Magellan Health Services 10-Q 2006
Documents found in this filing:
Washington, D.C. 20549
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2006
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 1-6639
MAGELLAN HEALTH SERVICES, INC.
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes o No x
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 x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x Accelerated filer o Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
APPLICABLE ONLY TO ISSUERS
INVOLVED IN BANKRUPTCY
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes x No o
The number of shares of the registrants Ordinary Common Stock outstanding as of June 30, 2006 was 37,148,742.
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
See accompanying notes to condensed consolidated financial statements.
(In thousands, except per share amounts)
(1) Net of income tax provision of $940 and $1,045 for the three months and six months ended June 30, 2005, respectively.
See accompanying notes to condensed consolidated financial statements.
See accompanying notes to condensed consolidated financial statements.
The accompanying unaudited condensed consolidated financial statements of Magellan Health Services, Inc., a Delaware corporation (Magellan), include the accounts of Magellan, its majority owned subsidiaries, and all variable interest entities (VIEs) for which Magellan is the primary beneficiary (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 Commissions (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 months and six months ended June 30, 2006 are not necessarily indicative of the results to be expected for the full year. All intercompany accounts and transactions have been eliminated in consolidation.
These unaudited condensed consolidated financial statements should be read in conjunction with the Companys audited consolidated financial statements for the year ended December 31, 2005 and the notes thereto, which are included in the Companys Annual Report on Form 10-K filed with the SEC on March 8, 2006.
On March 7, 2006, the Company announced that it was restating previously filed financial statements to correct the Companys accounting for reversals of valuation allowances pertaining to deferred tax assets (excluding deferred tax assets related to the Companys net operating loss carryforwards) that existed prior to the Companys emergence from bankruptcy on January 5, 2004. The Company had recorded the reversals of valuation allowances for such deferred tax assets as reductions to the Companys income tax provision. In accordance with American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 90-7, Financial Reporting by Entities in Reorganization Under the Bankruptcy Code (SOP 90-7), and the Financial Accounting Standard Boards Emerging Issues Task Force (EITF) Topic No. D-33, Timing of Recognition of Tax Benefits for Pre-Reorganization Temporary Differences and Carryforwards (EITF D-33), such reversals of valuation allowances should be recorded as reductions to goodwill. Accordingly, the Company has restated its consolidated financial statements for the fiscal year ended December 31, 2004, and for the quarters ended March 31, 2004, June 30, 2004, September 30, 2004, December 31, 2004, March 31, 2005, June 30, 2005 and September 30, 2005. All applicable financial information contained in this Form 10-Q gives effect to these restatements.
The quarterly impacts of the restatement adjustments for the three months and six months ended June 30, 2005 are reflected below (in thousands, except per share amounts):
The weighted average number of common shares outstanding, both basic and diluted, are not affected by the restatement.
Summary of Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Significant estimates of the Company include, among other things, accounts receivable realization, valuation allowances for deferred tax assets, valuation of goodwill and intangible assets, medical claims payable, other medical liabilities, stock-based compensation assumptions, tax contingencies and legal liabilities. Actual results could differ from those estimates.
Managed Care Revenue
Managed care revenue is recognized over the applicable coverage period on a per member basis for covered members. Managed care risk revenues approximated $413.3 million and $815.6 million for the three months and six months ended June 30, 2005, respectively and $349.9 million and $702.6 million for the three months and six months ended June 30, 2006, respectively.
The Company has the ability to earn performance-based revenue under certain risk and non-risk contracts. Performance-based revenue generally is based on either the ability of the Company to manage care for its clients below specified targets, or on other operating metrics. For each such contract, the Company estimates and records performance-based revenue after considering the relevant contractual terms and the data available for the performance-based revenue calculation. Pro-rata performance-based revenue is recognized on an interim basis pursuant to the rights and obligations of each party upon termination of the contracts. Performance-based revenues were $2.7 million and $6.9 million for the three months and six months ended June 30, 2005, respectively, and $3.0 million and $6.6 million for the three months and six months ended June 30, 2006, respectively.
The Companys contracts with the State of Tennessees TennCare program (TennCare) and with subsidiaries of WellPoint, Inc. (WellPoint), each generated revenues that exceeded, in the aggregate, ten percent of consolidated net revenues for each of the three months and six months ended June 30, 2005 and 2006. The Company also has a significant concentration of business from individual counties which are part of the Pennsylvania Medicaid program.
The Company provides managed behavioral healthcare services for TennCare, both through contracts held by the Companys wholly owned subsidiary Tennessee Behavioral Health, Inc. (TBH) and through a contract held by Premier Behavioral Health Systems of Tennessee, LLC (Premier), a joint venture in which the Company owned a fifty percent interest. In addition, the Company contracts with Premier to provide certain services to the joint venture. The Company consolidates the results of operations of Premier, including revenue and cost of care, in the Companys consolidated statements of income. On April 11, 2006, the Company purchased the other fifty percent interest in Premier for $1.5 million, so that Premier is now a wholly-owned subsidiary of the Company. TennCare has divided its program into three regions, and the Companys TennCare contracts, which extend through June 30, 2007, currently encompass all of the TennCare membership for all three regions. The Company recorded revenue of $113.6 million and $226.7 million during the three months and six months ended June 30, 2005, respectively, and $101.8 million and $210.3 million during the three months and six months ended June 30, 2006, respectively, from its TennCare contracts.
On April 7, 2006, TennCare issued a Request for Proposals (RFP) for the management of the integrated delivery of behavioral and physical medical care to TennCare enrollees in the Middle region by managed care organizations. The RFP states that the start date of any such contract awarded pursuant to the RFP is expected to be April 1, 2007. Because the Companys contracts with TennCare can be terminated by TennCare prior to June 30, 2007, the contract for the Middle region would be terminated by TennCare should an implementation occur prior to June 30, 2007 of any contract awarded pursuant to the RFP. On July 26, 2006, TennCare announced the two winning bidders to the RFP process. The Company had not partnered with either of these bidders. For the three months and six months ended June 30, 2006, revenue derived from TennCare enrollees residing in the Middle region amounted to $36.8 million and $77.2 million, respectively.
Total revenue from the Companys contracts with WellPoint approximated $54.6 million and $104.4 million during the three months and six months ended June 30, 2005, respectively, and approximated $50.4 million and $98.4 million during the three months and six months ended June 30, 2006, respectively. Included in the revenue amount for the three months and six months ended June 30, 2006 is revenue of $3.8 million and $6.2 million from contracts that National Imaging Associates, Inc. (NIA) has with WellPoint (see Note B for discussion of the Companys acquisition of NIA). The majority of the Companys managed behavioral healthcare contracts with WellPoint have terms that extend through December 31, 2007.
The Company derives a significant portion of its revenue from contracts with various counties in the State of Pennsylvania (the Pennsylvania Counties). Although these are separate contracts with individual counties, they all pertain to the Pennsylvania Medicaid program. Revenues from the Pennsylvania Counties in the aggregate totaled $54.0 million and $105.5 million in the three months and six months ended June 30, 2005, respectively and $61.9 million and $124.0 million in the three months and six months ended June 30, 2006, respectively.
The Company recorded net revenue from Aetna, Inc. (Aetna) of $60.7 million and $122.6 million for the three months and six months ended June 30, 2005, respectively, which represented in excess of ten percent of the consolidated revenues of the Company for such periods. The Companys contract with Aetna terminated on December 31, 2005. During the three months and six months ended June 30, 2006, the Company recognized $0.8 million and $5.4 million of revenue related to the performance of one-time, transitional activities associated with the contract termination.
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. The Company records as cash and cash equivalents, excess capital and undistributed earnings for its regulated subsidiaries, which as of June 30, 2006 was $32.5 million.
The Company has certain assets which are considered restricted for: (i) the payment of claims under the terms of certain managed behavioral healthcare contracts; (ii) regulatory purposes related to the payment of claims in certain jurisdictions; and (iii) the maintenance of minimum required tangible net equity levels for certain of the Companys subsidiaries. Significant restricted assets of the Company as of December 31, 2005 and June 30, 2006 were as follows (in thousands):
The Company accounts for its investments in accordance with Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities (SFAS 115).
As of June 30, 2006, there were no unrealized losses that the Company believed to be other-than-temporary, because the Company believes it is probable that: (i) all contractual terms of each investment will be satisfied, (ii) the decline in fair value is due primarily to changes in interest rates (and not because of increased credit risk), and (iii) the Company intends and has the ability to hold each investment for a period of time sufficient to allow a market recovery. Unrealized losses related to investments greater and less than one year are not material. No realized gains or losses were recorded for the three months and six months ended June 30, 2005 and 2006. The following is a summary of short-term and long-term investments at December 31, 2005 and June 30, 2006 (in thousands):
The maturity dates of the Companys investments as of June 30, 2006 are summarized below (in thousands):
Goodwill is accounted for in accordance with SFAS No. 142, Goodwill and Other Intangible Assets (SFAS 142). Pursuant to SFAS 142, the Company is required to test its goodwill for impairment on at least an annual basis. The Company has selected October 1 as the date of its annual impairment test. The balance of goodwill of $290.2 million at December 31, 2005 was allocated entirely to the Health Plan segment (as described below). At June 30, 2006, approximately $105.6 million of goodwill was allocated to the Radiology Benefits Management segment (as described below), and the remaining $261.2 million was allocated to the Health Plan segment.
The changes in the carrying amount of Company goodwill for the six months ended June 30, 2006 are reflected in the table below (in thousands):
(1) During fiscal 2006, the Company recorded tax benefits from the utilization of deferred tax assets, including net operating loss carryforwards (NOLs), that existed prior to the Companys emergence from bankruptcy on January 5, 2004. These tax benefits have been reflected as reductions of goodwill in accordance with SOP 90-7.
At December 31, 2005 and June 30, 2006, the Company had net identifiable intangible assets (primarily customer agreements and lists and provider networks) of approximately $30.4 million and $39.0 million, respectively, net of accumulated amortization of approximately $17.3 million and $22.2 million, respectively. Intangible assets are amortized over their estimated useful lives, which range from approximately four to eighteen years. Amortization expense was $3.5 million and $6.9 million for the three months and six months ended June 30, 2005, respectively and $2.6 million and $4.9 million for the three months and six months ended June 30, 2006, respectively.
Cost of Care, Medical Claims Payable and Other Medical Liabilities
Cost of care is recognized in the period in which members received managed healthcare services. In addition to actual benefits paid, cost of care 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 incurred but not yet reported (IBNR) related to the Companys managed healthcare businesses. 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. Although considerable variability is inherent in such estimates, management believes the liability for medical claims payable is adequate. Medical claims payable balances are continually monitored and reviewed. Changes in assumptions for cost of care caused by changes in actual experience could cause the estimates to change in the near term. The Company believes that the amount of medical claims payable is adequate to cover its ultimate liability for unpaid claims as of June 30, 2006; however, actual claims payments and other items may differ from established estimates.
Other medical liabilities consist primarily of reinvestment payables under certain managed behavioral healthcare contracts with Medicaid customers. Under this type of contract, 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.
The Companys effective income tax rate was 42.3 percent and 42.7 percent for the three months and six months ended June 30, 2005 (restated), respectively and 43.5 percent and 43.9 percent for the three months and six months ended June 30, 2006, respectively. The effective rates for the three months and six months ended June 30, 2005 and 2006 differ from federal statutory income tax rates primarily due to state income taxes and permanent differences between book and tax income.
At December 31, 2005 and June 30, 2006, the Company had stock-based employee incentive plans, which are described below.
Stock Option Plans
On January 5, 2004, (the Effective Date), the Company established the 2003 Management Incentive Plan (2003 MIP) which allows for the issuance of up to 6,373,689 shares of common stock pursuant to stock options or stock grants. During fiscal 2004, the Company granted options for the purchase of 4.4 million shares of common stock at a weighted average grant date fair value of approximately $14.61 per share. These options vest ratably on each anniversary date over the three to four years subsequent to grant, and have a 10 year life. During fiscal 2005, the Company granted options for the purchase of 1.1 million shares of common stock at a weighted average grant date fair value of approximately $10.90 per share. These options vest ratably on each anniversary date over the four years subsequent to grant, and have a 10 year life. Other than the 2004 Options (defined below) and certain options granted under the 2006 MIP (defined below), options granted by the Company have exercise prices equal to the fair market value on the date of grant.
Summarized information relative to the Companys stock options issued under the 2003 MIP for the years ended December 31, 2004 and 2005 is as follows:
The fair values of the stock options granted were estimated on the date of their grant using the Black-Scholes-Merton option pricing model based on the following weighted average assumptions for the years ended December 31, 2004 and 2005:
The following table illustrates pro forma net income and pro forma net income per share as if the fair value-based method of accounting for stock options under SFAS No. 123, Accounting for Stock-Based Compensation (SFAS 123) had been applied in measuring compensation cost for stock-based awards for the three months and six months ended June 30, 2005 (in thousands, except per share data):
On February 24, 2006, the board of directors of the Company approved three equity plans and recommended they be submitted for approval by the Companys shareholders at the 2006 Annual Meeting
of Shareholders. The board approved the 2006 Management Incentive Plan (2006 MIP), the 2006 Director Equity Compensation Plan (Director Plan) and the 2006 Employee Stock Purchase Plan (ESPP). All three of the aforementioned plans were approved by the Companys shareholders at the 2006 Annual Meeting of Shareholders on May 16, 2006.
The 2006 MIP, which is similar to the Companys 2003 MIP, authorizes the issuance of equity awards covering a total of 2,750,000 shares of the Companys common stock, no more than 300,000 shares of which may be restricted stock or restricted stock units. A restricted stock unit is a notional account representing the right to receive a share of Ordinary Common Stock (or, at the Companys option, cash in lieu thereof) at some future date. Under the 2006 MIP, the exercisability of certain options and the vesting of certain restricted stock units is subject to certain performance targets. The Director Plan covers 120,000 shares of the Companys common stock, no more than 15,000 of which may be restricted stock or restricted stock units, and provides for the issuance of options and restricted stock or restricted stock units to directors immediately following each annual meeting of shareholders in 2006 and 2007. The ESPP covers 100,000 shares of the Companys common stock and permits employees of the Company to purchase Common Stock at a 5 percent discount. The initial period of activity for the ESPP will be August 1, 2006 through December 31, 2006.
Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123 (revised 2004) Share-Based Payment (SFAS 123R), using the modified prospective transition method and therefore has not restated results for prior periods. Under this transition method, stock-based compensation expense for the three months and six months ended June 30, 2006 includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123. Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006 is based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. The Company recognizes these compensation costs on a straight-line basis over the requisite service period, which is generally the option vesting term ranging from three to four years. Prior to the adoption of SFAS 123R, the Company recorded stock-based compensation under Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees (APB 25).
The Company uses the Black-Scholes-Merton formula to estimate the fair value of stock options granted to employees and recorded stock compensation expense of $6.6 million and $12.1 million for the three months and six months ended June 30, 2006, respectively. As stock-based compensation expense recognized in the condensed consolidated statements of income for the three months and six months ended June 30, 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures, currently estimated at four percent, as required by SFAS 123R. In the Companys pro forma information that was required under SFAS 123 for the periods prior to January 1, 2006, the Company accounted for its forfeitures as they occurred. The impact of adopting SFAS 123R to the condensed consolidated financial statements for the three months and six months ended June 30, 2006 was a reduction to net income of $1.3 million and $2.5 million, respectively, or a decrease of $0.04 and $0.07, respectively, on basic income per common share and a decrease of $0.03 and $0.06, respectively, on fully-diluted income per common share.
SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow. In the three months and six ended June 30, 2006, the tax deductions related to stock compensation were not recognized because of the availability of NOLs, and thus there were no such financing cash flows reported.
For the six months ended June 30, 2006, the weighted average grant date fair value of the stock options granted was $14.17 as estimated using the Black-Scholes-Merton option-pricing model based on the following weighted average assumptions:
As part of its SFAS 123R adoption, management determined that volatility based on actively traded equities of companies that are similar to the Company is a better indicator of expected volatility and future stock price trends than historical volatility, due to the lack of sufficient history of the Company subsequent to the Companys emergence from bankruptcy on the Effective Date.
Summarized information related to the Companys stock options for the six months ended June 30, 2006 is as follows:
The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (based upon the difference between the Companys closing stock price on the last trading day of the fiscal 2006 second quarter of $45.31 and the exercise price) for all in-the-money options as of June 30, 2006. This amount changes based on the fair market value of the Companys stock. The total pre-tax intrinsic value of options exercised (based on the difference between the Companys closing stock price on the day the option was exercised and the exercise price) during the six months ended June 30, 2006 was $7.9 million.
As of June 30, 2006, there was $37.7 million of total unrecognized compensation expense related to nonvested stock options that is expected to be recognized over a weighted average remaining recognition period of 1.69 years. The total fair value of shares vested during the three months and six months ended June 30, 2006 was $0.1 million and $9.4 million, respectively.
During the six months ended June 30, 2006, the Company granted 956,002 options to members of management at a weighted average grant date fair value of approximately $13.35 and at an exercise price of $38.52, which was equal to the price of the Companys stock on February 24, 2006, the date that the option grants were approved by the board of directors of the Company.
The Company granted an additional 199,463 options pursuant to the January 31, 2006 acquisition of NIA (see Note B below), including 99,463 Incentive Stock Options (ISOs). The weighted average grant date fair value of the 100,000 options, other than ISOs, granted to NIA employees was approximately $11.01. The 99,463 ISOs were granted to three employees previously employed by NIA in exchange for outstanding NIA incentive stock options held by such individuals and were granted at exercise prices that ranged from $4.44 to $7.66 per share, which prices were determined based on the exercise price of the NIA options exchanged times the exchange ratio equal to the price of the Companys stock at closing to the
purchase price per share of NIA paid by the Company in the acquisition. The options had a weighted average grant date fair value of approximately $32.24. Stock-based compensation expense related to the ISOs for the three months and six months ended June 30, 2006 was approximately $0.3 million and $0.4 million, respectively. The remaining 296,088 options granted to management in the six months ended June 30, 2006 were granted at exercise prices which equaled the fair market value of the Companys Ordinary Common Stock on the respective grant dates, which included options to purchase 209,388 shares granted upon exercise of 2004 Options (defined below) pursuant to the amendments as described below.
All of the Companys options granted during the six months ended June 30, 2006 vest ratably on each anniversary date over the three years subsequent to grant, and all have a ten year life.
Restricted Stock Awards
During the year ended December 31, 2005, the Company granted 140,636 shares of restricted stock pursuant to the 2003 MIP, 14,507 of which were vested and 126,129 of which vest ratably on each anniversary date over the four years subsequent to grant. Of these grants, 10,872 shares were cancelled pursuant to terminations of employment, resulting in a total of 115,257 outstanding unvested shares of restricted stock at December 31, 2005.
Summarized information related to the Companys nonvested restricted stock awards for the six months ended June 30, 2006 is as follows:
The 6,750 restricted stock awards granted in the six months ended June 30, 2006 vest ratably on each anniversary date over the three years subsequent to grant. As of June 30, 2006, there was $2.6 million of unrecognized stock-based compensation expense related to nonvested restricted stock awards. This cost is expected to be recognized over a weighted-average period of 2.69 years.
Restricted Stock Units
During the six months ended June 30, 2006, the Company granted 116,327 restricted stock units pursuant to the 2006 MIP which vest ratably on each anniversary date over the three years subsequent to grant. As of June 30, 2006, there was $4.4 million of unrecognized stock-based compensation expense related to nonvested restricted stock units. This cost is expected to be recognized over a weighted-average period of 2.65 years.
Common Stock Warrants
On the Effective Date, Magellan and 88 of its subsidiaries consummated their Third Joint Amended Plan of Reorganization, as modified and confirmed (the Plan). Under the Plan, the Company issued 570,825 warrants to purchase common stock of the Company at a purchase price of $30.46 per share at anytime until January 5, 2011. As of June 30, 2006, 570,384 of these warrants remain outstanding. Also on the Effective Date and pursuant to the Plan, the Company entered into a warrant agreement with Aetna whereby Aetna had the option to purchase, between January 1, 2006 and January 5, 2009, 230,000 shares of Ordinary Common Stock at a purchase price of $10.48 per share. On January 30, 2006, Aetna effected a cashless exercise for all of their warrants, which resulted in 150,815 shares being issued to Aetna.
On January 3, 2006, the Company amended certain stock options outstanding under the 2003 MIP. The amendments, as further described below, were intended primarily to bring the features of such options into compliance with certain requirements established by Section 409A of the Internal Revenue Code of 1986, as amended (the Code), which was added to the Code by the American Jobs Creation Act of 2004 and governs as a general matter the federal income tax treatment of deferred compensation. The amended options were originally issued in connection with the consummation of the Plan, which occurred on the Effective Date (the 2004 Options). Because the exercise price of such 2004 Options may be considered to have been less than the fair market value of the shares that may be acquired upon exercise of such options as determined by the market trading in such shares following the consummation of the Plan, such options might be subject to the provisions of Section 409A, including certain penalty tax provisions on the option holders.
The amendments in each case reduced the period in which the 2004 Options, once vested, could be exercised from the tenth anniversary of the date of grant to the end of the calendar year in which each option first becomes exercisable. The vesting schedule of the options was not changed and no change was made in the exercise price or other material terms.
In addition, the 2004 Options issued to the Companys Chief Executive Officer, Chief Operating Officer and Chief Financial Officer (the Senior Executives) were also amended to defer until January 5, 2007 the exercisability of all but 137,398 of their options that vest in January 2006. This deferral was agreed upon in connection with the waiver by the Company of the restriction on sale before January 5, 2007 of 413,003 shares held by the Senior Executives, that they had previously acquired upon exercise of a portion of their 2004 Options that vested in January 2005.
In connection with these amendments, the Company agreed to grant new options to option holders, other than the Senior Executives, upon exercise of their 2004 Options. The new options will be in an amount equal to the number of options exercised, will have exercise prices equal to the market price on the date of grant and will vest ratably on each anniversary date over the three years subsequent to grant. Of the remaining 816,848 shares available for future grants under the terms of the 2003 MIP as of June 30, 2006, 682,403 shares are reserved for future issuances of such options, which issuances would occur in 2006, 2007 and 2008 as the 2004 Options vest and are exercised. In the six months ended June 30, 2006, options to purchase 209,388 shares were granted pursuant to these amendments upon exercise of 2004 Options during this period.
Recent Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation (FIN) No. 48, Accounting for Uncertainty in Income TaxesAn Interpretation of FASB Statement No. 109 (FIN 48), which prescribes a minimum recognition threshold and measurement methodology for tax positions taken or expected to be taken in a tax return. FIN 48 will be effective beginning January 1, 2007. The Company has not yet evaluated the impact of implementation of FIN 48 on its consolidated financial statements.
Certain amounts previously reported for the three months and six months ended June 30, 2005 have been reclassified to conform to the presentation of amounts reported for the three months and six months ended June 30, 2006.
Acquisition of National Imaging Associates
On January 31, 2006, the Company acquired all of the outstanding stock of NIA, a privately held radiology benefits management (RBM) firm headquartered in Hackensack, New Jersey, for approximately $121 million in cash, after giving effect to cash acquired in the transaction, and NIA became a wholly owned subsidiary of Magellan.
NIA manages diagnostic imaging services on a non-risk basis for its health plans to ensure that such services are clinically appropriate and cost effective. NIA has approximately 17.9 million covered lives under contract as of June 30, 2006. The Company reports the results of operations of NIA as a separate segment entitled Magellan Radiology Benefits Management (Radiology Benefits Management). See Note FBusiness Segment Information.
The estimated fair values of NIA assets acquired and liabilities assumed at the date of the acquisition are summarized as follows (in thousands):
The purchase price has been allocated based upon the estimated fair value of net assets acquired at the date of acquisition. A portion of the excess purchase price over tangible net assets acquired has been allocated to identified intangible assets totaling $13.5 million, consisting of customer contracts in the amount of $12.6 million, which is being amortized over 10 years, and developed software in the amount of $0.9 million, which is being amortized over 5 years. In addition, the excess of purchase price over tangible net assets and identified intangible assets acquired resulted in $105.6 million of non-tax deductible goodwill.
As a result of the acquisition of NIA, the Company approved an exit plan for certain NIA operations and activities. The Companys plan to exit certain facilities of NIA resulted in assumed liabilities of $0.7 million to terminate an initial estimate of 28 employees and $0.4 million to close excess facilities, which were recorded based on EITF No. 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination. Such assumed liabilities are reflected in Accrued liabilities in the condensed consolidated financial statements. Additional liabilities may be recognized in future periods as the Company completes its analysis of this acquisition. A rollforward of exit plan liabilities assumed is as follows (in thousands):
(1) The estimated costs of employee serverance and termination was adjusted to reflect the net retention of three employees, therefore reducing the number of employees receiving termination benefits to 25.
The results of NIA have been included in the Companys consolidated financial statements since January 31, 2006, the date of acquisition. Had NIAs results of operations been included in the Companys results of operations since January 1, 2006, there would have been no material effect on the Companys consolidated results of operations. The following unaudited supplemental pro forma information represents the Companys consolidated results of operations as if the acquisition of NIA had occurred on January 1, 2005 and after giving effect to certain adjustments including interest income, depreciation and amortization, and stock-based compensation. Such pro forma information does not purport to be indicative of operating results that would have been reported had the acquisition of NIA occurred on January 1, 2005 (in thousands):
Acquisition of ICORE Healthcare, LLC
On June 28, 2006, the Company entered into a definitive agreement to acquire all of the outstanding ownership interests of ICORE Healthcare LLC, (ICORE) a privately held specialty pharmaceutical management firm headquartered in Orlando, Florida. Under the terms of the definitive agreement, the Company will pay a base price of approximately $210 million, before giving effect to cash acquired in the transaction, and may be required to pay a potential earn-out of up to $75 million to the owners of ICORE, all of whom are members of ICOREs management team. The base price is payable in cash of approximately $186 million and, through a reinvestment, in restricted stock of approximately $24 million, which restricted stock will vest fifty percent each on the second and third anniversaries of the date of grant,
provided the individuals do not terminate their employment prior to each such anniversary. The portion of the base price paid in restricted stock will be treated as compensation expense and not as purchase price. Of the cash portion of the purchase price, $25 million will be held back by the Company for three years to cover any indemnity claims under the definitive agreement, and the remaining $161 million, as well as transaction and other related costs, will be paid at closing. The earn-out will be comprised of two parts; up to $25 million based on earnings targets, as defined, for the 18-month period ending December 31, 2007 and up to $50 million based on earnings targets, as defined, in 2008. The earn-out, if earned, is payable 33 percent in cash and 67 percent in restricted stock that will vest over two years after issuance. The earn-out will be paid to the five executives of ICORE, who will become employees of the Company. Upon achieving the targets, the earn-out will only be paid if the individuals remain employees in good standing with the Company. As a result of this requirement, the earn-out payments will be treated as compensation expense and not as additional purchase price.
ICORE works with health plans to manage specialty drugs used in the treatment of cancer, multiple sclerosis, hemophilia, infertility, rheumatoid arthritis, chronic forms of hepatitis and other diseases. ICORE holds contracts with approximately 36 health plans with approximately 60 million covered lives under contract in commercial, Medicare and Medicaid programs at June 30, 2006. The Company will report the results of operations of ICORE as a separate segment entitled Specialty Pharmaceutical Management. All material closing conditions for the transaction involving third parties have been met, and the Company expects that the transaction will be consummated on July 31, 2006.
Information with regard to the Companys long-term debt and capital lease obligations at December 31, 2005 and June 30, 2006 is as follows (in thousands):
The following tables reconcile income (numerator) and shares (denominator) used in the computations of income from continuing operations per common share (in thousands, except per share data):
The weighted average number of common shares outstanding for the three months and six months ended June 30, 2005 and 2006 was calculated using outstanding shares of the Companys Ordinary Common Stock and Multi-Vote Common Stock. Common stock equivalents included in the calculation of diluted weighted average common shares outstanding for the three months and six months ended June 30, 2005 and 2006 represent stock options to purchase shares of the Companys Ordinary Common Stock, restricted stock awards and restricted stock units, and shares of Ordinary Common Stock related to certain warrants issued on the Effective Date.
The Company maintains a program of insurance coverage for a broad range of risks in its business. As part of this program of insurance, the Company is self-insured for a portion of its general, professional and managed care liability risks.
The Company has renewed its general, professional and managed care liability insurance policies with unaffiliated insurers for a one-year period from June 17, 2006 to June 17, 2007. The general liability policies are written on an occurrence basis, subject to a $0.1 million per claim un-aggregated self-insured retention. The professional liability and managed care errors and omissions liability policies are written on a claims-made basis, subject to a $1.0 million per claim ($10.0 million per class action claim) un-aggregated self-insured retention for managed care liability, and a $0.1 million per claim un-aggregated self-insured retention for professional liability. The Company is responsible for claims within its self-insured retentions, including portions of claims reported after the expiration date of the policies if they are not renewed, or if policy limits are exceeded. The Company also purchases excess liability coverage in an amount that management believes to be reasonable for the size and profile of the organization.
The Company is subject to or party to certain litigation and claims relating to its operations and business practices. Except as otherwise provided under the Plan, litigation asserting claims against the Company and its subsidiaries that were parties to the chapter 11 proceedings for pre-petition obligations (the Pre-petition Litigation) was enjoined as of the Effective Date as a consequence of the confirmation of the Plan and may not be pursued over the objection of Magellan or such subsidiary unless relief is provided from the effect of the injunction. The Company believes that the Pre-petition Litigation claims with respect to which distributions have been provided for under the Plan constitute general unsecured claims and, to the extent allowed by the Plan, would be resolved as other general unsecured creditor claims.
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 all known litigation and claims will not have a material adverse effect on the Companys financial position or results of operations; however, there can be no assurance in that regard.
The Company leases certain of its operating facilities. The leases, which expire at various dates through January 2013, generally require the Company to pay all maintenance, property tax and insurance costs.
The Company is engaged in the specialty healthcare management services business. It currently provides managed behavioral healthcare services, and radiology benefits management, and will provide specialty pharmaceutical management as a result of its pending acquisition of ICORE.
The Company provides services to health plans, insurance companies, corporations, labor unions and various governmental agencies. The Companys business is divided into the following five segments, based on the services it provides and/or the customers that it serves, as described below.
Managed Behavioral Healthcare. The Companys Managed Behavioral Healthcare business is composed of three of the Companys segments, each as described further below. This line of business generally reflects the Companys coordination and management of the delivery of behavioral healthcare treatment services that are provided through its contracted network of third-party treatment providers, which includes psychiatrists, psychologists, other behavioral health professionals, psychiatric hospitals, general medical facilities with psychiatric beds, residential treatment centers and other treatment facilities. The treatment services provided through the Companys provider network include outpatient programs (such as counseling or therapy), intermediate care programs (such as intensive outpatient programs and partial hospitalization services), inpatient treatment and crisis intervention services. The Company, however, generally does not directly provide, or own any provider of, treatment services. The Managed Behavioral Healthcare business is managed based on the services provided and/or the customers served, through the following three segments:
Health Plan. The Managed Behavioral Healthcare Health Plan segment (Health Plan) generally reflects managed behavioral healthcare services provided under contracts with managed care companies, health insurers and other health plans. Health Plans contracts encompass both risk-based and administrative services only (ASO) contracts for commercial, Medicaid and Medicare members of the health plan. Although certain health plans provide their own managed behavioral healthcare services, many health plans carve out behavioral healthcare from their general
healthcare services and subcontract such services to managed behavioral healthcare companies such as the Company. In Health Plan, the Companys members are the beneficiaries of the health plan (the employees and dependents of the customer of the health plan), for which the behavioral healthcare services have been carved out to the Company.
Employer. The Managed Behavioral Healthcare Employer segment (Employer) generally reflects the provision of employee assistance program (EAP) services, managed behavioral healthcare services and integrated products under contracts with employers, including corporations and governmental agencies, and labor unions. Employer managed behavioral healthcare services are primarily ASO products.
Public Sector. The Managed Behavioral Healthcare Public Sector segment (Public Sector) generally reflects managed behavioral healthcare services provided to Medicaid recipients under contracts with state and local governmental agencies. Public Sector contracts encompass both risk-based and ASO contracts.
Radiology Benefits Mangagement. The Companys Radiology Benefits Management segment generally reflects the management of diagnostic imaging services on a non-risk basis for health plans to ensure that such services are clinically appropriate and cost effective.
Corporate and Other. This segment of the Company is comprised primarily of operational support functions such as sales and marketing and information technology, as well as corporate support functions such as executive, finance, human resources and legal.
The accounting policies of these segments are the same as those described in Note AGeneralSummary of Significant Accounting Policies. The Company evaluates performance of its segments based on profit or loss from continuing operations before depreciation and amortization, interest expense, interest income, stock compensation expense, gain on sale of assets, income taxes and minority interest (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. Intersegment sales and transfers are not significant. The following tables summarize, for the periods indicated, operating results by business segment (in thousands):