The following discussion and analysis of the Company's financial condition and results of operations should be read in conjunction with the Company's selected financial data and the Company's financial statements and the accompanying notes included herein. The following discussion may contain "forward-looking statements" within the meaning of the Securities Act and the Exchange Act. When used in this Form 10-K, the words "estimate," "anticipate," "expect," "believe," "should" and similar expressions are intended to be forward-looking statements. Although the Company believes that its plans, intentions and expectations 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 33
Table of Contents
factors currently known to management that could cause actual results to differ materially from those in forward-looking statements are set forth under the heading "Risk Factors" in Item 1A and elsewhere in this Form 10-K. Capitalized or defined terms included in this Item 7 have the meanings set forth in Item 1 of this Form 10-K. 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 table summarizes, for the periods indicated, consolidated operating results (in thousands):
December 31, Change Change Consolidated Results 2017 2018 2019 '17 vs '18 '18 vs '19 Statement of Operations Data: Net revenue$ 5,838,583 $ 7,314,151 $ 7,159,423 25.3% (2.1%) Cost of Care 2,413,770 3,762,412 3,940,531 55.9% 4.7% Cost of goods sold 2,211,910 2,283,022 1,898,871 3.2% (16.8%) Direct service costs and other operating expenses (1)(2) 941,883 1,071,535 1,090,731 13.8% 1.8%
Depreciation and amortization 115,706 132,660 131,509
14.7% (0.9%) Interest expense 25,977 35,396 36,153 36.3% 2.1% Interest and other income (5,887) (14,068) (19,189) 139.0% 36.4% Income before income taxes 135,224 43,194 80,817 (68.1%) 87.1% Provision for income taxes 25,083 19,013 24,915 (24.2%) 31.0% Net income 110,141 24,181 55,902 (78.0%) 131.2% Less: net loss attributable to non-controlling interest (66) - - (100.0%) - Net income attributable to Magellan$ 110,207 $ 24,181 $ 55,902 (78.1%) 131.2%
(1) Includes stock compensation expense of
years ended
Includes changes in fair value of contingent consideration of
respectively. 2019 compared to 2018
Net revenue, Cost of care, Cost of goods sold, and 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 decreased by 0.9 percent or
Interest Expense
Interest expense increased by$0.8 million from 2018 to 2019 mainly due to higher interest rates. 34 Table of Contents Interest and other income
Interest and other income increased by
Income taxes The Company's effective income tax rate was 44.0 percent in 2018 and 30.8 percent in 2019. These rates differ from the applicable federal statutory income tax rate for each year primarily due to state income taxes, permanent differences between book and tax income, and changes to the valuation allowances. The Company also accrues interest and penalties related to uncertain tax positions in its provision for income taxes. The effective income tax rate for 2019 was lower than 2018, primarily due to (i) suspension of the non-deductible Patient Protection and Affordable Care Act health insurer fee ("HIF") fees in 2019, and (ii) an increased relative impact in 2018 of the permanent differences for HIF fees and executive compensation as a result of reduced earnings. The statutes of limitations regarding the assessment of federal and most state and local income taxes for 2015 expired during 2019. As a result,$3.5 million of tax contingency reserves recorded as ofDecember 31, 2018 were reversed in 2019, of which$2.8 million was reflected as a reduction to income tax expense and$0.7 million as a decrease to deferred tax assets. Additionally,$0.3 million of accrued interest was reversed in 2019 and reflected as a reduction to income tax expense due to the closing of statutes of limitations on tax assessments. The statutes of limitations regarding the assessment of federal and most state and local income taxes for 2014 expired during 2018. As a result,$3.0 million of tax contingency reserves recorded as ofDecember 31, 2017 were reversed in 2018, of which$2.4 million was reflected as a reduction to income tax expense and$0.6 million as a decrease to deferred tax assets. Additionally,$0.2 million of accrued interest was reversed in 2018 and reflected as a reduction to income tax expense due to the closing of statutes of limitations on tax assessments. 2018 compared to 2017
Net revenue, Cost of care, Cost of goods sold, and 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 14.7 percent or$17.0 million from 2017 to 2018, primarily due to asset additions after 2017 and acquisition activity. Interest Expense
Interest expense increased by
Interest and other income
Interest and other income increased by
Income taxes
The Company's effective income tax rate was 18.6 percent in 2017 and 44.0 percent in 2018. These rates differ from the applicable federal statutory income tax rate for each year primarily due to state income taxes, remeasurement of deferred tax balances in 2017 due to the Tax Act, permanent differences between book and tax income, and changes to the valuation allowances. The Company also accrues interest and penalties related to uncertain tax positions in its provision for income taxes. Although the federal statutory rate was reduced under the Tax Act from 35% in 2017 to 21% in 2018, the effective income tax rate for 2018 was higher than 2017, primarily due to (i) suspension of the non-deductible Patient Protection and Affordable Care Act health insurer fee ("HIF") fees in 2017, (ii) a significant reversal 35
Table of Contents
of valuation allowances in 2017 for the AlphaCare net operating loss carryforwards ("NOLs"), (iii) remeasurement of deferred tax balances in 2017 as a result of the Tax Act, (iv) a significant increase in the amount of non-deductible executive compensation in 2018 as a result of the Tax Act, and (v) an increased relative impact in 2018 of the permanent differences for non-deductible HIF fees and non-deductible executive compensation as a result of reduced earnings. The statutes of limitations regarding the assessment of federal and most state and local income taxes for 2014 expired during 2018. As a result,$3.0 million of tax contingency reserves recorded as ofDecember 31, 2017 were reversed in 2018, of which$2.4 million was reflected as a reduction to income tax expense and$0.6 million as a decrease to deferred tax assets. Additionally,$0.2 million of accrued interest was reversed in 2018 and reflected as a reduction to income tax expense due to the closing of statutes of limitations on tax assessments. The statutes of limitations regarding the assessment of federal and most state and local income taxes for 2013 expired during 2017. As a result,$3.0 million of tax contingency reserves recorded as ofDecember 31, 2016 were reversed in 2017, of which$2.0 million was reflected as a reduction to income tax expense and$1.0 million as a decrease to deferred tax assets. Additionally,$0.2 million of accrued interest was reversed in 2017 and reflected as a reduction to income tax expense due to the closing of statutes of limitations on tax assessments. 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. The non-controlling portion of AlphaCare's Segment Loss is also excluded from the computation of Segment Profit in 2017. 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'sBehavioral & 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. 36 Table of Contents
The following table summarizes, for the periods indicated, operating results for the Healthcare segment (in thousands):
December 31, Change Change Healthcare Segment Results 2017 2018 2019 '17 vs '18 '18 vs '19Behavioral & Specialty Health revenue Risk-based, non-EAP$ 1,461,159 $ 1,511,532 $ 1,504,472 3.4% (0.5%) EAP risk-based 382,047 349,751 339,377 (8.5%) (3.0%) ASO 257,310 247,953 237,186 (3.6%) (4.3%) Magellan Complete Care revenue Risk-based, non-EAP 1,053,916 2,473,570 2,695,132 134.7% 9.0% ASO 51,845 55,816 62,379 7.7% 11.8% Managed care and other revenue 3,206,277 4,638,622
4,838,546 44.7% 4.3% Cost of care 2,413,770 3,762,412 3,940,531 55.9% 4.7% 792,507 876,210 898,015 10.6% 2.5%
Direct service costs and other 601,201 735,366
726,937 22.3% (1.1%) 191,306 140,844 171,078 (26.4%) 21.5% Stock compensation expense 10,689 6,982 8,467 (34.7%) 21.3%
Changes in fair value of contingent consideration 696 1,307
(2,124)
Less: non-controlling interest segment loss (56) - - Segment Profit$ 202,747 $ 149,133
Direct service cost as % of revenue 18.8% 15.9%
15.0%
MLR Behavioral & Specialty Health risk 88.5% 87.0%
87.2%
MLR Behavioral & Specialty Health EAP risk 68.6% 68.4%
68.3%
MLR Magellan Complete Care risk 81.5% 89.3%
88.9%
Membership
Behavioral & Specialty Health Risk (1) 13,030 12,321 11,517 EAP risk 14,471 15,189 14,710 ASO 27,825 26,655 28,394 Magellan Complete Care Risk 120 139 155 ASO 20 23 25
(1)May include some duplicate count of membership for customers that contract with Magellan for both behavioral and other specialty management services.
2019 compared to 2018
Managed Care and Other Revenue
Net revenue related to Healthcare increased by 4.3 percent or$199.9 million from 2018 to 2019. The increase in revenue is primarily due to new contracts implemented during (or after) 2018 of$296.7 million , higher membership and favorable rate changes of$267.2 million , program changes of$74.1 million , net unfavorable retroactive revenue adjustments in 2018 of$16.7 million , customer settlements in 2019 of$9.5 million and other net favorable variances of$22.4 million . These increases were partially offset by terminated contracts of$424.5 million , net revenue recorded for HIF fees in 2018 of$31.1 million , customer settlements in 2018 of$22.3 million and net unfavorable retroactive revenue adjustments in 2019 of$8.8 million . Retroactive revenue adjustments include the net retroactive impact for matters primarily related to membership, rates and the revenue impact of prior period medical claims development. 37 Table of Contents Cost of Care
Cost of care increased by 4.7 percent or$178.1 million from 2018 to 2019. The increase in cost of care is primarily due to new contracts implemented after (or during) 2018 of$238.4 million , increased membership and higher care from existing customers of$93.5 million , program changes of$63.5 million , net favorable prior period medical claims development recorded in 2018 of$9.7 million and care trends and other net favorable variances of$146.7 million . These increases were partially offset by terminated contracts of$351.4 million and favorable prior period medical claims development recorded in 2019 of$22.3 million . For our behavioral and specialty health contracts, cost of care as a percentage of risk revenue (excluding EAP business) increased slightly from 87.0 percent in 2018 to 87.2 percent in 2019. For our MCC contracts, cost of care decreased as a percentage of risk revenue (excluding EAP business) from 89.3 percent in 2018 to 88.9 percent in 2019, mainly due to favorable prior period medical claims development and business mix.
Direct Service Costs
Direct service costs decreased by 1.1 percent or$8.4 million from 2018 to 2019 primarily due to costs related to HIF fees in 2018 and terminated contracts, partially offset by discretionary benefits and new business growth. Direct service costs decreased as a percentage of revenue from 15.9 percent in 2018 to 15.0 percent in 2019, primarily due to HIF fees in 2018, and increased revenue from program changes and favorable rate changes.
2018 compared to 2017
Managed Care and Other Revenue
Net revenue related to Healthcare increased by 44.7 percent or$1,432.3 million from 2017 to 2018. The increase in revenue is primarily due to revenue forSenior Whole Health acquired onOctober 31, 2017 of$1,011.6 million , new contracts implemented during (or after) 2017 of$376.9 million , higher membership partially offset by unfavorable rate changes of$180.6 million , net revenue recorded for HIF fees in 2018 of$31.1 million , customer settlements in 2018 of$22.3 million and a performance penalty in 2017 of$4.6 million . These increases were partially offset by terminated contracts of$111.4 million , net retroactive program changes recorded in 2017 of$23.3 million , program changes of$21.8 million , net unfavorable retroactive revenue adjustments in 2018 of$16.7 million , favorable customer settlements in 2017 of$2.0 million and other net unfavorable variances of$19.6 million . Retroactive revenue adjustments include the net retroactive impact for matters primarily related to membership, rates and the revenue impact of prior period medical claims development.
Cost of Care
Cost of care increased by 55.9 percent or$1,348.6 million from 2017 to 2018. The increase in cost of care is primarily due to care cost forSenior Whole Health acquired onOctober 31, 2017 of$889.5 million , new contracts implemented after (or during) 2017 of$346.8 million , increased membership and higher care from existing customers partially offset by unfavorable rate changes of$160.6 million , favorable customers settlements in 2017 of$11.1 million , net favorable prior period medical claims development recorded in 2017 of$7.5 million and care trends and other net unfavorable variances of$87.9 million . These increases were partially offset by terminated contracts of$93.6 million , program changes of$27.3 million , net retroactive program changes recorded in 2017 of$21.2 million , net favorable care development recorded in 2018 of$9.7 million and litigation settlements in 2017 of$3.0 million . For our behavioral and specialty health contracts, cost of care as a percentage of risk revenue (excluding EAP business) decreased from 88.5 percent in 2017 to 87.0 percent in 2018, mainly due to revenue growth from new business and favorable rate changes, partially offset by terminated contracts. For our MCC contracts, cost of care increased as a percentage of risk revenue (excluding EAP business) from 81.5 percent in 2017 to 89.3 percent in 2018, mainly due to care trends and business mix.
Direct Service Costs
Direct service costs increased by 22.3 percent or$134.2 million from 2017 to 2018 primarily due to costs related toSenior Whole Health , new business and contract implementation costs, and HIF fees in 2018. Direct service costs decreased as a percentage of revenue from 18.8 percent in 2017 to 15.8 percent in 2018, mainly due to increased revenue from business growth and acquisition activity partially offset by terminated contracts. 38 Table of Contents Pharmacy Management The Pharmacy Management segment comprises products and solutions that provide clinical and financial management of pharmaceuticals paid under medical and pharmacy benefit programs. Pharmacy Management's services include: (i) PBM services; (ii) PBA for state Medicaid and other government sponsored programs; (iii) pharmaceutical dispensing operations; (iv) clinical and formulary management programs; (v) medical pharmacy management programs; and (vi) programs for the integrated management of specialty drugs. Pharmacy Management's services are provided under contracts with health plans, employers, state Medicaid programs, Medicare Part D and other government agencies.
The following table summarizes, for the periods indicated, operating results for the Pharmacy Management segment (in thousands, except state count):
December 31, Change Change Pharmacy Segment Results 2017 2018 2019 '17 vs '18 '18 vs '19 Formulary management$ 91,900 $ 70,900 $ 84,567 (22.9%) 19.3% PBA and other 181,589 169,527 180,872 (6.6%) 6.7% Managed care and other revenue 273,489 240,427 265,439 (12.1%) 10.4% PBM, including dispensing 1,980,044 2,183,151 1,949,225 10.3% (10.7%) Medicare Part D 511,000 442,266 287,604 (13.5%) (35.0%) PBM revenue 2,491,044 2,625,417 2,236,829 5.4% (14.8%) Total net revenue 2,764,533 2,865,844 2,502,268 3.7% (12.7%) Cost of goods sold 2,341,979 2,468,170 2,076,509 5.4% (15.9%) 422,554 397,674 425,759 (5.9%) 7.1%
Direct service costs and other 302,525 298,713
323,162 (1.3%) 8.2%
120,029 98,961 102,597 (17.6%) 3.7% Stock compensation expense 19,881 5,458 7,834 (72.5%) 43.5% Segment Profit$ 139,910 $ 104,419 $
110,431 (25.4%) 5.8%
Direct service cost as % of revenue 10.9% 10.4%
12.9%
COGS as % of PBM revenue 94.0% 94.0%
92.8%
Pharmacy Operational Statistics Adjusted commercial network claims 29,100 31,321
27,996 Adjusted PBA claims 80,700 70,429 78,799 Total adjusted claims 109,800 101,750 106,795 Generic dispensing rate 87.3% 87.4% 86.6% Commercial PBM covered lives 1,900 1,986 1,663
Medical pharmacy covered lives 13,100 13,910
13,988
Total states and DC that participate in PBA 27 27
27 2019 compared to 2018
Managed Care and Other Revenue
Managed care and other revenue related to Pharmacy Management increased by 10.4 percent or$25.0 million from 2018 to 2019. This increase is primarily due to increased formulary management revenue of$13.7 million mainly due to utilization, higher revenue in government pharmacy of$5.6 million mainly due to increased membership, increased medical pharmacy revenue of$4.7 million mainly due to favorable settlements, and other net favorable variances of$1.0 million .
PBM and Dispensing Revenue
PBM and dispensing revenue related to Pharmacy Management decreased by
14.8 percent or
39
Table of Contents
and utilization of$154.6 million , mainly due to a reduction in the Part D footprint. These decreases were partially offset by new contracts implemented after (or during 2018) of$83.8 million , customer guarantee penalties in 2018 of$3.3 million and other favorable variances of$4.7 million .
Cost of Goods Sold
Cost of goods sold decreased by 15.9 percent or$391.7 million from 2018 to 2019. This decrease is primarily due to terminated contracts of$320.8 million , decreased membership and utilization of$139.9 million and other favorable variances of$10.7 million . These decreases were partially offset by new contracts implemented after (or during) 2018 of$79.7 million . As a percentage of the portion of net revenue that relates to PBM, cost of goods sold decreased from 94.0 percent in 2018 to 92.8 percent in 2019, mainly due to business mix.
Direct Service Costs
Direct service costs increased by 8.2 percent or$24.4 million from 2018 to 2019. The increase is primarily due to an increase in discretionary benefits, an increase in stock compensation expense and new business growth. Direct service costs increased as a percentage of revenue from 10.4 percent in 2018 to 12.9 percent in 2019 due to higher discretionary benefits.
2018 compared to 2017
Managed Care and Other Revenue
Managed care and other revenue related to Pharmacy Management decreased by 12.1 percent or$33.1 million from 2017 to 2018. This decrease is primarily due to decreased formulary management revenue of$20.5 million , lower revenue in government pharmacy of$5.6 million , decreased medical pharmacy revenue of$3.3 million , terminated contracts of$1.2 million and other net unfavorable variances of$5.0 million . These decreases were partially offset by new contracts implemented after (or during) 2017 of$2.5 million .
PBM and Dispensing Revenue
PBM and dispensing revenue related to Pharmacy Management increased by 5.4 percent or$134.4 million from 2017 to 2018. This increase is primarily due to new contracts implemented after (or during) 2017 of$154.4 million and other net favorable variances of$0.3 million . These increases were partially offset by terminated contracts of$17.0 million and customer guarantee penalties in 2018 of$3.3 million . Cost of Goods Sold
Cost of goods sold increased by 5.4 percent or$126.2 million from 2017 to 2018. This increase is primarily due to new contracts implemented after (or during) 2017 of$147.2 million , partially offset by terminated contracts of$16.3 million and decreased membership and utilization of$4.7 million . As a percentage of the portion of net revenue that relates to PBM, cost of goods sold is consistent with 2017 at 94.0 percent.
Direct Service Costs
Direct service costs decreased by 1.3 percent or
40 Table of Contents Corporate Segment
The Corporate segment of the Company is comprised primarily of amounts not allocated to the Healthcare and Pharmacy Management segments that are largely associated with costs related to being a publicly traded company.
The following table summarizes, for the periods indicated, operating results for the Corporate segment (in thousands):
December 31, Change Change Corporate Segment & Eliminations 2017 2018 2019 '17 vs '18 '18 vs '19 Managed care and other revenue$ (584) $ (607) $ (592) 3.9% (2.5%) PBM revenue (131,643) (189,708) (180,799) 44.1% (4.7%) Cost of goods sold 130,069 185,148
177,638 42.3% (4.1%)
(2,158) (5,167) (3,753) 139.4% (27.4%) Direct service costs and other 38,157 37,456
40,632 (1.8%) 8.5%
(40,315) (42,623) (44,385) 5.7% 4.1% Stock compensation expense 8,546 17,032 9,200 99.3% (46.0%) Less: non-controlling interest segment loss (3) -
- (100.0%) 0.0% Segment Loss$ (31,766) $ (25,591) $ (35,185) (19.4%) 37.5% 2019 compared to 2018 Net expenses related to Corporate, which includes eliminations, increased 37.5 percent or$9.6 million , primarily due to higher discretionary benefits in 2019. As a percentage of revenue, corporate and elimination increased from 0.3 percent in 2018 to 0.5 percent in 2019, mainly due to decreased revenue and higher discretionary benefits.
2018 compared to 2017
Net expenses related to Corporate, which includes eliminations, decreased 19.4 percent or$6.2 million , primarily due to lower discretionary benefits in 2018, higher corporate development costs in 2017 related to the SWH acquisition and a litigation settlement recorded in 2017 partially offset by higher stock compensation expense in 2018. As a percentage of revenue, corporate and elimination decreased from 0.5 percent in 2017 to 0.3 percent in 2018, mainly due to increased revenue from business growth, higher corporate development costs in 2017 and lower 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 afterJanuary 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 41
Table of Contents
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 income before income taxes to segment profits for
the years ended
2017 2018 2019 Income before income taxes$ 135,224 $ 43,194 $ 80,817 Stock compensation expense 39,116 29,472 25,501
Changes in fair value of contingent consideration 696 1,307
(2,124)
Non-controlling interest segment loss 59 - - Depreciation and amortization 115,706 132,660
131,509 Interest expense 25,977 35,396 36,153 Interest and other income (5,887) (14,068) (19,189) Segment Profit$ 310,891 $ 227,961 $ 252,667
The following table reconciles net income attributable to Magellan to Adjusted
Net Income for the years ended
2017 2018 2019 Net income$ 110,207 $ 24,181 $ 55,902 Adjusted for acquisitions starting in 2013 Stock compensation expense 16,215 530 - Changes in fair value of contingent consideration 696 1,307 (2,124) Amortization of acquired intangibles 37,265 49,078 51,090 Tax impact (19,558) (13,435) (13,167) Adjusted Net Income$ 144,825 $ 61,661 $ 91,701
The following table reconciles net income per common share attributable to
Magellan-diluted to Adjusted EPS for the years ended
2017 2018
2019
Net income per common share-diluted$ 4.51 $ 0.97 $
2.28
Adjusted for acquisitions starting in 2013 Stock compensation expense 0.66 0.02
-
Changes in fair value of contingent consideration 0.03 0.05 (0.09) Amortization of acquired intangibles
1.52 1.96 2.08 Tax impact (0.80) (0.54) (0.54) Adjusted EPS$ 5.92 $ 2.46 $ 3.73 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 1A-"Risk Factors" 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. 42 Table of Contents
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 variable interest rate borrowings under the 2017 Credit Agreement. In addition, interest rates on the Notes are subject to adjustment upon the occurrence of certain credit rating events. Based on the amount of cash equivalents and investments and the borrowing levels under the 2017 Credit Agreement and the principal amount of the Notes as ofDecember 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
2019 compared to 2018
Operating Activities. The Company reported net cash provided by operating activities of$164.8 million and$115.8 million for 2018 and 2019, respectively. The$49.0 million decrease in operating cash flows from 2018 is mainly attributable to unfavorable working capital changes, partially offset by lower tax payments and higher segment profit. The net unfavorable impact of working capital changes between periods totaled$114.7 million . For 2018, operating cash flows were impacted by net unfavorable working capital changes of$3.0 million , mainly attributable to an increase in accounts receivables partially offset by an increase in payables. For 2019, operating cash flows were impacted by net unfavorable working capital changes of$117.7 million , mainly attributable to the timing of receivables and payables. Tax payments for 2019 decreased$35.4 million from 2018. Interest payments for 2019 decreased$4.3 million from 2018. Segment Profit for 2019 increased$24.7 million from 2018. Investing Activities. The Company utilized$68.3 million and$60.4 million during 2018 and 2019, respectively, for capital expenditures. The additions related to hard assets (equipment, furniture and leaseholds) and capitalized software for 2018 were$26.3 million and$42.0 million , respectively, as compared to additions for 2019 related to hard assets and capitalized software of$15.8 million and$44.6 million , respectively.
During 2018 the Company used
Financing Activities. During 2018, the Company paid$110.0 million on debt obligations,$62.6 million for the repurchase of treasury stock under the Company's share repurchase program,$12.2 million on finance lease obligations and had other net unfavorable items of$1.0 million . In addition, the Company received$23.1 million from the exercise of stock options. During 2019, the Company paid$59.8 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 and$7.7 million on finance lease obligations. In addition, the Company received$32.7 million from the exercise of stock options and had other net favorable items of$1.8 million .
2018 compared to 2017
Operating Activities. The Company reported net cash provided by operating activities of$162.3 million and$164.8 million for 2017 and 2018, respectively. The$2.5 million increase in operating cash flows from 2017 to 2018 is mainly attributable to favorable working capital changes and decreased tax payments between years, partially offset by a decrease in Segment Profit, increased interest payments between years and ACA activity.
The net favorable impact of working capital changes between periods totaled
43
Table of Contents
to timing related to receivables and payables. For 2018, operating cash flows were impacted by net unfavorable working capital changes of$3.0 million , which were largely attributable to an increase in accounts receivable, partially offset by an increase in payables. Segment Profit for 2018 decreased$82.9 million from 2017. Tax payments for 2018 decreased$19.3 million from 2017. Interest payments for 2018 increased by
$18.8 million from 2017.
Investing Activities. The Company utilized$57.2 million and$68.3 million during 2017 and 2018, respectively, for capital expenditures. The additions related to hard assets (equipment, furniture and leaseholds) and capitalized software for 2017 were$16.0 million and$41.2 million , respectively, as compared to additions for 2018 related to hard assets and capitalized software of$26.3 million and$42.0 million , respectively. During 2017 and 2018 the Company used net cash of$26.8 million and$59.2 million for the net purchase of "available-for-sale" securities. During 2017, the Company used net cash of$232.4 million related to investments in businesses and the acquisition of Veridicus and SWH. During 2018, the Company used net cash of$1.0 million related to investments in businesses. Financing Activities. During 2017, the Company paid$798.1 million on debt obligations,$21.8 million for the repurchase of treasury stock under the Company's share repurchase program,$9.9 million in debt issuance fees,$5.3 million on finance lease obligations and had other net unfavorable items of$2.7 million . In addition, the Company received$1,041.7 million from the issuance of debt and$44.4 million from the exercise of stock options.
During 2018, the Company paid
Outlook-Liquidity and Capital Resources
Liquidity. The Company may draw on the 2017 Credit Agreement as required to meet working capital needs associated with the timing of receivables and payables, fund share repurchases or support acquisition activities. The Company currently expects to have adequate liquidity to satisfy its existing financial commitments over the periods in which they will become due. The Company plans to maintain its current investment strategy of investing in a diversified, high quality, liquid portfolio of investments and continues to closely monitor the financial markets. The Company estimates that it has no risk of any material permanent loss on its investment portfolio; however, there can be no assurance the Company will not experience any such losses in the future.
Contractual Obligations and Commitments
The following table sets forth the future financial commitments of the Company
as of
Payments due by period Less than 13 35 More than Contractual Obligations Total 1 year years years 5 years Senior Notes$ 388,933 $ - $ -$ 388,933 $ - Term loan 280,625 - 22,500 258,125 - Operating leases(1) 58,628 13,030 26,123 14,817 4,658 Letters of credit(2) 66,427 - - - - Finance lease and deferred financing obligations(3) 19,980 4,862 7,494 7,624 - Purchase commitments(4) 1,210 1,207 3 - - Income tax contingencies(5) 13,870 - - - -$ 829,673 $ 19,099 $ 56,120 $ 669,499 $ 4,658
(1) Operating lease obligations include estimated future lease payments for both
open and closed offices.
(2) These letters of credit typically act as a guarantee of payment to certain
third parties in accordance with specified terms and conditions. 44 Table of Contents
(3) Finance lease and deferred financing obligations include imputed interest of
(4) Purchase commitments include open purchase orders as of
relating to ongoing capital expenditure and operational activities.
The Company is unable to make a reasonably reliable estimate of the period of
the cash settlement (if any) with the respective taxing authorities for these (5) contingencies. However, settlement of such amounts could require the
utilization of working capital. See further discussion in Note 7-"Income
Taxes" to the consolidated financial statements set forth elsewhere herein.
The Company also has a variety of other contractual agreements related to acquiring materials and services used in the Company's operations. However, the Company does not believe these other agreements contain material noncancelable commitments. Stock Repurchases 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. See Note 6-"Stockholders' Equity" to the consolidated financial statements for more information on the Company's share repurchase program.
Off-Balance Sheet Arrangements
As of
Senior Notes
OnSeptember 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 ofSeptember 22, 2017 (the "Base Indenture"), between the Company, as issuer, andU.S. Bank National Association , as trustee, as supplemented by a first supplemental indenture, dated as ofSeptember 22, 2017 (the "First Supplemental Indenture" together with the Base Indenture, the "Indenture"), between the Company, as issuer, andU.S. Bank National Association , as trustee. During the quarter endedDecember 31, 2019 , the Company purchased and subsequently retired$11.1 million of its Notes, which resulted in a loss on retirement of$0.3 million that is included in interest expense. The Notes were issued at a discount and had a carrying value of$399.3 million and$388.4 million atDecember 31, 2018 andDecember 31, 2019 , respectively. For more information on the Company's Senior Notes see Note 5-"Long-Term Debt, Finance Lease and Deferred Financing Obligations" to the consolidated financial statements set forth elsewhere herein.
Credit Agreements
OnSeptember 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. OnAugust 13, 2018 , the Company entered into an amendment to the 2017 Credit Agreement, which extended the maturity date by one year. OnFebruary 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 onSeptember 22, 2023 .
For more information on the Company's Credit Agreements see Note 5-"Long-Term Debt, Finance Lease and Deferred Financing Obligations" to the consolidated financial statements set forth elsewhere herein.
45
Table of Contents
Restrictive Covenants in Debt Agreements
The 2017 Credit Agreement contains covenants that limit management's discretion in operating the Company's business by 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, 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 ofDecember 31, 2019 , the Company was in compliance with all covenants, including financial covenants, under the 2017 Credit Agreement. 46 Table of Contents
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted inthe 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. Actual results could differ from those estimates. The Company considers the following to be its critical accounting policies and estimates:
Cost of Care, Medical Claims Payable and Other Medical Liabilities
Cost of care is recognized in the period in which members receive managed healthcare services. In addition to actual benefits paid, cost of care in a period also includes the impact of accruals for estimates of medical claims payable. Medical claims payable represents the liability for healthcare claims reported but not yet paid and claims IBNR related to the Company's managed healthcare businesses. Such liabilities are determined by employing actuarial methods that are commonly used by health insurance actuaries and that meet actuarial standards of practice. Cost of care for the Company's EAP contracts, which are mainly withthe United States federal government, pertain to the costs to employ licensed behavioral health counselors to deliver non-medical counseling for these contracts. The IBNR portion of medical claims payable is estimated based on past claims payment experience for member groups, enrollment data, utilization statistics, authorized healthcare services and other factors. This data is incorporated into contract-specific actuarial reserve models and is further analyzed to create "completion factors" that represent the average percentage of total incurred claims that have been paid through a given date after being incurred. Factors that affect estimated completion factors include benefit changes, enrollment changes, shifts in product mix, seasonality influences, provider reimbursement changes, changes in claims inventory levels, the speed of claims processing and changes in paid claim levels. Completion factors are applied to claims paid through the financial statement date to estimate the ultimate claim expense incurred for the current period. Actuarial estimates of claim liabilities are then determined by subtracting the actual paid claims from the estimate of the ultimate incurred claims. For the most recent incurred months (generally the most recent two months), the percentage of claims paid for claims incurred in those months is generally low. This makes the completion factor methodology less reliable for such months. Therefore, incurred claims for any month with a completion factor that is less than 70 percent are generally not projected from historical completion and payment patterns; rather they are projected by estimating claims expense based on recent monthly estimated cost incurred per member per month times membership, taking into account seasonality influences, benefit changes and healthcare trend levels, collectively considered to be "trend factors." For new contracts, the Company estimates IBNR based on underwriting data until it has sufficient data to utilize these methodologies. Medical claims payable balances are continually monitored and reviewed. If it is determined that the Company's assumptions in estimating such liabilities are significantly different than actual results, the Company's results of operations and financial position could be impacted in future periods. Adjustments of prior period estimates may result in additional cost of care or a reduction of cost of care in the period an adjustment is made. Further, due to the considerable variability of healthcare costs, adjustments to claim liabilities occur each period and are sometimes significant as compared to the net income recorded in that period. Prior period development is recognized immediately upon the actuary's judgment that a portion of the prior period liability is no longer needed or that additional liability 47
Table of Contents
should have been accrued. The following table presents the components of the change in medical claims payable for the years endedDecember 31, 2017 , 2018 and 2019 (in thousands): 2017 2018 2019 Claims payable and IBNR, beginning of period$ 188,618 $ 326,642 $ 394,140 Cost of care: Current year 2,421,270 3,772,112 3,962,831 Prior years(3) (7,500) (9,700) (22,300) Total cost of care 2,413,770 3,762,412 3,940,531 Claim payments and transfers to other medical liabilities(1): Current year 2,210,346 3,402,010 3,594,018 Prior years 161,798 292,904 332,650 Total claim payments and transfers to other medical liabilities 2,372,144 3,694,914 3,926,668 Acquisition of SWH 96,398 - - Claims payable and IBNR, end of period 326,642 394,140 408,003 Withhold (receivables) payable, end of period(2) 983 (593) 1,530 Medical claims payable, end of period$ 327,625 $
393,547
For any given period, a portion of unpaid medical claims payable could be (1) covered by risk share or reinvestment liabilities (discussed below) and may
not impact the Company's results of operations for such periods.
Medical claims payable is offset by customer withholds from capitation (2) payments in situations in which the customer has the contractual requirement
to pay providers for care incurred.
Favorable development in 2017, 2018 and 2019 was
trends and faster claims completion than originally assumed.
Actuarial standards of practice require that the claim liabilities be adequate under moderately adverse circumstances. Adverse circumstances are situations in which the actual claims experience could be higher than the otherwise estimated value of such claims. In many situations, the claims paid amount experienced will be less than the estimate that satisfies the actuarial standards of practice. Any prior period favorable cost of care development related to a lack of moderately adverse conditions is excluded from "Cost of Care-Prior Years " adjustments, as a similar provision for moderately adverse conditions is established for current year cost of care liabilities and therefore does not generally impact net income. Care trend factors and completion factors can have a significant impact on the medical claims payable liability. The following example provides the estimated impact to the Company'sDecember 31, 2019 unpaid medical claims payable liability assuming hypothetical changes in care trend factors and completion factors: Care Trend Factor(1) Completion
Factor(2)
(Decrease) Increase (Decrease)
Increase
Trend Factor Medical Claims Payable Completion Factor Medical Claims Payable (in thousands) (in thousands) -4 % $ (23,000) -2 % $ (59,000) -3 % (17,500) -1.5 % (44,500) -2 % (11,500) -1 % (29,500) -1 % (6,000) -0.5 % (15,000) 1 % 6,000 0.5 % 15,000 2 % 11,500 1 % 30,500 3 % 17,500 1.5 % 45,500 4 % 23,000 2 % 61,000
Approximately 70 percent of IBNR dollars is based on care trend factors.
Assumes a change in the care trend factor for any month that a completion (1) factor is not used to estimate incurred claims (which is generally any month
that is less than 70 percent complete). 48 Table of Contents
Assumes a change in the completion factor for any month for which completion (2) factors are used to estimate IBNR (which is generally any month that is
70 percent or more complete).
Due to the existence of risk sharing and reinvestment provisions in certain customer contracts, a change in the estimate for medical claims payable does not necessarily result in an equivalent impact on segment profit.
The Company believes that the amount of medical claims payable is adequate to cover its ultimate liability for unpaid claims as ofDecember 31, 2019 ; however, actual claims payments may differ from established estimates. Other medical liabilities consist primarily of amounts payable to pharmacies for claims that have been adjudicated by the Company but not yet paid, "reinvestment" payables under certain managed healthcare contracts with Medicaid customers and "profit share" payables under certain risk-based contracts. Under a contract with reinvestment features, if the cost of care is less than certain minimum amounts specified in the contract (usually as a percentage of revenue), the Company is required to "reinvest" such difference in behavioral healthcare programs when and as specified by the customer or to pay the difference to the customer for their use in funding such programs. Under a contract with profit share provisions, if the cost of care is below certain specified levels, the Company will "share" the cost savings with the customer at the percentages set forth in the contract. In addition, certain contracts include provisions to provide the Company additional funding if the cost of care is above the specified levels.
The Company is required to test its goodwill for impairment on at least an annual basis. The Company has selectedOctober 1 as the date of its annual impairment test. The goodwill impairment test is a two-step process that requires management to make judgments in determining what assumptions to use in the calculation. The first step of the process consists of estimating the fair value of each reporting unit with goodwill based on various valuation techniques, with the primary technique being a discounted cash flow analysis, which requires the input of various assumptions with respect to revenues, operating margins, growth rates and discount rates. The estimated fair value for each reporting unit is compared to the carrying value of the reporting unit, which includes goodwill. If the estimated fair value is less than the carrying value, a second step is performed to compute the amount of the impairment by determining an "implied fair value" of goodwill. The determination of a reporting unit's "implied fair value" of goodwill requires the Company to allocate the estimated fair value of the reporting unit to the assets and liabilities of the reporting unit. Any unallocated fair value represents the "implied fair value" of goodwill, which is compared to its corresponding carrying value.Goodwill is tested for impairment at a level referred to as a reporting unit, with the Company's reporting units with goodwill as ofDecember 31, 2019 comprised ofBehavioral & Specialty Health , Magellan Complete Care ("MCC") and Pharmacy Management. The fair value ofBehavioral & Specialty Health (a component of the Healthcare segment), MCC (a component of the Healthcare segment) and Pharmacy Management reporting units were determined using a discounted cash flow method. This method involves estimating the present value of estimated future cash flows utilizing a risk adjusted discount rate. Key assumptions for this method include cash flow projections, terminal growth rates and discount rates. The 2018 annual goodwill impairment testing as ofOctober 1, 2018 , determined that the fair value of the MCC reporting unit had declined, largely due to continued economic challenges in certain markets, and was in excess of its carrying value by a margin of approximately 5%, designating it as a reporting unit that was at-risk for impairment. After performing the 2019 annual goodwill impairment test, improvements were noted in the actual and expected results for such MCC markets which increased the estimated fair value of the MCC reporting unit. As ofOctober 1, 2019 , the excess of its fair value over the carrying value increased to an extent that it is no longer considered at-risk. While no units were determined to be impaired at this time, reporting unit goodwill is at risk of future impairment in the event of significant unfavorable changes in the Company's forecasted future results and cash flows. In addition, market factors utilized in the impairment analysis, including long-term growth rates or discount rates, could negatively impact the fair value of our reporting units. For testing purposes, management's best estimates of the expected future results are the primary driver in determining the fair value. Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions and factors. As a result, there can be no assurance that the estimates and assumptions made for purposes of the annual goodwill test will prove to be an accurate prediction of the future. 49
Table of Contents
Examples of events or circumstances that could reasonably be expected to negatively affect the underlying key assumptions and ultimately impact the estimated fair value of our reporting units may include such items as: (i) a decrease in expected future cash flows, specifically, a decrease in membership or rates or customer attrition and increase in costs that could significantly impact our immediate and long-range results, unfavorable working capital changes and an inability to successfully achieve our cost savings targets, (ii) adverse changes in macroeconomic conditions or an economic recovery that significantly differs from our assumptions in timing and/or degree (such as a recession); and (iii) volatility in the equity and debt markets or other country specific factors which could result in a higher weighted average cost of capital. Based on known facts and circumstances, we evaluate and consider recent events and uncertain items, as well as related potential implications, as part of our annual assessment and incorporate into the analyses as appropriate. These facts and circumstances are subject to change and may impact future analyses. While historical performance and current expectations have resulted in fair values of our reporting units and indefinite-lived intangible assets in excess of carrying values, if our assumptions are not realized, it is possible that an impairment charge may need to be recorded in the future.
2018 2019 Behavioral & Specialty Health$ 410,869 $ 410,869 Magellan Complete Care 211,735 211,735 Pharmacy Management 395,552 395,552 Total$ 1,018,156 $ 1,018,156
The changes in the carrying amount of goodwill for the years ended
2018
2019
Balance as of beginning of period$ 1,006,288 $
1,018,156
Other acquisitions and measurement period adjustments 11,868
-
Balance as of end of period$ 1,018,156 $
1,018,156
© Edgar Online, source