~CCC Plus contract with cause ~~as defined,~~at any time and for convenience upon ~~24 hour notice~~90 days’ notice. On August 1, 2018, the Company began providing integrated healthcare services to Medicaid enrollees in the Commonwealth of Virginia under the Medallion 4.0/FAMIS Managed Care Program (“Medallion”). The initial term of the Medallion contract is from August 1, 2018 through June 30, 2019, with six 12- month renewal options. The Commonwealth of Virginia has the right to terminate the Medallion contract with cause at any time and for convenience upon ~~30 days notice for any reason or no reason at all.~~180 days’ notice. The ~~Florida Contract~~Virginia Contracts generated net revenues of ~~$403.4~~$117.3 million and ~~$457.7~~$193.9 million for the ~~nine~~three months ended ~~September 30,~~March 31, 2018 and 2019, respectively.

The Company had a contract with the State of New York (the “New York Contract”) to provide integrated managed care services to Medicaid and Medicare enrollees in the State of New York. The Company’s New York Contract terminated on December 31, 2016; however, the Company, along with other participating managed care plans in the state, continues to provide services while a new contract is being finalized. The Company began recognizing revenue in relation to the New York Contract on January 1, 2014 as a result of the acquisition of AlphaCare Holdings, Inc. The Company’s revenues under the New York Contracts increased starting on November 1, 2017 as a result of the

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MAGELLAN HEALTH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

March 31, 2019

(Unaudited)

acquisition of SWH Holdings, Inc. The New York Contracts generated net revenues of $180.5 million and $195.2 million for the three months ended March 31, 2018 and 2019, respectively.

The Company has contracts with the Commonwealth of Massachusetts (the “Massachusetts Contracts”) to provide integrated managed care services to Medicaid and Medicare enrollees in the Commonwealth of Massachusetts. Medicaid services are provided under a Senior Care Options contract (“SCO Contract”) which began on January 1, 2016 and extends through December 31, 2020, with the potential for up to five additional one year extensions. The Commonwealth of Massachusetts may terminate the contract with cause without prior notice and upon 180 days’ notice without cause. Medicare services are provided under a one-year contract with the Center for Medicare and Medicaid Services (“CMS”). The CMS contract currently extends through December 31, 2019. The Company began recognizing revenue in relation to the Massachusetts Contracts on November 1, 2017 as a result of the acquisition of SWH Holdings, Inc. The Massachusetts Contracts generated net revenues of $163.7 million and $179.2 million for the three months ended March 31, 2018 and 2019, respectively.

Customers exceeding ten percent of segment net revenues

In addition to the ~~Florida~~Massachusetts Contract, New York Contract and Virginia Contract previously discussed, the following customers generated in excess of ten percent of net revenues for the respective segment for the ~~nine~~three months ended ~~September 30, 2016~~March 31, 2018 and ~~2017~~2019 (in thousands):

Segment

Term Date

2016

2017

Healthcare

None

Pharmacy Management

Customer A

December 31, 2016 (1)

$
261,094

$
3,709
*
Customer B

March 31, 2019

78,471

266,795

* Revenue amount did not exceed 10 percent of net revenues for the respective segment for the year presented. Amount is shown for comparative purposes only.

~~(1)~~

A vast majority of this customer’s revenues were generated from drug acquisition costs related to PBM services which terminated on September 1, 2016. The Company continues to provide specialty distribution services to the customer and is in negotiations with the customer to extend this contract.


Segment	Term Date	2018		2019
Healthcare
Customer A	December 31, 2023	$	152,386	$	62,929

Pharmacy Management
Customer B	March 31, 2021		91,442		89,340

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, with members under its contract with CMS and with various agencies and departments of the United States federal government. Net revenues from the Pennsylvania Counties in the aggregate totaled ~~$343.2~~$136.9 million and ~~$357.3~~$131.7 million for the ~~nine~~three months ended ~~September 30, 2016~~March 31, 2018 and ~~2017,~~2019, respectively. Net revenues from members in relation to its ~~contract~~contracts with CMS in aggregate totaled ~~$192.0~~$98.4 million and ~~$368.2~~$63.3 million for the ~~nine~~three months ended ~~September 30, 2016~~March 31, 2018 and ~~2017,~~2019, respectively. As of December 31, 2018 and March 31, 2019, the Company had $131.0 million and $128.4 million, respectively, in net receivables associated with Medicare Part D from CMS and other parties related to this business. Net revenues from contracts with various agencies and departments of the United States federal government in aggregate totaled ~~$164.3~~$84.6 million and ~~$257.7~~$79.5 million for the ~~nine~~three months ended ~~September 30, 2016~~March 31, 2018 and ~~2017,~~2019, respectively.

The Company’s contracts with customers typically have stated 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 6030 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.

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~~September 30, 2017~~March 31, 2019

(Unaudited)

Leases

The Company leases certain office space, distribution centers, land and equipment. We assess our contracts to determine if it contains a lease. This assessment is based on (i) the right to control the use of an identified asset; (ii) the right to obtain substantially all of the economic benefits from the use of the identified asset; and (iii) the right to use the identified asset. The Company elected the short-term lease practical expedient; thus, leases with an initial term of twelve months or less are not capitalized and the expense is recognized on a straight-line basis. Most leases include one or more options to renew, with renewal terms that can extend the lease from one to ten years. The exercise of renewal options are at the sole discretion of the Company. Renewal options that the Company is reasonably certain to accept are recognized as part of the ROU asset.

Operating leases are included in other long-term assets, accrued liabilities and deferred credits and other long-term liabilities in the consolidated balance sheets. Finance leases are included in property and equipment, current debt, capital lease deferred financing obligations and long-term debt, capital lease and deferred financing obligations in the consolidated balance sheets.

ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments per the lease. Operating lease ROU assets and liabilities are recognized at lease commencement date based on the present value of lease payments over the lease term. As the rate implicit in most of our leases is not readily determinable, the Company used its incremental borrowing rate to determine the present value of lease payments.

The following table shows the components of lease expenses for the three months ended March 31, 2019 (in thousands):


	Three months ended March 31, 2019
Operating lease cost	$	4,725
Finance lease cost:
Amortization of right-of-use asset		940
Interest on lease liabilities		216
Total finance lease cost		1,156
Short-term lease cost		318
Variable lease cost		874
Total lease cost		7,073
Sublease income		(98)
Net lease cost	$	6,975

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

March 31, 2019

(Unaudited)

The following table shows the components of the lease assets and liabilities as of March 31, 2019 (in thousands):


	March 31, 2019
Operating leases:
Other long-term assets	$	56,008

Accrued liabilities	$	14,200
Deferred credits and other long-term liabilities		50,015
Total operating lease liabilities	$	64,215

Finance leases:
Property and equipment, net	$	15,611

Current debt, finance lease and deferred financing obligations	$	4,192
Long-term debt, finance lease and deferred financing obligations		16,936
Total finance lease liabilities	$	21,128

The maturity dates of the Company’s leases as of March 31, 2019 are summarized below (in thousands):


	March 31, 2019
2019	$	14,648
2020		16,885
2021		16,248
2022		15,217
2023		11,228
2024 and beyond		13,672
Total lease payments		87,898
Less interest		(2,555)
Present value of lease liabilities	$	85,343

The following table shows the weighted average remaining lease term and discount rate as of March 31, 2019:


	March 31, 2019
Weighted average remaining lease term
Operating leases		4.81
Finance leases		5.33
Weighted average discount rate
Operating leases		4.79%
Finance leases		4.53%

Supplemental cash flow information relating to leases is as follows (in thousands):


	Three months ended March 31, 2019
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases	$	4,445
Operating cash flows from finance leases		1,035
Financing cash flows from finance leases		222
Right-of-use asset obtained in exchange for new lease obligation
Operating leases		26
Finance leases		—

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March 31, 2019

(Unaudited)

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.

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, ~~2016~~2018 and ~~September~~March 30, ~~2017~~2019 (in thousands):


	December 31, 2016								December 31, 2018
	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Assets
Cash and cash equivalents (1)	$	—	$	177,495	$	—	$	177,495	$	—	$	263,462	$	—	$	263,462
Investments:
U.S. Government and agency securities		5,817		—		—		5,817		67,815		—		—		67,815
Obligations of government-sponsored enterprises (2)		—		25,767		—		25,767		—		5,229		—		5,229
Corporate debt securities		—		272,219		—		272,219		—		292,049		—		292,049
Certificates of deposit		—		1,450		—		1,450		—		20,650		—		20,650
Total assets held at fair value	$	5,817	$	476,931	$	—	$	482,748	$	67,815	$	581,390	$	—	$	649,205

Liabilities
Contingent consideration	$	—	$	—	$	11,153	$	11,153	$	—	$	—	$	10,124	$	10,124
Total liabilities held at fair value	$	—	$	—	$	11,153	$	11,153	$	—	$	—	$	10,124	$	10,124


	September 30, 2017								March 31, 2019
	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Assets
Cash and cash equivalents (3)	$	—	$	392,039	$	—	$	392,039	$	—	$	219,855	$	—	$	219,855
Investments:
U.S. Government and agency securities		8,668		—		—		8,668		109,504		—		—		109,504
Obligations of government-sponsored enterprises ~~(4)~~(2)		—		13,264		—		13,264		—		5,244		—		5,244
Corporate debt securities		—		295,181		—		295,181		—		295,473		—		295,473
Taxable municipal bonds		—		5,014		—		5,014
Certificates of deposit		—		1,350		—		1,350		—		20,150		—		20,150
Total assets held at fair value	$	8,668	$	706,848	$	—	$	715,516	$	109,504	$	540,722	$	—	$	650,226

Liabilities
Contingent consideration	$	—	$	—	$	9,490	$	9,490	$	—	$	—	$	2,268	$	2,268
Total liabilities held at fair value	$	—	$	—	$	9,490	$	9,490	$	—	$	—	$	2,268	$	2,268

~~(1)~~

~~Excludes $127.0 million of cash held in bank accounts by the Company.~~

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

~~September 30, 2017~~March 31, 2019

(Unaudited)

(1)

Excludes $8.8 million of cash held in bank accounts by the Company.

(2)

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

(3)

Excludes ~~$112.7~~$13.6 million of cash held in bank accounts by the Company.

~~(4)~~

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

For the ~~nine~~three months ended ~~September 30, 2017,~~March 31, 2019, the Company has not transferred any assets between fair value measurement levels.

The carrying values of financial instruments, including accounts receivable, accounts payable and revolving loan borrowings, approximate their fair values due to their short-term maturities. The fair value of the Notes (as defined below) of ~~$406.2~~$382.0 million as of ~~September 30, 2017~~March 31, 2019 was determined based on quoted market prices and would be classified within Level 1 of the fair value hierarchy. The estimated fair value of the Company’s term loan of ~~$350.0~~$323.8 million as of ~~September 30, 2017~~March 31, 2019 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 Cobalt Therapeutics, LLC (“Cobalt”), The Management Group, LLC (“TMG”) and Armed Forces Services Corporation (“AFSC”) acquisitions. The Cobalt, TMG and AFSC purchase agreements provide for potential contingent payments of up to a maximum of $6.0 million, $15.0 million and $10.0 million, respectively. As of September 30, 2017, there are remaining potential future payments of $15.0 million and $10.0 million for TMG and AFSC, 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 operating income, member engagement and new contract execution. The Company used a probability weighted discounted cash flow method to arrive at the fair value of the contingent consideration. 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. The unobservable inputs used in the fair value measurement include the discount rate, probabilities of payment and projected payment dates.

As of December 31, ~~2016~~2018 and ~~September 30, 2017,~~March 31, 2019, the Company estimated undiscounted future contingent payments of ~~$12.7~~$10.6 million and ~~$9.9~~$2.6 million, respectively. ~~The net decrease was mainly due to payments made in 2017 and changes in operational forecasts and probabilities of payment.~~ As of ~~September 30, 2017,~~March 31, 2019, the aggregate ~~amounts~~amount and projected ~~dates~~date of future potential contingent consideration payments ~~were $9.0 million in 2017 and $0.9~~$2.6 million in 2020.

As of December 31, ~~2016,~~2018, the fair value of the short-term and long-term contingent consideration was ~~$9.4~~$8.0 million and ~~$1.8~~$2.1 million, respectively, and is included in short-term contingent consideration and long-term contingent consideration, respectively, in the consolidated balance sheets. As of ~~September 30, 2017,~~March 31, 2019, the fair value of the ~~short-term and~~ long-term contingent consideration was ~~$8.9~~$2.3 million ~~and $0.6 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 ~~$0.3~~$0.2 million and ~~$0.5~~$0.1 million for the three ~~and nine~~ months ended ~~September 30, 2016, respectively,~~March 31, 2018 and ~~$(0.8) million and $(0.6) million for the three and nine months ended September 30, 2017,~~2019, respectively, which were recorded as direct service costs and other operating expenses in the consolidated statements of comprehensive income. ~~The decreases during 2017 were mainly a result of changes in present value and the estimated undiscounted liability.~~

~~Table of Contents~~

~~MAGELLAN HEALTH, INC. AND SUBSIDIARIES~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~September 30, 2017~~

~~(Unaudited)~~

The following table summarizes the Company’s liability for contingent consideration for the ~~nine~~three months ended ~~September 30, 2017~~March 31, 2019 (in thousands):


	September 30,		March 31,
	2017		2019
Balance as of beginning of period	$	11,153	$	10,124
Changes in fair value		(631)		144
Payments		(1,032)		(8,000)
Balance as of end of period	$	9,490	$	2,268

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 ~~September 30, 2017,~~March 31, 2019, the Company’s excess

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

March 31, 2019

(Unaudited)

capital and undistributed earnings for the Company’s regulated subsidiaries of ~~$125.6~~$88.4 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 comprehensive 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~~net income and the non‑credit component of the other‑than‑temporary impairment is recognized in other comprehensive income in the consolidated statements of comprehensive income.

As of December 31, ~~2016~~2018 and ~~September 30, 2017,~~March 31, 2019, there were no material unrealized losses that the Company determined to be other‑than‑temporary. No realized gains or losses were recorded for the ~~nine~~three months ended ~~September 30, 2016~~March 31, 2018 or ~~2017.~~2019. The following is a summary of short‑term and long‑term investments at December 31, ~~2016~~2018 and ~~September 30, 2017~~March 31, 2019 (in thousands):


	December 31, 2016								December 31, 2018
			Gross		Gross						Gross		Gross
	Amortized		Unrealized		Unrealized		Estimated		Amortized		Unrealized		Unrealized		Estimated
	Cost		Gains		Losses		Fair Value		Cost		Gains		Losses		Fair Value
U.S. Government and agency securities	$	5,832	$	—	$	(15)	$	5,817	$	67,870	$	17	$	(72)	$	67,815
Obligations of government-sponsored enterprises (1)		25,779		2		(14)		25,767		5,257		—		(28)		5,229
Corporate debt securities		272,479		1		(261)		272,219		292,392		6		(349)		292,049
Certificates of deposit		1,450		—		—		1,450		20,650		—		—		20,650
Total investments at December 31, 2016	$	305,540	$	3	$	(290)	$	305,253
Total investments at December 31, 2018									$	386,169	$	23	$	(449)	$	385,743

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~~MAGELLAN HEALTH, INC. AND SUBSIDIARIES~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~September 30, 2017~~

~~(Unaudited)~~


	September 30, 2017								March 31, 2019
			Gross		Gross						Gross		Gross
	Amortized		Unrealized		Unrealized		Estimated		Amortized		Unrealized		Unrealized		Estimated
	Cost		Gains		Losses		Fair Value		Cost		Gains		Losses		Fair Value
U.S. Government and agency securities	$	8,689	$	—	$	(21)	$	8,668	$	109,476	$	62	$	(34)	$	109,504
Obligations of government-sponsored enterprises ~~(2)~~(1)		13,279		—		(15)		13,264		5,255		—		(11)		5,244
Corporate debt securities		295,384		1		(204)		295,181		295,496		64		(87)		295,473
Taxable municipal bonds		5,017		—		(3)		5,014
Certificates of deposit		1,350		—		—		1,350		20,150		—		—		20,150
Total investments at September 30, 2017	$	323,719	$	1	$	(243)	$	323,477
Total investments at March 31, 2019									$	430,377	$	126	$	(132)	$	430,371

(1)

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

~~(2)~~

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

The maturity dates of the Company’s investments as of ~~September 30, 2017~~March 31, 2019 are summarized below (in thousands):

Amortized

Estimated


Cost

Fair Value

2017

$
98,136

$
98,105

2018

216,697

216,498

2019

8,886

8,874

Total investments at September 30, 2017

$
323,719

$
323,477


	Amortized		Estimated
	Cost		Fair Value
2019	$	334,859	$	334,841
2020		95,518		95,530
Total investments at March 31, 2019	$	430,377	$	430,371

Income Taxes

The Company’s effective income tax rates were ~~51.9~~(0.7) percent and ~~34.4~~55.6 percent for the ~~nine~~three months ended ~~September 30, 2016~~March 31, 2018 and ~~2017,~~2019, 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.~~contingencies. The

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

March 31, 2019

(Unaudited)

Company also accrues interest and penalties related to uncertain tax positions in its provision for income taxes. The effective income tax rate for the ~~nine~~three months ended ~~September 30, 2017~~March 31, 2018 is ~~lower than the effective rate for the nine months ended September 30, 2016 mainly~~negative (a tax benefit) primarily due to ~~the suspension for 2017 of the non-deductible HIF fees, valuation allowance increases in 2016 with respect to losses at AlphaCare of New York, Inc. (“AlphaCare”) and~~ more significant tax deductions in ~~2017~~2018 in excess of recognized stock compensation expense. The effective income tax rate for the three months ended March 31, 2019 is higher than the federal and state statutory rates primarily due to recognized stock compensation expense in excess of tax deductions.

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. ~~The Company is no longer subject to~~

During 2018, the Internal Revenue Service (“IRS”) began examinations of the following federal consolidated income tax ~~assessments~~returns: (i) the Company for ~~years~~the year ended ~~prior to 2014 or, with few exceptions, to state or local income tax assessments~~December 31, 2015, (ii) SWH Holdings, Inc. for ~~years~~the year ended ~~prior to 2013. Further,~~December 31, 2016, and (iii) AlphaCare Holdings for the ~~statutes~~year ended December 31, 2016. During 2018, the IRS concluded its review of ~~limitation regarding~~ the ~~assessment~~Company’s 2015 return. In resolution of ~~2013~~that examination, the Company paid federal ~~and certain state and local income~~ taxes ~~expired during~~of $0.3 million in the quarter ended September 30, ~~2017 (“Current Year Quarter”). As~~2018. On April, 18, 2019, the Company received a ~~result, $1.7 million of~~“no change” letter regarding the AlphaCare Holdings examination. The IRS has made no tax ~~contingency reserves recorded as of December 31, 2016 were reversed~~assessments in connection with the ~~Current Year Quarter, of which $1.2 million is reflected as a discrete reduction~~SWH Holdings, Inc. examination, although the review could lead to income tax expense and $0.5 million as a decrease to deferred tax assets. Additionally, $0.1 million of accrued interest was reversed in the Current Year Quarter and reflected as a reduction to income tax expense dueproposed adjustments to the ~~closing~~reported tax liability. Under the terms of ~~statutes~~the SWH Holdings, Inc. Agreement and Plan of ~~limitation on~~Merger, the previous owners of SWH Holdings, Inc. provided the Company with an indemnification with respect to any such pre-acquisition period tax ~~assessments.~~liabilities.

Net Operating Loss Carryforwards

The Company has ~~$1.8~~$27.7 million of federal net operating loss carryforwards (“NOLs”) available to reduce ~~its federal~~ consolidated taxable income in ~~2017~~2019 and subsequent years. These NOLs (including $27.1 million incurred by AlphaCare prior to its membership in the Magellan consolidated group) will expire in ~~2018 and~~ 2019 ~~if not used and are subject to examination and adjustment by the Internal Revenue Service (“IRS”). AlphaCare has $40.4 million of~~

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~~MAGELLAN HEALTH, INC. AND SUBSIDIARIES~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~September 30, 2017~~

~~(Unaudited)~~

federal NOLs available to reduce its consolidated taxable income in 2017 and subsequent years. These NOLs will expire in 2033 through 2036 if not used and are subject to examination and adjustment by the IRS. The Company and its subsidiaries also have $104.2 million of state NOLs available to reduce state taxable income at certain subsidiaries in 2017 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 IRS. In addition, the Company’s utilization of these NOLs is subject to limitations under the Internal Revenue Code as to the timing and use. At this time, the Company does not believe these limitations will restrict the Company’s ability to use any federal NOLs before they expire. The Company and its subsidiaries also have $88.2 million of NOLs available to reduce state and local taxable income at certain subsidiaries in 2019 and subsequent years. Most of these NOLs will expire in 2019 through 2038 if not used and are subject to examination and adjustment by the respective ~~state~~ tax authorities. In addition, the Company’s utilization of certain of these NOLs is subject to limitations as to the timing and use. Other than those considered in determining the valuation allowances discussed below, the Company does not believe these limitations will restrict the Company’s ability to use any of these state and local NOLs before they expire.

Deferred tax assets as of December 31, ~~2016~~2018 and ~~September 30, 2017~~March 31, 2019 are shown net of valuation allowances of ~~$17.1 million and $17.2 million, respectively.~~$1.5 million. These valuation allowances mostly relate to uncertainties regarding the eventual realization of ~~the AlphaCare federal NOLs and~~ certain state NOLs. Reversals of valuation allowances are recorded in the period they occur, typically as reductions to income tax expense. 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~~The Company believes taxable income expected to be generated in the ~~estimated realizable portion~~future will be sufficient to support realization of the Company’s deferred tax assets, ~~could materially affect the Company’s financial condition~~as reduced by valuation allowances. This determination is based upon earnings history and ~~results of operations.~~future earnings expectations.

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 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,

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MAGELLAN HEALTH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

March 31, 2019

(Unaudited)

the fee may have a material impact on the Company. ~~The Consolidated Appropriations Act of 2016~~On January 23, 2018, the United States Congress passed the Continuing Resolution which imposed a one-year moratorium on the HIF fee, suspending its application for ~~2017. The~~2019. For 2018 the HIF fee ~~is scheduled to go back into effect for 2018. For 2016 the HIF fees were $26.5~~was $29.9 million which ~~has been paid. Of this amount, $6.7 million and $19.9 million~~ was ~~expensed~~paid in the three and nine months ended September 30, 2016, which was included in direct service costs and other operating expenses in the consolidated statements of income. The Company recorded revenues of $11.0 million and $32.4 million in the three and nine months ended September 30, 2016, associated with the accrual for the reimbursement of the economic impact of the HIF fees from its customers. As of September 30, 2017, the Company has a $13.3 million receivable related to a terminated contract that the customer has expressed their unwillingness to pay, however the Company believes the amount is collectible based on the IRS regulations and contractual arrangements that were executed and has not established a reserve. The Company continues to evaluate correspondence with the customer related to this rece~~ivable.~~2018.

~~Stock~~Stock Compensation

At December 31, ~~2016~~2018 and ~~September 30, 2017,~~March 31, 2019, 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, ~~2016,~~2018, which was filed with the SEC on February ~~24, 2017.~~28, 2019. The Company recorded stock compensation expense of ~~$9.2~~$7.6 million and ~~$27.6~~$9.6 million for the three ~~and nine~~ months ended ~~September 30, 2016~~March 31, 2018 and ~~$10.3 million and $31.8 million for the three and nine months ended September 30, 2017,~~2019, respectively. Stock compensation expense recognized in the consolidated statements of comprehensive income for the three ~~and nine~~ months ended ~~September 30, 2016~~March 31, 2018 and ~~2017~~2019 has been reduced for forfeitures, estimated at between zero and four percent for all periods.

The weighted average grant date fair value of all stock options granted during the ~~nine~~three months ended ~~September 30, 2017~~March 31, 2019 was ~~$17.15~~$20.61 as estimated using the Black‑Scholes‑Merton option pricing model, which also assumed an expected volatility of ~~27.8~~35.07 percent based on the historical volatility of the Company’s stock price.

For the ~~nine~~three months ended ~~September 30, 2016,~~March 31, 2018 the benefit of tax deductions in excess of recognized stock compensation expense (net of deficiencies) was ~~$0.3~~$4.1 million ~~which~~and was ~~reported~~included as a ~~change to additional paid‑in capital.~~reduction of tax expense. For the ~~nine~~three months ended ~~September 30, 2017,~~March 31, 2019 the ~~benefit~~tax on deficiencies (net of the tax deductions in excess of recognized stock

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~~MAGELLAN HEALTH, INC. AND SUBSIDIARIES~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~September 30, 2017~~

~~(Unaudited)~~

compensation ~~expense (net of deficiencies)~~expense) was ~~$3.7 million. Due to the adoption of ASU 2016-09 in the 4~~th ~~quarter of 2016, this net benefit is reported~~$0.8 million and was included as ~~a reduction~~an increase to income tax expense rather than as a change in additional paid-in-capital. As a result of the adoption of this standard, the net tax benefit is reflected as an operating cash flow rather than a financing cash flow.expense.

Summarized information related to the Company’s stock options for the ~~nine~~three months ended ~~September 30, 2017~~March 31, 2019 is as follows:


		Weighted			Weighted
		Average			Average
		Exercise			Exercise
	Options	Price		Options	Price
Outstanding, beginning of period	2,843,177	$	57.42	2,352,609	$	68.10
Granted	454,596		69.44	409,124		66.03
Forfeited	(53,596)		59.65	(30,835)		84.51
Exercised	(583,395)		52.76	(41,496)		49.28
Outstanding, end of period	2,660,782	$	60.46	2,689,402	$	67.89
Vested and expected to vest at end of period	2,640,924	$	60.41	2,666,529	$	67.84
Exercisable, end of period	1,597,984	$	57.12	1,828,120	$	63.73

All of the Company’s options granted during the ~~nine~~three months ended ~~September 30, 2017~~March 31, 2019 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 ~~nine~~three months ended ~~September 30, 2017~~March 31, 2019 is as follows:



		Weighted			Weighted
		Average			Average
		Grant Date			Grant Date
	Shares	Fair Value		Shares	Fair Value
Outstanding, beginning of period	615,472	$	58.71	11,795	$	89.05
Awarded	14,959		70.20	—		—
Vested	(47,710)		65.24	—		—
Forfeited	—		—	—		—
Outstanding, ending of period	582,721		58.47	11,795		89.05

~~Summarized information related to the Company’s nonvested restricted stock units (“RSUs”) for the nine months ended September 30, 2017 is as follows:~~

Weighted

Average

Grant Date


Shares

Fair Value

Outstanding, beginning of period

200,178

$
61.65

Awarded

107,417

68.53

Vested

(117,069)

60.52

Forfeited

(16,285)

65.48

Outstanding, ending of period

174,241

66.29

~~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.~~

1721

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MAGELLAN HEALTH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

~~September 30, 2017~~March 31, 2019

(Unaudited)

Summarized information related to the Company’s nonvested restricted stock units (“RSUs”) for the three months ended March 31, 2019 is as follows:



		Weighted
		Average
		Grant Date
	Shares	Fair Value
Outstanding, beginning of period	156,750	$	86.68
Awarded	184,074		66.57
Vested	(67,308)		81.77
Forfeited	(4,759)		92.34
Outstanding, ending of period	268,757		74.03

Grants of RSAs vest on the anniversary of the grant. In general, RSUs vest ratably on each anniversary over the three years subsequent to grant.

Summarized information related to the Company’s nonvested restricted performance stock units (“PSUs”) for the ~~nine~~three months ended ~~September 30, 2017~~March 31, 2019 is as follows:


		Weighted			Weighted
		Average			Average
		Grant Date			Grant Date
	Shares	Fair Value		Shares	Fair Value
Outstanding, beginning of period	102,977	$	93.03	209,019	$	103.38
Awarded	101,989		76.24	83,087		100.31
Vested	—		—	(43,109)		97.12
Forfeited	(2,651)		87.75	(12,157)		97.12
Outstanding, end of period	202,315		84.63	236,840		103.76

The weighted average estimated fair value of the PSUs granted in the ~~nine~~three months ended ~~September 30, 2017~~March 31, 2019 was ~~$76.24,~~$100.31, 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 ~~1.54%~~2.51%, and expected volatility of ~~18%~~19% to ~~61%~~82% (average of ~~33%~~36%). The PSUs granted in the ~~nine~~three months ended ~~September 30, 2017,~~March 31, 2019, 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, ~~2019~~2021 and vesting on March ~~3, 2020,~~5, 2022, 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~~is calculated as a percentage of ~~shares for which~~ the award ~~is targeted~~target 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~~varies 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, ~~2020~~2022 by the average share value of the Company’s common stock over the 30 trading days beginning on January 1, ~~2017,~~2019, with a deemed reinvestment of any dividends declared during the performance period. The Company’s peer group includes 5148 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~~Long-Term Debt and ~~Capital~~Finance Lease Obligations

Senior Notes

On September 22, 2017, the Company completed the public offering of $400.0 million aggregate principal amount of its 4.400% Senior Notes due 2024 (the “Notes”). The Notes are governed by an indenture, dated as of September 22, 2017 (the “Base Indenture”), between the Company, as issuer, and U.S. Bank National Association, as trustee, as supplemented by a first supplemental indenture, dated as of September 22, 2017 (the “First Supplemental

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MAGELLAN HEALTH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

March 31, 2019

(Unaudited)

Indenture” together, with the Base Indenture, the “Indenture”), between the Company, as issuer, and U.S. Bank National Association, as trustee. The Notes were issued at a discount and had a carrying value of $399.3 million as of December 31, 2018 and March 31, 2019.

The Notes bear interest payable semiannually in cash in arrears on March 22 and September 22 of each year, commencing on March 22, 2018, which rate is subject to an interest rate adjustment upon the occurrence of certain credit rating events. The Notes mature on September 22, 2024. The Indenture provides that the Notes are redeemable at the Company’s option, in whole or in part, at any time on or after July 22, 2024, at a redemption price equal to 100% of the principal amount of the Notes being redeemed plus accrued and unpaid interest thereon to, but excluding, the redemption date.

The Indenture also contains certain covenants which restrict the Company’s ability to, among other things, create liens on its and its subsidiaries’ assets; engage in sale and lease-back transactions; and engage in a consolidation, merger or sale of assets.

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~~MAGELLAN HEALTH, INC. AND SUBSIDIARIES~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~September 30, 2017~~

~~(Unaudited)~~

The net proceeds from the issuance and sale of the Notes were approximately $394.7 million after deducting the underwriting discounts and commissions and offering expenses. The net proceeds from this offering were and will be used for working capital and general corporate purposes, and the termination and repayment of the obligations under its Previous Credit Agreements (as defined below) which were scheduled to expire on July 23, 2019 and December 29, 2017.

~~Credit Agreements~~

~~On July 23, 2014, the Company entered into a $500.0 million~~ Credit Agreement with various lenders that provided for Magellan Rx Management, Inc. (a wholly owned subsidiary of Magellan) 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”). 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) became a party to the $500.0 million Credit Agreement as the borrower and assumed all of the obligations of Magellan Rx Management, Inc. 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 2014 Credit Facility was scheduled to mature on July 23, 2019. Upon consummation of the Refinancing (as defined below) on September 22, 2017, the 2014 Credit Facility was terminated. During the period the 2014 Term Loan was outstanding, from January 1, 2017 through September 22, 2017, the weighted average interest rate was approximately 2.634 percent.

On June 27, 2016, the Company entered into a $200.0 million Credit Agreement with various lenders that provided for a $200.0 million term loan (the “2016 Term Loan”) to Magellan Pharmacy Services, Inc. (the “2016 Credit Facility”). The 2016 Credit Facility was guaranteed by substantially all of the non-regulated subsidiaries of the Company and was scheduled to mature on December 29, 2017. Upon consummation of the Refinancing (as defined below) on September 22, 2017, the 2016 Credit Facility was terminated. During the period the 2016 Term Loan was outstanding, from January 1, 2017 through September 22, 2017, the weighted average interest rate was approximately 2.390 percent.

On January 10, 2017, the Company entered into a Credit Agreement with various lenders that provided for a $200.0 million delayed draw term loan (the “2017 Term Loan”) to Magellan Pharmacy Services, Inc. (the “2017 Credit Facility”). The 2017 Credit Facility was guaranteed by substantially all of the non-regulated subsidiaries of the Company and was scheduled to mature on December 29, 2017. Upon consummation of the Refinancing (as defined below) on September 22, 2017, the 2017 Credit Facility was terminated. During the period the 2017 Term Loan was outstanding, from January 1, 2017 through September 22, 2017, the weighted average interest rate was approximately 2.691 percent.

On September 22, 2017, the Company entered into a credit agreement with various lenders that provides for a $400.0 million senior unsecured revolving credit facility and a $350.0 million senior unsecured term loan facility to the Company, as the borrower (the “2017 Credit Agreement”). On August 13, 2018, the Company entered into an amendment to the 2017 Credit Agreement, which extended the maturity date by one year. On February 27, 2019, the Company entered into a second amendment to the 2017 Credit Agreement, which amended the total leverage ratio covenant, and which was necessary in order for us to remain in compliance with the terms of the 2017 Credit Agreement. The 2017 Credit Agreement is scheduled to mature on September 22, ~~2022.~~

The proceeds from the 2017 Credit Agreement were and will be used for (a) working capital and general corporate purposes of the Company and its subsidiaries, including investments and the funding of acquisitions, (b) the repayment of all outstanding loans and other obligations (and the termination of all commitments) under the 2014 Credit Facility, 2016 Credit Facility and 2017 Credit Facility (collectively, the “Previous Credit Agreements”) (the termination and repayment of the obligations under the Previous Credit Agreements, collectively, the “Refinancing”) and (c) payment of fees and expenses incurred in connection with (i) the entering into the 2017 Credit Agreement and related documents and the incurrence of loans and issuance of letters of credit thereunder and (ii) the consummation of the Refinancing. ~~Upon consummation of the Refinancing, the Previous Credit Agreements were terminated.~~2023.

Under the 2017 Credit Agreement, the annual interest rate on the loan borrowing is equal to (i) in the case of base rate loans, the sum of an initial borrowing margin of 0.500 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 1.000 percent, or (ii) in the case of Eurodollar rate loans, the sum of an initial borrowing margin of 1.500 percent plus the Eurodollar rate for the selected interest period. The borrowing margin is subject to adjustment based on the Company’s debt rating as provided

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~~MAGELLAN HEALTH, INC. AND SUBSIDIARIES~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~September 30, 2017~~

~~(Unaudited)~~

by certain rating agencies. The Company has the option to borrow in base rate loans or Eurodollar rate loans at its discretion. The commitment commission on the revolving credit facility under the 2017 Credit Agreement is 0.200 percent of the unused revolving credit commitment, which rate shall be subject to adjustment based on the Company’s debt rating as provided by certain rating agencies. ~~During~~For the ~~period the term loan was outstanding, from September 22, 2017 through September 30, 2017,~~three months ended March 31, 2019, the weighted average interest rate was approximately ~~2.740~~4.2609 percent.

On July 13, 2017, in connection with the Company’s pending acquisition of SWH Holdings, Inc. (“SWH”), the Company secured committed financing for up to $400.0 million at closing under a bridge facility (“SWH Bridge Facility”).

As of ~~September 30, 2017,~~March 31, 2019, the contractual maturities of the term loan under the 2017 Credit Agreement were as follows: ~~2017—$4.4 million; 2018—$17.5 million;~~ 2019—$~~17.5~~13.1 million; 2020—$17.5 million; 2021—$17.5 million; 2022—$17.5 million; and ~~2022—~~2023—$~~275.6~~258.1 million. The Company had $33.7 million and $5.0 million of letters of credit outstanding issued under credit facilities at December 31, 2016 and September 30, 2017, respectively. Beginning in April 2016, dueDue to the timing of working capital needs, the Company ~~had~~will periodically ~~borrowed~~borrow from the revolving loan under the ~~2014~~2017 Credit ~~Facility. The revolving loan borrowings had been in the form of Eurodollar rate loans and totaled $175.0 million at~~Agreement. At December 31, ~~2016, which were settled during the period from January 1, 207 through September 22, 2017. At September 30, 2017,~~2018 and March 31, 2019, the Company had no revolving loan ~~borrowings, resulting in~~borrowings. At March 31, 2019, the Company had a borrowing capacity of ~~$395.0~~$400.0 million under the 2017 Credit Agreement. Included in long-term debt, ~~and~~ capital lease and deferred financing obligations are deferred loan and bond issuance costs as of December 31, ~~2016~~2018 and ~~September 30, 2017 are deferred loan issuance costs~~March 31, 2019 of ~~$1.4~~$5.9 million and ~~$8.3~~$6.8 million, respectively.

Letter of Credit Agreement

On August 22, 2017, the Company entered into a Continuing Agreement for Standby Letters of Credit with The Bank of Tokyo-Mitsubishi UFJ, Ltd. (“BTMU”), as issuer (the “L/C Agreement”), under which BTMU, at its sole discretion, may provide stand-by letter of credit to the Company. The Company had ~~$21.5 million of~~ letters of credit outstanding ~~at September 30, 2017~~ under the L/C ~~Agreement.~~Agreement as of December 31, 2018 and March 31, 2019 of $66.1 million and $66.4 million, respectively.

~~Capital~~

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MAGELLAN HEALTH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

March 31, 2019

(Unaudited)

Finance Lease and Deferred Financing Obligations

There were ~~$26.0~~$31.2 million and ~~$23.8~~$31.6 million of ~~capital~~finance lease and deferred financing obligations at December 31, ~~2016~~2018 and ~~September 30, 2017,~~March 31, 2019, respectively. The Company’s ~~capital~~finance lease and deferred financing obligations represent amounts due under leases for certain properties, computer software (acquired prior to the prospective adoption of ASU 2015-05 on January 1, 2016) and equipment.

~~Redeemable Non‑Controlling Interest~~

As The recorded gross cost of September 30, 2017, 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 all or any portion of the remaining shares. In addition, 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 temporaryfinance lease assets was $51.9 million and ~~is therefore reported in a mezzanine level between liabilities and stockholders’ equity on the Company’s consolidated balance sheet~~$55.6 million 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, ~~2016~~2018 and ~~September 30, 2017 was $4.8 million and $4.7 million,~~March 31, 2019, respectively. The $(0.1) million decrease in carrying value is a result of operating losses. 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 September 30, 2017, the carrying value of the non‑controlling interest exceeded the redemption value and therefore no adjustment to the carrying value was required.

~~Table of Contents~~

~~MAGELLAN HEALTH, INC. AND SUBSIDIARIES~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~September 30, 2017~~

~~(Unaudited)~~

~~Reclassifications~~

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

The Company elected to early adopt ASUs 2016-09 and 2016-18 effective for the fiscal year ended December 31, 2016 and applied them retrospectively. Adoption of these standards resulted in a net reduction to the Company’s cash flows of $78.4 million for the nine months ended September 30, 2016. In addition, as a result of the adoption of ASU 2016-09, the diluted weighted average shares outstanding as of September 30, 2016 have been adjusted. There was no impact to the net income per common share – diluted.

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): for the three months ended March 31:

Three Months Ended

Nine Months Ended

September 30,

September 30,


2016

2017

2016

2017

Numerator:

Net income attributable to Magellan

$
25,509

$
32,451

$
42,704

$
55,698

Denominator:

Weighted average number of common shares outstanding—basic

23,052

23,282

23,394

23,135

Common stock equivalents—stock options (1)

226

572

287

485

Common stock equivalents—RSAs  (1)

696

483

647

461

Common stock equivalents—RSUs  (1)

29

61

28

46

Common stock equivalents—PSUs  (1)

2

162

23

111

Common stock equivalents—employee stock purchase plan

4

3

3

3

Weighted average number of common shares outstanding—diluted (1)

24,009

24,563

24,382

24,241

Net income attributable to Magellan per common share—basic

$
1.11

$
1.39

$
1.83

$
2.41

Net income attributable to Magellan per common share—diluted

$
1.06

$
1.32

$
1.75

$
2.30

~~(1)~~

During 2016, the Company early adopted ASU 2016-09. As a result, the common stock equivalents and diluted weighted average common shares outstanding as of September 30, 2016 have been adjusted. There was no impact to net income per common share – diluted.


	Three Months Ended
	March 31,
	2018		2019
Numerator:
Net income	$	11,452	$	431
Denominator:
Weighted average number of common shares outstanding—basic		24,349		23,946
Common stock equivalents—stock options		806		111
Common stock equivalents—RSAs		24		7
Common stock equivalents—RSUs		77		19
Common stock equivalents—PSUs		353		124
Common stock equivalents—employee stock purchase plan		3		6
Weighted average number of common shares outstanding—diluted		25,612		24,213
Net income per common share—basic	$	0.47	$	0.02
Net income per common share—diluted	$	0.45	$	0.02

The weighted average number of common shares outstanding for the ~~nine~~three months ended ~~September 30, 2016~~March 31, 2018 and ~~2017~~2019 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 ~~nine~~three months ended ~~September 30, 2016~~March 31, 2018 and ~~2017~~2019 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 ~~1.8~~0.2 million and 1.2 million options for the three ~~and nine~~ months ended ~~September 30, 2016, respectively,~~March 31, 2018 and ~~0.4 million and 0.6 million for the three and nine months ended September 30, 2017,~~2019, 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.

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

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~~MAGELLAN HEALTH, INC. AND SUBSIDIARIES~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~September 30, 2017~~

~~(Unaudited)~~

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

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MAGELLAN HEALTH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

March 31, 2019

(Unaudited)

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”.~~General.”

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


					Corporate								Corporate
			Pharmacy		and						Pharmacy		and
	Healthcare		Management		Elimination		Consolidated		Healthcare		Management		Elimination		Consolidated
Three Months Ended September 30, 2016
Three Months Ended March 31, 2018
Managed care and other revenue	$	690,572	$	61,106	$	(89)	$	751,589	$	1,157,601	$	62,307	$	(145)	$	1,219,763
PBM and dispensing revenue		—		570,231		(29,688)		540,543
PBM revenue										—		632,198		(46,884)		585,314
Cost of care		(480,243)		—		—		(480,243)		(928,661)		—		—		(928,661)
Cost of goods sold		—		(538,113)		28,440		(509,673)		—		(604,913)		45,248		(559,665)
Direct service costs and other		(152,992)		(66,475)		(9,627)		(229,094)		(186,246)		(75,586)		(7,245)		(269,077)
Stock compensation expense (1)		2,267		5,368		1,541		9,176		2,950		1,485		3,211		7,646
Changes in fair value of contingent consideration (1)		313		—		—		313		233		—		—		233
Less: non-controlling interest segment profit (loss) (2)		(189)		—		(5)		(194)
Segment profit (loss)	$	60,106	$	32,117	$	(9,418)	$	82,805
Segment Profit (Loss)									$	45,877	$	15,491	$	(5,815)	$	55,553

Corporate


Pharmacy

and


Healthcare

Management

Elimination
  ��
Consolidated

Three Months Ended September 30, 2017

Managed care and other revenue

$
769,451

$
65,131

$
(224)

$
834,358

PBM and dispensing revenue

—

618,178

(33,130)

585,048

Cost of care

(569,306)

—

—

(569,306)

Cost of goods sold

—

(575,327)

31,645

(543,682)

Direct service costs and other

(143,550)

(74,976)

(8,846)

(227,372)

Stock compensation expense (1)

2,623

5,680

2,020

10,323

Changes in fair value of contingent consideration (1)

(834)

—

—

(834)

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

789

—

(1)

788

Segment profit (loss)

$
57,595

$
38,686

$
(8,534)

$
87,747

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~~MAGELLAN HEALTH, INC. AND SUBSIDIARIES~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~September 30, 2017~~

~~(Unaudited)~~

Corporate


Pharmacy

and


Healthcare

Management

Elimination

Consolidated

Nine Months Ended September 30, 2016

Managed care and other revenue

$
1,947,470

$
180,658

$
(217)

$
2,127,911

PBM and dispensing revenue

—

1,535,864

(90,276)

1,445,588

Cost of care

(1,410,403)

—

—

(1,410,403)

Cost of goods sold

—

(1,448,699)

86,637

(1,362,062)

Direct service costs and other

(418,574)

(191,402)

(25,651)

(635,627)

Stock compensation expense (1)

6,737

16,338

4,498

27,573

Changes in fair value of contingent consideration (1)

383

127

—

510

Impairment of intangible assets (1)

4,800

—

—

4,800

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

(1,325)

—

(16)

(1,341)

Segment profit (loss)

$
131,738

$
92,886

$
(24,993)

$
199,631


					Corporate								Corporate
			Pharmacy		and						Pharmacy		and
	Healthcare		Management		Elimination		Consolidated		Healthcare		Management		Elimination		Consolidated
Nine Months Ended September 30, 2017
Three Months Ended March 31, 2019
Managed care and other revenue	$	2,190,097	$	195,970	$	(670)	$	2,385,397	$	1,164,253	$	59,895	$	(169)	$	1,223,979
PBM and dispensing revenue		—		1,856,856		(98,085)		1,758,771
PBM revenue										—		556,565		(41,055)		515,510
Cost of care		(1,634,624)		—		—		(1,634,624)		(941,961)		—		—		(941,961)
Cost of goods sold		—		(1,742,610)		93,940		(1,648,670)		—		(530,207)		40,414		(489,793)
Direct service costs and other		(428,432)		(225,782)		(26,016)		(680,230)		(179,190)		(79,635)		(13,099)		(271,924)
Stock compensation expense (1)		8,388		17,094		6,352		31,834		1,750		1,672		6,185		9,607
Changes in fair value of contingent consideration (1)		(631)		—		—		(631)		144		—		—		144
Less: non-controlling interest segment profit (loss) (2)		(56)		—		(3)		(59)
Segment profit (loss)	$	134,854	$	101,528	$	(24,476)	$	211,906
Segment Profit (Loss)									$	44,996	$	8,290	$	(7,724)	$	45,562

(1)

Stock compensation expense, changes in the fair value of contingent consideration recorded in relation to 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.~~

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


	Three Months Ended				Nine Months Ended				Three Months Ended
	September 30,				September 30,				March 31,
	2016		2017		2016		2017		2018		2019
Income before income taxes	$	43,940	$	44,975	$	83,271	$	84,838	$	11,377	$	970
Stock compensation expense		9,176		10,323		27,573		31,834		7,646		9,607
Changes in fair value of contingent consideration		313		(834)		510		(631)		233		144
Impairment of intangible assets		—		—		4,800		—
Non-controlling interest segment (profit) loss		194		(788)		1,341		59
Depreciation and amortization		26,885		28,189		77,472		82,896		30,407		30,708
Interest expense		3,038		7,663		6,780		16,711		8,366		9,107
Interest and other income		(741)		(1,781)		(2,116)		(3,801)		(2,476)		(4,974)
Segment Profit	$	82,805	$	87,747	$	199,631	$	211,906	$	55,553	$	45,562

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~~MAGELLAN HEALTH, INC. AND SUBSIDIARIES~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~September 30, 2017~~

~~(Unaudited)~~

NOTE D—Commitments and Contingencies

Legal

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MAGELLAN HEALTH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

March 31, 2019

(Unaudited)

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~~The Company has recorded reserves that, in the opinion of management, 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.

A Pharmacy Management segment network provider and the Company are currently in dispute regarding pricing and associated calculations pertaining to network reconciliations for a multi-year period. Depending upon the resolution of the dispute, the Company could incur liability to this provider. The unrecorded, potential loss related to these network reconciliations is estimated to range from $0 to $20 million. The ultimate resolution of this matter, if unfavorable, could be material to the Company’s results of operations.

Regulatory Issues

The managed healthcare industry is subject to numerous laws and regulations. The subjects of such laws and regulations cover, but are not limited to, matters such as licensure, accreditation, government healthcare program participation requirements, information privacy and security, reimbursement for patient services, and Medicare and Medicaid fraud and abuse. Over the past several years, government activity has increased with respect to investigations and/or allegations concerning possible violations of fraud and abuse and false claims statutes and/or regulations by healthcare organizations and insurers. Entities that are found to have violated these laws and regulations may be excluded from participating in government healthcare programs, subjected to fines or penalties or required to repay amounts received from the government for previously billed patient services. Compliance with such laws and regulations can be subject to future government review and interpretation, as well as regulatory actions unknown or unasserted at this time.

In addition, regulators of certain of the Company’s subsidiaries may exercise certain discretionary rights under regulations including increasing their supervision of such entities, requiring additional restricted cash or other security or seizing or otherwise taking control of the assets and operations of such subsidiaries.

The Company is subject to certain federal laws and regulations in connection with its contracts with the federal government. These laws and regulations affect how the Company conducts business with its federal agency customers and may impose added costs on its business. The Company’s failure to comply with federal procurement laws and regulations could cause it to lose business, incur additional costs and subject it to a variety of civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, harm to reputation, suspension of payments, fines, and suspension or debarment from doing business with federal government agencies. The Company’s wholly owned subsidiary, AFSC, conducts business with federal agency customers and federal contractors to such agencies. The Company is investigating, with the assistance of outside counsel, matters relating to compliance by AFSC with Small Business Administration ( “SBA”) regulations and other federal laws applicable to government contractors and has reported findings to the SBA and the Department of Defense, including facts indicating violations of SBA regulations and other federal laws, such as the Anti-Kickback Act, by former AFSC executives, none of which was disclosed to Magellan prior to its acquisition of AFSC. The Company is voluntarily responding to government requests for further information regarding the Company’s investigation. Contingencies, if any, arising from the results of this investigation and self-reporting could require us to record balance sheet liabilities or accrue expenses, the amount of which we are not able to currently estimate. While the Company believes that it has responded appropriately by self-reporting findings regarding matters that incepted prior to its acquisition of AFSC in order to mitigate the risk of adverse consequences, should the SBA, Department of Defense and/or other federal agencies seek to hold the Company or AFSC responsible for the reported conduct, we may be required to pay damages and/or penalties and AFSC could be suspended

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MAGELLAN HEALTH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

March 31, 2019

(Unaudited)

or debarred from government contracting. AFSC generated approximately 2% of the Company’s total revenue for the year ended December 31, 2018 and three months ended March 31, 2019.

Stock Repurchases

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 (the “2015 Repurchase Program”). On July 26, 2017, the Company’s board of directors approved an extension of the 2015 Repurchase Program through October 26, 2018. On May 24, 2018, the Company’s board of directors approved an increase of $200 million to the current $200 million stock repurchase plan which will now authorize the Company to purchase up to $400 million of its outstanding common stock under the 2015 Repurchase Program. As of March 31, 2019, the remaining capacity under the 2015 Repurchase Program was $186.3 million. The board also extended the program from October 22, 2018 to October 22, 2020. Stock repurchases under the programs may be carried out 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 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 the 2015 Stock Repurchase Program, the Company made purchases as follows (aggregate cost excludes broker commissions and is reflected in millions):


	Total Number	Average				Total Number	Average
	of Shares	Price Paid		Aggregate		of Shares	Price Paid		Aggregate
Period	Purchased	per Share		Cost		Purchased	per Share		Cost
October 26, 2015 - December 31, 2015	345,044	$	53.46	$	18.4	345,044	$	53.46	$	18.4
January 1, 2016 - December 31, 2016	1,828,183		58.40		106.8	1,828,183		58.40		106.8
January 1, 2017 - September 30, 2017	204,881		75.42		15.5
January 1, 2017 - December 31, 2017						280,140		77.67		21.8
January 1, 2018 - December 31, 2018						844,872		74.59		63.0
January 1, 2019 - March 31, 2019						60,901		61.15		3.7
	2,378,108			$	140.7	3,359,140			$	213.7

The Company made ~~additional open market purchases of 20,994 shares of the Company’s common stock at an aggregate cost of $1.8 million (excluding broker commissions) during the period~~no share repurchases from ~~October~~April 1, ~~2017~~2019 through ~~October 27, 2017.~~

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~~MAGELLAN HEALTH, INC. AND SUBSIDIARIES~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~September 30, 2017~~

~~(Unaudited)~~

~~NOTE E—Acquisitions~~

~~Acquisition of AFSC~~

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 (the “AFSC Acquisition”). 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.

The base purchase price for the AFSC Acquisition per the AFSC Agreement was $117.5 million, subject to working capital adjustments. The Company reports the results of operations of AFSC within its Healthcare segment. Pursuant to the AFSC Agreement, certain members of AFSC’s management, who were also shareholders of AFSC, purchased a total of $4.0 million in Magellan restricted common stock, which will vest over a two-year period, conditioned upon continued employment with the Company. Consideration for the AFSC Acquisition includes a net payment for the net base purchase price of $113.5 million in cash, subject to working capital adjustments, including adjustments for cash acquired. Proceeds from the sale of restricted common stock are recorded as stock compensation expense over the requisite service period.

In addition to the base purchase price, the AFSC Agreement provides for potential contingent payments up to a maximum aggregate amount of $10.0 million. The potential contingent payments are based on the retention of certain core business by AFSC.

~~As of September 30, 2017, the Company had a working capital receivable of $2.7 million.~~

~~Acquisition of Veridicus Holdings, LLC and Granite Alliance Insurance Company~~

Pursuant to the November 19, 2016 purchase agreements (the “Veridicus Agreements”) with Veridicus Holdings, LLC and Granite Alliance Insurance Company (collectively “Veridicus”) and Veridicus Health, LLC, on December 13, 2016 and February 7, 2017 the Company acquired all of the outstanding equity interests of Veridicus (the “Veridicus Acquisition”). Veridicus is a PBM with a unique set of clinical services and capabilities.

The base purchase price for the Veridicus Acquisition per the Veridicus Agreements was $74.5 million, subject to working capital adjustments. The Company reports the results of operations of Veridicus within its Pharmacy Management segment.

The Company’s estimated fair values of Veridicus assets acquired and liabilities assumed at the date of acquisition are determined based on certain valuations and analyses that have yet to be 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 allocation prior to the completion of the measurement period as required. During the nine months ended September 30, 2017, the Company made net measurement period adjustments of $2.1 million to increase the goodwill related to the Veridicus acquisition. The measurement period adjustments included a decrease to the customer contracts identified intangible assets of $2.9 million, partially offset by other measurement period adjustments of $0.8 million.

~~NOTE F—Subsequent Events~~

Pursuant to the July 13, 2017 Agreement and Plan of Merger (“the SWH Agreement”), on October 31, 2017 the Company acquired (the “SWH Acquisition”) all of the outstanding equity interests of SWH Holdings, Inc. (“SWH”). SWH is a healthcare company focused on serving complex, high-risk populations, providing Medicare and Medicaid dual-eligible benefits to members in Massachusetts and New York.

As consideration for the Acquisition, Magellan Healthcare paid $400.0 million in cash, inclusive of a $10.0 million payment based on SWH’s Medicare plan in Massachusetts receiving a Centers for Medicare & Medicaid

~~Table of Contents~~

~~MAGELLAN HEALTH, INC. AND SUBSIDIARIES~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~September 30, 2017~~

~~(Unaudited)~~

~~Services 2018 Star Rating of at least 4, subject to adjustments as provided in the SWH Agreement. The Company will report the results operations of SWH in it Healthcare segment.~~

On October 30, 2017, in order to fund the SWH Acquisition, the Company borrowed $135.0 million of the available revolving loans under the 2017 Credit Agreement. The Company did not need to draw on the SWH Bridge Facility to close the SWH Acquisition. The SWH Bridge Facility was terminated on October, 23, 2017.

The Company has received all regulatory approvals necessary for the merger (the “NY MLTC Merger”) of its existing New York managed long-term care (“NY MLTC”) plan, AlphaCare of New York, Inc. (“AlphaCare of NY”), and Senior Whole Health of New York, Inc., SWH’s NY MLTC plan. The Company plans to close on the NY MLTC Merger by year-end 2017 so as to more fully integrate its NY MLTC operations.

On October 25, 2017, minority shareholder of AlphaCare Holdings, Inc., the holding company for Alpha Care of NY, filed a lawsuit against the Company in U.S. District Court for the Eastern District of New York, alleging that the planned NY MLTC Merger is unfair to them. The complaint seeks an injunction, money damages and any other relief that the court deems appropriate. On OctoberApril 26, 2017, the court denied the plaintiffs’ request for a temporary restraining order prohibiting the completion of the NY MLTC Merger. A further hearing for a preliminary injunction sought by the plaintiffs to prohibit the completion of the NY MLTC Merger is scheduled for December 4, 2017. The Company believes the lawsuit is without merit and intends to vigorously defend against it.

2019.

2627

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

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, TPAs, consultants and brokers. The Company’s business is divided into three segments, based on the services it provides and/or the customers that it serves. See Item 1—“Business” for more information on the Company’s business segments.

Results of Operations

The following ~~discussion~~table summarizes, for the periods indicated, consolidated operating results (in thousands):


	Three Months Ended
	March 31,				Change
Consolidated Results	2018		2019		'18 vs '19
Statement of Operations Data:
Net revenue	$	1,805,077	$	1,739,489	(3.6%)
Cost of Care		928,661		941,961	1.4%
Cost of goods sold		559,665		489,793	(12.5%)
Direct service costs and other operating expenses (1)(2)		269,077		271,924	1.1%
Depreciation and amortization		30,407		30,708	1.0%
Interest expense		8,366		9,107	8.9%
Interest and other income		(2,476)		(4,974)	100.9%
Income before income taxes		11,377		970	(91.5%)
(Benefit) provision for income taxes		(75)		539	(818.7%)
Net income	$	11,452	$	431	(96.2%)

(1)

Includes stock compensation expense of $7,646 and $9,607 for the three months ended March 31, 2018 and 2019, respectively.

(1)

Includes changes in fair value of contingent consideration of $233 and $144 for the three months ended March 31, 2018 and 2019, respectively.

Quarter ended March 31, 2019 (“Current Year Quarter”) compared to Quarter ended March 31, 2018 (“Prior Year Quarter”)

Net revenue, Cost of care, Cost of goods sold and ~~analysis~~Direct service costs and other operating expenses

Net revenue, cost of care, cost of goods sold and direct service costs and other operating expense variances are addressed within the segment results that follow.

Depreciation and amortization

Depreciation and amortization expense increased by 1.0 percent or $0.3 million from the Prior Year Quarter to the Current Year Quarter, primarily due to asset additions after the Prior Year Quarter.

Interest expense

Interest expense increased by $0.7 million from the Prior Year Quarter to the Current Year Quarter primarily due to higher interest rates.

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Interest and other income

Interest income increased by $2.5 million from the Prior Year Quarter to the Current Year Quarter primarily due to higher yields.

Income taxes

The Company’s effective income tax rates were (0.7) percent and 55.6 percent for the Prior Year Quarter and Current Year Quarter, respectively. The effective income tax rate for the Prior Year Quarter is negative (a tax benefit) primarily due to more significant tax deductions in 2018 in excess of recognized stock compensation expense. Theeffective income tax rate for the Current Year Quarter is higher than the federal and state statutory rates primary due to recognized stock compensation expense in excess of tax deductions.

Segment Results

The Company manages and measures operational performance through three segments: Healthcare, Pharmacy Management and Corporate. 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. Stock compensation expense and changes in fair value of contingent consideration recorded in relation to acquisitions are included in direct service costs and other operating expenses; however, these amounts are excluded from the computation of Segment Profit.

Healthcare

The Healthcare segment includes the Company’s: (i) management of behavioral healthcare services and 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. The Healthcare segment’s Behavioral & Specialty Health division provides management services to health plans, accountable care organizations, employers, state Medicaid agencies, the United States military and various federal government agencies for whom Magellan provides carve-out management services for behavioral health, employee assistance plans, and other areas of specialty healthcare including diagnostic imaging, musculoskeletal management, cardiac, and physical medicine. The MCC division contracts with state Medicaid agencies and CMS to manage care for beneficiaries under various Medicaid and Medicare programs.

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The following table summarizes, for the periods indicated, operating results for the Healthcare segment (in thousands):


	Three Months Ended
	March 31,				Change
Healthcare Segment Results	2018		2019		'18 vs '19
Behavioral & Specialty Health revenue
Risk-based, non-EAP	$	373,052	$	361,808	(3.0%)
EAP risk-based		94,658		89,617	(5.3%)
ASO		62,639		55,203	(11.9%)
Magellan Complete Care revenue
Risk-based, non-EAP		613,829		642,571	4.7%
ASO		13,423		15,054	12.2%
Managed care and other revenue		1,157,601		1,164,253	0.6%
Cost of care		928,661		941,961	1.4%
		228,940		222,292	(2.9%)
Direct service costs and other		186,246		179,190	(3.8%)
		42,694		43,102	1.0%
Stock compensation expense		2,950		1,750	(40.7%)
Changes in fair value of contingent consideration		233		144
Segment Profit	$	45,877	$	44,996	(1.9%)

Direct service cost as % of revenue		16.1%		15.4%
MLR Behavioral & Specialty Health risk		86.8%		86.0%
MLR Behavioral & Specialty Health EAP risk		68.9%		64.8%
MLR Magellan Complete Care risk		87.9%		89.2%

Membership
Behavioral & Specialty Health
Risk (1)		12,334		11,754	(4.7%)
EAP risk		15,343		15,227	(0.8%)
ASO		29,533		26,719	(9.5%)
Magellan Complete Care
Risk		131		139	6.1%
ASO		21		23	9.5%
		57,362		53,862	(6.1%)

(1)

May include some duplicate count of membership for customers that contract with Magellan for both behavioral and other specialty management services.

Current Year Quarter compared to the Prior Year Quarter

Managed care and other revenue

Net revenue increased by 0.6 percent or $6.7 million from the Prior Year Quarter to the Current Year Quarter. The increase in revenue is primarily due to new contracts implemented after (or during) the Prior Year Quarter of $89.7 million, program changes of $15.7 million, favorable rate changes partially offset by decreased membership of $9.8 million and the revenue impact of favorable prior period medical claims development recorded in the Prior Year Quarter of $1.3 million. These increases were partially offset by terminated contracts of $93.1 million, net revenue recorded for HIF fees in the Prior Year Quarter of $7.8 million, the revenue impact of net favorable prior period medical claims development recorded in the Current Year Quarter of $3.1 million, unfavorable retroactive rate adjustments in the Current Year Quarter of $3.1 million and other net unfavorable variances of $2.7 million.

Cost of care

Cost of care increased by 1.4 percent or $13.3 million from the Prior Year Quarter to the Current Year Quarter. The increase is primarily due to the care cost for new contracts implemented after (or during) the Prior Year Quarter of

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$78.6 million, program changes of $12.6 million, net favorable prior period medical claims recorded in the Prior Year Quarter of $6.5 million and care trends and other net unfavorable variances of $38.5 million. These increases were partially offset by terminated contracts of $75.0 million, favorable medical claims development for the Prior Year Quarter which was recorded after the Prior Year Quarter of $19.9 million, decreased membership of $17.5 million and favorable prior period care development recorded in the Current Year Quarter of $10.5 million. For our behavioral specialty health contracts, cost of care as a percentage of risk revenue (excluding EAP business) decreased from 86.8 percent in Prior Year Quarter to 86.0 percent in the Current Year Quarter primarily due to the net impact of prior period medical claims development and business mix. For our MCC contracts, cost of care increased as a percentage of risk revenue from 87.9 percent in the Prior Year Quarter to 89.2 percent in the Current Year Quarter mainly due to HIF fees in the Prior Year Quarter and care trends in excess of rate increases.

Direct service costs and other

Direct service costs decreased by 3.8 percent or $7.1 million from the Prior Year Quarter to the Current Year Quarter primarily due to HIF fees incurred in the Prior Year Quarter and lower corporate allocations. Direct service costs decreased as a percentage of revenue from 16.1 percent in the Prior Year Quarter to 15.4 percent in the Current Year Quarter, primarily due to HIF fees in the Prior Year Quarter.

Pharmacy Management

The Pharmacy Management segment 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) PBM services; (ii) 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. Pharmacy Management’s services are provided under contracts with health plans, employers, state Medicaid programs, Medicare Part D and other government agencies.

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The following table summarizes, for the periods indicated, operating results for the Pharmacy Management segment (in thousands, except state count):


	Three Months Ended
	March 31,				Change
Pharmacy Segment Results	2018		2019		'18 vs '19
Formulary management	$	20,377	$	17,183	(15.7%)
PBA and other		41,930		42,712	1.9%
Managed care and other revenue		62,307		59,895	(3.9%)
PBM, including dispensing		533,792		493,224	(7.6%)
Medicare Part D		98,406		63,341	(35.6%)
PBM revenue		632,198		556,565	(12.0%)
Total net revenue		694,505		616,460	(11.2%)
Cost of goods sold		604,913		530,207	(12.3%)
		89,592		86,253	(3.7%)
Direct service costs and other		75,586		79,635	5.4%
		14,006		6,618	(52.7%)
Stock compensation expense		1,485		1,672	12.6%
Segment Profit	$	15,491	$	8,290	(46.5%)

Direct service cost as % of revenue		10.9%		12.9%
COGS as % of PBM revenue		95.7%		95.3%

Pharmacy Operational Statistics
Adjusted commercial network claims		7,552		6,845
Adjusted PBA claims		18,089		19,867
Total adjusted claims		25,641		26,712

Generic dispensing rate		86.8%		87.6%
Commercial PBM covered lives		2,023		1,910
Medical pharmacy covered lives		13,870		13,936
Total states and DC that participate in PBA		27		27

Current Year Quarter compared to the Prior Year Quarter

Managed care and other revenue

Managed care and other revenue decreased by 3.9 percent or $2.4 million from the Prior Year Quarter to the Current Year Quarter primarily due to decreased formulary management revenue for terminated contracts.

PBM revenue

PBM revenue decreased by 12.0 percent or $75.6 million from the Prior Year Quarter to the Current Year Quarter. The decrease is primarily due to lower revenue from terminated contracts of $82.3 million, net decreased membership and utilization of $15.1 million and other net unfavorable variances of $0.4 million. These decreases were partially offset by new business of $22.2 million.

Cost of goods sold

Cost of goods sold decreased by 12.3 percent or $74.7 million from the Prior Year Quarter to the Current Year Quarter. This decrease is primarily due to terminated contracts of $81.6 million, net decreased membership and utilization of $12.3 million, network guarantees in the Prior Year Quarter of $4.3 million and other net favorable variances of $0.3 million. These decreases were partially offset by new contracts of $21.1 million and network guarantee penalties in the Current Year Quarter of $2.7 million. As a percentage of the portion of net revenue that relates to PBM, cost of goods sold decreased slightly from 95.7 percent in the Prior Year Quarter to 95.3 percent in the Current Year Quarter.

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Direct service costs and other

Direct service costs increased by 5.4 percent or $4.0 million from the Prior Year Quarter to the Current Year Quarter primarily due higher discretionary benefits and corporate allocations. Direct service costs increased as a percentage of revenue from 10.9 percent in the Prior Year Quarter to 12.9 percent in the Current Year Quarter primarily due to a decrease in revenue from net decreased membership and terminated contracts.

Corporate Segment

The Corporate segment of the Company is comprised primarily of amounts not allocated to the Healthcare and Pharmacy Management segments that are largely associated with costs related to being a publicly traded company.

The following table summarizes, for the periods indicated, operating results for the Corporate segment (in thousands):


	Three Months Ended
	March 31,				Change
Corporate Segment & Eliminations	2018		2019		'18 vs '19
Managed care and other revenue	$	(145)	$	(169)	16.6%
PBM revenue		(46,884)		(41,055)	(12.4%)
Cost of goods sold		45,248		40,414	(10.7%)
		(1,781)		(810)	(54.5%)
Direct service costs and other		7,245		13,099	80.8%
		(9,026)		(13,909)	54.1%
Stock compensation expense		3,211		6,185	92.6%
Segment Loss	$	(5,815)	$	(7,724)	32.8%

Current Year Quarter compared to the Prior Year Quarter

The Corporate segment loss increased by 32.8 percent or $1.9 million from the Prior Year Quarter to the Current Year Quarter primarily due to higher discretionary benefits. As a percentage of revenue, the Corporate segment loss increased from 0.3 percent in the Prior Year Quarter to 0.4 percent in the Current Year Quarter primarily due to net decreased revenue, mainly from terminated contracts, and higher discretionary benefits.

Inter segment revenues and expenses

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 within the Corporate segment.

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 (“Adjusted Net Income”) and adjusted net income per common share attributable to Magellan 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, amortization of identified acquisition intangibles, as well as impairment 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 disclosed, 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 income before income taxes to Segment Profit (in thousands):


	Three Months Ended
	March 31,
	2018		2019
Income before income taxes	$	11,377	$	970
Stock compensation expense		7,646		9,607
Changes in fair value of contingent consideration		233		144
Depreciation and amortization		30,407		30,708
Interest expense		8,366		9,107
Interest and other income		(2,476)		(4,974)
Segment Profit	$	55,553	$	45,562

The following table reconciles Adjusted Net Income to net income (in thousands):


	Three Months Ended
	March 31,
	2018		2019
Net income	$	11,452	$	431
Adjusted for acquisitions starting in 2013
Stock compensation expense		262		—
Changes in fair value of contingent consideration		233		144
Amortization of acquired intangibles		11,871		12,272
Tax impact		(3,013)		(3,282)
Adjusted Net Income	$	20,805	$	9,565

The following table reconciles Adjusted EPS to net income per common share—diluted:


	Three Months Ended
	March 31,
	2018		2019
Net income per common share—diluted	$	0.45	$	0.02
Adjusted for acquisitions starting in 2013
Stock compensation expense		0.01		—
Changes in fair value of contingent consideration		0.01		0.01
Amortization of acquired intangibles		0.46		0.50
Tax impact		(0.12)		(0.13)
Adjusted EPS	$	0.81	$	0.40

The Company believes these non‑GAAP measures provide a 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.

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; (viii) the timing of recognition of pharmacy revenues, including rebates and Medicare Part D; and (ix) changes in the estimates of contingent consideration.

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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 healthcare services and higher costs of such 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.

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 the variable interest rate borrowings under the 2017 Credit Agreement. In addition, interest rates on the Notes is subject to adjustment upon the occurrence of certain credit rating events. Based on the amount of cash equivalents and investments, the borrowing levels under the 2017 Credit Agreement and the principal amount of the Notes as of March 31, 2019, 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 $81.0 million and $35.4 million for the Prior Year Quarter and Current Year Quarter, respectively. The $45.6 million decrease in operating cash flows from the Prior Year Quarter is mainly attributable to unfavorable working capital changes and lower segment profit, partially offset by lower tax payments.

The net unfavorable impact of working capital changes between periods totaled $39.4 million. For the Prior Year Quarter, operating cash flows were impacted by net favorable working capital changes of $42.6 million, largely attributable to timing related to receivables and payables partially offset by discretionary benefits. For the Current Year Quarter, operating cash flows were impacted by net favorable working capital changes of $3.1 million, mainly attributable to timing.

Segment Profit for the Current Year Quarter decreased $10.0 million from the Prior Year Quarter.

Investing Activities. The Company utilized $19.5 million and $12.6 million during the Prior Year Quarter and the Current Year Quarter, respectively, for capital expenditures. The additions related to hard assets (equipment, furniture, and leaseholds) and capitalized software for the Prior Year Quarter were $6.3 million and $13.2 million, respectively, as compared to additions for the Current Year Quarter related to hard assets and capitalized software of $3.6 million and $9.0 million, respectively.

During the Prior Year Quarter and the Current Year Quarter, the Company used $23.9 million and $44.0 million, respectively, for the net purchase of "available-for-sale" securities.

Financing Activities. During the Prior Year Quarter, the Company paid $54.4 million on debt obligations, $1.5 million on capital lease obligations and had other net unfavorable items of $3.1 million. In addition, the Company received $16.9 million from the exercise of stock options.

During the Current Year Quarter, the Company paid $4.4 million on debt obligations, $6.2 million for payments on contingent consideration, $4.1 million for the repurchase of treasury stock under the Company's share repurchase program, $2.9 million on capital lease obligations and had other net unfavorable items of $1.7 million. In addition, the Company received $2.0 million from the exercise of stock options.

Outlook—Liquidity and Capital Resources

Liquidity. The Company may draw on the 2017 Credit Agreement as required to meet working capital needs associated with the timing of receivables and payables, fund share repurchases or support acquisition activities. The Company currently expects to have adequate liquidity to satisfy its existing financial commitments over the periods in which they will become due. 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 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 the Company will not experience any such losses in the future.

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Stock Repurchases. 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. On July 26, 2017, the Company’s board of directors approved an extension of the 2015 Repurchase Program through October 26, 2018. On May 24, 2018, the Company’s board of directors approved an increase of $200 million to the current $200 million stock repurchase plan which will now authorize the Company to purchase up to $400 million of its outstanding common stock. The board also extended the program from October 22, 2018 to October 22, 2020. As of March 31, 2019, the remaining capacity under the 2015 Repurchase Program was $186.3 million. See Note D—“Commitments and Contingencies” for more information on the Company’s share repurchase program.

Off‑Balance Sheet Arrangements. As of March 31, 2019, the Company has no material off‑balance sheet arrangements.

Credit Agreement. On September 22, 2017, the Company entered into the 2017 Credit Agreement with various lenders that provides for a $400.0 million senior unsecured revolving credit facility and a $350.0 million senior unsecured term loan facility to the Company, as the borrower. On August 13, 2018, the Company entered into an amendment to the 2017 Credit Agreement, which extended the maturity date by one year. On February 27, 2019, the Company entered into a second amendment to the 2017 Credit Agreement, which amended the total leverage ratio covenant, and which was necessary in order for the Company to remain in compliance with the terms of the 2017 Credit Agreement. The 2017 Credit Agreement is scheduled to mature on September 22, 2023. See Note A—“General” for more information on the 2017 Credit Agreement.

Restrictive Covenants in Debt Agreements. The 2017 Credit Agreement 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:

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

pay dividends and make other distributions;

repurchase equity interests;

make certain advances, investments and loans;

enter into sale and leaseback transactions;

create liens;

sell and otherwise dispose of assets;

acquire or merge or consolidate with another company; and

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 2017 Credit Agreement also requires the Company to comply with specified financial ratios and tests. Failure to do so, unless waived by the lenders under the 2017 Credit Agreement pursuant to its terms, or amended, would result in an event of default under the 2017 Credit Agreement. As of March 31, 2019, the Company was in compliance with all covenants, including financial covenants, under the 2017 Credit Agreement.

Critical Accounting Policies and Estimates

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amounts of revenue and expenses during the reporting period. Significant estimates of the Company can include, among other things, valuation of goodwill and intangible assets, medical claims payable, other medical liabilities, stock compensation assumptions, tax contingencies and legal liabilities. In addition, the Company also makes estimates in relation to revenue recognition under ASC 606 which are explained in more detail in Note A—“General – Revenue Recognition.” Actual results could differ from those estimates. Except as noted above, the ~~Consolidated Financial Statements included elsewhere~~Company’s critical accounting policies are summarized in ~~this Quarterly Report on Form 10‑Q and~~ the Company’s Annual Report on Form 10‑K, ~~for the year ended December 31, 2016, which was~~ filed with the SEC on February ~~24, 2017.~~28, 2019.

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;

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;

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the impact of healthcare reform legislation;

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

government regulation;

proposed changes to current Federal law and regulations;

noncompliance with regulations;

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

failure to maintain satisfactory Medicare and Medicaid quality performance measures;

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 it does business;

risk associated with outsourcing services and functions to third parties;

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;

the Company’s ability to successfully implement its margin improvement initiatives and plans;

tax matters, including changes in corporate tax rates, disagreements with taxing authorities and imposition of new taxes; 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, ~~2016.~~2018. 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 it serves. 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

September 30, 2017

Risk-based

ASO

Commercial

Behavioral(1)

14,394

11,266

Specialty

9,101

16,075

Government(2)

4,042

1,017

Revenue for the nine months ended

September 30, 2017


Risk-based

ASO

Total

Commercial

Behavioral(1)

$
302,650

$
97,883

$
400,533

Specialty

446,169

53,323

499,492

Government(2)

1,218,513

71,559

1,290,072

Total

$
1,967,332

$
222,765

$
2,190,097

~~(1)~~

~~Includes revenues of $36.8 million from EAP services provided on a risk basis to health plans and employers with 10.7 million covered lives.~~

~~(2)~~

~~Includes revenues of $251.1 million from EAP services provided on a risk basis to federal governmental entities with 3.5 million covered lives.~~

During the nine months ended September 30, 2017, Pharmacy Management paid 21.6 million adjusted commercial network claims in its PBM business, 55.4 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 September 30, 2017, Pharmacy Management had a generic dispensing rate of 86.9 percent within its commercial PBM business and served 1.9 million commercial PBM members, 13.1 million members in its medical pharmacy management programs, and 27 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 24, 2017.

~~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. 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”.

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

Corporate


Pharmacy

and


Healthcare

Management

Elimination

Consolidated

Three Months Ended September 30, 2016

Managed care and other revenue

$
690,572

$
61,106

$
(89)

$
751,589

PBM and dispensing revenue

—

570,231

(29,688)

540,543

Cost of care

(480,243)

—

—

(480,243)

Cost of goods sold

—

(538,113)

28,440

(509,673)

Direct service costs and other

(152,992)

(66,475)

(9,627)

(229,094)

Stock compensation expense (1)

2,267

5,368

1,541

9,176

Changes in fair value of contingent consideration (1)

313

—

—

313

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

(189)

—

(5)

(194)

Segment profit (loss)

$
60,106

$
32,117

$
(9,418)

$
82,805

Corporate


Pharmacy

and


Healthcare

Management

Elimination

Consolidated

Three Months Ended September 30, 2017

Managed care and other revenue

$
769,451

$
65,131

$
(224)

$
834,358

PBM and dispensing revenue

—

618,178

(33,130)

585,048

Cost of care

(569,306)

—

—

(569,306)

Cost of goods sold

—

(575,327)

31,645

(543,682)

Direct service costs and other

(143,550)

(74,976)

(8,846)

(227,372)

Stock compensation expense (1)

2,623

5,680

2,020

10,323

Changes in fair value of contingent consideration (1)

(834)

—

—

(834)

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

789

—

(1)

788

Segment profit (loss)

$
57,595

$
38,686

$
(8,534)

$
87,747

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Corporate


Pharmacy

and


Healthcare

Management

Elimination

Consolidated

Nine Months Ended September 30, 2017

Managed care and other revenue

$
2,190,097

$
195,970

$
(670)

$
2,385,397

PBM and dispensing revenue

—

1,856,856

(98,085)

1,758,771

Cost of care

(1,634,624)

—

—

(1,634,624)

Cost of goods sold

—

(1,742,610)

93,940

(1,648,670)

Direct service costs and other

(428,432)

(225,782)

(26,016)

(680,230)

Stock compensation expense (1)

8,388

17,094

6,352

31,834

Changes in fair value of contingent consideration (1)

(631)

—

—

(631)

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

(56)

—

(3)

(59)

Segment profit (loss)

$
134,854

$
101,528

$
(24,476)

$
211,906

~~(1)~~

~~(2)~~

~~The non‑controlling portion of AlphaCare’s segment profit (loss) is excluded from the computation of Segment Profit.~~

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

Three Months Ended

Nine Months Ended

September 30,

September 30,

2016

2017

2016

2017


Income before income taxes

$
43,940

$
44,975

$
83,271

$
84,838

Stock compensation expense

9,176

10,323

27,573

31,834

Changes in fair value of contingent consideration

313

(834)

510

(631)

Impairment of intangible assets

—

—

4,800

—

Non-controlling interest segment (profit) loss

194

(788)

1,341

59

Depreciation and amortization

26,885

28,189

77,472

82,896

Interest expense

3,038

7,663

6,780

16,711

Interest and other income

(741)

(1,781)

(2,116)

(3,801)

Segment Profit

$
82,805

$
87,747

$
199,631

$
211,906

~~Quarter ended September 30, 2017 (“Current Year Quarter”), compared to the quarter ended September 30, 2016 (“Prior Year Quarter”)~~

~~Healthcare~~

~~Net Revenue~~

Net revenue related to Healthcare increased by 11.4 percent or $78.9 million. The increase in revenue is mainly due to higher membership and net favorable rate changes of $75.1 million, contracts implemented after (or during) the Prior Year Quarter of $55.2 million, net retroactive program changes in the Current Year Quarter of $6.2 million, the revenue impact of unfavorable prior period medical claims development recorded in the Current Year Quarter of $5.7 million, net program changes of $4.5 million and favorable retroactive rate adjustments in the Current Year Quarter of $2.8 million. These increases were partially offset by terminated contracts of $36.7 million, net revenue recorded for HIF fees in the Prior Year Quarter of $11.0 million, the revenue impact of unfavorable prior period medical claims development recorded in the Prior Year Quarter of $3.4 million, performance penalty in the Current Year Quarter of $1.8 million and other net unfavorable variances of $17.7 million (mainly profit share impact of favorable care trends).

~~Table of Contents~~

~~Cost of Care~~

Cost of care increased by 18.5 percent or $89.1 million. The increase is mainly due to increased membership and higher care associated with net favorable rate changes of $62.0 million, new contracts implemented after (or during) the Prior Year Quarter of $48.4 million, net favorable prior period medical claims development recorded in the Prior Year Quarter of $9.6 million, net unfavorable prior period medical claims development recorded in the Current Year Quarter of $7.2 million, net retroactive program changes in the Current Year Quarter of $5.6 million and net program changes of $3.9 million. These increases were partially offset by terminated contracts of $29.5 million and care trends and other net favorable variances of $18.1 million. For our commercial contracts, cost of care increased as a percentage of risk revenue (excluding EAP business) from 80.0 percent in the Prior Year Quarter to 87.6 percent in the Current Year Quarter, mainly due to unfavorable care trends and business mix. For our government contracts, cost of care increased as a percentage of risk revenue (excluding EAP business) from 81.3 percent in the Prior Year Quarter to 83.3 percent in the Current Year Quarter, mainly due to business mix.

~~Direct Service Costs~~

Direct service costs decreased by 6.2 percent or $9.4 million, primarily due to the impact of terminated contracts and HIF fees in the Prior Year Quarter, partially offset by costs related to new business. Direct service costs decreased as a percentage of revenue from 22.2 percent in the Prior Year Quarter to 18.7 percent in the Current Year Quarter, mainly due to an increase in revenue from business growth, partially offset by terminated contracts.

~~Pharmacy Management~~

~~Managed Care and Other Revenue~~

Managed care and other revenue related to Pharmacy Management increased by 6.6 percent or $4.0 million. This increase is primarily due to new contracts implemented after (or during) the Prior Year Quarter of $2.3 million, medical pharmacy revenue of $2.3 million and revenue for Veridicus acquired on December 13, 2016 of $1.3 million. These increases were partially offset by terminated contracts of $0.8 million and other net unfavorable variances of $1.1 million.

~~PBM and Dispensing Revenue~~

PBM and dispensing revenue related to Pharmacy Management increased by 8.4 percent or $47.9 million. This increase is primarily due to Medicare revenue of $56.2 million, revenue for Veridicus of $48.0 million, pharmacy MCO revenue of $8.3 million, new contracts implemented after (or during) the Prior Year Quarter of $8.0 million and an increase in government pharmacy revenue of $4.3 million. These favorable variances were partially offset by terminated contracts of $64.2 million, net decreased dispensing activity from existing customers of $8.3 million, decrease in pharmacy employer revenue of $3.4 million and other net unfavorable variances of $1.0 million.

~~Cost of Goods Sold~~

Cost of goods sold increased by 6.9 percent or $37.2 million. This increase is primarily due to an increase in Medicare of $55.8 million, cost for Veridicus of $44.4 million, an increase in pharmacy MCO of $7.7 million, new contracts implemented after (or during) the Prior Year Quarter of $7.2 million and an increase in government pharmacy of $4.2 million. These increases were partially offset by terminated contracts of $63.0 million, decrease in pharmacy employer of $10.5 million, net decreased dispensing activity from existing customers of $8.1 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 decreased from 94.4 percent in the Prior Year Quarter to 93.1 percent in the Current Year Quarter, mainly due to business mix.

~~Direct Service Costs~~

Direct service costs increased by 12.8 percent or $8.5 million, mainly due to the acquisition of Veridicus, contract implementation costs and ongoing costs to support new business. Direct service costs increased as a percentage of revenue from 10.5 percent in the Prior Year Quarter to 11.0 percent in the Current Year Quarter, mainly due to business mix and implementation costs to support business growth.

~~Table of Contents~~

~~Corporate and Elimination~~

Net expenses related to Corporate, which includes eliminations, decreased by 3.7 percent or $0.4 million, primarily due to a decrease in discretionary benefits partially offset by an increase in stock and other compensation expense in the Current Year Quarter. As a percentage of revenue, corporate and elimination was 0.7 percent in the Current Year Quarter, which decreased slightly from the Prior Year Quarter.

~~Depreciation and Amortization~~

~~Depreciation and amortization expense increased by 4.9 percent or $1.3 million, primarily due to asset additions after the Prior Year Quarter and acquisition activity.~~

~~Interest Expense~~

~~Interest expense increased by $4.6 million, primarily due to an increase in interest rates, the amount of outstanding debt and the acceleration of loan costs due to the extinguishment of debt.~~

~~Interest Income~~

~~Interest income increased by $1.0 million, primarily due to higher yields and invested balances.~~

~~Income Taxes~~

The Company’s effective income tax rates were 42.4 percent and 26.1 percent for the Prior Year Quarter and Current Year Quarter, respectively. The effective income tax rate for the Current Year Quarter is lower than the Prior Year Quarter mainly due to the suspension for 2017 of the non-deductible HIF fees, valuation allowance increases in 2016 with respect to losses at AlphaCare, and more significant tax deductions in 2017 in excess of recognized stock compensation expense.

The statutes of limitation regarding the assessment of 2013 federal and certain state and local income taxes expired during the Current Year Quarter. As a result, $1.7 million of tax contingency reserves recorded as of December 31, 2016 were reversed in the Current Year Quarter, of which $1.2 million is reflected as a discrete reduction to income tax expense and $0.5 million as a decrease to deferred tax assets. Additionally, $0.1 million of accrued interest was reversed in the Current Year Quarter and reflected as a reduction to income tax expense due to the closing of statutes of limitation on tax assessments.

The statutes of limitation regarding the assessment of 2012 federal and certain state and local income taxes expired during the Prior Year Quarter. As a result, $1.6 million of tax contingency reserves recorded as of December 31, 2015 were reversed in the Prior Year Quarter, of which $1.1 million was reflected as a discrete reduction to income tax expense and $0.5 million as a decrease to deferred tax assets. Additionally, $0.1 million of accrued interest was reversed in the Prior Year Quarter and reflected as a reduction to income tax expense due to the closing of statutes of limitation on tax assessments.

~~Nine months ended September 30, 2017 (“Current Year Period”), compared to the nine months ended September 30, 2016 (“Prior Year Period”)~~

~~Healthcare~~

~~Net Revenue~~

Net revenue related to Healthcare increased by 12.5 percent or $242.6 million. The increase in revenue is mainly due to higher membership and net favorable rate changes of $194.8 million, contracts implemented after (or during) the Prior Year Period of $108.9 million, revenue for AFSC acquired July 1, 2016 of $92.3 million, net retroactive program changes recorded in the Current Year Period of $23.3 million, revenue for TMG acquired February 29, 2016 of $8.5 million, retroactive profit share in the Current Year Period of $3.3 million, favorable retroactive rate adjustments in the Current Year Period of $2.2 million and customer settlements in the Current Year

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Period of $2.0 million. These increases were partially offset by terminated contracts of $106.9 million, net revenue recorded for HIF fees in the Prior Year Period of $32.4 million, net program changes of $16.6 million, the revenue impact of favorable prior period medical claims development recorded in the Current Year Period of $4.9 million, performance penalty in the Current Year Period of $4.1 million, favorable retroactive rate adjustments in the Prior Year Period of $3.3 million, the revenue impact of unfavorable prior period medical claims development recorded in the Prior Year Period of $3.4 million and other net unfavorable variances of $21.1 million (mainly profit share impact of favorable care trends).

~~Cost of Care~~

Cost of care increased by 15.9 percent or $224.2 million. The increase is mainly due to increased membership and higher care associated with net favorable rate changes of $153.8 million, new contracts implemented after (or during) the Prior Year Period of $104.2 million, care costs for AFSC of $77.5 million, net retroactive program changes recorded in the Current Year Period of $21.2 million and net favorable prior period medical claims development recorded in the Prior Year Period of $3.6 million. These increases were partially offset by terminated contracts of $84.5 million, net program changes of $14.2 million, favorable medical claims development for the Prior Year Period which was recorded after the Prior Year Period of $11.9 million, net favorable prior period medical claims development recorded in the Current Year Period of $8.4 million, customer settlements of $2.7 million and care trends and other net favorable variances of $14.4 million. For our commercial contracts, cost of care increased as a percentage of risk revenue (excluding EAP business) from 82.7 percent in the Prior Year Period to 87.6 percent in the Current Year Period, mainly due to unfavorable care trends. For our government contracts, cost of care decreased as a percentage of risk revenue (excluding EAP business) from 84.4 percent in the Prior Year Period to 84.0 percent in the Current Year Period, mainly due to favorable care trends and business mix.

~~Direct Service Costs~~

Direct service costs increased by 2.4 percent or $9.9 million, primarily due to costs related to TMG and AFSC and contract implementation cost, partially offset by the impact of terminated contracts and HIF fees in the Prior Year Period. Direct service costs decreased as a percentage of revenue from 21.5 percent in the Prior Year Period to 19.6 percent in the Current Year Period, mainly due to an increase in revenue from business growth and acquisition activity, partially offset by terminated contracts and the acquisition of TMG and AFSC.

~~Pharmacy Management~~

~~Managed Care and Other Revenue~~

Managed care and other revenue related to Pharmacy Management increased by 8.5 percent or $15.3 million. This increase is primarily due to new contracts implemented after (or during) the Prior Year Period of $6.3 million, medical pharmacy revenue of $4.2 million, revenue for Veridicus acquired on December 13, 2016 of $3.9 million, increased rebate revenue of $1.4 million and other net favorable variances of $1.9 million. These increases were partially offset by terminated contracts of $2.4 million.

~~PBM and Dispensing Revenue~~

PBM and dispensing revenue related to Pharmacy Management increased by 20.9 percent or $321.0 million. This increase is primarily due to new contracts implemented after (or during) the Prior Year Period of $210.6 million, Medicare revenue of $176.6 million, revenue for Veridicus of $133.5 million, pharmacy employer revenue of $34.4 million, pharmacy MCO revenue of $20.6 million, government pharmacy revenue of $4.9 million and other net favorable variances of $2.3 million. These favorable variances were partially offset by terminated contracts of $251.0 million and net decreased dispensing activity from existing customers of $10.9 million.

~~Cost of Goods Sold~~

Cost of goods sold increased by 20.3 percent or $293.9 million. This increase is primarily due to new contracts implemented after (or during) the Prior Year Period of $206.0 million, an increase in Medicare of $175.9 million, cost for Veridicus of $122.2 million, pharmacy employer of $22.7 million, an increase in pharmacy MCO of $19.0 million, government pharmacy of $4.9 million and other net unfavorable variances of $2.1 million. These increases were partially

~~Table of Contents~~

offset by terminated contracts of $246.7 million and net decreased dispensing activity from existing customers of $12.2 million. As a percentage of the portion of net revenue that relates to PBM and dispensing activity, cost of goods sold decreased from 94.3 percent in the Prior Year Period to 93.8 percent in the Current Year Period, mainly due to business mix.

~~Direct Service Costs~~

Direct service costs increased by 18.0 percent or $34.4 million, mainly due to the acquisition of Veridicus, contract implementation costs and ongoing costs to support new business. Direct service costs decreased as a percentage of revenue from 11.2 percent in the Prior Year Period to 11.0 percent in the Current Year Period, mainly due to an increase in revenue from business growth and acquisition activity.

~~Corporate and Elimination~~

Net expenses related to Corporate, which includes eliminations, increased by 4.5 percent or $1.3 million, primarily due to an increase in stock and other compensation expense in the Current Year Period. As a percentage of revenue, corporate and elimination was 0.7 percent, which decreased slightly from the Prior Year Period.

~~Depreciation and Amortization~~

~~Depreciation and amortization expense increased by 7.0 percent or $5.4 million, primarily due to asset additions after the Prior Year Period and acquisition activity.~~

~~Interest Expense~~

~~Interest expense increased by $9.9 million primarily due to an increase in interest rates, the amount of outstanding debt and the acceleration of loan costs due to the extinguishment of debt.~~

~~Interest Income~~

~~Interest income increased by $1.7 million, primarily due to higher yields and invested balances.~~

~~Income Taxes~~

The Company’s effective income tax rates were 51.9 percent and 34.4 percent for the Prior Year Period and Current Year Period, respectively. The effective income tax rate for the Current Year Period is lower than the Prior Year Period mainly due the suspension for 2017 of the non-deductible HIF fees, valuation allowance increases in 2016 with respect to losses at AlphaCare, and more significant tax deductions in 2017 in excess of recognized stock compensation expense.

The statutes of limitation regarding the assessment of 2013 federal and certain state and local income taxes expired during the Current Year Period. As a result, $1.7 million of tax contingency reserves recorded as of December 31, 2016 were reversed in the Current Year Period, of which $1.2 million is reflected as a discrete reduction to income tax expense, and $0.5 million as a decrease to deferred tax assets. Additionally, $0.1 million of accrued interest was reversed in the Current Year Period and reflected as a reduction to income tax expense due to the closing of statutes of limitation on tax assessments.

The statutes of limitation regarding the assessment of 2012 federal and certain state and local income taxes expired during the Prior Year Period. As a result, $1.6 million of tax contingency reserves recorded as of December 31, 2015 were reversed in the Prior Year Period, of which $1.1 million was reflected as a discrete reduction to income tax expense and $0.5 million as a decrease to deferred tax assets. Additionally, $0.1 million of accrued interest was reversed in the Prior Year Period and reflected as a reduction to income tax expense due to the closing of statutes of limitation on tax assessments.

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~~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 (“Adjusted Net Income”) and adjusted net income per common share attributable to Magellan 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, amortization of identified acquisition intangibles, as well as impairment 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 disclosed, 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.

~~The following table reconciles Adjusted Net Income to net income attributable to Magellan (in thousands):~~

Three Months Ended

Nine Months Ended

September 30,

September 30,

2016

2017

2016

2017

Net income attributable to Magellan

$
25,509

$
32,451

$
42,704

$
55,698

Adjusted for acquisitions starting in 2013

Stock compensation expense relating to acquisitions

5,105

4,960

14,217

14,718

Changes in fair value of contingent consideration

313

(834)

510

(631)

Amortization of acquired intangibles

6,649

8,424

17,938

25,189

Impairment of intangible assets, net of non-controlling interest

—

—

3,936

—

Tax impact

(4,254)

(4,605)

(12,203)

(14,372)

Adjusted Net Income

$
33,322

$
40,396

$
67,102

$
80,602

~~The following table reconciles Adjusted EPS to net income per common share attributable to Magellan—diluted:~~

Three Months Ended

Nine Months Ended

September 30,

September 30,

2016

2017

2016

2017

Net income per common share attributable to Magellan—diluted

$
1.06

$
1.32

$
1.75

$
2.30

Adjusted for acquisitions starting in 2013

Stock compensation expense relating to acquisitions

0.22

0.20

0.59

0.61

Changes in fair value of contingent consideration

0.01

(0.03)

0.02

(0.03)

Amortization of acquired intangibles

0.28

0.34

0.74

1.04

Impairment of intangible assets, net of non-controlling interest

—

—

0.16

—

Tax impact

(0.18)

(0.19)

(0.50)

(0.59)

Adjusted EPS

$
1.39

$
1.64

$
2.76

$
3.33

~~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 and other pharmacy 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 claims incurred but not reported (“IBNR”) ; and (viii) changes in the estimates of contingent consideration.

~~Table of Contents~~

~~Care Trends.~~ ~~The Company expects that same‑store normalized cost of care trend for the 12 month forward outlook to be 3 to 7 percent for commercial products and 0 to 2 percent for government business.~~

~~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 the variable interest rate borrowings under the 2017 Credit Agreement. In addition, interest rates on the Notes is subject to adjustment upon the occurrence of certain credit rating events. Based on the amount of cash equivalents and investments, the borrowing levels under the 2017 Credit Agreement and the principal amount of the Notes as of September 30, 2017, 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 used by operating activities of $7.6 million for the Prior Year Period and net cash provided by operating activities of $112.7 million for the Current Year Period. The $120.3 million increase in operating cash flows from the Prior Year Period is attributable to favorable working capital changes and an increase in Segment Profit partially offset by increased tax payments between years.

The net favorable impact of working capital changes between periods totaled $112.6 million. For the Prior Year Period, operating cash flows were impacted by net unfavorable working capital changes of $166.0 million, which were largely attributable to an increase in accounts receivable, specifically related to our Medicare Part D business, payment of the HIF fee and contingent consideration payments of $91.7 million, of which $51.1 million is reflected as operating activities. For the Current Year Period, operating cash flows were impacted by net unfavorable working capital changes of $53.4 million, a large portion of which was attributable to timing of discretionary bonus activity and an increase in accounts receivable related to our Medicare Part D business.

Segment Profit for the Current Year Period increased $12.3 million from the Prior Year Period. Tax payments for the Current Year Period totaled $45.8 million, which represents an increase of $4.6 million compared to the Prior Year Period.

~~Investing Activities.~~ The Company utilized $44.3 million and $42.7 million during the Prior Year Period and Current Year Period, respectively, for capital expenditures. The additions related to hard assets (equipment, furniture, and leaseholds) and capitalized software for the Prior Year Period were $9.8 million and $34.5 million, respectively, as compared to additions for the Current Year Period related to hard assets and capitalized software of $11.7 million and $31.0 million, respectively.

During the Prior Year Period the Company received net cash of $8.1 million from the net maturity of "available-for-sale" securities, with the Company using $21.2 million during the Current Year Period for the net purchase of "available-for-sale" securities. During the Prior Year Period, the Company used net cash of $111.4 million and $16.0 million for the acquisition of AFSC and TMG, respectively, partially offset by a working capital adjustment of $0.5 million related to the acquisition of 4D Pharmacy Management Systems, Inc. During the Current Year Period, the Company used net cash of $3.2 million related to investments in businesses and the acquisition of Veridicus.

~~Financing Activities.~~ During the Prior Year Period, the Company paid $106.8 million for the repurchase of treasury stock under the Company’s share repurchase program, $9.4 million on debt obligations and $4.2 million on capital lease obligations. The Company made a contingent consideration payment totaling $91.7 million, of which $40.6 million was related to financing activities. In addition, the Company received $290.0 million from the issuance of debt, $10.9 million from exercise of stock options, and had other net favorable items of $1.4 million.

During the Current Year Period, the Company paid $793.8 million on debt obligations, $15.5 million for the repurchase of treasury stock under the Company's share repurchase program, $8.5 million in debt issuance fees, $4.6

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million on capital lease obligations and had other net unfavorable items of $0.4 million. In addition, the Company received $949.2 million from the issuance of debt and $28.3 million from the exercise of stock options.

~~Outlook—Liquidity and Capital Resources~~

~~Liquidity.~~ During the remainder of 2017, the Company will have estimated capital expenditures of between $22.3 million and $32.3 million. The Company may draw on the 2017 Credit Agreement as required to meet working capital needs associated with the timing of receivables and payables, fund share repurchases or support acquisition activities. The Company currently expects to have adequate liquidity to satisfy its existing financial commitments over the periods in which they will become due. 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 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 the Company will not experience any such losses in the future.

~~Stock Repurchases.~~ 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. On July 26, 2017, the Company’s board of directors approved an extension of the 2015 Repurchase Program through October 26, 2018. See Note D~~—“Commitments and Contingencies”~~ ~~for more information on the Company’s share repurchase program.~~

~~Off‑Balance Sheet Arrangements.~~ ~~As of September 30, 2017, the Company has no material off‑balance sheet arrangements.~~

~~Credit Agreement.~~ On September 22, 2017, the Company entered into a credit agreement with various lenders that provides for a $400.0 million senior unsecured revolving credit facility and a $350.0 million senior unsecured term loan facility to the Company, as the borrower (the “2017 Credit Agreement”). The 2017 Credit Agreement is scheduled to mature on September 22, 2022. See Note A—“~~General” for more information on the 2017 Credit Agreement.~~

~~Restrictive Covenants in Debt Agreements.~~ The 2017 Credit Agreement contain 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:

~~incur or guarantee additional indebtedness or issue preferred or redeemable stock;~~

~~pay dividends and make other distributions;~~

~~repurchase equity interests;~~

~~make certain advances, investments and loans;~~

~~enter into sale and leaseback transactions;~~

~~create liens;~~

~~sell and otherwise dispose of assets;~~

~~acquire or merge or consolidate with another company; and~~

~~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.~~

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required by law.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

Changes in interest rates affect interest income earned on the Company’s cash equivalents and investments, as well as interest expense on the variable interest rate borrowings under the 2017 Credit Agreement. In addition, interest rates on the Notes is subject to adjustment upon the occurrence of certain credit rating events. Based on the amount of cash equivalents and investments, the borrowing levels under the 2017 Credit Agreement and the principal amount of the Notes as of ~~September 30, 2017,~~March 31, 2019, 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.

Item 4. Controls and ~~Procedures.~~Procedures

a) The Company’s management evaluated, with the participation of the Company’s principal executive and principal financial officers, the effectiveness of the Company’s disclosure controls and procedures (as defined in ~~Rules~~Rule 13a‑15(e) under the Exchange Act), as of ~~September 30, 2017.~~March 31, 2019. Based on their evaluation, the Company’s principal executive and principal financial officers concluded that the Company’s disclosure controls and procedures were effective as of ~~September 30, 2017.~~March 31, 2019.

b) Under the supervision and with the participation of management, including the Company’s principal executive and principal financial officers, the Company has determined that there has been no change in the Company’s internal control over financial reporting (as defined in Rule 13a‑15(f) under the Exchange Act) that occurred during the Company’s quarter ended ~~September 30, 2017~~March 31, 2019 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

~~Table of Contents~~

PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

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.

Item 1A. Risk Factors.

There has been no material change in our risk factors as disclosed in Part I—Item 1A—“Risk Factors” of the Company’s Annual Report on Form 10‑K for the year ended December 31, ~~2016,~~2018, which was filed with the SEC on February ~~24, 2017.~~28, 2019.

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

The Company’s board of directors has previously authorized a series of stock repurchase plans. Stock repurchases for each such plan could be executed through open market repurchases, privately negotiated transactions, accelerated share repurchases or other means. The board of directors authorized management to execute stock repurchase transactions from time to time and in such amounts and via such methods as management deemed appropriate. Each stock repurchase program could be limited or terminated at any time without prior notice.

Total number

Average

Total Number of Shares

Approximate Dollar Value of

of Shares

Price Paid

Purchased as Part of Publicly

Shares that May Yet Be

Period

Purchased

per Share(1)

Announced Plans or Programs

Purchased Under the Plans(1)(2)

July 1 - 31, 2017

18,004

$
73.98

18,004

$
68.1

August 1-31, 2017

67,668

77.05

67,668

62.9

September 1-30, 2017

43,028

82.12

43,028

59.4

128,700

128,700


	Total number	Average		Total Number of Shares	Approximate Dollar Value of
	of Shares	Price Paid		Purchased as Part of Publicly	Shares that May Yet Be
Period	Purchased	per Share(1)		Announced Plans or Programs	Purchased Under the Plans(1)(2)
January 1 - 31, 2019	50,537	$	60.64	50,537	$	186.9
February 1 - 28, 2019	10,364		63.66	10,364		186.3
March 1 - 31, 2019	—		—	—		186.3
	60,901			60,901

(1)

Excludes amounts that could be used to repurchase shares acquired under the Company’s equity incentive plans to satisfy withholding tax obligations of employees and non-employee directors upon the vesting of restricted stock units.

(2)

Excludes broker commissions.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

None.

~~Table of Contents~~

Item 5. Other Information.

None.

Item 6. Exhibits.

See Exhibit Index.

4140

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Exhibit Index


Exhibit Number		Description of Exhibit
~~1.1~~10.1		~~Underwriting~~Form of Stock Option Agreement, ~~dated September 15, 2017, among Magellan Health, Inc., as issuer, and J.P. Morgan Securities LLC, MUFG Securities Americas Inc. and Wells Fargo Securities, LLC, as representatives of~~relating to options granted under the ~~several underwriters named therein,~~2016 Management Incentive Plan, which was filed as Exhibit ~~1.1~~10.1 to the Company’s current report on Form 8-K, which was filed on ~~September 18, 2017.~~March 7, 2019 and is incorporated herein by reference.
~~4.1~~10.2		~~Base Indenture, dated as~~Form of ~~September 22, 2017, between~~Notice of Stock Option Grant, relating to options granted under the ~~Company, as issuer and U.S. Bank National Association, as trustee,~~2016 Management Incentive Plan, which was filed as Exhibit ~~4.1~~10.2 to the Company’s current report on Form 8-K, which was filed on ~~September 25, 2017.~~March 7, 2019 and is incorporated herein by reference.
~~4.2~~10.3		~~First Supplemental Indenture, dated September 22, 2017, between~~Form of Performance-Based Restricted Stock Unit Agreement, relating to performance-based restricted stock units granted under the ~~Company, as issuer and U.S. Bank National Association, as trustee,~~2016 Management Incentive Plan, which was filed as Exhibit ~~4.2~~10.3 to the Company’s current report on Form 8-K, which was filed on ~~September 25, 2017.~~March 7, 2019 and is incorporated herein by reference.
~~4.3~~10.4		Form of ~~Global Note for~~Notice of Performance-Based Restricted Stock Unit Award, relating to performance-based restricted stock units granted under the ~~4.400% Senior Notes due 2024 (included as an exhibit to Exhibit 4.2),~~2016 Management Incentive Plan, which was filed as Exhibit ~~4.3~~10.4 to the Company’s current report on Form 8-K, which was filed on ~~September 25, 2017.~~March 7, 2019 and is incorporated herein by reference.
~~4.4~~10.5		~~Credit~~ Agreement dated as of ~~September 22, 2017,~~March 28, 2019, by and among ~~the Company, as borrower, BTMU, JPMorgan Chase Bank, N.A., Compass Bank (d/b/a BBVA Compass), U.S. Bank National Association~~Magellan Health, Inc. and ~~Wells Fargo Securities, LLC as co-syndication agents, BTMU as administrative agent~~Starboard Value LP and ~~the lenders party thereto from time to time,~~certain of its affiliates, which was filed as Exhibit ~~4.4~~10.1 to the Company’s current report on Form 8-K, which was filed on ~~September 25, 2017.~~March 29, 2019 and is incorporated herein by reference.
31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes‑Oxley Act of 2002.
32.1		Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes‑Oxley Act of 2002 (furnished).
32.2		Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes‑Oxley Act of 2002 (furnished).
101		The following materials from the Company’s Quarterly Report on Form 10‑Q for the quarter ended ~~September~~March ~~30, 2017~~31, 2019 formatted in Extensible Business Reporting Language (XBRL): (i) the Consolidated Statements of Comprehensive Income, (ii) the Consolidated ~~Statements of Comprehensive Income,~~Balance Sheets, (iii) the Consolidated ~~Balance Sheets,~~Statements of Changes in Stockholders’ Equity, (iv) the Consolidated Statements of Cash Flows and (v) related notes.

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Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


Date: ~~November 1, 2017~~May 2, 2019	Magellan Health, Inc. (Registrant)

	By:	/s/ Jonathan N. Rubin
		Jonathan N. Rubin
		Chief Financial Officer (Principal Financial Officer and Duly Authorized Officer)

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	Covered lives as of
	September 30, 2017
	Risk-based	ASO
Commercial
Behavioral(1)	14,394	11,266
Specialty	9,101	16,075
Government(2)	4,042	1,017


	Revenue for the nine months ended
	September 30, 2017
	Risk-based		ASO		Total
Commercial
Behavioral(1)	$	302,650	$	97,883	$	400,533
Specialty		446,169		53,323		499,492
Government(2)		1,218,513		71,559		1,290,072
Total	$	1,967,332	$	222,765	$	2,190,097