NOTE A—General

Basis of Presentation

The accompanying unaudited consolidated financial statements of Magellan Health, Inc., a Delaware corporation ("Magellan"), include Magellan and its subsidiaries (together with Magellan, the "Company"). The financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the Securities and Exchange Commission's (the "SEC") instructions to Form 10-Q. Accordingly, the financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring adjustments considered necessary for a fair presentation, have been included. The results of operations for the three and nine months ended September 30, 2015 are not necessarily indicative of the results to be expected for the full year. All significant intercompany accounts and transactions have been eliminated in consolidation.

The Company has evaluated subsequent events for recognition or disclosure in the consolidated financial statements filed on this Form 10-Q. Other than as described in Note F—"Subsequent Events," the Company did not have any material events during the period.

These unaudited consolidated financial statements should be read in conjunction with the Company's audited consolidated financial statements for the year ended December 31, 2014 and the notes thereto, which are included in the Company's Annual Report on Form 10-K filed with the SEC on February 26, 2015.

Business Overview

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

Effective as of July 1, 2015, the Company reorganized into two business units—Magellan Healthcare and Magellan Rx Management, which are supported by corporate. As a result of this business reorganization, the Company concluded that changes to its reportable segments were warranted, with the Healthcare segment ("Healthcare") comprised of the operating segments previously defined as the Commercial, Public Sector and the Specialty Solutions segments. Prior period balances have been reclassified to reflect this change. The Company's business is divided into the following segments, which are differentiated based on the services it provides, as described below.

Healthcare

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

The Company's coordination and management of these healthcare services are provided through its comprehensive network of medical and behavioral health professionals, clinics, hospitals and ancillary service providers. This network of credentialed and privileged providers is integrated with clinical and quality improvement programs to improve access to care and enhance the healthcare experience for individuals in need of care, while at the same time making the cost of these services more affordable for our customers. The Company generally does not directly provide or own any provider of treatment services, although it does employ licensed behavioral health counselors to deliver non-medical counseling under certain government contracts.

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

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

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

	Revenue for nine months ended September 30, 2015
	Risk-based		ASO		Total
Commercial
Behavioral(1)	$	245,493	$	93,193	$	338,686
Specialty		353,896		42,162		396,058
Government(2)		1,383,627		51,990		1,435,617

Total	$	1,983,016	$	187,345	$	2,170,361

	Covered lives as of September 30, 2015
	Risk-based		ASO
Commercial
Behavioral(1)		12,815		12,518
Specialty		7,704		16,538
Government(2)		5,059		1,946


(1)	Includes revenues of $36.9 million from EAP services provided on a risk basis to health plans and employers with 10.2 million covered lives.
(2)	Includes revenues of $115.1 million from EAP services provided on a risk basis to federal governmental entities with 3.5 million covered lives.

Pharmacy Management

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

The Company's Pharmacy Management programs are provided under contracts with health plans, employers, Medicaid MCOs, state Medicaid programs, and other government agencies, and encompass risk-based and fee-for-service ("FFS") arrangements. During the nine months ended September 30, 2015, Pharmacy Management paid 13.2 million adjusted commercial network claims in the Company's PBM business. As of September 30, 2015, the Company had a generic dispensing rate of 84.2 percent within its commercial PBM business. In addition, during the nine months ended September 30, 2015, the Company paid 44.2 million adjusted PBA claims and 0.1 million specialty dispensing claims. Adjusted claim totals apply a multiple of three for each 90-day and traditional mail claim. In addition, as of September 30, 2015, Pharmacy Management served 1.6 million commercial PBM members, 9.8 million members in its medical pharmacy management programs, and 25 states and the District of Columbia in its PBA business.

Corporate

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.

Summary of Significant Accounting Policies

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, "Revenue from Contracts with Customers (Topic 606)" ("ASU 2014-09"), which is a new comprehensive revenue recognition standard that will supersede virtually all existing revenue guidance under GAAP. In July 2015, the FASB approved to defer the effective date of ASU 2014-09. This ASU is now effective for calendar years beginning after December 15, 2017. The Company is currently assessing the potential impact this ASU will have on the Company's consolidated results of operations, financial position, and cash flows.

In June 2014, the FASB issued ASU No. 2014-12, "Compensation—Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved After the Requisite Service Period" ("ASU 2014-12"), which revises the accounting treatment for stock compensation tied to performance targets. This ASU is effective for calendar years beginning after December 15, 2015. The guidance is not expected to materially impact the Company's consolidated results of operations, financial position, or cash flows.

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

In February 2015, the FASB issued ASU No. 2015-02, "Amendments to the Consolidation Analysis" ("ASU 2015-02"), which amends certain requirements for determining whether a variable interest entity must be consolidated. The amendments are effective for annual and interim reporting periods of public entities beginning after December 31, 2015. The guidance is not expected to materially impact the Company's consolidated results of operations, financial position, or cash flows.

In April 2015, the FASB issued ASU No. 2015-03, "Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs" ("ASU 2015-03"). The amendments in this ASU require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. This guidance is effective for annual and interim reporting periods of public entities beginning after December 15, 2015. The guidance is not expected to materially impact the Company's consolidated results of operations, financial position, or cash flows.

In April 2015, the FASB issued ASU No. 2015-05, "Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer's Accounting for Fees Paid in a Cloud Computing Arrangement" ("ASU 2015-05"), which provides guidance to clarify the customer's accounting for fees paid in a cloud computing arrangement. This guidance is effective for annual and interim reporting periods of public entities beginning after December 15, 2015. The guidance is not expected to materially impact the Company's consolidated results of operations, financial position, or cash flows.

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

In September 2015, the FASB issued ASU No. 2015-16, "Business Combinations (Topic 805): Simplifying the Accounting for Measurement Period Adjustments" ("ASU 2015-16"). The amendment under this ASU requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. This guidance is effective for annual and interim reporting periods of public entities beginning after December 15, 2015. The guidance is not expected to materially impact the Company's consolidated results of operations, financial position, or cash flows.

Use of Estimates

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

Managed Care and Other Revenue

Managed Care Revenue. Managed care revenue, inclusive of revenue from the Company's risk, EAP and ASO contracts, is recognized over the applicable coverage period on a per member basis for covered members. The Company is paid a per member fee for all enrolled members, and this fee is recorded as revenue in the month in which members are entitled to service. The Company adjusts its revenue for retroactive membership terminations, additions and other changes, when such adjustments are identified, with the exception of retroactivity that can be reasonably estimated. The impact of retroactive rate amendments is generally recorded in the accounting period that terms to the amendment are finalized, and that the amendment is executed. Any fees paid prior to the month of service are recorded as deferred revenue. Managed care revenues approximated $611.4 million and $1,935.0 million for the three and nine months ended September 30, 2014, respectively, and $689.5 million and $2,004.4 million for the three and nine months ended September 30, 2015, respectively.

Fee-For-Service and Cost-Plus Contracts. The Company has certain fee-for-service contracts, including cost-plus contracts, with customers under which the Company recognizes revenue as services are performed and as costs are incurred. This includes revenues received in relation to the Patient Protection and Affordable Care Act health insurer fee ("HIF fee") billed on a cost reimbursement basis. Revenues from these contracts approximated $72.9 million and $205.6 million for the three and nine months ended September 30, 2014, respectively, and $85.1 million and $248.7 million for the three and nine months ended September 30, 2015, respectively.

Block Grant Revenues. The Maricopa Contract (as defined below) was partially funded by federal, state and county block grant money, which represented annual appropriations. The Company recognized revenue from block grant activity ratably over the period to which the block grant funding applied. Block grant revenues were approximately $0.0 million and $33.3 million for the three and nine months ended September 30, 2014, respectively. The Maricopa Contract terminated on March 31, 2014.

Performance-Based Revenue. 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 may be recognized on an interim basis pursuant to the rights and obligations of each party upon termination of the contracts. Performance-based revenues approximated $1.6 million and $7.0 million, respectively, for the three and nine months ended September 30, 2014, respectively, and $4.4 million and $10.1 million for the three and nine months ended September 30, 2015, respectively.

Rebate Revenue. The Company administers a rebate program for certain clients through which the Company coordinates the achievement, calculation and collection of rebates and administrative fees from pharmaceutical manufacturers on behalf of clients. Each period, the Company estimates the total rebates earned based on actual volumes of pharmaceutical purchases by the Company's clients, as well as historical and/or anticipated sharing percentages. The Company earns fees based upon the volume of rebates generated for its clients. The Company does not record as rebate revenue any rebates that are passed through to its clients. Total rebate revenues approximated $14.3 million and $27.6 million for the three and nine months ended September 30, 2014, respectively, and $23.5 million and $56.3 million for the three and nine months ended September 30, 2015, respectively.

In relation to the Company's PBM business, the Company administers rebate programs through which it receives rebates from pharmaceutical manufacturers that are shared with its customers. The Company recognizes rebates when the Company is entitled to them and when the amounts of the rebates are determinable. The amount recorded for rebates earned by the Company from the pharmaceutical manufacturers is recorded as a reduction of cost of goods sold.

PBM and Dispensing Revenue

Pharmacy Benefit Management Revenue. The Company recognizes PBM revenue, which consists of a negotiated prescription price (ingredient cost plus dispensing fee), co-payments collected by the pharmacy and any associated administrative fees, when claims are adjudicated. The Company recognizes PBM revenue on a gross basis (i.e. including drug costs and co-payments) as it is acting as the principal in the arrangement and is contractually obligated to its clients and network pharmacies, which is a primary indicator of gross reporting. In addition, the Company is solely responsible for the claims adjudication process, negotiating the prescription price for the pharmacy, collection of payments from the client for drugs dispensed by the pharmacy, and managing the total prescription drug relationship with the client's members. If the Company enters into a contract where it is only an administrator, and does not assume any of the risks previously noted, revenue will be recognized on a net basis. PBM revenues approximated $155.7 million and $383.2 million for the three and nine months ended September 30, 2014, respectively, and $327.1 million and $842.9 million for the three and nine months ended September 30, 2015, respectively.

Dispensing Revenue. The Company recognizes dispensing revenue, which includes the co-payments received from members of the health plans the Company serves, when the specialty pharmaceutical drugs are shipped. At the time of shipment, the earnings process is complete; the obligation of the Company's customer to pay for the specialty pharmaceutical drugs is fixed, and, due to the nature of the product, the member may neither return the specialty pharmaceutical drugs nor receive a refund. Revenues from the dispensing of specialty pharmaceutical drugs on behalf of health plans were $64.5 million and $179.6 million for the three and nine months ended September 30, 2014, respectively, and $53.7 million and $151.6 million for the three and nine months ended September 30, 2015, respectively.

Significant Customers

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

The Company provides behavioral healthcare management and other related services to members in the state of Iowa pursuant to contracts with the State of Iowa (the "Iowa Contracts"). The Company currently has two contracts; the Iowa Medicaid Contract and Iowa Medicaid Integrated Health Home Provider Agreement ("IHH Agreement"). Under the Iowa Medicaid Contract, the Company is responsible for providing managed mental health and substance abuse treatment to enrollees under a Medicaid 1915(b) waiver, as well as substance abuse treatment services plan funded by federal block grant and state appropriations under the authority of the Iowa Department of Public Health. The Iowa Health and Wellness Plan for members who qualify as an "exempt individual", as defined in 441 of the Iowa Administrative Code, were also added to the contract on January 1, 2014. The latest Iowa Medicaid Contract began on January 1, 2010 and extended through June 30, 2015. The Iowa Department of Human Services and the Iowa Department of Public Health has the right to terminate the Iowa Medicaid Contract upon 30 days notice for any reason or no reason at all. In June 2015, the Company received a notice of intent to extend the Iowa Medicaid Contract through December 31, 2015, to coincide with the start date of the new Iowa High Quality Healthcare Initiative, as discussed below. Under the IHH Agreement, the Company establishes a health home for individuals identified with serious and persistent mental illness through enrolled provider organizations capable of providing enhanced care. The IHH Agreement began on July 1, 2013 and extends through June 30, 2016 unless sooner terminated by either party with 60 days notice for any reason or no reason at all. The IHH program is part of the new Iowa High Quality Healthcare Initiative and we expect that the end of the IHH agreement will coincide with the start date of the new initiative. The Iowa Contracts generated net revenues of $337.9 million and $394.8 million for the nine months ended September 30, 2014 and 2015, respectively.

On February 16, 2015 the Iowa Department of Human Services (the "Agency") released the Iowa High Quality Healthcare Initiative Request for Proposal ("RFP"). The RFP includes the services provided by the Company's current Iowa Contracts. On August 17, 2015, the Company was notified that it was not selected as a winning bidder by the Agency for the RFP.

The Company provides behavioral healthcare management and other related services to members in the state of Florida pursuant to contracts with the State of Florida (the "Florida Contracts"). The Company had behavioral healthcare contracts with various areas in the State of Florida (the "Florida Areas") which were part of the Florida Medicaid program. The State of Florida implemented a new system of mandated managed care through which Medicaid enrollees receive integrated healthcare services, and in 2014 phased out the behavioral healthcare programs under which the Florida Areas' contracts operated. The Company has a contract with the State of Florida to provide integrated healthcare services under the new program ("the Florida Medicaid Contract"). The Florida Medicaid Contract began on February 4, 2014 and extends through December 31, 2018, unless sooner terminated by the parties. The State of Florida has the right to terminate the Florida Medicaid Contract with cause, as defined, upon 24 hour notice and upon 30 days notice for any reason or no reason at all. The Florida Contracts generated net revenues of $143.9 million and $324.1 million for the nine months ended September 30, 2014 and 2015, respectively.

Through March 31, 2014, the Company provided behavioral healthcare management and other related services to approximately 680,000 members in Maricopa County, Arizona as the Regional Behavioral Health Authority ("RBHA") for GSA6 ("Maricopa County") pursuant to a contract with the State of Arizona (the "Maricopa Contract"). The Maricopa Contract was for the management of the publicly funded behavioral health system that delivered mental health, substance abuse and crisis services for adults, youth, and children. The Maricopa Contract terminated on March 31, 2014. The Maricopa Contract generated net revenues of $213.3 million for the nine months ended September 30, 2014.

Customers exceeding ten percent of segment net revenues

In addition to the Iowa Contracts, the Florida Contracts, and the Maricopa Contract previously discussed, the following customers generated in excess of ten percent of net revenues for the respective segment for the nine months ended September 30, 2014 and 2015 (in thousands):

Segment	Term Date	2014		2015
Healthcare
None
Pharmacy Management
Customer A	November 30, 2015 to April 4, 2016(1)		92,793		93,908	*
Customer B	December 16, 2016		105,079		241,556


*	Revenue amount did not exceed ten percent of net revenues for the respective segment for the period presented. Amount is shown for comparative purposes only.
(1)	The customer has more than one contract. The individual contracts are scheduled to terminate at various points during the time period indicated above.

Concentration of Business

The Company also has a significant concentration of business with various counties in the State of Pennsylvania (the "Pennsylvania Counties") which are part of the Pennsylvania Medicaid program. Net revenues from the Pennsylvania Counties in the aggregate totaled $272.0 million and $294.9 million for the nine months ended September 30, 2014 and 2015, respectively.

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

Fair Value Measurements

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

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

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

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

In accordance with the fair value hierarchy described above, the following table shows the fair value of the Company's assets and liabilities that are required to be measured at fair value as of December 31, 2014 and September 30, 2015 (in thousands):

	December 31, 2014
	Level 1		Level 2		Level 3		Total
Assets
Cash and cash equivalents(1)	$	—	$	139,280	$	—	$	139,280
Restricted cash(2)		—		65,992		—		65,992
Investments:
U.S. government and agency securities		4,303		—		—		4,303
Obligations of government-sponsored enterprises(3)		—		15,315		—		15,315
Corporate debt securities		—		246,886		—		246,886
Certificates of deposit		—		1,150		—		1,150

Total assets held at fair value	$	4,303	$	468,623	$	—	$	472,926


Liabilities
Contingent consideration	$	—	$	—	$	58,153	$	58,153

Total liabilities held at fair value	$	—	$	—	$	58,153	$	58,153

	September 30, 2015
	Level 1		Level 2		Level 3		Total
Assets
Cash and cash equivalents(4)	$	—	$	45,091	$	—	$	45,091
Restricted cash(5)		—		61,220		—		61,220
Investments:
U.S. government and agency securities		4,982		—		—		4,982
Obligations of government-sponsored enterprises(6)		—		43,067		—		43,067
Corporate debt securities		—		321,606		—		321,606
Certificates of deposit		—		1,150		—		1,150

Total assets held at fair value	$	4,982	$	472,134	$	—	$	477,116


Liabilities
Contingent consideration	$	—	$	—	$	108,443	$	108,443

Total liabilities held at fair value	$	—	$	—	$	108,443	$	108,443


(1)	Excludes $116.0 million of cash held in bank accounts by the Company.
(2)	Excludes $149.3 million of restricted cash held in bank accounts by the Company.
(3)	Includes investments in notes issued by the Federal Home Loan Bank.
(4)	Excludes $51.8 million of cash held in bank accounts by the Company.
(5)	Excludes $74.1 million of restricted cash held in bank accounts by the Company.
(6)	Includes investments in notes issued by the Federal Home Loan Bank and Federal Farm Credit Banks.

For the nine months ended September 30, 2015, the Company has not transferred any assets between fair value measurement levels.

The carrying values of financial instruments, including accounts receivable and accounts payable, approximate their fair values due to their short-term maturities. The estimated fair value of the Company's term loan of $237.5 million as of September 30, 2015 was based on current interest rates for similar types of borrowings and is in Level 2 of the fair value hierarchy. The estimated fair values may not represent actual values of the financial instruments that could be realized as of the balance sheet date or that will be realized in the future.

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

The contingent consideration liability reflects the fair value of potential future payments related to the CDMI, LLC ("CDMI"), Cobalt Therapeutics, LLC ("Cobalt"), and 4D Pharmacy Management Systems, Inc. ("4D") acquisitions. The CDMI purchase agreement provides for potential contingent payments up to a maximum aggregate amount of $165.0 million. The potential future payments are contingent upon CDMI meeting certain client retention, client conversion, and gross profit milestones through December 31, 2016. The Cobalt purchase agreement provides for potential contingent payments up to a maximum aggregate amount of $6.0 million. The potential future payments are contingent upon engagement of new members and new contract execution through June 30, 2017. The 4D purchase agreement provides for potential contingent payments up to a maximum aggregate amount of $30.0 million. The potential future payments are contingent upon the achievement of certain growth targets in the underlying dual eligible membership served by 4D during calendar year 2015 and retention of certain business through 2018.

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

For CDMI, the following unobservable inputs were used in the fair value measurement of contingent consideration: (i) discount rate of approximately 0.33 percent to 14.5 percent; (ii) probabilities of payment for the individual components of the contingent consideration arrangement of approximately zero to 100 percent; and (iii) projected payment dates of 2016 to 2017. For CDMI, the Company estimated undiscounted future contingent payments of $65.7 million and $90.4 million as of December 31, 2014 and September 30, 2015, respectively. The net increase is due to changes in operational forecasts and probabilities of payment of $34.6 million, partially offset by a decrease of $9.9 million due to payments. As of September 30, 2015, the fair value of the short term and long term contingent consideration for CDMI was $89.8 million and $0.3 million, respectively.

For Cobalt, the following unobservable inputs were used in the fair value measurement of contingent consideration: (i) discount rate of approximately 14.5 percent; (ii) probabilities of payment for the individual components of the contingent consideration arrangement of approximately zero to 50 percent; and (iii) projected payment dates of 2016 to 2017. For Cobalt, the Company estimated undiscounted future contingent payments of $4.2 million and $2.7 million as of December 31, 2014 and September 30, 2015, respectively. The decrease is due to changes in operational forecasts and probabilities of payment of $1.2 million and payments of $0.3 million. As of September 30, 2015, the fair value of the short term and long term contingent consideration for Cobalt was $1.0 million and $1.3 million, respectively.

For 4D, the following unobservable inputs were used in the fair value measurement of contingent consideration: (i) discount rate of approximately 11.0 percent; (ii) probabilities of payment for the individual components of the contingent consideration arrangement of approximately 5 to 100 percent; and (iii) projected payment dates of 2015 to 2016. For 4D, the Company estimated undiscounted future contingent payments of $20.6 million and $16.4 million as of the acquisition date and September 30, 2015, respectively. The net $4.2 million decrease is due to payments of $6.0 million, partially offset by a net increase of $1.8 million, mainly due to changes in operational forecasts and probabilities of payment. As of September 30, 2015, the fair value of the short term contingent consideration for 4D was $16.0 million.

As of September 30, 2015, the fair value of the short term and long term contingent consideration was $106.8 million and $1.6 million, respectively, and is included in accrued liabilities and contingent consideration, respectively, in the consolidated balance sheets. The change in the fair value of the contingent consideration was $29.7 million and $47.3 million for the three and nine months ended September 30, 2015, respectively, which was recorded as direct service costs and other operating expenses in the consolidated statements of income (loss). The increase was mainly a result of changes in the present value and estimated undiscounted liability, as noted above.

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

	September 30, 2015
Balance as of beginning of period	$	58,153
Acquistion of 4D		19,290
Change in fair value		47,274
Payments		(16,274	)

Balance as of end of period	$	108,443

Cash and Cash Equivalents

Cash and cash equivalents include cash on hand and at banks, short-term deposits with an original maturity of three months or less with financial institutions. Bank overdrafts are reflected within accounts payable on the balance sheets. Bank overdrafts for the nine months ended September 30, 2014 and 2015 are $0.0 million and $28.5 million, respectively.

Investments

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

As of December 31, 2014 and September 30, 2015, there were no unrealized losses that the Company determined to be other-than-temporary. No realized gains or losses were recorded for the nine months ended September 30, 2014 or 2015. The following is a summary of short-term and long-term investments at December 31, 2014 and September 30, 2015 (in thousands):

	December 31, 2014
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
U.S. government and agency securities	$	4,305	$	—	$	(2	)	$	4,303
Obligations of government-sponsored enterprises(1)		15,318		1		(4	)		15,315
Corporate debt securities		247,118		8		(240	)		246,886
Certificates of deposit		1,150		—		—			1,150

Total investments at December 31, 2014	$	267,891	$	9	$	(246	)	$	267,654

	September 30, 2015
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
U.S. government and agency securities	$	4,976	$	6	$	—		$	4,982
Obligations of government-sponsored enterprises(2)		43,045		25		(3	)		43,067
Corporate debt securities		321,817		24		(235	)		321,606
Certificates of deposit		1,150		—		—			1,150

Total investments at September 30, 2015	$	370,988	$	55	$	(238	)	$	370,805


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

The maturity dates of the Company's investments as of September 30, 2015 are summarized below (in thousands):

	Amortized Cost		Estimated Fair Value
2015	$	110,723	$	110,679
2016		258,579		258,439
2017		1,686		1,687

Total investments at September 30, 2015	$	370,988	$	370,805

Income Taxes

The Company's effective income tax rates were 34.3 percent and 43.5 percent for the nine months ended September 30, 2014 and 2015, respectively. These rates differ from the federal statutory income tax rate primarily due to state income taxes, permanent differences between book and tax income, and changes to recorded tax contingencies and valuation allowances. The Company also accrues interest and penalties related to uncertain tax positions in its provision for income taxes. The effective income tax rate for the nine months ended September 30, 2015 is higher than the effective rate for the nine months ended September 30, 2014 mainly due to fewer reversals of tax contingencies in the current year from the closure of statutes of limitation, and a more significant relative impact in the current year from the non-deductible HIF fees due to lower overall income.

The Company files a consolidated federal income tax return with most of its eighty-percent or more controlled subsidiaries. The Company files a separate consolidated federal income tax return for AlphaCare of New York, Inc. ("AlphaCare") and its parent, AlphaCare Holdings, Inc. ("AlphaCare Holdings"). The Company and its subsidiaries also file income tax returns in various state and local jurisdictions. The Company is no longer subject to federal income tax assessments for years ended prior to 2012 or, with few exceptions, to state or local income tax assessments for years ended prior to 2010. Further, the statutes of limitation regarding the assessment of 2011 federal and certain state and local income taxes expired during the current quarter. As a result, $1.7 million of tax contingency reserves recorded as of December 31, 2014 were reversed in the current quarter, of which $1.2 million is reflected as a discrete reduction to income tax expense and $0.5 million as a decrease to deferred tax assets. Additionally, $0.1 million of accrued interest was reversed in the current quarter and reflected as a reduction to income tax expense due to the closing of statutes of limitation on tax assessments.

Net Operating Loss Carryforwards

The Company has $3.0 million of federal net operating loss carryforwards ("NOLs") available to reduce its federal consolidated taxable income in 2015 and subsequent years. These NOLs will expire in 2018 and 2019 if not used and are subject to examination and adjustment by the Internal Revenue Service ("IRS"). AlphaCare has $26.2 million of federal NOLs available to reduce its consolidated taxable income in 2015 and subsequent years. These NOLs will expire in 2033 and 2034 if not used and are subject to examination and adjustment by the IRS. The Company and its subsidiaries also have $144.7 million of state NOLs available to reduce state taxable income at certain subsidiaries in 2015 and subsequent years. Most of these state NOLs will expire in 2017 through 2034 if not used and are subject to examination and adjustment by the respective state tax authorities.

Deferred tax assets as of December 31, 2014 and September 30, 2015 are shown net of valuation allowances of $12.4 million and $12.9 million, respectively. These valuation allowances mostly relate to uncertainties regarding the eventual realization of the AlphaCare federal NOLs and certain state NOLs. Determination of the amount of deferred tax assets considered realizable requires significant judgment and estimation regarding the forecasts of future taxable income which are consistent with the plans and estimates the Company uses to manage the underlying businesses. Although consideration is also given to potential tax planning strategies which might be available to improve the realization of deferred tax assets, none were identified which were both prudent and reasonable. Future changes in the estimated realizable portion of deferred tax assets could materially affect the Company's financial condition and results of operations.

Health Care Reform

The Patient Protection and the Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively, the "Health Reform Law"), imposes a mandatory annual fee on health insurers for each calendar year beginning on or after January 1, 2014. The Company has obtained rate adjustments from customers which the Company expects will cover the direct costs of these fees and the impact from non-deductibility of such fees for federal and state income tax purposes. To the extent the Company has such a customer that does not renew, there may be some impact due to taxes paid where the timing and amount of recoupment of these additional costs is uncertain. In the event the Company is unable to obtain rate adjustments to cover the financial impact of the annual fee, the fee may have a material impact on the Company. For 2014 and 2015, the HIF fees were $21.4 million and $26.5 million, respectively, which have been paid. Of these amounts, $5.4 million and $16.1 million was expensed in the three and nine months ended September 30, 2014, respectively, and $6.7 million and $19.9 million was expensed in the three and nine months ended September 30, 2015, respectively, which was included in direct service costs and other operating expenses in the consolidated statements of income (loss). The Company recorded revenues of $8.8 million and $22.9 million in the three and nine months ended September 30, 2014, respectively, and $11.6 million and $34.0 million in the three and nine months ended September 30, 2015, respectively, associated with the accrual for the reimbursement of the economic impact of the HIF fees from its customers.

Stock Compensation

At December 31, 2014 and September 30, 2015, the Company had equity-based employee incentive plans, which are described more fully in Note 6 in the Company's Annual Report on Form 10-K for the year ended December 31, 2014, with the exception of the Performance-Based Restricted Stock Units ("PSUs") issued during the nine months ended September 30, 2015, which are described below. The Company recorded stock compensation expense of $11.9 million and $26.0 million for the three and nine months ended September 30, 2014 and $12.9 million and $40.6 million for the three and nine months ended September 30, 2015, respectively. Stock compensation expense recognized in the consolidated statements of income (loss) for the nine months ended September 30, 2014 and 2015 has been reduced for forfeitures, estimated at between zero and four percent for both periods.

The weighted average grant date fair value of all stock options granted during the nine months ended September 30, 2015 was $13.91 as estimated using the Black-Scholes-Merton option pricing model, which also assumed an expected volatility of 25.03 percent based on the historical volatility of the Company's stock price.

The benefits of tax deductions in excess of recognized stock compensation expense are reported as a financing cash flow, rather than as an operating cash flow. In the nine months ended September 30, 2014 and 2015, $2.8 million and $3.9 million, respectively, of benefits of such tax deductions related to stock compensation expense were realized and as such were reported as financing cash flows. For the nine months ended September 30, 2014, the net change to additional paid in capital related to tax benefits (deficiencies) was $2.5 million, which includes $2.8 million of excess tax benefits offset by $(0.3) million of excess tax deficiencies. For the nine months ended September 30, 2015, the net change to additional paid in capital related to tax benefits (deficiencies) was $3.8 million, which includes $3.9 million of excess tax benefits offset by $(0.1) million of excess tax deficiencies.

Summarized information related to the Company's stock options for the nine months ended September 30, 2015 is as follows:

	Options			Weighted Average Exercise Price
Outstanding, beginning of period		3,321,063		$	50.58
Granted		902,928			63.61
Forfeited		(140,940	)		60.21
Exercised		(1,062,878	)		47.17

Outstanding, end of period		3,020,173		$	55.23


Vested and expected to vest at end of period		2,983,943		$	55.15


Exercisable, end of period		1,417,576		$	49.46

All of the Company's options granted during the nine months ended September 30, 2015 vest ratably on each anniversary date over the three years subsequent to grant and have a ten year life.

Summarized information related to the Company's nonvested restricted stock awards ("RSAs") for the nine months ended September 30, 2015 is as follows:

	Shares			Weighted Average Grant Fair Value
Outstanding, beginning of period		1,626,827		$	57.66
Awarded		20,115			67.12
Vested		(94,547	)		57.48
Forfeited		—			—

Outstanding, end of period		1,552,395		$	57.79

Summarized information related to the Company's nonvested restricted stock units ("RSUs") for the nine months ended September 30, 2015 is as follows:

	Shares			Weighted Average Grant Fair Value
Outstanding, beginning of period		156,695		$	54.88
Awarded		172,810			63.95
Vested		(79,036	)		52.82
Forfeited		(21,144	)		61.65

Outstanding, end of period		229,325		$	61.80

The vesting period for RSAs ranges from 12 months to 42 months. In general, RSUs vest ratably on each anniversary over the three years subsequent to grant. In addition, the RSUs outstanding at the beginning of the period contain associated performance hurdle(s) that must be met in order for the awards to vest. The RSUs granted during the nine months ended September 30, 2015 do not contain associated performance hurdles.

During the nine months ended September 30, 2015, the Company granted 43,900 PSUs to members of management. During the nine months ended September 30, 2015, 3,906 of the PSUs awarded were forfeited. The PSUs are subject to market-based conditions. The estimated fair value of the PSUs granted was $85.00, which was derived from a Monte Carlo simulation. Significant assumptions utilized in estimating the value of the awards granted include an expected dividend yield of 0%, a risk free rate of 1%, and expected volatility of 15% to 52% (average of 28%). The PSUs will entitle the grantee to receive a number of shares of the Company's Common Stock determined over a three-year performance period ending on December 31, 2017 and vesting on March 4, 2018, the settlement date, provided the grantee remains in the service of the Company on the settlement date. The Company expenses the cost of these awards ratably over the requisite service period. The number of shares for which the PSUs will be settled will be a percentage of shares for which the award is targeted and will depend on the Company's Total Shareholder Return (as defined below), expressed as a percentile ranking of the Company's Total Shareholder Return as compared to the Company's Peer Group (as defined below). The number of shares for which the PSUs will be settled vary from zero to 200 percent of the shares specified in the grant. Total Shareholder Return is determined by dividing the average share value of the Company's Common Stock over the 30 trading days preceding January 1, 2018 by the average share value of the Company's Common Stock over the 30 trading days beginning on January 1, 2015, with a deemed reinvestment of any dividends declared during the performance period. The Company's Peer Group includes 54 companies which comprise the S&P Health Care Services Industry Index, which was selected by the Compensation Committee of the Company's Board of Directors and includes a range of healthcare companies operating in several business segments.

Long Term Debt and Capital Lease Obligations

On July 23, 2014, the Company entered into a $500.0 million Credit Agreement with various lenders that provides for Magellan Rx Management, Inc. (a wholly owned subsidiary of Magellan Health, Inc.) to borrow up to $250.0 million of revolving loans, with a sublimit of up to $70.0 million for the issuance of letters of credit for the account of the Company, and a term loan in an original aggregate principal amount of $250.0 million (the "2014 Credit Facility"). The 2014 Credit Facility is guaranteed by substantially all of the non-regulated subsidiaries of the Company and will mature on July 23, 2019, but the Company holds an option to extend the 2014 Credit Facility for an additional one year period.

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

On September 30, 2014, the Company completed a draw-down of the $250.0 million term loan. The borrowings will initially be maintained as a Eurodollar loan. The term loan is subject to certain quarterly amortization payments. As of September 30, 2015 the remaining balance on the term loan was $237.5 million. The term loan will mature on July 23, 2019. As of September 30, 2015, the term loan bore interest at a rate of 1.50 percent plus the London Interbank Offered Rate ("LIBOR"), which was equivalent to a total interest rate of 1.6936 percent. For the nine months ended September 30, 2015, the weighted average interest rate was 1.6813 percent. As of September 30, 2015, the contractual maturities of the term loan were as follows: 2015—$3.1 million; 2016—$15.6 million; 2017—$25.0 million; 2018—$25.0 million; and 2019—$168.8 million.

There were $24.6 million and $24.8 million of capital lease obligations at December 31, 2014 and September 30, 2015, respectively. The Company had $32.9 million and $33.4 million of letters of credit outstanding at December 31, 2014 and September 30, 2015, respectively, and no revolving loan borrowings at December 31, 2014 or September 30, 2015.

Redeemable Non-Controlling Interest

As of September 30, 2015 the Company held an 82% equity interest in AlphaCare Holdings. The other shareholders of AlphaCare Holdings have the right to exercise put options, requiring the Company to purchase up to 50% of the remaining shares prior to January 1, 2017 provided certain membership levels are attained. After December 31, 2016 the other shareholders of AlphaCare Holdings have the right to exercise put options requiring the Company to purchase all or any portion of the remaining shares. In addition, after December 31, 2016 the Company has the right to purchase all remaining shares. Non-controlling interests with redemption features, such as put options, that are not solely within the Company's control are considered redeemable non-controlling interests. Redeemable non-controlling interest is considered to be temporary and is therefore reported in a mezzanine level between liabilities and stockholders' equity on the Company's consolidated balance sheet at the greater of the initial carrying amount adjusted for the non-controlling interest's share of net income or loss or its redemption value. The carrying value of the non-controlling interest as of December 31, 2014 and September 30, 2015 was $5.9 million and $8.2 million, respectively. The $2.3 million increase in carrying value is a result of the impact of additional capital provided by the Company, partially offset by operating losses. The Company recognizes changes in the redemption value on a quarterly basis and adjusts the carrying amount of the non-controlling interest to equal the redemption value at the end of each reporting period. Under this method, this is viewed at the end of the reporting period as if it were also the redemption date for the non-controlling interest. The Company will reflect redemption value adjustments in the earnings per share calculation if redemption value is in excess of the carrying value of the non-controlling interest. As of September 30, 2015, the carrying value of the non-controlling interest exceeded the redemption value and therefore no adjustment to the carrying value was required.

Reclassifications

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