UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the fiscal year ended | |
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.
(Exact name of registrant as specified in its charter)
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Registrant’s telephone number, including area code: (
Securities registered pursuant to Section 12(b) of the Act:
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Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ☐
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.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “accelerated filer,” “large accelerated filer”, “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
☒ | Accelerated filer ☐ | Non-accelerated filer ☐ | Smaller reporting company Emerging growth company |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C.7262(b)) by the registered public accounting firm that prepared or issued its audit report.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
The aggregate market value of the Common Stock (“common stock”) held by non-affiliates of the registrant based on the closing price on June 30, 2020 (the last business day of the registrant’s most recently completed second fiscal quarter) was approximately $
The number of shares of Magellan Health, Inc.’s common stock outstanding as of February 19, 2021 was
DOCUMENTS INCORPORATED BY REFERENCE
Unless earlier included in an amendment to this Form 10-K, portions of the definitive proxy statement for the 2021 Annual Meeting of Shareholders are incorporated by reference into Part III of this Form 10-K.
MAGELLAN HEALTH, INC.
REPORT ON FORM 10-K
For the Fiscal Year Ended December 31, 2020
Table of Contents
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Management’s Discussion and Analysis of Financial Condition and Results of Operations | 33 | |||
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Changes in and Disagreements with Accountants on Accounting and Financial Disclosure | 50 | |||
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Item 10. | Directors and Executive Officers of the Registrant | 55 | ||
Item 11. | Executive Compensation | 55 | ||
Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters | 55 | ||
Item 13. | Certain Relationships and Related Transactions and Director Independence | 55 | ||
Item 14. | Principal Accounting Fees and Services | 55 | ||
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PART I
Cautionary Statement Concerning Forward-Looking Statements
This Form 10-K includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Examples of forward-looking statements include, but are not limited to, statements the Company (as defined below) makes regarding our future operating results and liquidity needs. Although the Company believes that its plans, intentions and expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such plans, intentions or expectations will be achieved. Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements. Important factors currently known to management that could cause actual results to differ materially from those in forward-looking statements are set forth under the heading “Risk Factors” in Item 1A and elsewhere in this Form 10-K. When used in this Form 10-K, the words “estimate,” “anticipate,” “expect,” “believe,” “should” and similar expressions are intended to be forward-looking statements.
Any forward-looking statement made by the Company in this Form 10-K speaks only as of the date on which it is made. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for the Company to predict all of them. The Company undertakes no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.
You should also be aware that while the Company from time to time communicates with securities analysts, the Company does not disclose to them any material non-public information, internal forecasts or other confidential business information. Therefore, to the extent that reports issued by securities analysts contain projections, forecasts or opinions, those reports are not the Company’s responsibility and are not endorsed by the Company. You should not assume that the Company agrees with any statement or report issued by any analyst, irrespective of the content of the statement or report.
Item 1. Business
Magellan Health, Inc. (“Magellan”) provides managed care services for some of the most complex areas of healthcare. The Company offers innovative solutions that combine analytics, technology and clinical rigor to drive better decision making, positively impact members’ health outcomes and optimize the cost of care for the customers Magellan serves. The Company provides services to health plans and other managed care organizations (“MCOs”), employers, labor unions, various military and governmental agencies and third-party administrators (“TPAs”). Magellan operates three segments: Healthcare, Pharmacy Management and Corporate. In this report, references to “we”, “us”, “our” and the “Company” include Magellan and its subsidiaries. Magellan was incorporated in 1969 under the laws of the State of Delaware.
Business Developments
Sale of the MCC Business
On December 31, 2020, we completed the sale of our Magellan Complete Care business (the “MCC Business”) to Molina Healthcare, Inc. (“Molina”), pursuant to a Stock and Asset Purchase Agreement, dated as of April 30, 2020, by and between the Company and Molina, for cash in the amount of $850 million plus closing adjustments of $158 million (subject to post-closing adjustments, if any), and the assumption by Molina of liabilities of the MCC Business (the “MCC Sale”). The MCC Business was the Company’s business of contracting with state Medicaid agencies and the U.S. Centers for Medicare and Medicaid Services to manage total medical benefits or long-term support services for Medicaid and dual eligible Medicaid and Medicare populations.
Pending Merger with Centene Corporation
On January 4, 2021, the Company and Centene Corporation (“Centene”) entered into an Agreement of Plan of Merger (the “Merger Agreement”) by and among the Company, Centene, and Mayflower Merger Sub, Inc., a Delaware
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corporation and a wholly owned subsidiary of Centene (“Merger Sub”), pursuant to which, subject to the terms and conditions set forth therein, Merger Sub will merge with and into the Company, with the Company surviving such merger (the “Merger”) as a wholly-owned subsidiary of Centene. Pursuant to the Merger Agreement, each issued and outstanding share of the Company’s common stock will be automatically canceled and converted into the right to receive $95.00 in cash. The Company expects to complete the transaction in the second half of 2021.
The Merger has been approved by both the Company’s board of directors and the board of directors of Centene. The completion of the Merger is subject to customary closing conditions, including, among others, the required approval of Magellan’s stockholders and the receipt of various regulatory approvals. For additional information on the Merger Agreement and the Merger, please refer to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission (the “SEC”) on January 4, 2021, and our definitive proxy statement filed with the SEC on February 19, 2021 (the “Proxy Statement”). The Company cannot guarantee that the Merger will be completed on a timely basis or at all or that, if completed, it will be completed on the terms set forth in the Merger Agreement.
For additional information regarding the Merger, including associated risks and uncertainties, see Part I, Item 1A - Risk Factors, Part II, Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 14 “Subsequent Events” in the notes to consolidated financial statements.
Recent Healthcare Acquisitions
In recent years, the Company has expanded its Healthcare segment with various acquisitions and strategic investments. The acquisition of a 70 percent majority interest in Aurelia Health, LLC and its subsidiary Michael B. Bayless, LLC (collectively “Bayless”) in December 2020 expanded Magellan’s capabilities as a provider of outpatient primary care and behavioral health. Also during 2020, the Company made strategic minority investments in Kaden Health and Neuroflow which are technology-enabled companies designed to enhance the Company’s capabilities. Magellan also increased its presence within the federal marketplace through the acquisition of Armed Forces Services Corporation (“AFSC”) in 2016 which falls under the Behavioral & Specialty Health reporting unit.
Recent Pharmacy Management Acquisitions
In recent years, the Company has expanded its Pharmacy Management segment with various acquisitions. The acquisitions of Partners Rx Management, LLC (“Partners Rx”) in 2013, 4D Pharmacy Management Systems, Inc. (“4D”) in 2015 and Veridicus Holdings, LLC (“Veridicus”) in 2016 expanded the Company’s presence in the PBM market. The Company expanded its formulary management programs with the acquisition of CDMI, LLC (“CDMI”) in 2014.
Healthcare
The Healthcare segment (“Healthcare”) previously consisted of two reporting units – Behavioral & Specialty Health and Magellan Complete Care (“MCC”). As a result of the sale of the MCC Business to Molina, the Healthcare segment now only includes Behavioral and Specialty Healthcare reporting unit. Accordingly, the accompanying consolidated financial statements for all periods presented reflect the MCC business as discontinued operations. See Note 9—“Discontinued Operations” for additional information.
The Behavioral & Specialty Health reporting unit’s customers include health plans, accountable care organizations (“ACOs”), employers, the United States military and various federal government agencies for whom Magellan provides carve-out management services for (i) behavioral health, (ii) employee assistance plans (“EAP”) and (iii) other areas of specialty healthcare including diagnostic imaging, musculoskeletal management, cardiac and physical medicine. These management services can be applied broadly across commercial, Medicaid and Medicare populations, or on a more targeted basis for our health plans and ACO customers. The Behavioral & Specialty Health reporting unit also includes Magellan’s carve-out behavioral health contracts with various state Medicaid agencies, as well as certain provider assets that deliver primary care and behavioral healthcare services through an integrated approach.
The MCC business, which is now reflected as discontinued operations, contracted with state Medicaid agencies and the Centers for Medicare and Medicaid Services (“CMS”) to manage care for beneficiaries under various Medicaid and Medicare programs. MCC managed a wide range of services from total medical cost to carve out long-term support services. MCC largely focused on managing care for more acute special populations including individuals with serious mental illness (“SMI”), dual eligibles, aged, blind and disabled (“ABD”) and other populations with unique and often
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complex healthcare needs.
Magellan’s coordination and management of these healthcare and long-term support services are provided through its comprehensive network of medical and behavioral health professionals, clinics, hospitals, skilled nursing facilities, home care agencies and ancillary service providers. This network of credentialed 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. In addition to the Company’s provider assets where it provides treatment services in certain geographies, the Company also employs licensed behavioral health counselors to deliver non-medical counseling under certain government contracts.
The Company provides its Healthcare management services primarily through: (i) risk-based contractual arrangements, where the Company assumes all or a substantial portion of the responsibility for the cost of providing treatment services in exchange for a fixed per member per month (“PMPM”) fee, or (ii) administrative services only (“ASO”) contractual arrangements, where the Company provides services such as utilization review, claims administration and/or provider network management, but does not assume full responsibility for the cost of the treatment services, in exchange for an administrative fee and, in some instances, a gain share.
Pharmacy Management
The Pharmacy Management segment (“Pharmacy Management”) is comprised of services that provide clinical and financial management of pharmaceuticals paid under both the medical and the pharmacy benefit. Pharmacy Management’s customer solutions include: (i) pharmacy benefit management (“PBM”) services, including pharmaceutical dispensing operations and Medicare Part D; (ii) pharmacy benefit administration (“PBA”) for state Medicaid and other government sponsored programs; (iii) clinical and formulary management 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.
These services are available individually, in combination, or in a fully integrated manner. The Company markets its pharmacy management services to managed care organizations, employers, third party administrators, state governments, Medicare Part D, and other government agencies, exchanges, brokers and consultants. In addition, the Company will continue to upsell its pharmacy services to its existing customers and market its pharmacy solutions to the Healthcare customer base, including through integrated Pharmacy Management and Healthcare service offerings.
Pharmacy Management contracts with its customers for services using risk-based, gain share or ASO arrangements. In addition, Pharmacy Management provides services to the Healthcare segment for most of the MCC business.
On May 11, 2020, the Company announced its decision to exit the Medicare Part D business at the end of 2020. The Company will retain its Medicare Employer Group Waiver Plan as well as full capabilities to serve the PBM needs of its existing and prospective Medicare customers.
Corporate
This segment of the Company is comprised primarily of amounts not allocated to the Healthcare and Pharmacy Management segments that are largely associated with costs related to being a publicly traded company.
See Note 12—“Business Segment Information” to the consolidated financial statements for certain segment financial data relating to our business set forth elsewhere herein.
Industry
According to the Centers for Medicare and Medicaid Services (“CMS”), national health expenditure growth is expected to average 5.4 percent annually over 2019-2028. Growth in national health spending is projected to be faster than projected growth in Gross Domestic Product (“GDP”) by 1.1 percentage points over 2019-2028. As a result, the report projects the health share of GDP to rise from 17.7 percent in 2018 to 19.7 percent by 2028.
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With the dynamic economic environment, rising healthcare costs, increased fiscal pressures on federal and state governments and the uncertainty around the future of healthcare reform, healthcare spending will continue to be one of the greatest pressing issues for the American public and government agencies. The rapidly evolving clinical and technological environment demands the expertise of specialized healthcare management services to provide both high-quality and affordable care.
Business Strategy
Magellan is executing on a strategy that focuses on meeting market demands for our customers, improving health outcomes for our members, and creating value for our shareholders. We are confident that our strategy will improve our effectiveness, expand our margins and position us to reinvest in the business to drive sustainable long-term growth. The Company’s strategy is organized around four key areas of focus:
| 1. | Deliver on our commitments; |
| 2. | Execute on operational transformation; |
| 3. | Accelerate innovation; and |
| 4. | Build a robust growth engine. |
Deliver on our commitments: We are focused on delivering the commitments we make to our members, customers, providers and shareholders.
Execute on operational transformation: We are focused on executing on operational transformation initiatives to reduce our cost structure and improve efficiency, reliability and effectiveness. Our operational transformation team has prioritized over one dozen workstreams that are focused on four broad categories: process improvements, human capital, worksite strategy, and vendor management to drive lower operating costs and reduce our real estate footprint, while also enhancing our competitive position.
Accelerate innovation: We are focused on accelerating innovation to develop new product offerings and build enhanced capabilities that will strengthen our competitive position to create compelling, contemporary and competitive new solutions for the market.
Build a robust growth engine: We are focused on building a strong growth engine across our businesses through an enhanced enterprise sales organization and improved sales execution.
Customer Contracts
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 30 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. The Company’s contracts for managed healthcare and specialty solutions services generally provide for payment of a per member per month fee to the Company. See “Item 1A. Risk Factors—Risk-Based Products” and “Item 1A. Risk Factors—Reliance on Customer Contracts.”
The Company has significant concentrations of business for managed behavioral health services with various counties in the State of Pennsylvania (the “Pennsylvania Counties”) which are part of the Pennsylvania Medicaid Program, with members under its Medicare Part D contract with CMS, and with various agencies and departments of the United States federal government. See further discussion related to these significant customers in “Item 1A. Risk Factors—Reliance on Customer Contracts.” In addition, see “Item 1A. Risk Factors—Dependence on Government Spending” for discussion of risks to the Company related to government contracts.
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Provider Network
The Company’s managed healthcare services are primarily provided by a contracted network of third-party providers. The number and type of providers in a particular area depend upon customer preference, site, geographic concentration and demographic composition of the beneficiary population in that area. The Company’s network consists of approximately 170,000 healthcare providers providing various levels of care nationwide. The Company’s network providers are almost exclusively independent contractors located throughout the local areas in which the Company’s customers’ beneficiary populations reside. Outpatient network providers work out of their own offices, although the Company’s personnel are available to assist them with consultation and other needs.
Non-facility network providers typically execute standard contracts with the Company under which they are generally paid on a fee-for-service basis.
The Company contracts with facilities on a per diem or fee-for-service basis and, in some limited cases, on a “case rate” or capitated basis. The contracts between the Company and inpatient and other facilities typically are for one-year terms and are terminable by the Company or the facility upon 30 to 120 days notice.
The Company also provides capability to support client-specific networks. Many of the Company’s clients have their own contracted networks. The Company establishes and administers these private networks segregating and reporting to the clients. In addition, the Company can lease networks on behalf of specific entities in order to enhance coverage.
The Company also has a national network of contracted retail pharmacies which is offered to its pharmacy benefit management customers. We contract with and manage these pharmacies to optimize drug cost and member access to fill covered prescriptions. Pharmacies can work with us both electronically and telephonically at the point of service for member eligibility, claim adjudication and member cost share, if applicable.
Competition
The Company’s business is highly competitive. The Company competes with insurance companies and other healthcare organizations, including health maintenance organizations (“HMOs”), preferred provider organizations (“PPOs”), TPAs, independent practitioner associations (“IPAs”), multi-disciplinary medical groups, PBMs, healthcare information technology companies and other specialty healthcare and managed care companies. Many of the Company’s competitors, particularly certain insurance companies, HMOs, technology companies and PBMs are significantly larger and have greater financial, marketing and other resources than the Company, and some of the Company’s competitors provide a broader range of services. The Company competes based upon quality and reliability of its services, a focus on clinical excellence, product and service innovation and proven expertise across its business lines. The Company may also encounter competition in the future from new market entrants. In addition, some of the Company’s customers that are managed care companies may seek to provide specialty managed healthcare services directly to their members, rather than subcontracting with the Company for such services. Because of these factors, the Company does not expect to be able to rely to a significant degree on price increases to achieve revenue growth and anticipates continued pricing pressures.
Insurance
The Company maintains a program of insurance coverage for a broad range of risks in its business. The Company has renewed its general, professional and managed care liability insurance policies with unaffiliated insurers for a one-year period from June 17, 2020 to June 17, 2021. The general liability policy is written on an “occurrence” basis, subject to a $0.25 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 ($5.0 million per anti-trust claim and $10.0 million per class action claim) un-aggregated self-insured retention for managed care errors and omissions liability, and a $0.25 million per claim un-aggregated self-insured retention for professional liability.
The Company maintains a separate general and professional liability insurance policy with an unaffiliated insurer for its specialty pharmaceutical dispensing operations. The specialty pharmaceutical dispensing operations insurance policy has a one-year term for the period June 17, 2020 to June 17, 2021. The general liability policy is written
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on an “occurrence” basis and the professional liability policy is written on a “claims-made” basis, subject to a $0.05 million per claim and $0.25 million aggregated self-insured retention.
The Company is responsible for claims within its self-insured retentions, and for 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.
See “Item 1A. Risk Factors—Professional Liability and Other Insurance,” for a discussion of the risks associated with the Company’s insurance coverage.
Regulation
General
The Company’s operations are subject to extensive and evolving state and federal laws and regulation in the jurisdictions in which we do business. This includes applicable federal and state laws and regulations in connection with its role in providing pharmacy benefit management; behavioral health benefit management; radiology benefit management; utilization review; customer employee benefit plan services; pharmacy; healthcare services; Medicaid; Medicare; health insurance, and laws and regulations impacting its federal government contracts.
Regulation of the healthcare industry as well as government contracting is constantly evolving, with new legislative enactments and regulatory initiatives at the state and federal levels being implemented on a regular basis. Consequently, it is possible that a court or regulatory agency may take a position under existing or future laws or regulations, or as a result of a change in the interpretation thereof that such laws or regulations apply to the Company in a different manner than the Company believes such laws or regulations apply. In addition, existing laws and regulations may be repealed or modified. Such changes may require significant alterations to the Company’s business operations in order to comply with such laws or regulations, or interpretations thereof. Expansion of the Company’s business to cover additional geographic areas, to serve different types of customers, to provide new services or to commence new operations could also subject the Company to additional licensure requirements and/or regulation. Failure to comply with applicable regulatory requirements could have a material adverse effect on the Company.
State Licensure and Regulation
The Company is subject to certain state laws and regulations governing the licensing of insurance companies, HMOs, PPOs, TPAs, PBMs, pharmacies and companies engaged in utilization review. In addition, the Company is subject to state laws and regulations concerning the licensing of healthcare professionals, including restrictions on business corporations from providing, controlling or exercising excessive influence over healthcare services through the direct employment of physicians, psychiatrists or, in certain states, psychologists and other healthcare professionals. These laws and regulations vary considerably among states, and the Company may be subject to different types of laws and regulations depending on the specific regulatory approach adopted by each state to regulate the managed care and pharmaceutical management businesses and the provision of healthcare treatment services.
Further, certain regulatory agencies having jurisdiction over the Company possess discretionary powers when issuing or renewing licenses or granting approval of proposed actions such as mergers, a change in ownership, and certain intra-corporate transactions. One or multiple agencies may require as a condition of such license or approval that the Company cease or modify certain of its operations or modify the way it operates in order to comply with applicable regulatory requirements or policies. In addition, the time necessary to obtain a license or approval varies from state to state, and difficulties in obtaining a necessary license or approval may result in delays in the Company’s plans to expand operations in a particular state and, in some cases, lost business opportunities.
The Company has sought and obtained licenses as a utilization review agent, single service HMO, TPA, PBM, Pharmacy, discount prescription drug plan, PPO, HMO and Health Insurance Company in one or more jurisdictions. The company owns a majority interest in an entity that holds several outpatient treatment center licenses and one counseling facility license in Arizona. Numerous states in which the Company does business have adopted regulations governing entities engaging in utilization review. Utilization review regulations typically impose requirements with respect to the qualifications of personnel reviewing proposed treatment, timeliness and notice of the review of proposed treatment and
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other matters. Many states also license TPA activities. These regulations typically impose requirements regarding claims processing and payments and the handling of customer funds.
Some states require TPA licensure for PBM entities as a way to regulate the PBM lines of business. Other states regulate PBMs through a PBM specific license. The Company has obtained these licenses as required to support the PBM business. In some cases, single purpose HMO or insurance licenses are required for the Company to take risk on business in that state. Some states require PPO or other network licenses to offer a network of providers in the state. Almost all states require licensure for pharmacies dispensing or shipping medications into the state. The Company has obtained all of these necessary licenses.
To the extent that the Company operates or is deemed to operate in some states as an insurance company, HMO, PPO or similar entity, it may be required to comply with certain laws and regulations that, among other things, may require the Company to maintain certain types of assets and minimum levels of deposits, capital, surplus, reserves or net worth. Being licensed as an insurance company, HMO or similar entity could also subject the Company to regulations governing reporting and disclosure, coverage, mandated benefits, rate setting, grievances and appeals, prompt pay laws and other traditional insurance regulatory requirements.
Regulators in a few states have adopted policies that require HMOs or, in some instances, insurance companies, to contract directly with licensed healthcare providers, entities or provider groups, such as IPAs, for the provision of treatment services, rather than with unlicensed intermediary companies. In such states, the Company’s customary model of contracting directly is modified so that, for example, the IPAs (rather than the Company) contract directly with the HMO or insurance company, as appropriate, for the provision of treatment services.
The National Association of Insurance Commissioners (“NAIC”) has developed a “health organizations risk-based capital” formula, designed specifically for managed care organizations, that establishes a minimum amount of capital necessary for a managed care organization to support its overall operations, allowing consideration for the organization’s size and risk profile. The NAIC also adopted a model regulation in the area of health plan standards, which could be adopted by individual states in whole or in part, and could result in the Company being required to meet additional or new standards in connection with its existing operations. Certain states, for example, have adopted regulations based on the NAIC initiative, and as a result, the Company has been subject to certain minimum capital requirements in those states. Certain other states, such as Maryland, Texas, New York, Florida and New Jersey, have also adopted their own regulatory initiatives that subject entities, such as certain of the Company’s subsidiaries, to regulation under state insurance laws. This includes, but is not limited to, requiring adherence to specific financial solvency standards. State insurance laws and regulations may limit the Company’s ability to pay dividends, make certain investments and repay certain indebtedness.
Regulators may impose operational restrictions on entities granted licenses to operate as insurance companies or HMOs. For example, the California Department of Managed Health Care has imposed certain restrictions on the ability of the Company’s California subsidiaries to fund the Company’s operations in other states, to guarantee or cosign for the Company’s financial obligations, or to pledge or hypothecate the stock of these subsidiaries and on the Company’s ability to make certain operational changes with respect to these subsidiaries. In addition, regulators of certain of the Company’s subsidiaries may exercise certain discretionary rights under regulations including, without limitation, increasing its supervision of such entities or requiring additional restricted cash or other security.
Failure to obtain and maintain required licenses typically also constitutes an event of default under the Company’s contracts with its customers. The loss of business from one or more of the Company’s major customers as a result of an event of default or otherwise could have a material adverse effect on the Company. Licensure requirements may increase the Company’s cost of doing business in the event that compliance requires the Company to retain additional personnel to meet the regulatory requirements and to take other required actions and make necessary filings. Although compliance with licensure regulations has not had a material adverse effect on the Company, there can be no assurance that specific laws or regulations adopted in the future would not have such a result.
The provision of healthcare treatment services by physicians, psychiatrists, psychologists, pharmacists and other providers is subject to state regulation with respect to the licensing of healthcare professionals. The Company believes that the healthcare professionals, who provide healthcare treatment on behalf of or under contracts with the Company, and the case managers and other personnel of the health services business, are in compliance with the applicable state licensing requirements and current interpretations thereof. Regulations imposed upon healthcare providers include but
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are not limited to, provisions relating to the conduct of, and ethical considerations involved in, the practice of medicine, psychiatry, psychology, social work and related behavioral healthcare professions, radiology, pharmacy, privacy, accreditation, state corporate practice of medicine doctrines, state telemedicine laws, health care facility licensure, fee-splitting rules government healthcare program participation requirements, reimbursements for patient services, Medicare, Medicaid, federal and state laws governing fraud, waste and abuse and, federal and state laws relating to self-referrals, anti-kickback, false claims, and other laws and regulations governing government contractors and the use of government funds. In certain cases, the common law or statutory duty to warn others of danger or to prevent patient self-injury or the statutory duties to report matters of abuse or neglect of individuals. However, there can be no assurance that changes in such requirements or interpretations thereof will not adversely affect the Company’s existing operations or limit expansion. To the extent that the Company is or is deemed to be engaged in the provision of healthcare treatment services, the Company may be subject to medical malpractice claims and other tort claims related to the provision of such services.
With respect to the Company’s employee assistance crisis intervention program, additional licensing of clinicians who provide telephonic assessment or stabilization services to individuals who are calling from out-of-state may be required if such assessment or stabilization services are deemed by regulatory agencies to be treatment provided in the state of such individual’s residence. The Company believes that any such additional licenses could be obtained. In California, the Company’s employee assistance programs are regulated by the California Department of Managed Health Care. This subjects the Company to regulations governing reporting and disclosure, coverage, mandated benefits, grievances and appeals and other traditional insurance regulatory requirements.
The corporate practice of medicine laws of some states limit the ability of a business corporation to directly provide, control or exercise excessive influence over healthcare services through the direct employment of physicians, psychiatrists, psychologists, or other healthcare professionals, who are providing direct clinical services. In addition, the laws of some states prohibit physicians, psychiatrists, psychologists, or other healthcare professionals from splitting fees with other persons or entities. These laws and their interpretations vary from state to state and enforcement by the courts and regulatory authorities may vary from state to state and may change over time. There can be no assurance that the Company’s existing operations and its contractual arrangements with physicians, psychiatrists, psychologists and other healthcare professionals will not be successfully challenged under state laws prohibiting fee splitting or the practice of a profession by an unlicensed entity, or that the enforceability of such contractual arrangements will not be limited. The Company believes that it could, if necessary, restructure its operations to comply with changes in the interpretation or enforcement of such laws and regulations, and that such restructuring would not have a material adverse effect on its operations.
Employee Retirement Income Security Act (“ERISA”)
Certain of the Company’s services are subject to the provisions of ERISA. ERISA governs certain aspects of the relationship between employer-sponsored healthcare benefit plans and certain providers of services to such plans through a series of complex laws and regulations that are subject to periodic interpretation by the Internal Revenue Service (“IRS”) and the U.S. Department of Labor (“DOL”). In some circumstances, and under certain customer contracts, the Company may be expressly named as a “fiduciary” under ERISA, or be deemed to have assumed duties that make it an ERISA fiduciary, and thus be required to carry out its operations in a manner that complies with ERISA in all material respects. In other circumstances, particularly in the administration of pharmacy benefits, the Company does not believe that its services are subject to the fiduciary obligations and requirements of ERISA. In addition, the DOL has not yet finalized guidance regarding whether discounts and other forms of remuneration from pharmaceutical manufacturers are required to be reported to ERISA-governed plans in connection with ERISA reporting requirements.
Numerous states require the licensing or certification of entities performing TPA or PBM activities; however, certain federal courts have held that such licensing requirements are preempted by ERISA. ERISA preempts state laws that mandate employee benefit structures or their administration, as well as those that provide alternative enforcement mechanisms. The Company believes that its TPA and PBM activities performed for its self-insured employee benefit plan customers are exempt from otherwise applicable state licensing or registration requirements based upon federal preemption under ERISA and have relied on this general principle in determining not to seek licenses for certain of the Company’s activities in some states. Existing case law is not uniform on the applicability of ERISA preemption with respect to state regulation of PBM and/or TPA activities. In some states, the Company has licensed its self-funded pharmacy related business as a TPA or PBM after a review of state regulatory requirements and case law. There can be no assurance that additional licenses will not be required with respect to utilization review or TPA and/or PBM activities
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in certain states.
Some of the state regulatory requirements described herein may be preempted in whole or in part by ERISA, which provides for comprehensive federal regulation of employee benefit plans. However, the scope of ERISA preemption is uncertain and is subject to conflicting court rulings. In this regard, in a December 2020 decision, the United States Supreme Court ruled in Rutledge v. Pharmaceutical Care Management Association that ERISA does not pre-empt state rate or cost regulations that do not force plans to adopt particular benefit coverage. The Rutledge decision does not address other issues apart from rate regulations, however and so the Company could be subject to overlapping federal and state regulatory requirements with respect to certain of its operations and may need to implement compliance programs that satisfy multiple regulatory regimes. There can be no assurance that continuing ERISA compliance efforts or any future changes to ERISA, or the interpretation of ERISA, will not have a material adverse effect on the Company.
The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) and Other Privacy Regulation
HIPAA contains standards relating to the transmission, privacy and security of health information by healthcare providers and healthcare plans. Confidentiality and patient privacy requirements are particularly strict in the Company’s behavioral managed care business.
The Health Information Technology for Economic and Clinical Health Act (“HITECH Act”), passed as part of the American Recovery and Reinvestment Act of 2009, represented a significant expansion of the HIPAA privacy and security laws.
HIPAA generally does not preempt state law. Therefore, because many states have privacy laws that provide more stringent privacy protections than those imposed by HIPAA, the Company must address privacy issues under those state laws as well.
In addition to HIPAA and the HITECH Act, the Company is also subject to federal laws and regulations governing patient records involving substance abuse treatment, as well as other federal privacy laws and regulations.
The European Union (“EU”) General Data Protection Regulation (“GDPR”) became effective May 25, 2018. The Company believes its exposure to the GDPR is at present limited to EAP services to US-based companies that decide to offer EAP to their EU-based employees, which is a very small subset of the Company’s EAP line of business. The Company does not market its EAP services within the EU or to persons in the EU or compete for business with countries solely established in jurisdictions subject to GDPR, or monitor the behavior of persons in the EU, and its EAP contracts with its customers are entered into in the United States with companies either US-established or not solely established in jurisdictions subject to GDPR. When a US customer chooses to make EAP services available to EU-based employees, the EAP services are managed through an EU-based subcontractor and EAP personal data subject to the GDPR processed by that subcontractor does not leave the EU. The Company has received contractual assurances from its subcontractor of the subcontractor’s compliance with the GDPR. Thus, the Company does not believe the GDPR at present poses material compliance risks for the Company. However, there can be no assurances that the GDPR could not be interpreted by EU supervisory authorities or courts in a manner that would require the Company to restructure its EAP services in the EU, or the GDPR could be changed or interpreted in a manner causing material adverse impact on the Company. The Company has not yet determined its legal risks under UK privacy laws post-Brexit.
Fraud, Waste and Abuse Laws
The Company is subject to federal and state laws and regulations protecting against fraud, waste and abuse. Fraud, waste and abuse prohibitions cover a wide range of activities, including kickbacks and other inducements for referral of members or the coverage of products, billing for unnecessary services by a healthcare provider and improper marketing. Companies involved in public healthcare programs such as Medicare and Medicaid are required to maintain compliance programs to detect and deter fraud, waste and abuse, and are often subject to audits. The regulations and contractual requirements applicable to the Company in relation to these programs are complex and subject to change.
The federal healthcare Anti-Kickback Statute (the “Anti-Kickback Statute”) prohibits, among other things, an entity from paying or receiving, subject to certain exceptions and “safe harbors,” any remuneration, directly or indirectly, to induce the referral of individuals covered by federally funded healthcare programs, or the purchase, or the arranging for or recommending of the purchase, of items or services for which payment may be made in whole, or in part, under
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Medicare, Medicaid, TRICARE or other federally funded healthcare programs. Sanctions for violating the Anti-Kickback Statute may include imprisonment, criminal and civil fines and exclusion from participation in the federally funded healthcare programs. The Anti-Kickback Statute has been interpreted broadly by courts, the Office of Inspector General (“OIG”), the Department of Health and Human Services (“DHHS”) and other administrative bodies.
Section 1877 of the Social Security Act, commonly known as the “Stark Law,” prohibits physicians, subject to certain exceptions described below, from referring Medicare or Medicaid patients to an entity providing “designated health services” in which the physician, or an immediate family member, has an ownership or investment interest or with which the physician, or an immediate family member, has entered into a compensation arrangement. These prohibitions, contained in the Omnibus Budget Reconciliation Act of 1993, commonly known as “Stark II,” amended prior federal physician self-referral legislation known as “Stark I” by expanding the list of designated health services to a total of 11 categories of health services. The professional groups with which we are affiliated provide one or more of these designated health services. Persons or entities found to be in violation of the Stark Law are subject to denial of payment for services furnished pursuant to an improper referral, civil monetary penalties, and exclusion from the Medicare and Medicaid programs.
Many states also have enacted laws similar in scope and purpose to the Anti-Kickback Statute and, in more limited instances, the Stark Law, that are not limited to services for which Medicare or Medicaid payment is made. In addition, most states have statutes, regulations, or professional codes that restrict a physician from accepting various kinds of remuneration in exchange for making referrals. These laws vary from state to state and have seldom been interpreted by the courts or regulatory agencies. In states that have enacted these statutes, we believe that regulatory authorities and state courts interpreting these statutes may regard federal law under the Anti-Kickback Statute and the Stark Law as persuasive.
It also is a crime under the Public Contracts Anti-Kickback Act, for any person to knowingly and willfully offer or provide any remuneration to a prime contractor to the United States, in order to obtain favorable treatment in a subcontract. Violators of this law also may be subject to civil monetary penalties. There have been a series of substantial civil and criminal investigations and settlements over the last several years in connection with alleged kickback schemes.
The federal civil monetary penalty (“CMP”) statute provides for civil monetary penalties for any person who provides something of value to a beneficiary covered under a federal healthcare program, such as Medicare or Medicaid, in order to influence the beneficiary’s choice of a provider. ERISA, to which certain of our customers’ services are subject, generally prohibits any person from providing to a plan fiduciary a remuneration in order to affect the fiduciary’s selection of or decisions with respect to service providers. Unlike the federal healthcare Anti-Kickback Statute, ERISA regulations do not provide specific safe harbors and its application may be unclear.
The Federal Civil False Claims Act imposes civil penalties for knowingly making or causing to be made false claims with respect to government contracts and governmental programs, such as Medicare and Medicaid, for services not rendered, or for misrepresenting actual services rendered, in order to obtain higher reimbursement. Private individuals may bring qui tam or whistleblower suits under the Federal Civil False Claims Act, which authorizes the payment of a portion of any recovery to the individual bringing suit.
Further, pursuant to the Patient Protection and Affordable Care Act (“ACA”), a violation of the Anti-Kickback Statute is also a per se violation of the Federal Civil False Claims Act. The Federal Civil False Claims Act generally provides for the imposition of civil penalties and for treble damages, resulting in the possibility of substantial financial penalties for small billing discrepancies. Criminal provisions that are similar to the Federal Civil False Claims Act provide that a corporation may be fined if it is convicted of presenting to any federal agency a claim or making a statement that it knows to be false, fictitious or fraudulent. Even in situations where the Company does not directly provide services to beneficiaries of federally funded health programs and, accordingly, does not directly submit claims to the federal government, it is possible that the Company could nevertheless become involved in a situation where false claim issues are raised based on allegations that it caused or assisted a government contractor in making a false claim.
The Company is subject to certain provisions of the Deficit Reduction Act of 2005 (the “Act”). The Act requires entities that receive $5 million or more in annual Medicaid payments to establish written policies that provide detailed information about the Federal Civil False Claims Act and the remedies thereunder, as well as any state laws pertaining to civil or criminal penalties for false claims and statements, the “whistleblower” protections afforded under such laws, and the role of such laws in preventing and detecting fraud, waste and abuse.
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The Company is also subject to The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). Under the law, those with independent knowledge of a financial fraud committed by a business required to report to the U.S. Securities and Exchange Commission (“SEC”) or the U.S. Commodity Futures Trading Commission (“CFTC”) may be entitled to a percentage of the money recovered. Included in Dodd-Frank are provisions which protect employees of publicly traded companies from retaliation for reporting securities fraud, fraud against shareholders and violation of the SEC rules/regulations. Dodd-Frank also amends the Sarbanes-Oxley Act (“SOX”) and Federal Civil False Claims Act to expand their whistleblower protections.
Many states have laws and/or regulations similar to the federal fraud, waste and abuse laws described above. Sanctions for violating these laws may include injunction, imprisonment, criminal and civil fines and exclusion from participation in the state Medicaid programs. The Company has a corporate compliance and ethics program, policies and procedures and internal controls in place designed to ensure that the Company conducts business appropriately. However, there can be no assurance that the Company will not be subject to scrutiny or challenge under such laws or regulations and that any such challenge would not have a material adverse effect on the Company’s business, results of operations, financial condition or cash flows.
Mental Health Parity
The Paul Wellstone and Pete Domenici Mental Health Parity Act of 2008 (“MHPAEA”) establishes parity in financial requirements (e.g., co-pays, deductibles, etc.) and treatment limitations (e.g., limits on the number of visits) between mental health and substance abuse benefits and medical/surgical benefits for health plan members. The law applies to ERISA plans, Medicaid managed care plans and State Children’s Health Insurance Program (“SCHIP”) plans. On November 13, 2013 the Department of the Treasury, the Department of Labor and the Department of Health and Human Services issued Final Rules on the MHPAEA (“Final Rules”). The Final Rules include some concepts not included under the statute including the requirement to conduct the parity review at the category level within the plan, introducing the concept of non-quantitative treatment limitations and prohibiting separate but equal deductibles. The Company believes it is in compliance with these requirements. In March 2016, CMS promulgated a final rule on the application of parity to Medicaid Managed Care Plans, CHIP and alternative benefit plans. The Company believes it is in compliance with these requirements. On December 7, 2016, the Congress adopted the Twenty-First Century Cures Act, which codified some concepts in the Final Rules. The Consolidated Appropriations Bill, effective December 27, 2020 contained some new reporting requirements related to mental health parity that are effective February 10, 2021. The Company’s risk contracts allow for repricing to occur effective the same date that any legislation/regulation becomes effective if that legislation/regulation is projected to have a material effect on cost of care.
Health Care Reform
The ACA is a broad and sweeping piece of legislation creating numerous changes in the healthcare regulatory environment. Some of the regulations interpreting the ACA, most notably the Medical Loss Ratio regulations, the Internal Claims and Appeals and External Review Processes Regulations and Health Insurance Exchanges have an impact on the Company and its business. Others, such as the regulation on dependent coverage to age 26 and coverage of preventative health services, could impact the nature of the members that we serve and the utilization rates. Medicaid expansion under the ACA has had some impact on the Company’s Medicaid business. The Company has customers that are participating in the state and federal Health Insurance Exchanges. The Company has taken necessary steps to support our customers in their administration of these plans.
Federal and State Medicaid Laws and Regulations
The Company directly contracts with various states to provide Medicaid services to states. In addition, the Company directly contracts with various states to provide Medicaid managed care services to state Medicaid beneficiaries. As such, it is subject to certain federal and state laws and regulations affecting Medicaid as well as state contractual requirements. In addition to state regulation, certain Medicaid contracts require the Company to maintain Medicare Advantage special needs plan status, which is regulated by CMS.
The Company also is a sub-contractor to health plans that provide Medicaid managed care services to state Medicaid beneficiaries. In the Company’s capacity as a subcontractor with these health plans, the Company is indirectly subject to certain federal and state laws and regulations as well as contractual requirements pertaining to the operation of this business. If a state or a health plan customer determines that the Company has not performed satisfactorily as a
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subcontractor, the state or the health plan customer may require the Company to cease these activities or responsibilities under the subcontract. While the Company believes that it provides satisfactory levels of service under its respective subcontracts, the Company can give no assurances that a state or health plan will not terminate the Company’s business relationships insofar as they pertain to these services.
On April 16, 2019 CMS promulgated a final rule to revise the Medicare Advantage (MA) program (Part C) regulations and Prescription Drug Benefit program (Part D) regulations to implement certain provisions of the Bipartisan Budget Act of 2018; improve quality and accessibility; clarify certain program integrity policies for MA, Part D, and cost plans and PACE organizations; reduce burden on providers, MA plans, and Part D sponsors through providing additional policy clarification; and implement other technical changes regarding quality improvement. This final rule revises the appeals and grievances requirements for certain Medicaid managed care and MA special needs plans for dual eligible individuals to implement certain provisions of the Bipartisan Budget Act of 2018.
May 1, 2020 (CMS–9115–F) – Per CMS, “This final rule which is intended to move the health care ecosystem in the direction of interoperability, and to signal our commitment to the vision set out in the 21st Century Cures Act and Executive Order 13813 to improve the quality and accessibility of information that Americans need to make informed health care decisions, including data about health care prices and outcomes, while minimizing reporting burdens on affected health care providers and payers.”
On November 13, 2020, CMS promulgated a final rule advances CMS' efforts to streamline the Medicaid and Children's Health Insurance Program (CHIP) managed care regulatory framework and reflects a broader strategy to relieve regulatory burdens; support state flexibility and local leadership; and promote transparency, flexibility, and innovation in the delivery of care. These revisions of the Medicaid and CHIP managed care regulations are intended to ensure that the regulatory framework is efficient and feasible for states to implement in a cost-effective manner and ensure that states can implement and operate Medicaid and CHIP managed care programs without undue administrative burdens.”
Interoperability Rule
In April 2020, the Centers for Medicare & Medicaid Services (CMS) issued a final rule on interoperability and patient access to health data to provide patients access to their electronic health information. In the final Interoperability and Patient Access rule, CMS states that a core policy principal in the final rule is that all Americans should be able, without special effort or advanced technical skills, to see, obtain, and use all electronically available information that is relevant to their health, care, and choices – of plans, providers, and special treatment options.
Under the final rule, Medicare Advantage (MA) plans, state Medicaid and Children’s Health Insurance Program (CHIP) agencies, Medicaid and CHIP managed care plans, and qualified health plan (QHP) issuers in the federally-facilitated exchanges (FFEs) (referred to herein as “CMS-regulated health insurers/payers”) must meet certain requirements regarding patient access to their health care information, including requirements related to application programming interfaces (APIs). The effective date of these API requirements is January 1, 2021 for all payers, except QHP issuers/payers in FFEs. For QHPs in FFEs, the API requirements are effective for plan years beginning on or after January 1, 2021. However, CMS will not exercise enforcement regarding these provisions until July 1, 2021 due to the COVID-19 pandemic, and to provide additional flexibility to payers.
CMS-regulated health insurers/payers are required to implement, test and maintain a secure, standards-based application programming interface (API) that permits third-party applications to retrieve, with the approval/permission and direction of the individual/patient, the individual’s claims and encounter information, including cost, as well as a defined sub-set of their clinical information through third-party applications of their choice. CMS-regulated plans/payers must also implement and maintain a publicly accessible standards-based API that maintains a complete and accurate directory of contracted providers which is updated within 30 calendar days of a payer receiving provider directory information or an update to the provider directory information. Since Magellan is not a CMS-regulated payer, but is a first tier, downstream or related entity (FDR) or a subcontractor to health plan customers who are CMS-regulated payers, in such instances where Magellan maintains data that falls under the rule on behalf of a CMS-regulated payer/health plan customer, Magellan is collaborating with such health plans to ensure that the required data is provided to the health plans accordingly and in a timely fashion.
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Transparency Rule
On October 29, 2020, the U.S. Department of Health and Human Services, the Department of Labor and the Department of the Treasury issued a final rule which requires most group health plans and health insurance issuers in the individual and group markets to disclose price and cost-sharing information for all items and services to participants and enrollees. The cost-sharing information requirements under the rule take effect in a phased approach beginning January 1, 2023. In addition to providing personalized cost-sharing information, health plans and health insurers must also publicly disclose in-network provider negotiated rates and historical out-of-network allowed amounts starting January 1, 2022. Many of the rule’s requirements apply directly to Magellan clients which are group health plans and health insurance issuers. The rule provides that health plans and insurers may contract with vendors (including third-party administrators, pharmacy benefit managers, and utilization review agents like Magellan) to support these disclosure requirements; however the plans and insurers remain responsible for compliance with the requirements. Clients may seek Magellan’s assistance in complying with certain information disclosure requirements in the rule. Magellan will work with impacted clients to address the implications of the rule and its implementation.
In connection with its PBM business, the Company negotiates rebates with and provides services for drug manufacturers. The manufacturers are subject to Medicaid “best price” regulations requiring essentially that the manufacturer provide its deepest level of discounts to the Medicaid program. In some instances, the government has challenged a manufacturer’s calculation of best price and we cannot be certain what effect, if any, the outcome of any such investigation or proceeding will have on our ability to negotiate favorable terms.
Medicare Laws and Regulations
The Company is contracted with CMS as a Prescription Drug Plan (“PDP” or “Part D Plan”) to provide health services and prescription drug benefits to Medicare beneficiaries within employer group health plans. The regulations and contractual requirements applicable to the Company and other participants in Medicare programs are complex and subject to change. CMS regularly audits the performance of contracted health plans to determine compliance with contracts and CMS regulations, and to assess the quality of services provided to Medicare beneficiaries. CMS penalties for noncompliance include premium refunds, civil monetary penalties, prohibiting a company from continuing to market and/or enroll members in the company’s Medicare products, contract termination, and exclusion from participation in federally funded healthcare programs and other sanctions.
The Company is also a subcontractor to health plans that are Medicare Advantage Organizations and PDPs. In the Company’s capacity as a subcontractor with these health plans, the Company administers benefits to Medicare beneficiaries and is indirectly subject to certain federal laws and regulations, as well as contractual requirements pertaining to the operation of this business. If CMS or a health plan customer determines that the Company has not performed satisfactorily as a subcontractor, CMS or the health plan customer may require the Company to cease these activities or responsibilities under the subcontract. While the Company believes that it provides satisfactory levels of service under its respective subcontracts, the Company can give no assurances that CMS or a health plan will not terminate the Company’s business relationships with respect to these services.
CMS requires PDPs to report all price concessions received for PBM services. The applicable CMS guidance requires PDPs to contractually require the right to audit their PBMs as well as require full transparency as to manufacturer rebates and administrative fees paid for drugs or services provided in connection with the sponsor’s plan, including the portion of such rebates retained by the PBM.
Additionally, CMS requires MAOs and PDPs to ensure through their contractual arrangements with first tier, downstream and related entities that CMS has access to such entities’ books and records pertaining to services performed in connection with CMS contracts. CMS regulations also require that MAOs and PDPs contractually require their first tier, downstream and related entities (subcontractors) to comply with certain elements of the MAO’s and PDP’s compliance program. The Company has not experienced, and does not anticipate, that such disclosure and auditing requirements, to the extent required by its MAO and PDP partners, will have a materially adverse effect on the Company’s business.
The Company expects CMS and the U.S. Congress to continue to closely scrutinize each component of the Medicare program, modify the terms and requirements of the program and possibly seek to modify private insurers’ role. Therefore, it is not possible to predict the outcome of any Congressional or regulatory activity, either of which could
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have a material adverse effect on the Company.
Other Federal and State Laws and Regulations
Federal Laws and Regulations affecting Procurement. In addition to the laws and regulations cited in the section entitled Fraud, Waste and Abuse laws above, the Company is subject to other federal laws and regulations in connection with its contracts with the federal government. These laws and regulations affect how the Company conducts business with its federal agency customers and may impose added costs on its business. The Company’s failure to comply with federal procurement laws and regulations could cause it to lose business, incur additional costs and subject it to a variety of civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, harm to reputation, suspension of payments, fines, and suspension or debarment from doing business with federal government agencies. The Company conducts business with federal agency customers and federal contractors to such agencies.
The Company’s wholly owned subsidiary, Armed Forces Services Corporation (“AFSC”), conducts business with federal agency customers and federal contractors to such agencies. The Company investigated, with the assistance of outside counsel, matters relating to compliance by AFSC with Small Business Administration ( “SBA”) regulations and other federal laws applicable to government contractors and reported findings to the SBA and the Department of Defense, including facts indicating violations of SBA regulations and other federal laws, such as the Anti-Kickback Act, by former AFSC executives, none of which was disclosed to Magellan prior to its acquisition of AFSC. The Company voluntarily responded to government requests for further information regarding the Company’s investigation. As a result of the Company's disclosure and the ensuing government investigation, a former AFSC executive pleaded guilty in the United States District Court for the Eastern District of Virginia to one count of honest services fraud, and at sentencing in September 2020, the Court ordered the former AFSC executive to pay restitution to AFSC as the victim of that offense. In June 2020, the United States Attorney’s Office for the Eastern District of Virginia (“U.S. Attorney’s Office”) informed the Company of a civil investigation regarding the Company and AFSC related to potential violations of the False Claims Act and/or the Anti-Kickback Act also stemming from the matters self-disclosed by the Company. While the Company believes that it has responded appropriately by self-reporting findings regarding matters that incepted prior to its acquisition of AFSC in order to mitigate the risk of adverse consequences, should the Company or AFSC be held responsible for the reported conduct in a proceeding initiated by the U.S. Attorney’s Office, SBA, Department of Defense and/or other federal agencies, we may be required to pay damages and/or penalties and AFSC could be suspended or debarred from government contracting. Management believes that the resolution of such investigations will not have a material adverse effect on the Company’s financial condition or results of operations; however, there can be no assurance in this regard. AFSC generated approximately 3.0% and 2.4% of the Company’s total revenue from continuing operations for the year ended December 31, 2019 and 2020, respectively.
The Company also provides services to various state Medicaid programs. Services procurement related to Medicaid programs is governed in part by federal regulations because the federal government provides a substantial amount of funding for the services. The Company’s state customers risk loss of federal funding if the Company is not in compliance with federal regulations. The Company’s non-compliance may also lead to unanticipated, negative financial consequences including corrective action plans or contract default risks.
FDA Regulation. The U.S. Food and Drug Administration (“FDA”) generally has authority to regulate drug promotional activities that are performed “by or on behalf of” a drug manufacturer. The Company provides certain consulting and related services to drug manufacturers, and there can be no assurance that the FDA will not attempt to assert jurisdiction over certain aspects of the Company’s activities. The impact of future FDA regulation could materially adversely affect the Company’s business, results of operations, financial condition or cash flows.
State PBM Regulation. States continue to introduce broad legislation to regulate PBM activities. This legislation encompasses some of the services offered by the Company’s PBM business. Legislation in this area is varied and encompasses licensing, audit provisions, network access, recoupment of funds, submission of claims data to state all payor claims databases, potential fiduciary duties, pass through of cost savings and disclosure obligations, including the disclosure of information regarding the company’s maximum allowable cost pricing with pharmacies. In some circumstances, claims or inquiries against PBMs have been asserted under state consumer protection laws, which exist in most states. The Company has obtained licenses as necessary to support current business and future opportunities. The Company generally believes that state regulation relating to employer sponsored benefit plans is pre-empted by ERISA. However, in a December 2020 decision, the United States Supreme Court ruled in Rutledge v. Pharmaceutical Care
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Management Association that ERISA does not pre-empt state rate or cost regulations that do not force plans to adopt particular benefit coverages. The various state laws enacted to date do not appear to have a material adverse effect on the Company’s pharmaceutical management business. However, the Company can give no assurance that these and other states will not enact legislation with more adverse consequences in the near future; nor can the Company be certain that future regulations or interpretations of existing laws, including ERISA, will not adversely affect its business.
State Legislation Affecting Plan or Benefit Design. Some states have enacted legislation that prohibits certain types of managed care plan sponsors from implementing certain restrictive formulary and network design features, and many states have legislation regulating various aspects of managed care plans, including provisions relating to pharmacy benefits. Other states mandate coverage of certain benefits or conditions and require health plan coverage of specific drugs, if deemed medically necessary by the prescribing physician. Such legislation does not generally apply to the Company directly, but may apply to certain clients of the Company, such as HMOs and health insurers. These types of laws would generally have an adverse effect on the ability of a PBM to reduce cost for its plan sponsor customers.
Prompt Pay Laws. Under Medicare Part D and some state laws, the Company or customer may be required to pay network pharmacies within certain time periods and/or by electronic transfer instead of by check. The shorter time periods may negatively impact our cash flow. We cannot predict whether additional states will enact some form of prompt pay legislation.
Legislation and Regulation Affecting Drug Price and Rebates. Specialty pharmaceutical manufacturers generally report various price metrics to the federal government, including “average sales price” (“ASP”), “average manufacturer price” (“AMP”) and “best price” (“BP”). The Company does not calculate these price metrics, but the Company notes that the ASP, AMP and BP methodologies may create incentives for some drug manufacturers to reduce the levels of discounts or rebates available to purchasers, including the Company, or their clients with respect to specialty drugs. Any changes in the guidance affecting pharmaceutical manufacturer price metric calculations could materially adversely affect the Company’s business.
Additionally, most of the Company’s pharmacy benefit management and dispensing contracts with its customers use “average wholesale price” (“AWP”) as a benchmark for establishing pricing. There can be no guarantee that AWP will continue to be an available pricing metric in the future. The discontinuance of AWP reporting by one data source has not had a material adverse effect on the Company’s results of operations and the Company expects that were AWP data to no longer be available, other equitable pricing measures would be available to avoid a material adverse impact on the Company’s business. Separately, on a monthly basis CMS publishes the National Average Drug Acquisition Cost (“NADAC”), a data set that purports to provide the average acquisition cost of retail drugs based on a nationwide voluntary survey of retail pharmacies. At this time, the Company does not anticipate that NADAC will materially adversely impact its operations, but it is too early to speculate what impact, if any, such a reimbursement shift might have in pharmacy reimbursement and/or costs in the future.
In November 2020, the Department of Health and Human Services Office of Inspector General (“HHS-OIG”) published a final rule which would remove the anti-kickback regulatory safe harbor protection for prescription drug rebates paid by manufacturers to plan sponsors under Medicare Part D. It also would create a new safe harbor protection for price discounts between manufacturers and PBMs if given at the point-of-sale (“POS”). This rule does not apply to commercial rebates. The legality of the rule has been challenged in federal district court. In connection with that proceeding and with HHS’ consent, on January 30, 2021, the federal district court ordered that implementation of the rule be postponed until January 1, 2023, and the litigation challenging the rule be briefly held in abeyance while HHS reviews the rule but will continue at a later date. While we do not believe the proposed rule would have a material adverse impact on our business, we anticipate that President Biden and Congress may seek to adopt laws to control drug prices and other related measures, which could materially and adversely affect our commercial pharmacy benefits management rebate business.
Regulations Affecting the Company’s Pharmacies. The Company owns three pharmacies that provide services primarily to members of certain of the Company’s health plan customers. The activities undertaken by the Company’s pharmacies subject the pharmacies to state and federal statutes and regulations governing, among other things, the licensure and operation of mail order and nonresident pharmacies, repackaging of drug products, stocking of prescription drug products and dispensing of prescription drug products, including controlled substances. The Company’s pharmacy facilities are located in Florida and Utah, and are duly licensed to conduct business in those states. However, almost all states require out-of-state mail order pharmacies to register with or be licensed by the state board of pharmacy or similar
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governing body when pharmaceuticals are delivered by mail into the state, and some states require that an out-of-state pharmacy employ a pharmacist that is licensed in the state into which pharmaceuticals are shipped. The Company holds mail order and nonresident pharmacy licenses where required. The Company also maintains Medicare and Medicaid provider licenses where required in order for the pharmacies to provide services to these plans. In some states, the Company is not able to obtain Medicaid licenses to dispense because those states require that the pharmacy have a physical location in the state to participate in the Medicaid network.
Regulation of Controlled Substances. The Company’s pharmacies must register with the United States Drug Enforcement Administration (the “DEA”) and individual state-controlled substance authorities in order to dispense controlled substances. Federal law requires the Company to comply with the DEA’s security, recordkeeping, inventory control and labeling standards in order to dispense controlled substances. State controlled substance law requires registration and compliance with state pharmacy licensure, registration or permit standards promulgated by the state pharmacy licensing authority and in some states drug database reporting requirements.
Human Capital
Employees of the Registrant
Magellan’s mission of leading humanity to healthy, vibrant lives is powered by its workforce, and is at the center of our talent strategy and culture. It gives purpose to the work that we do and our employees are committed to it.
Our Workforce. Our workforce is made up of almost 9,000 professionals (after the Magellan Complete Care divesture at the end of 2020). These professionals represent 3,500 credentialed healthcare professions, from MDs and Physicians, to Social Workers, Counselors, Therapists, RNs, Pharmacists and Pharmacy Technicians. The average tenure of our employees is just over 5 years. Our employee population is located in all 50 states, as well as Puerto Rico and Canada, and on U.S. military bases in 16 foreign countries where they provide counseling to military families.
Diversity, Equity & Inclusion (DE&I). Magellan serves the needs of diverse member populations. To this end, we and our leaders promote a diverse, equitable and inclusive work environment through diversity initiatives and programs.
Our workforce reflects the diversity of our customers and members and demonstrates our commitment to DE&I:
| ● | 74% of our employees are women |
| ● | 59% of our leadership roles are held by women |
| ● | 40% of our employees are people of color |
| ● | 25% of our leadership roles are held by people of color |
| ● | 26% of our employees are Millennials, and 50% are members of Generation X |
Training & Development. We believe that the training and development of our workforce is critical to our ongoing success, not only to support the advancement of their skills and leadership abilities, but also because it helps us attract and retain the talent we need to successfully serve our customers and members. As part of our talent strategy, we offer extensive training and development programs through our Learning Center which emphasize self-directed development and continuous learning.
Available Information
The Company makes its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and Section 16 filings available, free of charge, on the SEC’s website, which contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, at www.sec.gov, and on the Company’s website at www.magellanhealth.com as soon as practicable after the Company has electronically filed such material with, or furnished it to, the SEC. The information on the Company’s website is not part of or incorporated by reference in this report on Form 10-K.
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Item 1A. Risk Factors
RISK ASSOCIATED WITH THE CENTENE TRANSACTION
Regulatory approvals may not be received, may take longer than expected or may impose conditions that are not presently anticipated or cannot be met.
Before the transactions contemplated by the Merger Agreement, including the Merger, may be completed, various approvals must be obtained from regulatory authorities. These regulatory authorities may impose conditions on the granting of such approvals. Such conditions or changes and the process of obtaining regulatory approvals could have the effect of delaying completion of the Merger or of imposing additional costs or limitations on the combined company following the Merger. The regulatory approvals may not be received at all, may not be received in a timely fashion, or may contain conditions on the completion of the Merger that are not anticipated or cannot be, or are not required under the Merger Agreement to be, met. If the consummation of the Merger is delayed, including by a delay in receipt of necessary regulatory approvals, the business, financial condition and results of operations of each company may also be materially and adversely affected. Please see the section entitled “The Merger—Regulatory Approvals” in our definitive proxy statement filed with the SEC on February 19, 2021 (the “Proxy Statement”).
Failure of the Merger to be completed, the termination of the Merger Agreement or a significant delay in the consummation of the Merger could negatively impact us.
The Merger Agreement is subject to a number of conditions which must be fulfilled in order to complete the Merger. Please see the section entitled “The Merger Agreement—Conditions to the Merger” in the Proxy Statement. These conditions to the consummation of the Merger may not be fulfilled and, accordingly, the Merger may not be completed or may be significantly delayed. In addition, if the Merger is not completed by October 4, 2021 (as may be extended to January 4, 2022 under certain circumstances related to regulatory approvals described in the Merger Agreement), either Centene or we may choose to terminate the Merger Agreement at any time after that date if the failure to consummate the transactions contemplated by the Merger Agreement is not proximately caused by any breach of or failure to perform or comply with, in any material respect, any obligation under the Merger Agreement by the party electing to terminate the Merger Agreement. Furthermore, the consummation of the Merger may be significantly delayed due to various factors, including potential litigation related to the Merger.
If the Merger is not consummated or significantly delayed, our ongoing business, financial condition and results of operations may be materially adversely affected and the market price of our common stock may decline significantly, particularly to the extent that the current market price reflects a market assumption that the Merger will be consummated. If the consummation of the Merger is delayed, including by the receipt of a competing acquisition proposal, our business, financial condition and results of operations may be materially adversely affected.
In addition, we have incurred and will incur substantial expenses in connection with the negotiation and completion of the transactions contemplated by the Merger Agreement. If the Merger is not completed or significantly delayed, we would have to recognize these expenses without realizing the expected benefits of the Merger. Any of the foregoing, or other risks arising in connection with the failure of or delay in consummating the Merger, including the diversion of management attention from pursuing other opportunities and the constraints in the Merger Agreement on our ability to make significant changes to our ongoing business during the pendency of the Merger, could have a material adverse effect on our business, financial condition and results of operations.
Additionally, our business may have been adversely impacted by the failure to pursue other beneficial opportunities due to the focus of management on the Merger, without realizing any of the anticipated benefits of completing the Merger, and the market price of our common stock might decline to the extent that the current market price reflects a market assumption that the Merger will be completed. If the Merger Agreement is terminated and our board of directors seeks an alternative transaction, our stockholders cannot be certain that we will be able to find a party willing to engage in a transaction on more attractive terms than the Merger. If the Merger Agreement is terminated under specified circumstances, we also may be required to pay Centene a termination fee. Please see the section entitled “The Merger Agreement—Termination Fees” in the Proxy Statement for a description of the termination fees applicable to us.
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We will be subject to business uncertainties and contractual restrictions while the Merger is pending.
Uncertainty about the effect of the Merger on employees, customers, suppliers and vendors may have an adverse effect on our business, financial condition and results of operations. These uncertainties may impair our ability to attract, retain and motivate key personnel and customers pending the consummation of the Merger, as such personnel and customers may experience uncertainty about their future roles and relationships following the consummation of the Merger. Additionally, these uncertainties could cause our customers, suppliers, vendors and others with whom we deal to seek to change, or fail to extend, existing business relationships with us. In addition, competitors may target our existing customers by highlighting potential uncertainties and integration difficulties that may result from the Merger.
The pursuit of the Merger and the preparation for the integration may place a burden on our management and internal resources. Any significant diversion of management attention away from ongoing business concerns and any difficulties encountered in the transition and integration process could have a material adverse effect on our business, financial condition and results of operations.
In addition, the Merger Agreement restricts us from taking certain actions without Centene’s consent while the Merger is pending. If the Merger is not completed, these restrictions could have a material adverse effect on our business, financial condition and results of operations. Please see the section entitled “The Merger Agreement—Covenants and Agreements—Conduct of Business of the Company” in the Proxy Statement for a description of the restrictive covenants applicable to us.
Certain provisions of the Merger Agreement may limit our ability to pursue alternatives to the Merger.
The Merger Agreement contains provisions that may discourage a third party from submitting an acquisition proposal to us that might result in greater value to our stockholders than the Merger, or may result in a potential competing acquirer proposing to pay a lower per share price to acquire us than it might otherwise have proposed to pay. These provisions include a general prohibition on our soliciting or, subject to certain exceptions relating to the exercise of fiduciary duties by our board of directors, entering into discussions with any third party regarding any acquisition proposal or offer for a competing transaction and a termination fee that is payable to Centene if we terminate the Merger Agreement to accept a superior acquisition proposal.
Litigation against us or Centene, or the members of our or Centene’s board of directors, could prevent or delay the completion of the Merger.
While we and Centene believe that any claims that may be asserted by purported stockholder plaintiffs related to the Merger would be without merit, the results of any such potential legal proceedings are difficult to predict and could delay or prevent the Merger from being completed in a timely manner. Moreover, any litigation could be time consuming and expensive, could divert our and Centene’s management’s attention away from their regular business and any lawsuit adversely resolved against us, Centene or members of our or Centene’s board of directors could have a material adverse effect on each party’s business, financial condition and results of operations.
One of the conditions to the consummation of the Merger is the absence of any law or order, whether preliminary, temporary or permanent, having the effect of making the Merger illegal or otherwise preventing or prohibiting consummation of the Merger. Consequently, if a settlement or other resolution is not reached in any lawsuit that is filed or any regulatory proceeding and a claimant secures injunctive or other relief or a regulatory authority issues an order or other directive having the effect of making the Merger illegal or otherwise prohibiting consummation of the Merger, then such injunctive or other relief may prevent the Merger from becoming effective in a timely manner or at all.
RISK RELATED TO OUR BUSINESS
Reliance on Customer Contracts—The Company’s inability to renew, extend or replace expiring or terminated contracts could adversely affect the Company’s liquidity, profitability and financial condition.
Substantially all of the Company’s net revenue is derived from contracts that may be terminated immediately with cause and many, including some of the Company’s most significant contracts, are terminable without cause by the customer upon notice and the passage of a specified period of time (typically between 60 and 180 days), or upon the occurrence of certain other specified events. The Company’s ten largest customers accounted for approximately
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45.5 percent, 44.1 percent and 42.0 percent of the Company’s net revenue in the years ended December 31, 2018, 2019 and 2020, respectively. Loss of all of these contracts or customers would, and loss of any one of these contracts or customers could, materially reduce the Company’s net revenue and have a material adverse effect on the Company’s liquidity, profitability and financial condition. See Note 2—“Summary of Significant Accounting Policies—Significant Customers” to the consolidated financial statements set forth elsewhere herein for a discussion of the Company’s significant customers.
Changes in the Medical Managed Care Carve-Out Industry—Certain changes in the business practices of this industry could negatively impact the Company’s resources, profitability and results of operations.
A portion of the Company’s Healthcare and Pharmacy Management segments’ net revenues from continuing operations are derived from customers in the medical managed healthcare industry, including managed care companies, health insurers and other health plans. Some types of changes in this industry’s business practices could negatively impact the Company. For example, if the Company’s managed care customers seek to provide services directly to their subscribers, instead of contracting with the Company for such services, the Company could be adversely affected. In this regard, certain of the Company’s major customers in the past have not renewed all or part of their contracts with the Company, and instead provided managed healthcare services directly to their subscribers. In addition, the Company has a significant number of contracts with Blue Cross Blue Shield plans and other regional health plans. Consolidation of the healthcare industry through acquisitions and mergers could potentially result in the loss of contracts for the Company. In addition, in some instances state Medicaid agencies may look to procure certain services, such as pharmacy benefit management services, directly instead of contracting with a managed care company to do so, potentially reducing the amount of business opportunities from managed care customers. Any of these changes could reduce the Company’s net revenue, and adversely affect the Company’s profitability and financial condition.
Changes in the Contracting Model for Medicaid Contracts—Certain changes in the contracting model used by states for managed healthcare services contracts relating to Medicaid lives could negatively impact the Company’s resources, profitability and results of operations.
A portion of the Company’s Healthcare segment net revenue is derived from direct contracts that it has with state or county governments for the provision of services to Medicaid enrollees. Certain states have recently contracted with managed care companies to manage both the behavioral and physical medical care of their Medicaid enrollees. If other governmental entities change the method for contracting for Medicaid business to a fully integrated model, the Company will attempt to subcontract with the managed care organizations to provide behavioral healthcare management for such Medicaid business; however, there is no assurance that the Company would be able to secure such arrangements. Accordingly, if such a change in the contracting model were to occur, it is possible that the Company could lose current contracted revenues, as well as be unable to bid on potential new business opportunities, thus negatively impacting the Company’s profitability and financial condition.
Risk-Based Products—Because the Company provides services at a fixed fee, if the Company is unable to maintain historical margins, or is unable to accurately predict and control healthcare costs, the Company’s profitability could decline.
The Company derives its net revenue primarily from arrangements under which the Company assumes responsibility for costs of treatment in exchange for a fixed fee. The Company refers to such arrangements as “risk-based contracts” or “risk-based products,” which include EAP services. These arrangements provided 37.5 percent, 40.4 percent and 37.5 percent of the Company’s net revenue from continuing operations in the years ended December 31, 2018, 2019 and 2020, respectively.
The profitability of the Company’s risk contracts could be reduced if the Company is unable to maintain its historical margins. The competitive environment for the Company’s risk products could result in pricing pressures which cause the Company to reduce its rates. In addition, customer demands or expectations as to margin levels could cause the Company to reduce its rates. A reduction in risk rates which are not accompanied by a reduction in services covered or expected underlying care trend could result in a decrease in the Company’s operating margins.
Profitability of the Company’s risk contracts could also be reduced if the Company is unable to accurately estimate the rate of service utilization by members or the cost of such services when the Company prices its services. The Company’s assumptions of utilization and costs when the Company prices its services may not ultimately reflect
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actual utilization rates and costs, many aspects of which are beyond the Company’s control. If the cost of services provided to members under a contract together with the administrative costs exceeds the aggregate fees received by the Company under such contract, the Company will incur a loss on the contract.
The Company’s profitability could also be reduced if the Company is required to make adjustments to estimates made in reporting historical financial results regarding cost of care, reflected in the Company’s financial statements as medical claims payable. Medical claims payable includes reserves for incurred but not reported (“IBNR”) claims, which are claims for covered services rendered by the Company’s providers which have not yet been submitted to the Company for payment. The Company estimates and reserves for IBNR claims based on past claims payment experience, including the average interval between the date services are rendered and the date the claims are received and between the date services are rendered and the date claims are paid, enrollment data, utilization statistics, adjudication decisions, authorized healthcare services and other factors. This data is incorporated into contract-specific reserve models. The estimates for submitted claims and IBNR claims are made on an accrual basis and adjusted in future periods as required.
If such risk-based products are not correctly underwritten, the Company’s profitability and financial condition could be adversely affected. Factors that affect the Company’s ability to price the Company’s services, or accurately make estimates of IBNR claims and other expenses for which the Company creates reserves may include differences between the Company’s assumptions and actual results arising from, among other things: changes in the delivery system; changes in utilization patterns; changes in the number of members seeking treatment; unforeseen fluctuations in claims backlogs; unforeseen increases in the costs of the services; the occurrence of catastrophes; regulatory changes; and changes in benefit plan design.
Some of these factors could impact the ability of the Company to manage and control the medical costs to the extent assumed in the pricing of its services.
Competition—The competitive environment in the managed healthcare industry may limit the Company’s ability to maintain or increase the Company’s rates, which would limit or adversely affect the Company’s profitability, and any failure in the Company’s ability to respond adequately may adversely affect the Company’s ability to maintain contracts or obtain new contracts.
The Company’s business is highly competitive. The Company competes with other healthcare organizations as well as with insurance companies, including HMOs, PPOs, TPAs, IPAs, multi-disciplinary medical groups, PBMs, specialty pharmacy companies, radiology benefits management companies and other specialty healthcare and managed care companies. Many of the Company’s competitors, particularly certain insurance companies, HMOs and PBMs are significantly larger and have greater financial, marketing and other resources than the Company, which can create downward pressure on prices through economies of scale. The entrance or expansion of these larger companies in the managed healthcare industry (including the Company’s customers who have in-sourced or who may choose to in-source healthcare services) could increase the competitive pressures the Company faces and could limit the Company’s ability to maintain or increase the Company’s rates. If this happens, the Company’s profitability could be adversely affected. In addition, if the Company does not adequately respond to these competitive pressures, it could cause the Company to not be able to maintain its current contracts or to not be able to obtain new contracts.
Provider Agreements—Failure to maintain or to secure cost-effective healthcare provider contracts may result in a loss of membership or higher medical costs.
The Company’s profitability depends, to an extent, upon the ability to contract favorably with certain healthcare providers. The Company may be unable to enter into agreements with providers in new markets on a timely basis or under favorable terms. If the Company is unable to retain its current provider contracts or enter into new provider contracts timely or on favorable terms, the Company’s profitability could be reduced.
Pharmacy Management—Loss of Relationship with Providers—If we lose our relationship, or our relationship otherwise changes in an unfavorable manner, with one or more key pharmacy providers or if significant changes occur within the pharmacy provider marketplace, or if other issues arise with respect to our pharmacy networks, our business could be adversely affected.
Our operations are dependent to a significant extent on our ability to obtain discounts on prescription purchases from retail pharmacies that can be utilized by our clients and their members. Our contracts with retail pharmacies, which
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are non-exclusive, are generally terminable by either party on short notice. If one or more of our top pharmacy chains elects to terminate its relationship with us, or if we are only able to continue our relationship on terms less favorable to us, access to retail pharmacies by our clients and their health plan members, and consequently our business, results of operations, financial condition or cash flows could be adversely affected.
Pharmacy Management—Loss of Relationship with Vendors—Our specialty pharmacies, pharmacy claims processing, and mail processing are dependent on our relationships with a limited number of vendors and suppliers and the loss of any of these relationships could significantly impact our ability to sustain our financial performance.
We acquire a substantial percentage of our specialty pharmacies prescription drug supply from a limited number of suppliers. Some of our agreements with these suppliers may be short-term and cancelable by either party without cause with a relatively short time-frame of prior notice. Further, certain parts of these agreements allow pricing and other terms of these relationships to be periodically adjusted based upon required service levels. A termination or modification to any of these relationships could have an adverse effect on our business, financial condition and results of operations. An additional risk related to supply is that many products dispensed by our specialty pharmacy business are manufactured with ingredients that are susceptible to supply shortages. If any products we dispense are in short supply for long periods of time, this could result in a material adverse effect on our business, financial condition and results of operations. Further, we source from a limited number of vendors certain aspects of our pharmacy claims and mail processing capabilities. An interruption of service, termination or modification to the terms to any of these agreements may adversely affect our business and financial condition.
Pharmacy Management—Loss of Relationship with Manufacturers—If we lose relationships with one or more key pharmaceutical manufacturers or third-party rebate administrators or if rebate payments we receive from pharmaceutical manufacturers and rebate processing service providers decline, our business, results of operations, financial condition or cash flows could be adversely affected.
We receive fees or other compensation from our clients, in some cases based upon the retention of rebate amounts paid by pharmaceutical manufacturers or third-party rebate administrators based on the use of selected drugs by members of health plans sponsored by our clients, all pursuant to the terms of our customer contracts. In addition, pharmaceutical manufacturers often pay administrative fees to us based upon our provision of rebate administration services under agreements with such manufacturers or third-party rebate administrators. Our business, results of operations, financial condition or cash flows could be adversely affected if: we lose relationships with one or more key pharmaceutical manufacturers or third-party rebate administrators; we are unable to renew or finalize rebate contracts with one or more key pharmaceutical manufacturers or third-party rebate administrators in the future, or are unable to negotiate interim arrangements; rebates decline due to the failure of our health plan sponsors to meet market share or other thresholds; legal restrictions are imposed on the ability of pharmaceutical manufacturers to offer rebates or purchase our services relating to the administration of rebates; pharmaceutical manufacturers choose not to offer rebates or purchase our services; or rebates decline due to contracted branded products losing their patents.
Dependence on Government Spending—The Company can be adversely affected by changes in federal, state and local healthcare policies, programs, funding and enrollments.
A portion of the Company’s net revenues are derived, directly or indirectly, from governmental agencies, including state Medicaid programs. Contract rates vary from state to state, are subject to periodic negotiation and may limit the Company’s ability to maintain or increase rates. The Company is unable to predict the impact on the Company’s operations of future regulations or legislation affecting Medicaid programs, or the healthcare industry in general. Future regulations or legislation may have a material adverse effect on the Company. Moreover, any reduction in government spending for such programs could also have a material adverse effect on the Company (See “Reliance on Customer Contracts”). In addition, the Company’s contracts with federal, state and local governmental agencies, under both direct contract and subcontract arrangements, generally are conditioned upon financial appropriations by one or more governmental agencies, especially in the case of state Medicaid programs. These contracts generally can be terminated or modified by the customer if such appropriations are not made. The Company faces increased risks in this regard as state budgets have come under increasing pressure. Finally, some of the Company’s contracts with federal, state and local governmental agencies, under both direct contract and subcontract arrangements, require the Company to perform additional services if federal, state or local laws or regulations imposed after the contract is signed so require, in exchange for additional compensation, to be negotiated by the parties in good faith. Government and other third-party
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payors generally seek to impose lower contract rates and to renegotiate reduced contract rates with service providers in a trend toward cost control.
Restrictive Covenants in the Company’s Debt Instruments—Restrictions imposed by the Company’s debt agreements limit the Company’s operating and financial flexibility. These restrictions may adversely affect the Company’s ability to finance the Company’s future operations or capital needs or engage in other business activities that may be in the Company’s interest.
On September 22, 2017, the Company completed the public offering of $400.0 million aggregate principal amount of its 4.400% Senior Notes due 2024 (the “Notes”). The Notes are governed by an indenture dated as of September 22, 2017 (the “Base Indenture”), between the Company, as issuer, and U.S. Bank National Association, as trustee, and are supplemented by a first supplemental indenture dated as of September 22, 2017 (the “First Supplemental Indenture” together, with the Base Indenture, the “Indenture”), between the Company, as issuer, and U.S. Bank National Association, as trustee. During the years ended December 31, 2019 and 2020, the Company purchased and subsequently retired $11.1 million and $28.9 million of its Notes, respectively, which resulted in a loss on retirement of $0.3 million and $0.7 million, respectively, that is included in interest expense. The Notes were issued at a discount and had a carrying value of $388.4 million and $359.6 million as of December 31, 2019 and 2020, respectively.
The Indenture contains certain covenants which restrict the Company’s ability to, among other things, create liens on its and its subsidiaries’ assets; engage in sale and lease-back transactions; and engage in a consolidation, merger or sale of assets.
On September 22, 2017, the Company entered into a credit agreement with various lenders that provides for a $400.0 million senior unsecured revolving credit facility and a $350.0 million senior unsecured term loan facility to the Company, as the borrower (the “2017 Credit Agreement”). On August 13, 2018, the Company entered into an amendment to the 2017 Credit Agreement, which extended the maturity date by one year. On February 27, 2019, the Company entered into a second amendment to the 2017 Credit Agreement, which amended the total leverage ratio covenant and which was necessary in order for the Company to remain in compliance with the terms of the 2017 Credit Agreement. The 2017 Credit Agreement is scheduled to mature on September 22, 2023.
The 2017 Credit Agreement contains covenants that limit management’s discretion in operating the Company’s business by restricting or limiting the Company’s ability, among other things, to: incur or guarantee additional indebtedness or issue preferred or redeemable stock; pay dividends and make other distributions; repurchase equity interests; make certain advances, investments and loans; enter into sale and leaseback transactions; create liens; sell and otherwise dispose of assets; acquire or merge or consolidate with another company; and enter into some types of transactions with affiliates.
These restrictions could adversely affect the Company’s ability to finance future operations or capital needs or engage in other business activities that may be in the Company’s interest. The 2017 Credit Agreement also requires the Company to comply with specified financial ratios and tests. Failure to do so, unless waived by the lenders under the 2017 Credit Agreement, pursuant to its terms, or amended, would result in an event of default.
Required Assurances of Financial Resources—The Company’s liquidity, financial condition, prospects and profitability can be adversely affected by present or future state regulations and contractual requirements that the Company provide financial assurance of the Company’s ability to meet the Company’s obligations.
Some of the Company’s contracts and certain state regulations require the Company or certain of the Company’s subsidiaries to maintain specified cash reserves or letters of credit and/or to maintain certain minimum tangible net equity in certain of the Company’s subsidiaries as assurance that the Company has financial resources to meet the Company’s contractual obligations. Many of these state regulations also restrict the investment activity of certain of the Company’s subsidiaries. Some state regulations also restrict the ability of certain of the Company’s subsidiaries to pay dividends to Magellan. Additional state regulations could be promulgated that would increase the cash or other security the Company would be required to maintain. In addition, the Company’s customers may require additional restricted cash or other security with respect to the Company’s obligations under the Company’s contracts, including the Company’s obligation to pay IBNR claims and other medical claims not yet processed and paid. In addition, certain of the Company’s contracts and state regulations limit the profits that the Company may earn on risk-based business. The Company’s liquidity, financial condition, prospects and profitability could be adversely affected
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by the effects of such regulations and contractual provisions. See Note 2—“Summary of Significant Accounting Policies—Restricted Assets” to the consolidated financial statements set forth elsewhere herein for a discussion of the Company’s restricted assets.
Risks Related to Realization of Goodwill and Intangible Assets—The Company’s profitability could be adversely affected if the value of intangible assets is not fully realized.
The Company’s total assets at December 31, 2020 reflect goodwill of approximately $0.9 billion, representing approximately 26.0 percent of total assets. The Company completed its annual impairment analysis of goodwill as of October 1, 2020, noting that no impairment was identified.
At December 31, 2020, identifiable intangible assets (customer lists, contracts, provider networks and trade names) totaled approximately $79.7 million. Intangible assets are generally amortized over their estimated useful lives, which range from approximately one to eighteen years. The amortization periods used may differ from those used by other entities. In addition, the Company may be required to shorten the amortization period for intangible assets in future periods based on changes in the Company’s business. There can be no assurance that such goodwill or intangible assets will be realizable.
The Company evaluates, on a regular basis, whether for any reason the carrying value of the Company’s intangible assets and other long-lived assets may no longer be completely recoverable, in which case a charge to earnings for impairment losses could become necessary. When events or changes in circumstances occur that indicate the carrying amount of long-lived assets may not be recoverable, the Company assesses the recoverability of long-lived assets other than goodwill by determining whether the carrying value of such assets will be recovered through the future cash flows expected from the use of the asset and its eventual disposition.
While no units were determined to be impaired at this time, reporting unit goodwill is at risk of future impairment in the event of significant unfavorable changes in the Company’s forecasted future results and cash flows. In addition, market factors utilized in the impairment analysis, including long-term growth rates or discount rates, could negatively impact the fair value of our reporting units. For testing purposes, management's best estimates of the expected future results are the primary driver in determining the fair value. Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions and factors. As a result, there can be no assurance that the estimates and assumptions made for purposes of the annual goodwill test will prove to be an accurate prediction of the future.
Examples of events or circumstances that could reasonably be expected to negatively affect the underlying key assumptions and ultimately impact the estimated fair value of our reporting units may include such items as: (i) a decrease in expected future cash flows, specifically, a decrease in membership or rates or customer attrition and increase in costs that could significantly impact our immediate and long-range results, unfavorable working capital changes and an inability to successfully achieve our cost savings targets, (ii) adverse changes in macroeconomic conditions or an economic recovery that significantly differs from our assumptions in timing and/or degree (such as a recession); and (iii) volatility in the equity and debt markets or other country specific factors which could result in a higher weighted average cost of capital.
Based on known facts and circumstances, we evaluate and consider recent events and uncertain items, as well as related potential implications, as part of our annual assessment and incorporate into the analyses as appropriate. These facts and circumstances are subject to change and may impact future analyses.
While historical performance and current expectations have resulted in fair values of our reporting units and indefinite-lived intangible assets in excess of carrying values, if our assumptions are not realized, it is possible that an impairment charge may need to be recorded in the future.
Any event or change in circumstances leading to a future determination requiring write-off of a significant portion of unamortized intangible assets or goodwill would adversely affect the Company’s profitability.
The Company faces risks related to unauthorized disclosure of sensitive or confidential member and other protected personal or health information.
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As part of its normal operations, the Company collects, processes and retains confidential member and protected personal or health information making the Company subject to various federal and state laws and rules regarding the use and disclosure of confidential member and protected personal or health information, including HIPAA. The Company also maintains other confidential information related to its business and operations. Despite our security measures, the Company is subject to security breaches, acts of vandalism, acts of ransomware and other cyber-attacks, computer viruses, misplaced or lost data, programming and/or human errors or other similar events. For example, we have experienced data security breaches resulting in disclosure of confidential or protected personal or health information. Noncompliance with any privacy or security laws and regulations (including, but not limited to, state and federal laws and international regulations, such as GDPR) or any security incident or breach, whether by the Company or by its vendors, could result in enforcement actions, material fines and penalties, reputational and financial harm to the Company, and could also subject the Company to litigation.
IT Systems – The Company’s ability to effectively maintain and upgrade its information systems is critical to its business.
The Company’s operations are dependent on effective information systems. Our information systems require routine maintenance, enhancements and upgrades in order to meet operational needs and regulatory requirements. The maintenance, upgrade and enhancement of our information systems requires significant economic resources. If the Company encounters difficulties in its information systems, or with the transition to or from its information systems, or does not appropriately maintain, enhance and upgrade its information systems, such events could adversely impact the Company’s operations materially.
Cyber-Security—The Company faces risks related to a breach or failure in our operational security systems or infrastructure, or those of third parties with which we do business.
Our business requires us to securely store, process and transmit confidential, proprietary and other information in our operations, including protected personal or health information. Security incidents or breaches may arise from, among other things, computer hackers penetrating our systems or approaching our employees to obtain personal information for financial gain, attempting to cause harm to our operations, or intending to obtain competitive, confidential or protected personal or health information. It is widely reported that the healthcare industry, including providers, plans and pharmacies, are increasingly prime targets for cyber-attacks. Our data assets and systems continue to be subject to attack by viruses, worms, phishing attempts and other malicious software programs on a regular basis, and we routinely identify attempts to gain unauthorized access to our systems.
We maintain a comprehensive system of preventive and detective controls through our security programs; however given the rapidly evolving nature and proliferation of cyber threats, our controls may not prevent or identify all such attacks in a timely manner or otherwise prevent unauthorized access to, damage to, or interruption of our systems and operations, and we cannot eliminate the risk of human error or employee or vendor malfeasance. For example, we were the target of a criminal ransomware attack on our computer network, which resulted in a temporary systems outage and the exfiltration of certain confidential company and personal information as well as protected health information of certain members.
Any costs that we incur as a result of a data security incident or breach, including costs to update our security protocols to mitigate such an incident or breach could be significant. Any breach or failure in our operational security systems can result in loss of data or an unauthorized disclosure of or access to sensitive or confidential member or protected personal or health information and could result in significant penalties or fines, litigation, loss of customers, significant damage to our reputation and business, and other losses, which could adversely impact the Company’s financial condition and results of operations materially.
We are subject to risks associated with outsourcing services and functions to third parties.
We contract with third party vendors and service providers who provide services to us and our subsidiaries or to whom we delegate selected functions. Some of these third parties also have direct access to our systems. Our arrangements with third party vendors and service providers may make our operations vulnerable if those third parties fail to satisfy their obligations to us, including their obligations to maintain and protect the security and confidentiality of our information and data or the protected personal or health information and data relating to our members or customers. We are also at risk of a data security incident or breach involving a vendor or third party, which could result in a
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breakdown of such third party’s data protection processes or cyber-attackers gaining access to our infrastructure through the third party, or can result in loss of data or an unauthorized disclosure of or access to sensitive or confidential member or protected personal or health information.
To the extent that a vendor or third party suffers a security incident or breach that compromises its operations, we could incur significant costs and possible service interruption, which could have an adverse effect on our business, operations and reputation. In addition, we may have disagreements with third party vendors and service providers regarding relative responsibilities for any such failures or security incidents or breaches under applicable business associate agreements or other applicable outsourcing agreements.
Any contractual remedies and/or indemnification obligations we may have for vendor or service provider failures or security incidents or breaches may not be adequate to fully compensate us for any losses suffered as a result of any vendor’s failure to satisfy its obligations to us or under applicable law. Further, we may not be adequately indemnified against all possible losses through the terms and conditions of our contracts with third party vendors and service providers. Our outsourcing arrangements could be adversely impacted by changes in vendors’ or service providers’ operations or financial condition or other matters outside of our control.
If we fail to adequately monitor and regulate the performance of our third-party vendors and service providers, we could be subject to additional risk, including significant cybersecurity risk. Violations of, or noncompliance with, laws and/or regulations governing our business (including, but not limited to, state and federal laws and international regulations, such as GDPR) or noncompliance with contract terms by third-party vendors and service providers could increase our exposure to liability to our members, providers, or other third parties, or sanctions and/or fines from the regulators that oversee our business, as well as litigation. In turn, this could increase the costs associated with the operation of our business or have an adverse impact on our business and reputation. Moreover, if these vendor and service provider relationships were terminated for any reason, we may not be able to find alternative partners in a timely manner or on acceptable financial terms, and may incur significant costs and/or disruption to our operations in connection with any such vendor or service provider transition. As a result, we may not be able to meet the full demands of our members or customers and, in turn, our business, financial condition, or results of operations may be harmed materially. In addition, we may not fully realize the anticipated economic and other benefits from our outsourcing projects or other relationships we enter into with third party vendors and service providers, as a result of regulatory restrictions on outsourcing, unanticipated delays in transitioning our operations to the third party, vendor or service provider noncompliance with contract terms or violations of laws and/or regulations, or otherwise. This could result in substantial costs or other operational or financial problems that could have a material adverse effect on our business, financial condition, cash flows, or results of operations.
RISK RELATED TO REGULATORY AND LEGAL MATTERS
Possible Impact of Federal Mental Health Parity—could impact the Company’s revenues or profitability.
In October 2008, the United States Congress passed the Paul Wellstone and Pete Dominici Mental Health Parity Act of 2008 (“MHPAEA”) establishing parity in financial requirements (e.g. co-pays, deductibles, etc.) and treatment limitations (e.g., limits on the number of visits) between mental health and substance abuse benefits and medical/surgical benefits for health plan members. The law applies to ERISA plans, Medicaid managed care plans and SCHIP plans. In 2010 regulations were issued that apply to ERISA plans and insured business. These regulations included some significant concepts not included under the statute including the requirement to conduct the parity review at the category level within the plan, introducing the concept of non-quantitative treatment limitations, and prohibiting separate but equal deductibles. In 2016 regulations were released imposing similar requirements and concepts on Medicaid Managed Care. The Company believes it is in compliance with the requirements of these regulations, however additional guidance or new parity laws could impact the business. The Company’s risk contracts do allow for repricing to occur effective the same date that any legislation/regulation becomes effective if that legislation/regulation is projected to have a material effect on cost of care.
Government Regulation—The Company is subject to substantial government regulation and scrutiny, which increase the Company’s costs of doing business and could adversely affect the Company’s profitability.
The managed healthcare industry is subject to extensive and evolving federal and state regulation. Such laws and regulations cover, but are not limited to, matters such as licensure, accreditation, government healthcare program
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participation requirements, information privacy and security, reimbursement for patient services, and Medicare and Medicaid fraud and abuse. The Company’s pharmaceutical management business is also the subject of substantial federal and state governmental regulation and scrutiny.
Regulatory issues may also affect the Company’s operations including, but not limited to: additional state licenses that may be required to conduct the Company’s businesses, including utilization review, PBM, pharmacy, HMO and TPA activities; limits imposed by state authorities upon corporations’ control or excessive influence over managed healthcare services through the direct employment of physicians, psychiatrists, psychologists or other professionals, and prohibiting fee splitting; laws that impose financial terms and requirements on the Company due to the Company’s assumption of risk under contracts with licensed insurance companies or HMOs; laws in certain states that impose an obligation to contract with any healthcare provider willing to meet the terms of the Company’s contracts with similar providers; compliance with HIPAA (including the federal HITECH Act, which strengthens and expands HIPAA) and other federal and state laws impacting the confidentiality of member information; state and federal laws governing telemedicine; state legislation regulating PBMs or imposing fiduciary status on PBMs; pharmacy laws and regulation; legislation imposing benefit plan design restrictions, which limit how our clients can design their drug benefit plans; and network pharmacy access laws, including “any willing provider” and “due process” legislation, that affect aspects of our pharmacy network contracts.
The imposition of additional licensing and other regulatory requirements may, among other things, increase the Company’s equity requirements, increase the cost of doing business or force significant changes in the Company’s operations to comply with these requirements. In this regard, in a December 2020 decision, the United States Supreme Court ruled in Rutledge v. Pharmaceutical Care Management Association that ERISA does not pre-empt state rate or cost regulations that do not force plans to adopt particular benefit coverage. The Rutledge decision does not address other issues apart from rate regulations, however and so the Company could be subject to overlapping federal and state regulatory requirements with respect to certain of its operations and may need to implement compliance programs that satisfy multiple regulatory regimes.
The costs associated with compliance with government regulation as discussed above may adversely affect the Company’s financial condition and results of operation.
Proposed changes to current Federal law and regulations could have a material and adverse impact on our PBM business.
There are various proposed federal laws that could change some aspects of our pharmacy benefit management business. For example, the laws, if enacted, could require the pass-through of all rebate amounts to customer, or prohibit the use of “traditional” pricing, under which a pharmacy benefit manager pays a pharmacy one price under its pharmacy contract, and charges a different price to the customer based on the terms of the customer contract. These and other changes, if enacted into law, may change the manner in which industry participants contract with customers, and we cannot predict with any certainty whether such alternative contract structures would be materially less profitable than current contracts.
Noncompliance with Regulations—Noncompliance with regulations may have a material adverse effect on the Company’s business, financial condition and results of operations, including from monetary or criminal liabilities and penalties, investigations or regulatory actions, additional compliance requirements, heightened governmental scrutiny, or exclusion from participating in government programs.
Extensive laws and regulation are applicable to all of our business operations. In addition to laws and regulations generally applicable to our business, the Company is subject to other federal laws and regulations in connection with its contracts with the federal government. These laws and regulations affect how the Company conducts business with its federal agency customers and may impose added costs on its business. Noncompliance by the Company with these laws and regulations may have a material adverse effect on the Company’s business, financial condition and results of operations.
Government investigations and allegations have become more frequent concerning possible violations of statutes and regulations by healthcare organizations. The Company also conducts its own investigations into these matters and may choose to self-report its findings to governmental agencies. Violations by the Company with certain laws and regulations may result in it being excluded from participating in government healthcare programs, subject to
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fines or penalties or required to repay amounts received from the government for previously billed services. The Company’s failure to comply with federal procurement laws and regulations could cause it to lose business, incur additional costs and subject it to a variety of civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, harm to reputation, suspension of payments, fines, and suspension or debarment from doing business with federal government agencies. In addition, alleged violations may result in litigation or regulatory action. A subsequent legal liability or a significant regulatory action against the Company could have a material adverse effect on the Company’s business, financial condition and results of operations. Moreover, even if the Company ultimately prevails in any litigation, regulatory action or investigation, such litigation, regulatory action or investigation could have a material adverse effect on the Company’s business, financial condition and results of operations.
The Company also receives notifications from and engages in discussions with various government agencies concerning the Company’s businesses and operations. As a result of these contacts with regulators, the Company may, as appropriate, be required to implement changes to the Company’s operations, revise the Company’s filings with such agencies and/or seek additional licenses to conduct the Company’s business. The Company’s inability to comply with the various regulatory requirements may have a material adverse effect on the Company’s business.
Reference is made to information set forth under “Regulation—Other Federal and State Laws and Regulations” under Item 1 of this Report.
Medicare Part D—The Company’s participation in Medicare Part D is subject to government regulation and failure to comply with regulatory requirements could adversely impact the Company’s profitability.
There are many uncertainties about the financial and regulatory risks of participating in the Medicare Part D program, and we can give no assurance these risks will not materially adversely impact the Company’s results. Certain of the Company’s subsidiaries have been approved by CMS to offer Medicare Part D prescription drug plans to employer groups. Such subsidiaries are required to comply with Medicare Part D laws and regulations and, because CMS requires that Medicare Part D sponsors be licensed as risk-bearing entities, also with applicable state laws and regulations regarding the business of insurance. The Company also provides services in support of our clients’ Medicare Part D plans and must be able to deliver such services in a manner that complies with applicable regulatory requirements. The adoption of new or more complex regulatory requirements or changes in the interpretation of existing regulatory requirements associated with Medicare Part D may require us to incur significant costs or otherwise impact our ability to earn a profit on such business. In addition, the Company’s receipt of federal funds made available through the Medicare Part D program is subject to compliance with the laws and regulations governing the federal government’s payment for healthcare goods and services, including the Federal Anti-Kickback law and False Claims Acts. If we fail to comply materially with applicable regulatory or contractual requirements, whether identified through CMS or other government audits, client audits, or otherwise, we may be subject to certain sanctions, penalties, or other remedies, including, but not limited to, suspension of marketing or enrollment activities, restrictions on expanding our service area, civil monetary penalties or other monetary amounts, termination of our contract(s) with CMS or Part D clients, and exclusion from federal healthcare programs.
The Company faces additional regulatory risks associated with its Pharmacy Management segment which could subject it to additional regulatory scrutiny and liability and which could adversely affect the profitability of the Pharmacy Management segment in the future.
Various aspects of the Company’s Pharmacy Management segment are governed by federal and state laws and regulations. Pharmaceutical management services are provided by the Company to Medicaid and Medicare plans as well as commercial insurance plans. There has been enhanced scrutiny on federal programs and the Company must remain vigilant in ensuring compliance with the requirements of these programs. Significant sanctions may be imposed for violations of these laws and compliance programs are a significant operational requirement of the Company’s business. There are significant uncertainties involving the application of many of these legal requirements to the Company. Accordingly, the Company may be required to incur additional administrative and compliance expenses in determining the applicable requirements and in adapting its compliance practices, or modifying its business practices, in order to satisfy changing interpretations and regulatory policies. In addition, there are numerous proposed healthcare laws and regulations at the federal and state levels, many of which, if adopted, could adversely affect the Company’s business. See “Regulation” above.
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Claims for Professional Liability—Pending or future actions or claims for professional liability (including any associated judgments, settlements, legal fees and other costs) could require the Company to make significant cash expenditures and consume significant management time and resources, which could have a material adverse effect on the Company’s profitability and financial condition.
The Company’s operating activities entail significant risks of liability. In recent years, participants in the healthcare industry generally, as well as the managed healthcare industry, have become subject to an increasing number of lawsuits. From time to time, the Company is subject to various actions and claims of professional liability alleging negligence in performing utilization review and other managed healthcare activities, as well as for the acts or omissions of the Company’s employees, including employed physicians and other clinicians, network providers, pharmacists, or others. In the normal course of business, the Company receives reports relating to deaths and other serious incidents involving patients whose care is being managed by the Company. Such incidents occasionally give rise to malpractice, professional negligence and other related actions and claims against the Company, the Company’s employees or the Company’s network providers. The Company is also subject to actions and claims for the costs of services for which payment was denied. Many of these actions and claims seek substantial damages and require the Company to incur significant fees and costs related to the Company’s defense and consume significant management time and resources. While the Company maintains professional liability insurance, there can be no assurance that future actions or claims for professional liability (including any judgments, settlements or costs associated therewith) will not have a material adverse effect on the Company’s profitability and financial condition.
Professional Liability and Other Insurance—Claims brought against the Company that exceed the scope of the Company’s liability coverage or denial of coverage could materially and adversely affect the Company’s profitability and financial condition.
The Company maintains a program of insurance coverage against a broad range of risks in the Company’s business. As part of this program of insurance, the Company carries professional liability insurance, subject to certain deductibles and self-insured retentions. The Company also is sometimes required by customer contracts to post surety bonds with respect to the Company’s potential liability on professional responsibility claims that may be asserted in connection with services the Company provides. As of December 31, 2020, the Company had approximately $154.1 million of such bonds outstanding. The Company’s insurance may not be sufficient to cover any judgments, settlements or costs relating to present or future claims, suits or complaints. Upon expiration of the Company’s insurance policies, sufficient insurance may not be available on favorable terms, if at all. To the extent the Company’s customers are entitled to indemnification under their contracts with the Company relating to liabilities they incur arising from the operation of the Company’s programs, such indemnification may not be covered under the Company’s insurance policies. To the extent that certain actions and claims seek punitive and compensatory damages arising from the Company’s alleged intentional misconduct, such damages, if awarded, may not be covered, in whole or in part, by the Company’s insurance policies. If the Company is unable to secure adequate insurance in the future, or if the insurance the Company carries is not sufficient to cover any judgments, settlements or costs relating to any present or future actions or claims, such judgments, settlements or costs may have a material adverse effect on the Company’s profitability and financial condition. If the Company is unable to obtain needed surety bonds in adequate amounts or make alternative arrangements to satisfy the requirements for such bonds, the Company may no longer be able to operate in those states, which would have a material adverse effect on the Company.
Class Action Suits and Other Legal Proceedings—The Company is subject to class action and other lawsuits that could result in material liabilities to the Company or cause the Company to incur material costs, to change the Company’s operating procedures in ways that increase costs or to comply with additional regulatory requirements.
Managed healthcare companies and PBM companies have been targeted as defendants in national class action lawsuits regarding their business practices. The Company is subject to such national class actions as defendants and is also subject to or a party to other class actions, lawsuits and legal proceedings in conducting the Company’s business, including but not limited to, network provider reimbursement, employment practices, and privacy and data protection. In addition, certain of the Company’s customers are parties to pending class action lawsuits regarding the customers’ business practices for which the customers could seek indemnification from the Company. These lawsuits may take years to resolve and cause the Company to incur substantial litigation expense, and the outcomes could have a material adverse effect on the Company’s profitability and financial condition. In addition to potential damage awards, depending upon the outcomes of such cases, these lawsuits may cause or force changes in practices of the Company’s industry and
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may also cause additional regulation of the industry through new federal or state laws or new applications of existing laws or regulations. Such changes could increase the Company’s operating costs.
Our amended bylaws provide that the Court of Chancery of the State of Delaware and the federal district courts of the United States of America will be the exclusive forums for substantially all disputes between us and our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers, or employees.
Our bylaws provide that the Court of Chancery of the State of Delaware is the exclusive forum for: (1) any derivative action or proceeding brought on our behalf; (2) any action asserting a breach of fiduciary duty; (3) any action asserting a claim against us arising under the General Corporation Law of the State of Delaware, our certificate of incorporation, or our bylaws; and (4) any action asserting a claim against us that is governed by the internal-affairs doctrine.
This provision would not apply to actions brought to enforce a duty or liability created by the Exchange Act or any other claim for which the federal courts have exclusive jurisdiction. Furthermore, Section 22 of the Securities Act creates concurrent jurisdiction for federal and state courts over all Securities Act claims, which means both courts have jurisdiction to entertain such claims. To prevent having to litigate claims in multiple jurisdictions and the threat of inconsistent or contrary rulings by different courts, among other considerations, our bylaws provides that the federal district courts of the United States of America will be the exclusive forum for resolving any complaint asserting a cause of action arising under the Securities Act.
These exclusive forum provisions may limit a stockholder’s ability to bring an action in a judicial forum that it finds favorable for disputes with us or our directors, officers, or other employees, which may discourage lawsuits against us and our directors, officers, and other employees. While the Delaware courts have determined that such choice of forum provisions are facially valid, a stockholder may nevertheless seek to bring an action in a venue other than those designated in the exclusive forum provisions. In such instance, we would expect to vigorously assert the validity and enforceability of our exclusive forum provisions, which may require significant additional costs associated with resolving such action in other jurisdictions, and there can be no assurance that the provisions will be enforced by a court in those other jurisdictions. If a court were to find either exclusive forum provision in our bylaws to be inapplicable or unenforceable in an action, we may incur further significant additional costs associated with resolving the dispute in other jurisdictions, all of which could seriously harm our business.
GENERAL RISK FACTORS
Negative Publicity—The Company may be subject to negative publicity which may adversely affect the Company’s business, financial position, results of operations or cash flows.
From time to time, the managed healthcare industry has received negative publicity. This publicity has led to increased legislation, regulation, review of industry practices and private litigation. These factors may adversely affect the Company’s ability to market our services, require the Company to change its services, or increase the overall regulatory burden under which the Company operates. Any of these factors may increase the costs of doing business and adversely affect the Company’s business, financial position, results of operations or cash flows.
Investment Portfolio—The value of the Company’s investments is influenced by varying economic and market conditions, and a decrease in value may result in a loss charged to income.
All of the Company’s investments are classified as “available-for-sale” and are carried at fair value. The Company’s available-for-sale investment securities were $143.5 million and represented 4.3 percent of the Company’s total assets at December 31, 2020.
The current economic environment and recent volatility of securities markets increase the difficulty of assessing investment impairment and the same influences tend to increase the risk of potential impairment of these assets. The Company believes it has adequately reviewed its investment securities for impairment and that its investment securities are carried at fair value. However, over time, the economic and market environment may provide additional insight regarding the fair value of certain securities, which could change the Company’s judgment regarding impairment. This could result in realized losses relating to other-than-temporary declines being charged against future income. Given the
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current market conditions and the significant judgments involved, there is a risk that declines in fair value may occur and material other-than-temporary impairments may be charged to income in future periods, resulting in realized losses. In addition, if it became necessary for the Company to liquidate its investment portfolio on an accelerated basis, it could have an adverse effect on the Company’s results of operations.
Adverse Economic Conditions—Adverse changes in national economic conditions could adversely affect the Company’s business and results of operations.
Changes in national economic conditions could adversely affect the Company’s reimbursement from state Medicaid programs in its Healthcare segment. Adverse economic conditions could also adversely affect the Company’s customers in the Healthcare and Pharmacy Management segments resulting in increased pressures on the Company’s operating margins. In addition, economic conditions may result in decreased membership in the Healthcare and Pharmacy Management segments, thereby adversely affecting the revenues to the Company from such customers as well as the Company’s operating profitability.
Adverse economic conditions in the debt markets could affect the Company’s ability to refinance the Company’s existing Credit Agreement upon its maturity on acceptable terms, or at all.
Talent Management – The Company’s ability to attract and retain employees and manage the succession and retention of key executives is critical to our success.
The Company’s ability to attract and retain qualified employees is critical to the Company’s success. There is competition among potential employers for qualified and experienced employees and there is no assurance that the Company will be able to attract or retain such employees. In addition, competition among potential employers could result in increased salaries and benefits. If the Company is unable to retain its employees, or attract additional employees, such events could result in a material adverse impact on our business.
The Company also could be impacted adversely if the Company is unable to plan adequately for the succession of executives and senior management. The Company has succession plans in place, however, such plans do not guarantee that the services of these employees will continue to be available to us.
Tax matters, including the changes in corporate tax rates, disagreements with taxing authorities and imposition of new taxes could impact our results of operations and financial condition.
We are subject to income and other taxes in the U.S., and our operations, plans and results of operations are affected by tax and other initiatives. As a result of the passage of the Tax Cuts and Jobs Act (the “Tax Act”), corporate tax rates in the United States decreased in 2018, which resulted in changes to our valuation of our deferred tax assets and liabilities. These changes in valuation were material to our income tax expense and deferred tax balances.
We are also subject to regular reviews, examinations, and audits by the Internal Revenue Service and other taxing authorities with respect to our taxes. Although we believe our tax estimates are reasonable, if a taxing authority disagrees with the positions we have taken, we could face additional tax liability, including interest and penalties. There can be no assurance that payment of such additional amounts upon final adjudication of any disputes will not have a material impact on our results of operations and financial position.
Our effective tax rate in the future could be adversely affected by changes to our operating structure, changes in the mix of earnings in jurisdictions with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in the application or interpretation of the Tax Act, or other changes in tax laws.
Extraordinary Events—Extraordinary events, including the ongoing COVID-19 pandemic, could adversely affect the Company’s business, financial condition and results of operations.
The Company’s operations could be subject to an epidemic or health crisis such as the COVID-19 pandemic, natural disasters, political disruptions, acts of war or terrorism and other such extraordinary events. These events could cause significant disruptions in the Company’s operations and its ability to serve its members. If a business interruption occurs and we are unsuccessful in our continuing efforts to minimize the impact of these events, our business, results of operations, financial position and cash flows could be materially adversely affected. Such events could also impact the
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Company’s utilization, which could have a favorable or unfavorable impact to its medical loss ratios. In addition, such events could impact the financial markets, which could adversely impact the Company’s investment portfolio and its ability to access the credit markets.
In 2020, the spread of the COVID-19 pandemic caused significant financial market volatility and economic uncertainty, and is currently impacting countries, communities and workforces around the world. To date, the Company has not experienced any negative impact on its medical loss ratios and, other than the transition of our employees to a work at home environment, the Company has not experienced any significant interruptions to normal business activities and has not experienced any disruptions in its services. In addition, the Company does not expect the valuation of its investments to be materially affected. The extent to which the COVID-19 pandemic impacts our business, results of operations and financial condition are dependent on future developments for which there is significant uncertainty at this time and cannot be predicted, such as the scope, duration and severity of the pandemic, the extent and effectiveness of containment actions, any actions that may be taken by various governmental authorities in response to the outbreak, the possible impact on the global economy and local economies in which we operate and the resumption of normal economic conditions. The long-term financial and economic impacts of the COVID-19 pandemic may continue for a significant period of time and cannot be reliably quantified or estimated at this time due to the uncertainty of future developments.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
The Company currently occupies under lease approximately 886,000 square feet of office space comprising 49 offices in 20 states and the District of Columbia with terms expiring between January 31, 2021 and August 31, 2029. The Company’s headquarters are located in Phoenix, Arizona, which lease expires in March 2024. The Company believes that its current facilities are suitable for and adequate to support the level of its present operations. In addition, the Company is lessee of approximately 235,000 square feet of office space, which as of February 26, 2021, was unoccupied.
Item 3. Legal Proceedings
The Company’s operating activities entail significant risks of liability. From time to time, the Company is subject to various actions and claims arising from the acts or omissions of its employees, network providers or other parties. In the normal course of business, the Company receives reports relating to deaths and other serious incidents involving patients whose care is being managed by the Company. Such incidents occasionally give rise to malpractice, professional negligence and other related actions and claims against the Company or its network providers. Many of these actions and claims received by the Company seek substantial damages and therefore require the Company to incur significant fees and costs related to their defense.
The Company is also subject to or party to certain class actions and other litigation and claims relating to its operations or business practices, including network provider reimbursement, employment practices and privacy and data protection. The Company has recorded reserves that, in the opinion of management, are adequate to cover litigation, claims or assessments that have been or may be asserted against the Company, and for which the outcome is probable and reasonably estimable. Management believes that the resolution of such litigation and claims will not have a material adverse effect on the Company’s financial condition or results of operations; however, there can be no assurance in this regard.
Item 4. Mine Safety Disclosures
Not applicable.
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Shares of the Company’s Common Stock, $0.01 par value per share (“common stock”) trade on the NASDAQ Stock Market under the symbol “MGLN.” For further information regarding the Company’s common stock, see Note 6—“Stockholders’ Equity” to the consolidated financial statements set forth elsewhere herein.
As of December 31, 2020, there were approximately 224 stockholders of record of the Company’s common stock. The stockholders of record data for common stock does not reflect persons whose stock was held on that date by the Depository Trust Company or other intermediaries.
Comparison of Cumulative Total Return
The following graph compares the change in the cumulative total return on the Company’s common stock to (a) the change in the cumulative total return on the stocks included in the Standard & Poor’s (“S&P”) 500 Stock Index and (b) the change in the cumulative total return on the stocks included in the S&P 500 Managed Health Care Index, assuming an investment of $100 made at the close of trading on December 31, 2015, and comparing relative values on December 31, 2016, 2017, 2018, 2019 and 2020. The Company did not pay any dividends during the period reflected in the graph. The common stock price performance shown below should not be viewed as being indicative of future performance.
December 31, |
| ||||||||||||||||||
| 2015 |
| 2016 |
| 2017 |
| 2018 |
| 2019 |
| 2020 |
| |||||||
Magellan Health, Inc. | $ | 100.00 | $ | 122.04 | $ | 156.58 | $ | 92.26 | $ | 126.91 | $ | 134.35 | |||||||
S&P 500 Index |
| 100.00 |
| 111.96 |
| 136.40 |
| 130.42 |
| 171.49 |
| 203.04 | |||||||
S&P 500 Managed Health Care Index(1) |
| 100.00 |
| 119.51 |
| 172.18 |
| 190.76 |
| 229.25 |
| 265.60 | |||||||
| (1) | The S&P 500 Managed Health Care Index consists of Anthem, Inc., Centene Corporation, Humana, Inc. and UnitedHealth Group, Inc. |
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The information set forth above under the “Comparison of Cumulative Total Return” does not constitute soliciting material and should not be deemed filed or incorporated by reference into any other of the Company’s filings under the Securities Act or the Exchange Act, except to the extent the filing specifically incorporates such information by reference therein.
Stock Repurchases
The Company’s board of directors has previously authorized a series of stock repurchase plans. Stock repurchases for each such plan could be executed through open market repurchases, privately negotiated transactions, accelerated share repurchases or other means. The board of directors authorized management to execute stock repurchase transactions from time to time and in such amounts and via such methods as management deemed appropriate. Each stock repurchase program could be limited or terminated at any time without prior notice. Pursuant to the terms of the Merger Agreement the Company suspended its stock repurchase programs on January 4, 2021, the date we announced our planned merger with Centene.
The Company’s board of directors approved, and subsequently amended, a stock repurchase plan which authorizes the Company to purchase up to $400 million of its outstanding common stock through November 15, 2021 (the “Repurchase Program”). As of December 31, 2020, the remaining capacity under the Repurchase Program was $186.3 million. Stock repurchases under the programs may be carried out from time to time in open market transactions (including blocks) or in privately negotiated transactions. The timing of repurchases and the actual amount purchased will depend on a variety of factors including the market price of the Company’s shares, general market and economic conditions, and other corporate considerations. Repurchases may be made pursuant to plans intended to comply with Rule 10b5-1 under the Securities Exchange Act of 1934, which could allow the Company to purchase its shares during periods when it otherwise might be prevented from doing so under insider trading laws or because of self-imposed trading blackout periods. Repurchases are expected to be funded from working capital and anticipated cash from operations. The repurchase authorization does not require the purchase of a specific number of shares and is subject to suspension or termination by the Company’s board of directors at any time.
Dividends
The Company does not expect to pay a dividend in 2021. Should the Company pay any dividends in the future, there can be no assurance that the Company will continue to pay such dividends.
Recent Sales of Unregistered Securities
During the quarter ended December 31, 2020, the Company had no sales of unregistered securities.
Item 6. Selected Financial Data
Pursuant to Release No. 33-10890 (including the transition guidance therein), which was adopted by the SEC on November 19, 2020, the Company has elected to exclude the disclosures formerly required by this Item 6.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the Company’s selected financial data and the Company’s financial statements and the accompanying notes included herein. The following discussion may contain “forward-looking statements” within the meaning of the Securities Act and the Exchange Act. When used in this Form 10-K, the words “estimate,” “anticipate,” “expect,” “believe,” “should” and similar expressions are intended to be forward-looking statements. Although the Company believes that its plans, intentions and expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such plans, intentions or expectations will be achieved. Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements. Important factors currently known to management that could cause actual results to differ materially from those in forward-looking
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statements are set forth under the heading “Risk Factors” in Item 1A and elsewhere in this Form 10-K. Capitalized or defined terms included in this Item 7 have the meanings set forth in Item 1 of this Form 10-K.
Business Overview
The Company is engaged in the healthcare management business, and is focused on meeting needs in areas of healthcare that are fast growing, highly complex and high cost, with an emphasis on special population management. The Company provides services to health plans and other MCOs, employers, labor unions, various military and governmental agencies, TPAs, consultants and brokers. The Company’s business is divided into three segments, based on the services it provides and/or the customers that it serves. See Item 1—“Business” for more information on the Company’s business segments.
Results of Operations
The following table summarizes, for the periods indicated, continuing operating results (in thousands):
December 31, | Change | Change | ||||||||||
Continuing Operations | 2018 | 2019 | 2020 | '18 vs '19 | '19 vs '20 | |||||||
Statement of Operations Data: | ||||||||||||
Net revenue | $ | 4,957,522 | $ | 4,565,613 | $ | 4,577,531 | (7.9)% | 0.3% | ||||
Cost of Care | 1,554,691 | 1,543,524 | 1,397,855 | (0.7)% | (9.4)% | |||||||
Cost of goods sold | 2,452,703 | 2,059,285 | 2,180,717 | (16.0)% | 5.9% | |||||||
Direct service costs and other operating expenses (1)(2) | 773,915 | 801,667 | 880,168 | 3.6% | 9.8% | |||||||
Depreciation and amortization | 112,284 | 110,367 | 98,387 | (1.7)% | (10.9)% | |||||||
Interest expense | 35,180 | 35,868 | 30,865 | 2.0% | (13.9)% | |||||||
Interest and other income | (4,884) | (6,857) | (4,054) | 40.4% | (40.9)% | |||||||
Special charges | — | — | 34,078 | |||||||||
Income (loss) before income taxes | 33,633 | 21,759 | (40,485) | (35.3)% | (286.1)% | |||||||
Provision (benefit) for income taxes | 11,457 | 9,162 | (44,531) | (20.0)% | (586.0)% | |||||||
Net income from continuing operations | $ | 22,176 | $ | 12,597 | $ | 4,046 | (43.2)% | (67.9)% | ||||
| (1) | Includes stock compensation expense of $28,936, $24,673 and $25,172 for the years ended December 31, 2018, 2019 and 2020, respectively. |
| (2) | Includes changes in fair value of contingent consideration of $1,108 for the year ended December 31, 2018. |
2020 compared to 2019
Net revenue, Cost of care, Cost of goods sold, and Direct service costs and other operating expenses
Net revenue, cost of care, cost of goods sold, and direct service costs and other operating expense variances are addressed within the segment results that follow.
Depreciation and amortization
Depreciation and amortization expense decreased by 10.9 percent or $12.0 million from 2019 to 2020, primarily due to asset maturities and office impairments, partially offset by normal asset additions in the current year.
Interest Expense
Interest expense decreased by $5.0 million from 2019 to 2020 primarily due to lower interest rates and lower debt balances.
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Interest and other income
Interest and other income decreased by $2.8 million from 2019 to 2020 primarily due to a reduction in rates.
Special charges
Special charges increased by $34.1 million from 2019 to 2020 due to recognition of the special charges in the current year, see Note 10—“Special Charges” for further discussion.
Income taxes
The Company’s effective income tax rate from continuing operations was 42.1 percent in 2019 and 110.0 percent in 2020. These rates differ from the applicable federal statutory income tax rate for each year primarily due to state income taxes, permanent differences between book and tax income, changes to the valuation allowances, and an adjustment for the recognition of a $38.9 million nonrecurring tax benefit in the current year for tax basis in excess of net book value for certain assets included in the MCC Sale. The Company also accrues interest and penalties related to uncertain tax positions in its provision for income taxes. The significant effective income tax rate for 2020 is primarily due to the adjustment for the nonrecurring tax benefit related to the MCC Sale realized in the current year, relative to the pre-tax loss for the period.
The statutes of limitations regarding the assessment of federal and most state and local income taxes for 2016 expired during 2020. As a result, $1.8 million of tax contingency reserves recorded as of December 31, 2019 were reversed in 2020, of which $1.4 million was reflected as a reduction to income tax expense from continuing operations and $0.4 million as a decrease to deferred tax assets. Additionally, $0.1 million of accrued interest was reversed in 2020 and reflected as a reduction to income tax expense from continuing operations due to the closing of statutes of limitations on tax assessments.
The statutes of limitations regarding the assessment of federal and most state and local income taxes for 2015 expired during 2019. As a result, $3.2 million of tax contingency reserves recorded as of December 31, 2018 were reversed in 2019, of which $2.5 million was reflected as a reduction to income tax expense from continuing operations and $0.7 million as a decrease to deferred tax assets. Additionally, $0.3 million of accrued interest was reversed in 2019 and reflected as a reduction to income tax expense from continuing operations due to the closing of statutes of limitations on tax assessments.
2019 compared to 2018
Net revenue, Cost of care, Cost of goods sold, and Direct service costs and other operating expenses
Net revenue, cost of care, cost of goods sold, and direct service costs and other operating expense variances are addressed within the segment results that follow.
Depreciation and amortization
Depreciation and amortization expense decreased by 1.7 percent or $1.9 million from 2018 to 2019, primarily due to asset maturation after 2018.
Interest Expense
Interest expense increased by $0.7 million from 2018 to 2019 mainly due to higher interest rates.
Interest and other income
Interest and other income increased by $2.0 million from 2018 to 2019 primarily due to higher yields.
Income taxes
The Company’s effective income tax rate from continuing operations was 34.1 percent in 2018 and 42.1 percent
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in 2019. These rates differ from the applicable federal statutory income tax rate for each year primarily due to state income taxes, permanent differences between book and tax income, and changes to the valuation allowances. The Company also accrues interest and penalties related to uncertain tax positions in its provision for income taxes. The effective income tax rate for 2019 was higher than 2018, primarily due to an increased relative impact in 2019 of the permanent differences for executive compensation as a result of reduced earnings in continuing operations.
The statutes of limitations regarding the assessment of federal and most state and local income taxes for 2015 expired during 2019. As a result, $3.2 million of tax contingency reserves recorded as of December 31, 2018 were reversed in 2019, of which $2.5 million was reflected as a reduction to income tax expense from continuing operations and $0.7 million as a decrease to deferred tax assets. Additionally, $0.3 million of accrued interest was reversed in 2019 and reflected as a reduction to income tax expense from continuing operations due to the closing of statutes of limitations on tax assessments.
The statutes of limitations regarding the assessment of federal and most state and local income taxes for 2014 expired during 2018. As a result, $2.9 million of tax contingency reserves recorded as of December 31, 2017 were reversed in 2018, of which $2.3 million was reflected as a reduction to income tax expense from continuing operations and $0.6 million as a decrease to deferred tax assets. Additionally, $0.2 million of accrued interest was reversed in 2018 and reflected as a reduction to income tax expense from continuing operations due to the closing of statutes of limitations on tax assessments.
Segment Results
The Company manages and measures operational performance through three segments: Healthcare, Pharmacy Management and Corporate. The Company evaluates performance of its segments based on Segment Profit. Management uses Segment Profit information for internal reporting and control purposes and considers it important in making decisions regarding the allocation of capital and other resources, risk assessment and employee compensation, among other matters. Stock compensation expense and changes in fair value of contingent consideration recorded in relation to acquisitions are included in direct service costs and other operating expenses; however, these amounts are excluded from the computation of Segment Profit.
Healthcare
The Healthcare segment includes the Company’s: (i) management of behavioral healthcare services and EAP services and (ii) management of other specialty areas including diagnostic imaging and musculoskeletal management. The Healthcare segment provides management services to health plans, accountable care organizations, employers, state Medicaid agencies, the United States military and various federal government agencies for whom Magellan provides carve-out management services for behavioral health, employee assistance plans, and other areas of specialty healthcare including diagnostic imaging, musculoskeletal management, cardiac, and physical medicine.
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The following table summarizes, for the periods indicated, operating results for the Healthcare segment (in thousands):
December 31, | Change | Change | ||||||||||
Healthcare Segment Results | 2018 | 2019 | 2020 | '18 vs '19 | '19 vs '20 | |||||||
Risk-based, non-EAP | $ | 1,511,532 | $ | 1,504,472 | $ | 1,399,532 | (0.5)% | (7.0)% | ||||
EAP risk-based | 349,751 | 339,377 | 315,306 | (3.0)% | (7.1)% | |||||||
ASO | 249,473 | 238,239 | 245,031 | (4.5)% | 2.9% | |||||||
Managed care and other revenue | 2,110,756 | 2,082,088 | 1,959,869 | (1.4)% | (5.9)% | |||||||
Cost of care | 1,554,691 | 1,543,524 | 1,397,855 | (0.7)% | (9.4)% | |||||||
556,065 | 538,564 | 562,014 | (3.1)% | 4.4% | ||||||||
Direct service costs and other | 401,083 | 402,006 | 433,723 | 0.2% | 7.9% | |||||||
154,982 | 136,558 | 128,291 | (11.9)% | (6.1)% | ||||||||
Stock compensation expense | 6,446 | 7,639 | 6,876 | 18.5% | (10.0)% | |||||||
Changes in fair value of contingent consideration | 1,108 | — | — | |||||||||
Segment Profit | $ | 162,536 | $ | 144,197 | $ | 135,167 | (11.3)% | (6.3)% | ||||
Direct service cost as % of revenue | 19.0% | 19.3% | 22.1% | |||||||||
MLR Behavioral & Specialty Health risk | 87.0% | 87.2% | 84.2% | |||||||||
MLR Behavioral & Specialty Health EAP risk | 68.4% | 68.3% | 69.5% | |||||||||
Membership | ||||||||||||
Risk (1) | 12,321 | 11,517 | 10,141 | |||||||||
EAP risk | 15,189 | 14,710 | 14,036 | |||||||||
ASO | 26,655 | 28,394 | 25,828 | |||||||||
| (1) | May include some duplicate count of membership for customers that contract with Magellan for both behavioral and other specialty management services. |
2020 compared to 2019
Managed Care and Other Revenue
Net revenue related to Healthcare decreased by 5.9 percent or $122.2 million from 2019 to 2020. The decrease in revenue is primarily due to terminated contracts of $152.1 million, program changes of $40.5 million, revenue impact of favorable prior period medical claims development recorded in 2020 of $5.0 million, and customer settlements in 2019 of $4.3 million. These decreases were partially offset by new contracts implemented during (or after) 2019 of $50.2 million, net revenue recorded for health insurance fees (“HIF”) in 2020 of $15.8 million, higher membership and favorable rate changes of $6.0 million, revenue for Bayless acquired December 21, 2020 of $1.1 million, and net favorable variances of $6.6 million.
Cost of Care
Cost of care decreased by 9.4 percent or $145.7 million from 2019 to 2020. The decrease in cost of care is primarily due to terminated contracts of $105.0 million, program changes of $36.9 million, increased membership and higher care from existing customers of $10.8 million, favorable prior period medical claims development recorded in 2020 of $5.7 million and other net favorable variances of $17.6 million. These decreases were partially offset by new contracts implemented after (or during) 2019 of $24.6 million and favorable prior period medical claims development recorded in 2019 of $5.7 million. For our behavioral and specialty health contracts, cost of care as a percentage of risk revenue (excluding EAP business) decreased from 87.2 percent in 2019 to 84.2 percent in 2020 mainly due to business mix.
Direct Service Costs
Direct service costs increased by 7.9 percent or $31.7 million from 2019 to 2020 primarily due to costs related
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to HIF fees in 2020 and increased discretionary benefits. Direct service costs increased as a percentage of revenue from 19.3 percent in 2019 to 22.1 percent in 2020, primarily due to the previously discussed revenue decreases as well as increased discretionary benefits and HIF fees in the current year.
2019 compared to 2018
Managed Care and Other Revenue
Net revenue related to Healthcare decreased by 1.4 percent or $28.7 million from 2018 to 2019. The decrease in revenue is primarily due to terminated contracts of $119.5 million, net revenue recorded for HIF fees in 2018 of $13.3 million and lower membership and unfavorable rate changes of $3.3 million. These decreases were partially offset by program changes of $74.1 million, new contracts implemented during (or after) 2018 of $21.1 million, customer settlements in 2019 of $4.3 million, net unfavorable retroactive revenue adjustments in 2018 of $3.2 million and other net favorable variances of $4.7 million. Retroactive revenue adjustments include the net retroactive impact for matters primarily related to membership, rates and the revenue impact of prior period medical claims development.
Cost of Care
Cost of care decreased by 0.7 percent or $11.2 million from 2018 to 2019. The decrease in cost of care is primarily due to terminated contracts of $85.3 million, decreased membership and lower care from existing customers of $21.0 million and favorable prior period medical claims development recorded in 2019 of $5.7 million. These decreases were partially offset by program changes of $63.5 million, new contracts implemented after (or during) 2018 of $4.4 million, net favorable prior period medical claims development recorded in 2018 of $0.9 million and care trends and other net favorable variances of $32.0 million. For our behavioral and specialty health contracts, cost of care as a percentage of risk revenue (excluding EAP business) increased slightly from 87.0 percent in 2018 to 87.2 percent in 2019.
Direct Service Costs
Direct service costs increased by 0.2 percent or $0.9 million from 2018 to 2019 primarily due to discretionary benefits and new business growth, partially offset by costs related to HIF fees in 2018 and terminated contracts. Direct service costs remained consistent as a percentage of revenue with 19.0 percent in 2018 and 19.3 percent in 2019.
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Pharmacy Management
The Pharmacy Management segment comprises products and solutions that provide clinical and financial management of pharmaceuticals paid under medical and pharmacy benefit programs. Pharmacy Management’s services include: (i) PBM services; (ii) PBA for state Medicaid and other government sponsored programs; (iii) pharmaceutical dispensing operations; (iv) clinical and formulary management programs; (v) medical pharmacy management programs; and (vi) programs for the integrated management of specialty drugs. Pharmacy Management’s services are provided under contracts with health plans, employers, state Medicaid programs, Medicare Part D and other government agencies.
The following table summarizes, for the periods indicated, operating results for the Pharmacy Management segment (in thousands, except state count):
December 31, | Change | Change | |||||||||||
Pharmacy Segment Results | 2018 | 2019 | 2020 | '18 vs '19 | '19 vs '20 | ||||||||
Formulary management | $ | 70,900 | $ | 84,567 | $ | 104,891 | 19.3% | 24.0% | |||||
PBA and other | 169,527 | 180,872 | 185,964 | 6.7% | 2.8% | ||||||||
Managed care and other revenue | 240,427 | 265,439 | 290,855 | 10.4% | 9.6% | ||||||||
PBM, including dispensing | 2,183,151 | 1,949,225 | 2,103,702 | (10.7)% | 7.9% | ||||||||
Medicare Part D | 442,266 | 287,604 | 243,744 | (35.0)% | (15.3)% | ||||||||
PBM revenue | 2,625,417 | 2,236,829 | 2,347,446 | (14.8)% | 4.9% | ||||||||
Total net revenue | 2,865,844 | 2,502,268 | 2,638,301 | (12.7)% | 5.4% | ||||||||
Cost of goods sold | 2,468,170 | 2,076,509 | 2,199,674 | (15.9)% | 5.9% | ||||||||
397,674 | 425,759 | 438,627 | 7.1% | 3.0% | |||||||||
Direct service costs and other | 298,713 | 323,162 | 360,970 | 8.2% | 11.7% | ||||||||
98,961 | 102,597 | 77,657 | 3.7% | (24.3)% | |||||||||
Stock compensation expense | 5,458 | 7,834 | 7,723 | 43.5% | (1.4)% | ||||||||
Segment Profit | $ | 104,419 | $ | 110,431 | $ | 85,380 | 5.8% | (22.7)% | |||||
Direct service cost as % of revenue | 10.4% | 12.9% | 13.7% | ||||||||||
COGS as % of PBM revenue | 94.0% | 92.8% | 93.7% | ||||||||||
Pharmacy Operational Statistics | |||||||||||||
Adjusted commercial network claims | 31,321 | 27,996 | 27,979 | ||||||||||
Adjusted PBA claims | 70,429 | 78,799 | 53,263 | ||||||||||
Total adjusted claims | 101,750 | 106,795 | 81,242 | ||||||||||
Generic dispensing rate | 87.4% | 86.6% | 88.5% | ||||||||||
Commercial PBM covered lives | 1,986 | 1,663 | 1,895 | ||||||||||
Medical pharmacy covered lives | 13,910 | 13,988 | 15,772 | ||||||||||
Total states and DC that participate in PBA | 27 | 27 | 26 | ||||||||||
2020 compared to 2019
Managed Care and Other Revenue
Managed care and other revenue related to Pharmacy Management increased by 9.6 percent or $25.4 million from 2019 to 2020. This increase is primarily due to increased formulary management revenue of $19.0 million mainly due to utilization, increased medical pharmacy management revenue of $10.7 million due to increased membership, increased government pharmacy revenue of $7.7 million mainly due to favorable settlements, and other net favorable variances of $5.5 million. These increases were partially offset by terminated contracts of $17.5 million.
PBM and Dispensing Revenue
PBM and dispensing revenue related to Pharmacy Management increased by 4.9 percent or $110.6 million from
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2019 to 2020. This increase is primarily due to new contracts implemented after (or during 2019) of $75.2 million and increased membership and utilization of $46.1 million. These increases were partially offset by other unfavorable variances of $10.7 million.
Cost of Goods Sold
Cost of goods sold increased by 5.9 percent or $123.2 million from 2019 to 2020. This increase is primarily due to an increase in new contracts implemented after (or during) 2019 of $74.3 million, membership and utilization of $42.9 million, and other unfavorable variances of $6.0 million. As a percentage of the portion of net revenue that relates to PBM, cost of goods sold increased from 92.8 percent in 2019 to 93.7 percent in 2020, mainly due to higher utilization and business mix.
Direct Service Costs
Direct service costs increased by 11.7 percent or $37.8 million from 2019 to 2020. The increase is primarily due to start-up costs associated with new contract implementation costs and discretionary benefits. Direct service costs increased as a percentage of revenue from 12.9 percent in 2019 to 13.7 percent in 2020 due to higher contract implementation costs and discretionary benefits.
2019 compared to 2018
Managed Care and Other Revenue
Managed care and other revenue related to Pharmacy Management increased by 10.4 percent or $25.0 million from 2018 to 2019. This increase is primarily due to increased formulary management revenue of $13.7 million mainly due to utilization, higher revenue in government pharmacy of $5.6 million mainly due to increased membership, increased medical pharmacy revenue of $4.7 million mainly due to favorable settlements, and other net favorable variances of $1.0 million.
PBM and Dispensing Revenue
PBM and dispensing revenue related to Pharmacy Management decreased by 14.8 percent or $388.6 million from 2018 to 2019. This decrease is primarily due to terminated contracts of $325.8 million and decreased membership and utilization of $154.6 million, mainly due to a reduction in the Part D footprint. These decreases were partially offset by new contracts implemented after (or during 2018) of $83.8 million, customer guarantee penalties in 2018 of $3.3 million and other favorable variances of $4.7 million.
Cost of Goods Sold
Cost of goods sold decreased by 15.9 percent or $391.7 million from 2018 to 2019. This decrease is primarily due to terminated contracts of $320.8 million, decreased membership and utilization of $139.9 million and other favorable variances of $10.7 million. These decreases were partially offset by new contracts implemented after (or during) 2018 of $79.7 million. As a percentage of the portion of net revenue that relates to PBM, cost of goods sold decreased from 94.0 percent in 2018 to 92.8 percent in 2019, mainly due to business mix.
Direct Service Costs
Direct service costs increased by 8.2 percent or $24.4 million from 2018 to 2019. The increase is primarily due to an increase in discretionary benefits, an increase in stock compensation expense and new business growth. Direct service costs increased as a percentage of revenue from 10.4 percent in 2018 to 12.9 percent in 2019 due to higher discretionary benefits.
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Corporate Segment
The Corporate segment of the Company is comprised primarily of amounts not allocated to the Healthcare and Pharmacy Management segments that are largely associated with costs related to being a publicly traded company.
The following table summarizes, for the periods indicated, operating results for the Corporate segment (in thousands):
December 31, | Change | Change | ||||||||||
Corporate Segment & Eliminations | 2018 | 2019 | 2020 | '18 vs '19 | '19 vs '20 | |||||||
Managed care and other revenue | $ | (607) | $ | (592) | $ | (703) | (2.5)% | 18.8% | ||||
PBM revenue | (18,471) | (18,151) | (19,936) | (1.7)% | 9.8% | |||||||
Cost of goods sold | 15,467 | 17,224 | 18,957 | 11.4% | 10.1% | |||||||
(3,611) | (1,519) | (1,682) | (57.9)% | 10.7% | ||||||||
Direct service costs and other | 74,119 | 76,499 | 85,475 | 3.2% | 11.7% | |||||||
(77,730) | (78,018) | (87,157) | 0.4% | 11.7% | ||||||||
Stock compensation expense | 17,032 | 9,200 | 10,573 | (46.0)% | 14.9% | |||||||
Segment Loss | $ | (60,698) | $ | (68,818) | $ | (76,584) | 13.4% | 11.3% | ||||
2020 compared to 2019
Net expenses related to Corporate, which includes eliminations, increased 11.3 percent or $7.8 million, primarily due to higher discretionary benefits in 2020. As a percentage of revenue, corporate and elimination increased from 1.5 percent in 2019 and 1.7 percent in 2020, mainly due to higher discretionary benefits.
2019 compared to 2018
Net expenses related to Corporate, which includes eliminations, increased 13.4 percent or $8.1 million, primarily due to higher discretionary benefits in 2019. As a percentage of revenue, corporate and elimination increased from 1.2 percent in 2018 to 1.5 percent in 2019, mainly due to decreased revenue and higher discretionary benefits.
Inter segment revenues and expenses
Healthcare subcontracts with Pharmacy Management to provide pharmacy benefits management services for certain of Healthcare’s customers. In addition, Pharmacy Management provides pharmacy benefits management for the Company’s employees covered under its medical plan. As such, revenue, cost of goods sold and direct service costs and other related to these arrangements are eliminated within the Corporate segment.
Non-GAAP Measures
The Company reports its financial results in accordance with GAAP, however the Company’s management also assesses business performance and makes business decisions regarding the Company’s operations using certain non-GAAP measures.
In addition to Segment Profit, as defined above, the Company also uses adjusted net income from continuing operations (“Adjusted Net Income from Continuing Operations”) and adjusted net income from continuing operations per common share on a diluted basis (“Adjusted EPS”). Adjusted Net Income from Continuing Operations and Adjusted EPS reflect certain adjustments made for acquisitions completed after January 1, 2013 to exclude non-cash stock compensation expense resulting from restricted stock purchases by sellers, changes in the fair value of contingent consideration, amortization of identified acquisition intangibles, as well as impairment of identified acquisition intangibles, special charges and any impact related to the sale of MCC. The Company believes these non-GAAP measures provide a more useful comparison of the Company’s underlying business performance from period to period and are more representative of the earnings capacity of the Company. Non-GAAP financial measures disclosed, such as
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Segment Profit, Adjusted Net Income from Continuing Operations and Adjusted EPS, should not be considered a substitute for, or superior to, financial measures determined or calculated in accordance with GAAP.
The following table reconciles income before income taxes to Segment Profit for the years ended December 31, 2018, 2019 and 2020 (in thousands):
2018 |
| 2019 |
| 2020 | |||||
Income (loss) from continuing operations before income taxes | $ | 33,633 | $ | 21,759 | $ | (40,485) | |||
Stock compensation expense |
| 28,936 |
| 24,673 |
| 25,172 | |||
Changes in fair value of contingent consideration | 1,108 | — | — | ||||||
Depreciation and amortization |
| 112,284 |
| 110,367 |
| 98,387 | |||
Interest expense |
| 35,180 |
| 35,868 |
| 30,865 | |||
Interest and other income |
| (4,884) |
| (6,857) |
| (4,054) | |||
Special charges | — | — | 34,078 | ||||||
Segment Profit from continuing operations | $ | 206,257 | $ | 185,810 | $ | 143,963 | |||
The following table reconciles net income attributable to Magellan to Adjusted Net Income for the years ended December 31, 2018, 2019 and 2020:
| ||||||||||
| 2018 |
| 2019 |
| 2020 | |||||
Net income from continuing operations | $ | 22,176 | $ | 12,597 | $ | 4,046 | ||||
Adjustments | ||||||||||
Stock compensation expense |
| 530 |
| — |
| — | ||||
Changes in fair value of contingent consideration |
| 1,108 |
|
| — | |||||
Amortization of acquired intangibles |
| 31,239 |
| 33,002 |
| 39,793 | ||||
Special charges | — | — | 34,078 | |||||||
Tax impact |
| (9,051) |
| (8,874) |
| (19,465) | ||||
Nonrecurring tax benefit - divestiture | — | — | (38,859) | |||||||
Adjusted Net Income from continuing operations | $ | 46,002 | $ | 36,725 | $ | 19,593 | ||||
The following table reconciles net income per common share attributable to Magellan—diluted to Adjusted EPS for the years ended December 31, 2018, 2019 and 2020:
| ||||||||||
| 2018 |
| 2019 |
| 2020 | |||||
Net income from continuing operations per common share—diluted | $ | 0.89 | $ | 0.51 | $ | 0.16 | ||||
Adjustments | ||||||||||
Stock compensation expense |
| 0.02 |
| — |
| — | ||||
Changes in fair value of contingent consideration |
| 0.04 |
| — |
| — | ||||
Amortization of acquired intangibles |
| 1.25 |
| 1.34 |
| 1.56 | ||||
Special charges | — | — | 1.33 | |||||||
Tax impact |
| (0.36) |
| (0.36) |
| (0.76) | ||||
Nonrecurring tax benefit - divestiture | — | — | (1.52) | |||||||
Adjusted EPS from continuing operations | $ | 1.84 | $ | 1.49 | $ | 0.77 | ||||
Outlook—Results of Operations
The Company’s Segment Profit and net income are subject to significant fluctuations from period to period. These fluctuations may result from a variety of factors such as those set forth under Item 1A—“Risk Factors” as well as a variety of other factors including: (i) changes in utilization levels by enrolled members of the Company’s risk-based contracts, including seasonal utilization patterns; (ii) contractual adjustments and settlements; (iii) retrospective membership adjustments; (iv) timing of implementation of new contracts, enrollment changes and contract terminations; (v) pricing adjustments upon contract renewals (and price competition in general); (vi) the timing of acquisitions;
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(vii) changes in estimates regarding medical costs and IBNR; (viii) the timing of recognition of pharmacy revenues, including rebates and Medicare Part D; and (ix) changes in the estimates of contingent consideration.
A portion of the Company’s business is subject to rising care costs due to an increase in the number and frequency of covered members seeking healthcare services and higher costs of such services. Many of these factors are beyond the Company’s control. Future results of operations will be heavily dependent on management’s ability to obtain customer rate increases that are consistent with care cost increases and/or to reduce operating expenses.
Interest Rate Risk. Changes in interest rates affect interest income earned on the Company’s cash equivalents and investments, as well as interest expense on variable interest rate borrowings under the 2017 Credit Agreement. In addition, interest rates on the Notes are subject to adjustment upon the occurrence of certain credit rating events. Based on the amount of cash equivalents and investments and the borrowing levels under the 2017 Credit Agreement and the principal amount of the Notes as of December 31, 2020, a hypothetical 10 percent increase or decrease in the interest rate associated with these instruments, with all other variables held constant, would not materially affect the Company’s future earnings and cash outflows.
Historical—Liquidity and Capital Resources
2020 compared to 2019
Operating Activities. The Company reported net cash provided by operating activities of $115.8 million and $450.8 million for 2019 and 2020, respectively. The $335.0 million increase in operating cash flows from 2019 is mainly attributable to higher segment profit and favorable working capital changes, partially offset by increased tax payments and lower interest income collected.
The net favorable impact of working capital changes between periods totaled $306.6 million. For 2019, operating cash flows were impacted by net unfavorable working capital changes of $117.7 million, mainly attributable to the timing of receivable and payables. For 2020, operating cash flows were impacted by net favorable working capital changes of $188.9 million, mainly attributable to the timing of receivables and payables.
Segment Profit for 2020, inclusive of Segment Profit from MCC, increased $77.0 million from 2019.
Investing Activities. The Company utilized $60.4 million and $75.5 million during 2019 and 2020, respectively, for capital expenditures. The additions related to hard assets (equipment, furniture, and leaseholds) and capitalized software for 2019 were $15.8 million and $44.6 million, respectively, as compared to additions for 2020 related to hard assets and capitalized software of $20.1 million and $55.4 million, respectively.
During 2019 the Company received $41.6 million for the net maturity of "available-for-sale" securities. During 2020 the Company used $158.8 million for the net purchase of "available-for-sale" securities. During 2020, the Company received net cash of $1,013.8 million in relation to the sale of MCC and used net cash of $79.8 million for the acquisition of Bayless and $20.8 million for investments in other non-consolidated investees.
Financing Activities. During 2019, the Company paid $59.8 million on debt obligations, $6.2 million for payments on contingent consideration, $4.1 million for the repurchase of treasury stock under the Company's share repurchase program and $7.7 million on finance lease obligations. In addition, the Company received $32.7 million from the exercise of stock options and had other net favorable items of $1.8 million.
During 2020, the Company received $80.0 million from the issuance of debt, $64.2 million from the exercise of stock options and had other net favorable items of $0.6 million. In addition, the Company paid $126.4 million on debt obligations and $5.2 million on finance lease obligations.
2019 compared to 2018
Operating Activities. The Company reported net cash provided by operating activities of $164.8 million and $115.8 million for 2018 and 2019, respectively. The $49.0 million decrease in operating cash flows from 2018 is mainly attributable to unfavorable working capital changes, partially offset by lower tax payments and higher segment profit.
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The net unfavorable impact of working capital changes between periods totaled $114.7 million. For 2018, operating cash flows were impacted by net unfavorable working capital changes of $3.0 million, mainly attributable to an increase in accounts receivables partially offset by an increase in payables. For 2019, operating cash flows were impacted by net unfavorable working capital changes of $117.7 million, mainly attributable to the timing of receivables and payables.
Tax payments for 2019 decreased $35.4 million from 2018. Interest payments for 2019 decreased $4.3 million from 2018. Segment Profit for 2019 increased $24.7 million from 2018.
Investing Activities. The Company utilized $68.3 million and $60.4 million during 2018 and 2019, respectively, for capital expenditures. The additions related to hard assets (equipment, furniture and leaseholds) and capitalized software for 2018 were $26.3 million and $42.0 million, respectively, as compared to additions for 2019 related to hard assets and capitalized software of $15.8 million and $44.6 million, respectively.
During 2018 the Company used $59.2 million for the net purchase of "available-for-sale" securities. During 2019 the Company received $41.6 million for the net maturity of "available-for-sale" securities.
Financing Activities. During 2018, the Company paid $110.0 million on debt obligations, $62.6 million for the repurchase of treasury stock under the Company's share repurchase program, $12.2 million on finance lease obligations and had other net unfavorable items of $1.0 million. In addition, the Company received $23.1 million from the exercise of stock options.
During 2019, the Company paid $59.8 million on debt obligations, $6.2 million for payments on contingent consideration, $4.1 million for the repurchase of treasury stock under the Company's share repurchase program and $7.7 million on finance lease obligations. In addition, the Company received $32.7 million from the exercise of stock options and had other net favorable items of $1.8 million.
Outlook—Liquidity and Capital Resources
Liquidity. The Company may draw on the 2017 Credit Agreement as required to meet working capital needs associated with the timing of receivables and payables, fund share repurchases or support acquisition activities. The Company currently expects to have adequate liquidity to satisfy its existing financial commitments over the periods in which they will become due. The Company plans to maintain its current investment strategy of investing in a diversified, high quality, liquid portfolio of investments and continues to closely monitor the financial markets. The Company estimates that it has no risk of any material permanent loss on its investment portfolio; however, there can be no assurance the Company will not experience any such losses in the future.
44
Contractual Obligations and Commitments
The following table sets forth the future financial commitments of the Company as of December 31, 2020 (in thousands):
Payments due by period |
| |||||||||||||||
|
| Less than |
| 1‑3 |
| 3‑5 |
| More than |
| |||||||
Contractual Obligations | Total | 1 year | years | years | 5 years |
| ||||||||||
Senior Notes | $ | 360,000 | $ | — | $ | — | $ | 360,000 | $ | — | ||||||
Term loan | 263,125 | — | 263,125 | — | — | |||||||||||
Operating leases(1) |
| 39,449 |
| 14,471 |
| 16,375 |
| 7,930 |
| 673 | ||||||
Letters of credit(2) |
| 32,062 |
| — |
| — |
| — |
| — | ||||||
Finance lease and deferred financing obligations(3) |
| 17,776 |
| 5,064 |
| 8,857 |
| 3,855 |
| — | ||||||
Purchase commitments(4) |
| 1,333 |
| 1,333 |
| — |
| — |
| — | ||||||
Income tax contingencies(5) |
| 10,444 |
| — |
| — |
| — |
| — | ||||||
$ | 724,189 | $ | 20,868 | $ | 288,357 | $ | 371,785 | $ | 673 | |||||||
| (1) | Operating lease obligations include estimated future lease payments for both open and closed offices. |
| (2) | These letters of credit typically act as a guarantee of payment to certain third parties in accordance with specified terms and conditions. |
| (3) | Finance lease and deferred financing obligations include imputed interest of $1.3 million and are net of leasehold improvement allowances. |
| (4) | Purchase commitments include open purchase orders as of December 31, 2020 relating to ongoing capital expenditure and operational activities. |
| (5) | The Company is unable to make a reasonably reliable estimate of the period of the cash settlement (if any) with the respective taxing authorities for these contingencies. However, settlement of such amounts could require the utilization of working capital. See further discussion in Note 7—“Income Taxes” to the consolidated financial statements set forth elsewhere herein. |
The Company also has a variety of other contractual agreements related to acquiring materials and services used in the Company’s operations. However, the Company does not believe these other agreements contain material noncancelable commitments.
Stock Repurchases
The Company’s board of directors has previously authorized a series of stock repurchase plans. Stock repurchases for each such plan could be executed through open market repurchases, privately negotiated transactions, accelerated share repurchases or other means. The board of directors authorized management to execute stock repurchase transactions from time to time and in such amounts and via such methods as management deemed appropriate. Each stock repurchase program could be limited or terminated at any time without prior notice. See Note 6—“Stockholders’ Equity” to the consolidated financial statements for more information on the Company’s share repurchase program.
Off-Balance Sheet Arrangements
As of December 31, 2020, the Company has no material off-balance sheet arrangements.
Senior Notes
On September 22, 2017, the Company completed the public offering of $400.0 million aggregate principal amount of its 4.400% Senior Notes due 2024 (the “Notes”). The Notes are governed by an indenture dated as of September 22, 2017 (the “Base Indenture”), between the Company, as issuer, and U.S. Bank National Association, as trustee, and is supplemented by a first supplemental indenture dated as of September 22, 2017 (the “First Supplemental Indenture” together, with the Base Indenture, the “Indenture”), between the Company, as issuer, and U.S. Bank National
45
Association, as trustee. During the years ended December 31, 2019 and 2020, the Company purchased and subsequently retired $11.1 million and $28.9 million of its Notes, respectively, which resulted in a loss on retirement of $0.3 million and $0.7 million, respectively, that is included in interest expense. The Notes were issued at a discount and had a carrying value of $388.4 million and $359.6 million as of December 31, 2019 and 2020, respectively.
For more information on the Company’s Senior Notes see Note 5—“Long-Term Debt, Finance Lease and Deferred Financing Obligations” to the consolidated financial statements set forth elsewhere herein.
Credit Agreements
On September 22, 2017, the Company entered into the 2017 Credit Agreement with various lenders that provides for a $400.0 million senior unsecured revolving credit facility and a $350.0 million senior unsecured term loan facility to the Company, as the borrower. On August 13, 2018, the Company entered into an amendment to the 2017 Credit Agreement, which extended the maturity date by one year. On February 27, 2019, the Company entered into a second amendment to the 2017 Credit Agreement, which amended the total leverage ratio covenant, and which was necessary in order for us to remain in compliance with the terms of the 2017 Credit Agreement. The 2017 Credit Agreement is scheduled to mature on September 22, 2023.
For more information on the Company’s Credit Agreements see Note 5—“Long-Term Debt, Finance Lease and Deferred Financing Obligations” to the consolidated financial statements set forth elsewhere herein.
Restrictive Covenants in Debt Agreements
The 2017 Credit Agreement contains covenants that limit management’s discretion in operating the Company’s business by restricting or limiting the Company’s ability, among other things, to:
| ● | incur or guarantee additional indebtedness or issue preferred or redeemable stock; |
| ● | pay dividends and make other distributions; |
| ● | repurchase equity interests; |
| ● | make certain advances, investments and loans; |
| ● | enter into sale and leaseback transactions; |
| ● | create liens; |
| ● | sell and otherwise dispose of assets; |
| ● | acquire, merge or consolidate with another company; and |
| ● | enter into some types of transactions with affiliates. |
These restrictions could adversely affect the Company’s ability to finance future operations or capital needs or engage in other business activities that may be in the Company’s interest.
The 2017 Credit Agreement also requires the Company to comply with specified financial ratios and tests. Failure to do so, unless waived by the lenders under the 2017 Credit Agreement, pursuant to its terms, or amended, would result in an event of default under the 2017 Credit Agreement. As of December 31, 2020, the Company was in compliance with all covenants, including financial covenants, under the 2017 Credit Agreement.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and
46
liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. The Company considers the following to be its critical accounting policies and estimates:
Cost of Care, Medical Claims Payable and Other Medical Liabilities
Cost of care is recognized in the period in which members receive managed healthcare services. In addition to actual benefits paid, cost of care in a period also includes the impact of accruals for estimates of medical claims payable. Medical claims payable represents the liability for healthcare claims reported but not yet paid and claims IBNR related to the Company’s managed healthcare businesses. Such liabilities are determined by employing actuarial methods that are commonly used by health insurance actuaries and that meet actuarial standards of practice. Cost of care for the Company’s EAP contracts, which are mainly with the United States federal government, pertain to the costs to employ licensed behavioral health counselors to deliver non-medical counseling for these contracts.
The IBNR portion of medical claims payable is estimated based on past claims payment experience for member groups, enrollment data, utilization statistics, authorized healthcare services and other factors. This data is incorporated into contract-specific actuarial reserve models and is further analyzed to create “completion factors” that represent the average percentage of total incurred claims that have been paid through a given date after being incurred. Factors that affect estimated completion factors include benefit changes, enrollment changes, shifts in product mix, seasonality influences, provider reimbursement changes, changes in claims inventory levels, the speed of claims processing and changes in paid claim levels. Completion factors are applied to claims paid through the financial statement date to estimate the ultimate claim expense incurred for the current period. Actuarial estimates of claim liabilities are then determined by subtracting the actual paid claims from the estimate of the ultimate incurred claims. For the most recent incurred months (generally the most recent two months), the percentage of claims paid for claims incurred in those months is generally low. This makes the completion factor methodology less reliable for such months. Therefore, incurred claims for any month with a completion factor that is less than 70 percent are generally not projected from historical completion and payment patterns; rather they are projected by estimating claims expense based on recent monthly estimated cost incurred per member per month times membership, taking into account seasonality influences, benefit changes and healthcare trend levels, collectively considered to be “trend factors.” For new contracts, the Company estimates IBNR based on underwriting data until it has sufficient data to utilize these methodologies.
Medical claims payable balances are continually monitored and reviewed. If it is determined that the Company’s assumptions in estimating such liabilities are significantly different than actual results, the Company’s results of operations and financial position could be impacted in future periods. Adjustments of prior period estimates may result in additional cost of care or a reduction of cost of care in the period an adjustment is made. Further, due to the considerable variability of healthcare costs, adjustments to claim liabilities occur each period and are sometimes significant as compared to the net income recorded in that period. Prior period development is recognized immediately upon the actuary’s judgment that a portion of the prior period liability is no longer needed or that additional liability should have been accrued. The following table presents the components of the change in medical claims payable for the years ended December 31, 2018, 2019 and 2020 (in thousands):
47
| 2018 |
| 2019 |
| 2020 |
| ||||
Claims payable and IBNR, beginning of period | $ | 126,861 | $ | 126,311 | $ | 123,276 | ||||
Cost of care: | ||||||||||
Current year |
| 1,555,491 |
| 1,545,024 |
| 1,403,555 | ||||
Prior years(3) |
| (800) |
| (1,500) |
| (5,700) | ||||
Total cost of care |
| 1,554,691 |
| 1,543,524 |
| 1,397,855 | ||||
Claim payments and transfers to other medical liabilities(1): | ||||||||||
Current year |
| 1,441,621 |
| 1,433,214 |
| 1,306,519 | ||||
Prior years |
| 113,620 |
| 113,345 |
| 107,241 | ||||
Total claim payments and transfers to other medical liabilities |
| 1,555,241 |
| 1,546,559 |
| 1,413,760 | ||||
Claims payable and IBNR, end of period |
| 126,311 |
| 123,276 |
| 107,371 | ||||
Withhold payable, end of period(2) |
| 3,418 |
| 4,838 |
| 4,480 | ||||
Medical claims payable, end of period | $ | 129,729 | $ | 128,114 | $ | 111,851 | ||||
| (1) | For any given period, a portion of unpaid medical claims payable could be covered by risk share or reinvestment liabilities (discussed below) and may not impact the Company’s results of operations for such periods. |
| (2) | Medical claims payable is offset by customer withholds from capitation payments in situations in which the customer has the contractual requirement to pay providers for care incurred. |
| (3) | Favorable development in 2018, 2019 and 2020 was $0.8 million, $1.5 million and $5.7 million, respectively, and was mainly related to lower medical trends and faster claims completion than originally assumed. |
Actuarial standards of practice require that the claim liabilities be adequate under moderately adverse circumstances. Adverse circumstances are situations in which the actual claims experience could be higher than the otherwise estimated value of such claims. In many situations, the claims paid amount experienced will be less than the estimate that satisfies the actuarial standards of practice. Any prior period favorable cost of care development related to a lack of moderately adverse conditions is excluded from “Cost of Care—Prior Years” adjustments, as a similar provision for moderately adverse conditions is established for current year cost of care liabilities and therefore does not generally impact net income.
Care trend factors and completion factors can have a significant impact on the medical claims payable liability. The following example provides the estimated impact to the Company’s December 31, 2020 unpaid medical claims payable liability assuming hypothetical changes in care trend factors and completion factors:
Care Trend Factor(1) | Completion Factor(2) |
| |||||||
(Decrease) Increase | (Decrease) Increase |
| |||||||
Trend Factor |
| Medical Claims Payable |
| Completion Factor |
| Medical Claims Payable |
| ||
(in thousands) | (in thousands) | ||||||||
−4 | % | $ | (8,500) |
| −2 | % | $ | (19,500) | |
−3 | % | (6,000) | −1.5 | % | (14,500) | ||||
−2 | % |
| (4,000) |
| −1 | % |
| (10,000) | |
−1 | % |
| (2,000) |
| −0.5 | % |
| (5,000) | |
1 | % |
| 2,000 |
| 0.5 | % |
| 5,000 | |
2 | % |
| 4,000 |
| 1 | % |
| 10,000 | |
3 | % | 6,000 | 1.5 | % | 15,000 | ||||
4 | % |
| 8,500 |
| 2 | % |
| 20,000 | |
Approximately 70 percent of IBNR dollars is based on care trend factors.
| (1) | Assumes a change in the care trend factor for any month that a completion factor is not used to estimate incurred claims (which is generally any month that is less than 70 percent complete). |
| (2) | Assumes a change in the completion factor for any month for which completion factors are used to estimate IBNR (which is generally any month that is 70 percent or more complete). |
48
Due to the existence of risk sharing and reinvestment provisions in certain customer contracts, a change in the estimate for medical claims payable does not necessarily result in an equivalent impact on segment profit.
The Company believes that the amount of medical claims payable is adequate to cover its ultimate liability for unpaid claims as of December 31, 2020; however, actual claims payments may differ from established estimates.
Other medical liabilities consist primarily of amounts payable to pharmacies for claims that have been adjudicated by the Company but not yet paid, “reinvestment” payables under certain managed healthcare contracts with Medicaid customers and “profit share” payables under certain risk-based contracts. Under a contract with reinvestment features, if the cost of care is less than certain minimum amounts specified in the contract (usually as a percentage of revenue), the Company is required to “reinvest” such difference in behavioral healthcare programs when and as specified by the customer or to pay the difference to the customer for their use in funding such programs. Under a contract with profit share provisions, if the cost of care is below certain specified levels, the Company will “share” the cost savings with the customer at the percentages set forth in the contract. In addition, certain contracts include provisions to provide the Company additional funding if the cost of care is above the specified levels.
Goodwill
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 goodwill impairment test is a two-step process that requires management to make judgments in determining what assumptions to use in the calculation. The first step of the process consists of estimating the fair value of each reporting unit with goodwill based on various valuation techniques, with the primary technique being a discounted cash flow analysis, which requires the input of various assumptions with respect to revenues, operating margins, growth rates and discount rates. The estimated fair value for each reporting unit is compared to the carrying value of the reporting unit, which includes goodwill. If the estimated fair value is less than the carrying value, a second step is performed to compute the amount of the impairment by determining an “implied fair value” of goodwill. The determination of a reporting unit’s “implied fair value” of goodwill requires the Company to allocate the estimated fair value of the reporting unit to the assets and liabilities of the reporting unit. Any unallocated fair value represents the “implied fair value” of goodwill, which is compared to its corresponding carrying value.
Goodwill is tested for impairment at a level referred to as a reporting unit, with the Company’s reporting units with goodwill as of December 31, 2020 comprised of Behavioral & Specialty Health and Pharmacy Management. On December 31, 2020, the Company completed the sale of its MCC reporting unit to Molina.
The fair value of Behavioral & Specialty Health and Pharmacy Management reporting units were determined using a discounted cash flow method. This method involves estimating the present value of estimated future cash flows utilizing a risk adjusted discount rate. Key assumptions for this method include cash flow projections, terminal growth rates and discount rates.
While no units were determined to be impaired at this time, reporting unit goodwill is at risk of future impairment in the event of significant unfavorable changes in the Company’s forecasted future results and cash flows. In addition, market factors utilized in the impairment analysis, including long-term growth rates or discount rates, could negatively impact the fair value of our reporting units. For testing purposes, management's best estimates of the expected future results are the primary driver in determining the fair value. Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions and factors. As a result, there can be no assurance that the estimates and assumptions made for purposes of the annual goodwill test will prove to be an accurate prediction of the future.
Examples of events or circumstances that could reasonably be expected to negatively affect the underlying key assumptions and ultimately impact the estimated fair value of our reporting units may include such items as: (i) a decrease in expected future cash flows, specifically, a decrease in membership or rates or customer attrition and increase in costs that could significantly impact our immediate and long-range results, unfavorable working capital changes and an inability to successfully achieve our cost savings targets, (ii) adverse changes in macroeconomic conditions or an economic recovery that significantly differs from our assumptions in timing and/or degree (such as a recession); and (iii) volatility in the equity and debt markets or other country specific factors which could result in a higher weighted average cost of capital.
49
Based on known facts and circumstances, we evaluate and consider recent events and uncertain items, as well as related potential implications, as part of our annual assessment and incorporate into the analyses as appropriate. These facts and circumstances are subject to change and may impact future analyses.
While historical performance and current expectations have resulted in fair values of our reporting units and indefinite-lived intangible assets in excess of carrying values, if our assumptions are not realized, it is possible that an impairment charge may need to be recorded in the future.
Goodwill for each of the Company’s reporting units with goodwill at December 31, 2019 and 2020 was as follows (in thousands):
|
|
| |||||
2019 | 2020 | ||||||
Behavioral & Specialty Health | $ | 410,869 | $ | 478,227 | |||
Pharmacy Management |
| 395,552 |
| 395,552 | |||
Total | $ | 806,421 | $ | 873,779 | |||
The changes in the carrying amount of goodwill for the years ended December 31, 2019 and 2020 are reflected in the table below (in thousands):
|
|
| |||||
2019 | 2020 | ||||||
Balance as of beginning of period | $ | 806,421 | $ | 806,421 | |||
Acquisition of Bayless |
| — |
| 67,358 | |||
Balance as of end of period | $ | 806,421 | $ | 873,779 | |||
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Changes in interest rates affect interest income earned on the Company’s cash equivalents and investments, as well as interest expense on variable interest rate borrowings under the 2017 Credit Agreement. In addition, interest rates on the Notes are subject to adjustment upon the occurrence of certain credit rating events. Based on the amount of cash equivalents and investments and the borrowing levels under the 2017 Credit Agreement and the principal amount of the Notes as of December 31, 2020, a hypothetical 10 percent increase or decrease in the interest rate associated with these instruments, with all other variables held constant, would not materially affect the Company’s future earnings and cash outflows.
Item 8. Financial Statements and Supplementary Data
Information with respect to this item is contained in the Company’s consolidated financial statements, including the reports of independent accountants, set forth elsewhere herein and financial statement schedule indicated in the Index on Page F-1 of this Report on Form 10-K, as included herein.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The Company’s management evaluated, with the participation of the Company’s principal executive and principal financial officers, the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of December 31, 2020. Based on their evaluation, management has concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2020.
50
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
In the fourth quarter ended December 31, 2020, there have been no changes in the Company’s internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). The Company’s internal control system was designed to provide reasonable assurance regarding the preparation and fair presentation of published financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Under the supervision and with the participation of management, including the Company’s Chief Executive Officer and Chief Financial Officer, the Company assessed the effectiveness of internal control over financial reporting as of December 31, 2020. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in its statement “Internal Control-Integrated Framework (2013).”
Management’s assessment of the effectiveness of internal control over financial reporting excludes the evaluation of the internal controls over reporting of Aurelia (Bayless Operations), which the company acquired a 70% majority interest on December 21, 2020. Aurelia’s operations represent 2.4 percent of total and net assets of the Company as of December 31, 2020, and 0.2 percent of revenues of the Company for the year then ended.
Based on this assessment, which excluded assessment of internal control of the acquired Bayless operations, management has concluded that, as of December 31, 2020, internal control over financial reporting is effective based on these criteria.
The Company’s independent registered public accounting firm has issued an audit report on the Company’s internal control over financial reporting. This report dated February 26, 2021 appears on page 53 of this Form 10-K.
51
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors of Magellan Health, Inc.
Opinion on Internal Control over Financial Reporting
We have audited Magellan Health, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Magellan Health, Inc. and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on the COSO criteria.
We also have audited in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the accompanying consolidated balance sheets of Magellan Health, Inc. and subsidiaries as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, changes in stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the “financial statements”) and our report dated February 26, 2021, expressed an unqualified opinion thereon.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definitions and Limitation of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As indicated in the accompanying Management's Report on Internal Control over Financial Reporting, management's assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal
52
controls of Aurelia Health, LLC, which is included in the 2020 consolidated financial statements of Magellan Health, Inc. and subsidiaries and which collectively constituted 2.4% of total and net assets as of December 31, 2020 as well as 0.2% of revenues for the year then ended. Our audit of internal control over financial reporting of the Company also did not include an evaluation of the internal control over financial reporting of Aurelia Health, LLC.
/s/ ERNST & YOUNG LLP | |
Baltimore, Maryland | |
February 26, 2021 |
53
PART III
Unless earlier included in an amendment to this Form 10-K, the information required by Items 10 through 14 is incorporated by reference to the Registrant’s definitive proxy statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, not later than 120 days after December 31, 2020, except for the following information required by Item 10 and Item 12 of this Part III.
The Company will also provide to any person without charge, upon request, copies of its Code of Ethics for Directors, Code of Ethics for Covered Officers, and Corporate Compliance Handbook for all employees (hereinafter referred to as the “Codes of Ethics”). Any such requests should be made in writing to the Investor Relations Department, InvestorRelations@magellanhealth.com. The Company intends to disclose any future amendments to the provisions of the Codes of Ethics and waivers from such Codes of Ethics, if any, made with respect to any of its directors and executive officers, on its internet site.
Securities Authorized for Issuance under Equity Compensation Plans
The following table sets forth certain information as of December 31, 2020 with respect to the Company’s compensation plans under which equity securities are authorized for issuance:
|
|
| Number of securities |
| ||||
remaining available |
| |||||||
for future issuance |
| |||||||
Number of securities | under equity |
| ||||||
to be issued upon | Weighted average | compensation plans |
| |||||
exercise of | exercise price of | (excluding securities |
| |||||
outstanding options, | outstanding options, | reflected in |
| |||||
Plan category | warrants and rights | warrants and rights | column(a)) |
| ||||
| (a) | |||||||
Equity compensation plans approved by security holders |
| 1,752,590 | (1) | $ | 75.48 | (2) | 2,058,875 | (3) |
Equity compensation plans not approved by security holders |
| — |
| — |
| — | ||
Total |
| 1,752,590 | (1) | $ | 75.48 | (2) | 2,058,875 | (3) |
| (1) | Consists of outstanding stock options, unvested restricted stock units and performance-based restricted stock units as of December 31, 2020. |
| (2) | Weighted average exercise price of outstanding stock options as of December 31, 2020. |
| (3) | Consists of shares remaining available for issuance as of December 31, 2020 under the Company’s equity compensation plans (pursuant to which the Company may issue stock options, restricted stock awards, stock bonuses, stock purchase rights and other equity incentives), after giving effect to the shares issuable upon the exercise of outstanding options and the shares of restricted stock. |
For further discussion, see Note 6—“Stockholders’ Equity” to the consolidated financial statements set forth elsewhere herein.
55
PART IV
Item 15. Exhibits and Financial Statement Schedules
| (a) | Documents furnished as part of the Report: |
1. | Financial Statements |
Information with respect to this item is contained on Pages F-1 to F-48 of this Report on Form 10-K.
2. | Exhibit Index |
Exhibit No. |
| Description of Exhibit |
| |
|---|---|---|---|---|
2.1 | ||||
2.2 | ||||
2.3 | ||||
3.1 | ||||
3.2 | ||||
3.3 | ||||
4.1 | ||||
4.2 | ||||
4.3 | ||||
4.4 | ||||
*10.1 | ||||
*10.2 | ||||
*10.3 | ||||
56
Exhibit No. |
| Description of Exhibit |
| |
|---|---|---|---|---|
*10.4 | ||||
*10.5 | ||||
*10.6 | ||||
*10.7 | ||||
*10.8 | ||||
*10.9 | ||||
*10.10 | ||||
*10.11 | ||||
*10.12 | ||||
*10.13 | ||||
*10.14 | ||||
*10.15 | ||||
*10.16 | ||||
*10.17 | ||||
*10.18 | ||||
*10.19 | ||||
*10.20 | ||||
57
Exhibit No. |
| Description of Exhibit |
| |
|---|---|---|---|---|
*10.21 | ||||
*10.22 | ||||
*10.23 | ||||
*10.24 | ||||
*10.25 | ||||
*10.26 | ||||
*10.27 | ||||
*10.28 | ||||
*10.29 | ||||
*10.30 | ||||
*10.31 | ||||
*10.32 | ||||
*10.33 | ||||
*10.34 | ||||
10.35 | ||||
10.36 | ||||
58
Exhibit No. |
| Description of Exhibit |
| |
|---|---|---|---|---|
*10.37 | ||||
*10.38 | ||||
*10.39 | ||||
*10.40 | ||||
*10.41 | ||||
*10.42 | ||||
*10.43 | ||||
*10.44 | ||||
*10.45 | ||||
*10.46 | ||||
*10.47 | ||||
*10.48 | ||||
*10.49 | ||||
*10.50 | ||||
*10.51 | ||||
59
Exhibit No. |
| Description of Exhibit |
| |
|---|---|---|---|---|
*10.52 | ||||
10.53 | ||||
10.54 | ||||
10.55 | ||||
*10.56 | ||||
*10.57 | ||||
*10.58 | ||||
*10.59 | ||||
*10.60 | ||||
*10.61 | ||||
#*10.62 | Employment Agreement, dated January 31, 2020, between the Company and David Haddock. | |||
#21 | ||||
#23 | ||||
#31.1 | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |||
#31.2 | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |||
†32.1 | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |||
†32.2 | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |||
#101 | The following materials from the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2020 formatted in Inline Extensible Business Reporting Language (iXBRL): (i) the cover page, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Balance Sheets, (v) the Consolidated Statements of Changes in Shareholders’ Equity, (vi) the Consolidated Statements of Cash Flows and (vii) related notes. | |||
#104 | Cover Page Interactive Data File (the cover page XBRL tags are embedded within the iXBRL document). | |||
* | Constitutes a management contract, compensatory plan or arrangement. |
# | Filed herewith. |
† | Furnished herewith. |
60
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
MAGELLAN HEALTH, INC. | |
Date: February 26, 2021 | /s/ DAVID P. BOURDON |
David P. Bourdon | |
Chief Financial Officer | |
(Principal Financial Officer) | |
Date: February 26, 2021 | /s/ JEFFREY N. WEST |
Jeffrey N. West | |
Senior Vice President and Controller | |
(Principal Accounting Officer) |
Pursuant to the requirements of the Securities Exchange Act of 1934, the following persons on behalf of the Registrant and in the capacities and on the dates indicated have signed this Report below.
/s/ KENNETH J. FASOLA | Chief Executive Officer | February 26, 2021 | ||
Kenneth J. Fasola | ||||
/s/ STEVEN J. SHULMAN | Chairman of the Board of Directors | February 26, 2021 | ||
Steven J. Shulman | ||||
/s/ SWATI ABBOTT | Director | February 26, 2021 | ||
Swati Abbott | ||||
/s/ CHRISTOPHER J. CHEN, MD | Director | February 26, 2021 | ||
Christopher J. Chen, MD | ||||
/s/ PETER A. FELD | Director | February 26, 2021 | ||
Peter A. Feld | ||||
/s/ Mural R. Josephson | Director | February 26, 2021 | ||
Mural R. Josephson | ||||
/s/ G. SCOTT MACKENZIE | Director | February 26, 2021 | ||
G. Scott MacKenzie | ||||
/s/ LESLIE V. NORWALK, ESQ. | Director | February 26, 2021 | ||
Leslie V. Norwalk | ||||
/s/ GUY P. SANSONE | Director | February 26, 2021 | ||
Guy P. Sansone | ||||
/s/ DAVID P. BOURDON | Chief Financial Officer | February 26, 2021 | ||
David P. Bourdon | ||||
/s/ JEFFREY N. WEST | Senior Vice President and Controller | February 26, 2021 | ||
Jeffrey N. West |
62
MAGELLAN HEALTH, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
The following consolidated financial statements of the registrant and its subsidiaries are submitted herewith in response to Item 8 and Item 15(a)1:
| Page(s) | |
Magellan Health, Inc. | ||
Audited Consolidated Financial Statements | ||
F-2 | ||
Consolidated balance sheets as of December 31, 2019 and 2020 | F-4 | |
Consolidated statements of income for the years ended December 31, 2018, 2019 and 2020 | F-5 | |
Consolidated statements of comprehensive income for the years ended December 31, 2018, 2019 and 2020 | F-6 | |
F-7 | ||
Consolidated statements of cash flows for the years ended December 31, 2018, 2019 and 2020 | F-8 | |
F-9 | ||
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.
F-1
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors of Magellan Health, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Magellan Health, Inc. and subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, changes in stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2020, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated February 26, 2021 expressed an unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the account or disclosure to which it relates.
Medical Claims Payable | ||
Description of the Matter | At December 31, 2020, the Company’s liability for medical claims payable totaled $111.9 million. As discussed in Note 2 of the consolidated financial statements, medical claims payable includes reserves for incurred but not reported (“IBNR”) claims, which are claims for covered services rendered by the Company’s providers that have not yet been submitted to the Company for payment. The amount of the liability is determined using actuarial reserve models that require the |
F-2
Company to develop completion factors, which represent the average percentage of total incurred claims that have been paid through a given date after being incurred, and trend factors, which are applied to recent costs incurred to estimate the liability for periods that the completion factors are considered less reliable. Auditing management’s estimate of the IBNR liability for medical claims payable was challenging and involved a high degree of subjectivity due to the complexity of the models used by management and the nature of the significant assumptions used in the measurement process. In particular, the determination of estimated completion and trend factors require management to exercise judgment when considering the effects of benefit design, enrollment, product mix, seasonality, provider reimbursement changes, claims processing patterns and changes in claims inventory levels. Both completion and trend factor estimates are determined by analyzing the assumptions described above using historical and recently emerging experience and changes in these assumptions can have a significant effect on the medical claims payable liability. | ||
How We Addressed the Matter in Our Audit | We obtained an understanding, evaluated the design and tested controls over the actuarial estimation process. For example, we tested controls over the completeness and accuracy of the data used in the actuarial projections, the transfer of data between underlying source systems, and management’s review and approval of the methods and significant assumptions used in estimating the IBNR liabilities, including the assumptions utilized to determine completion factors and trend factors described above. To test the IBNR liability for medical claims payable, we performed audit procedures with the assistance of our actuarial specialists that included, among others, testing the underlying data through agreement to original source documentation; comparing management’s methods and assumptions used in their analysis with historical experience, consistency with generally accepted actuarial methodologies used within the industry, and observable healthcare trend levels within the markets the Company operates; and, comparing management’s reserve to a range developed by our actuarial specialists based on assumptions developed by the specialists. We also assessed the historical accuracy of management’s estimates by comparing to actual claims paid. |
We have served as the Company’s auditor since 2002.
/s/ ERNST & YOUNG LLP | ||
Baltimore, Maryland | ||
February 26, 2021 |
F-3
MAGELLAN HEALTH, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31,
(In thousands, except per share amounts)
| 2019 |
| 2020 | ||||
ASSETS |
| ||||||
Current Assets: | |||||||
Cash and cash equivalents ($ | $ | | $ | | |||
Accounts receivable, net |
| |
| | |||
Short-term investments ($ |
| |
| | |||
Pharmaceutical inventory |
| |
| | |||
Other current assets ($ |
| |
| | |||
Current portion of assets held for sale | | — | |||||
Total Current Assets |
| |
| | |||
Property and equipment, net |
| |
| | |||
Long-term investments ($ |
| |
| | |||
Deferred income taxes | | | |||||
Other long-term assets |
| |
| | |||
Goodwill |
| |
| | |||
Other intangible assets, net |
| |
| | |||
Assets held for sale, less current portion | | — | |||||
Total Assets | $ | | $ | | |||
LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||
Current Liabilities: | |||||||
Accounts payable | $ | | $ | | |||
Accrued liabilities |
| |
| | |||
Medical claims payable |
| |
| | |||
Other medical liabilities |
| |
| | |||
Current debt, finance lease and deferred financing obligations |
| |
| | |||
Current portion of liabilities held for sale | | — | |||||
Total Current Liabilities |
| |
| | |||
Long-term debt, finance lease and deferred financing obligations |
| |
| | |||
Deferred income taxes | | | |||||
Tax contingencies |
| |
| | |||
Deferred credits and other long-term liabilities |
| |
| | |||
Liabilities held for sale, less current portion | | — | |||||
Total Liabilities |
| |
| | |||
Redeemable non-controlling interest |
| — |
| | |||
Preferred stock, par value $ | |||||||
Authorized— |
|
| |||||
Common stock, par value $ | |||||||
Authorized— |
| |
| | |||
Other Stockholders’ Equity: | |||||||
Additional paid-in capital |
| |
| | |||
Retained earnings |
| |
| | |||
Accumulated other comprehensive income (loss) |
| |
| ( | |||
Treasury stock, at cost, |
| ( |
| ( | |||
Total Stockholders’ Equity |
| |
| | |||
Total Liabilities and Stockholders’ Equity | $ | | $ | | |||
See accompanying notes to consolidated financial statements.
F-4
MAGELLAN HEALTH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31,
(In thousands, except per share amounts)
| 2018 |
| 2019 |
| 2020 | ||||||
Net revenue: | |||||||||||
Managed care and other | $ | | $ | | $ | | |||||
PBM |
| |
| |
| | |||||
Total net revenue |
| |
| |
| | |||||
Costs and expenses: | |||||||||||
Cost of care |
| |
| |
| | |||||
Cost of goods sold |
| |
| |
| | |||||
Direct service costs and other operating expenses (1)(2) |
| |
| |
| | |||||
Depreciation and amortization |
| |
| |
| | |||||
Interest expense |
| |
| |
| | |||||
Interest and other income |
| ( |
| ( |
| ( | |||||
Special charges | — | — | | ||||||||
Total costs and expenses |
| |
| |
| | |||||
Income (loss) from continuing operations before income taxes |
| |
| |
| ( | |||||
Provision (benefit) for income taxes |
| |
| |
| ( | |||||
Net income from continuing operations | | | | ||||||||
Income from discontinued operations, net of tax | | | | ||||||||
Net income | $ | | $ | | $ | | |||||
Net income per common share: | |||||||||||
Basic (See Note A) | |||||||||||
Continuing operations | $ | | $ | | $ | | |||||
Discontinued operations | | | | ||||||||
Consolidated operations | $ | | $ | | $ | | |||||
Diluted (See Note A) | |||||||||||
Continuing operations | $ | | $ | | $ | | |||||
Discontinued operations | | | | ||||||||
Consolidated operations | $ | | $ | | $ | | |||||
| (1) | Includes stock compensation expense of $ |
| (2) | Includes changes in fair value of contingent consideration of $ |
See accompanying notes to consolidated financial statements.
F-5
MAGELLAN HEALTH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31,
(In thousands)
| ||||||||||
| 2018 |
| 2019 |
| 2020 | |||||
Net income | $ | | $ | | $ | | ||||
Other comprehensive income: | ||||||||||
Unrealized (loss) gain on available-for-sale securities (1) | | | ( | |||||||
Comprehensive income | $ | | $ | | $ | | ||||
| (1) | Net of income tax (benefit) expense of $ |
See accompanying notes to consolidated financial statements.
F-6
MAGELLAN HEALTH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(In thousands)
| Accumulated |
|
| |||||||||||||||||||||
| Common Stock | Additional | Other | Total |
| |||||||||||||||||||
Common Stock | In Treasury | Paid in | Retained | Comprehensive | Stockholders’ |
| ||||||||||||||||||
| Shares |
| Amount |
| Shares |
| Amount |
| Capital |
| Earnings |
| (Loss) Income |
| Equity |
| ||||||||
Balance at December 31, 2017 |
| | $ | |
| ( | $ | ( | $ | | $ | | $ | ( | $ | | ||||||||
Stock compensation expense |
| — |
| — |
| — |
| — |
| |
| — |
| — |
| | ||||||||
Exercise of stock options |
| |
| |
| — |
| — |
| |
| — |
| — |
| | ||||||||
Issuance of equity |
| |
| |
| — |
| — |
| ( |
| — |
| — |
| ( | ||||||||
Repurchase of stock |
| — |
| — |
| ( |
| ( |
| — |
| — |
| — |
| ( | ||||||||
Net income |
| — |
| — |
| — |
| — |
| — |
| |
| — | | |||||||||
Other comprehensive loss—other |
| — |
| — |
| — |
| — |
| — |
| — |
| |
| | ||||||||
Adoption of ASC 606 | — |
| — |
| — |
| — |
| — |
| ( |
| — |
| ( | |||||||||
Balance at December 31, 2018 |
| | $ | |
| ( | $ | ( | $ | | $ | | $ | ( | $ | | ||||||||
Stock compensation expense |
| — |
| — |
| — |
| — |
| |
| — |
| — |
| | ||||||||
Exercise of stock options |
| |
| |
| — |
| — |
| |
| — |
| — |
| | ||||||||
Issuance of equity |
| |
| |
| — |
| — |
| |
| — |
| — |
| | ||||||||
Repurchase of stock |
| — |
| — |
| ( |
| ( |
| — |
| — |
| — |
| ( | ||||||||
Net income |
| — |
| — |
| — |
| — |
| — |
| |
| — |
| | ||||||||
Other comprehensive income—other | — | — | — | — | — | — | |
| | |||||||||||||||
Adoption of ASC 842 |
| — |
| — |
| — |
| — |
| — |
| ( |
| — |
| ( | ||||||||
Balance at December 31, 2019 | | $ | | ( | $ | ( | $ | | $ | | $ | | $ | | ||||||||||
Stock compensation expense |
| — |
| — |
| — |
| — |
| |
| — |
| — |
| | ||||||||
Exercise of stock options |
| |
| |
| — |
| — |
| |
| — |
| — |
| | ||||||||
Issuance of equity |
| |
| |
| — |
| — |
| |
| — |
| — |
| | ||||||||
Net income |
| — |
| — |
| — |
| — |
| — |
| |
| — |
| | ||||||||
Other comprehensive (loss)—other | — | — | — | — | — | — | ( | ( | ||||||||||||||||
Adoption of ASC 326 | — | — | — | — | — | ( | — | ( | ||||||||||||||||
Balance at December 31, 2020 |
| | $ | |
| ( | $ | ( | $ | | $ | | $ | ( | $ | | ||||||||
See accompanying notes to consolidated financial statements.
F-7
MAGELLAN HEALTH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31,
(In thousands)
2018 |
| 2019 |
| 2020 |
| |||||
Cash flows from operating activities: | ||||||||||
Net income | $ | | $ | | $ | | ||||
Adjustments to reconcile net income to net cash from operating activities: | ||||||||||
Depreciation and amortization |
| |
| |
| | ||||
Special charges | — | — | | |||||||
Gain on sale of MCC | — | — | ( | |||||||
Non-cash interest expense |
| | | | ||||||
Non-cash stock compensation expense |
| | | | ||||||
Non-cash income tax (benefit) provision |
| ( | | ( | ||||||
Non-cash accretion (amortization) on investments |
| | ( | | ||||||
Changes in assets and liabilities, net of effects from acquisitions of businesses: | ||||||||||
Accounts receivable, net |
| ( | ( | | ||||||
Pharmaceutical inventory |
| | ( | | ||||||
Other assets |
| ( | | ( | ||||||
Accounts payable and accrued liabilities |
| | | | ||||||
Medical claims payable and other medical liabilities |
| | ( | | ||||||
Contingent consideration | | ( | — | |||||||
Tax contingencies |
| | ( | ( | ||||||
Deferred credits and other long-term liabilities |
| | ( | | ||||||
Other |
| | | ( | ||||||
Net cash provided by operating activities | | | | |||||||
Net cash provided by (used in) operating activities from discontinued operations | | ( | | |||||||
Net cash provided by operating activities from continuing operations |
| |
| |
| | ||||
Cash flows from investing activities: | ||||||||||
Capital expenditures |
| ( | ( | ( | ||||||
Acquisitions and investments in businesses, net of cash acquired |
| ( | ( | ( | ||||||
Sale of MCC | — | — | | |||||||
Purchases of investments |
| ( | ( | ( | ||||||
Proceeds from maturities and sales of investments |
| | | | ||||||
Net cash (used in) provided by investing activities | ( | ( | | |||||||
Net cash (used in) provided by investing activities from discontinued operations | ( | | ( | |||||||
Net cash (used in) provided by investing activities from continuing operations |
| ( |
| ( |
| | ||||
Cash flows from financing activities: | ||||||||||
Proceeds from borrowings on revolving line of credit |
| — |
| — |
| | ||||
Payments to acquire treasury stock |
| ( |
| ( |
| — | ||||
Proceeds from exercise of stock options |
| |
| |
| | ||||
Payments on debt, finance lease and deferred financing obligations | ( | ( | ( | |||||||
Payments on contingent consideration | — | ( | — | |||||||
Other |
| ( |
| |
| | ||||
Net cash (used in) provided by financing activities | ( | ( | | |||||||
Net cash (used in) provided by financing activities from discontinued operations | ( | | ( | |||||||
Net cash (used in) provided by financing activities from continuing operations |
| ( |
| ( |
| | ||||
Net (decrease) increase in cash and cash equivalents from continuing operations |
| ( |
| |
| | ||||
Cash and cash equivalents at beginning of period |
| |
| |
| | ||||
Cash and cash equivalents at end of period | $ | | $ | | $ | | ||||
See accompanying notes to consolidated financial statements.
F-8
MAGELLAN HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020
1. General
Basis of Presentation
The consolidated financial statements of Magellan Health, Inc., a Delaware corporation (“Magellan”), include Magellan and its subsidiaries (together with Magellan, the “Company”). All significant intercompany accounts and transactions have been eliminated in consolidation.
On December 31, 2020, Magellan Health, Inc. (the “Company”) completed the sale of its Magellan Complete Care business (the “MCC Business”) to Molina Healthcare, Inc. (“Molina”), pursuant to a Stock and Asset Purchase Agreement, dated as of April 30, 2020, by and between the Company and Molina, for cash in the amount of $
On January 4, 2021, the Company and Centene Corporation (“Centene”) entered into an Agreement of Plan of Merger (the “Merger Agreement”) by and among the Company, Centene, and Mayflower Merger Sub, Inc., a Delaware corporation and a wholly owned subsidiary of Centene (“Merger Sub”), pursuant to which, subject to the terms and conditions set forth therein, Merger Sub will merge with and into the Company, with the Company surviving such merger as a wholly-owned subsidiary of Centene. The Company expects to complete the transaction in the second half of 2021.
Business Overview
The Company provides managed care and pharmacy solutions for some of the most complex areas of healthcare. The Company offers innovative solutions that combine analytics, technology and clinical rigor to drive better decision making, positively impact members’ health outcomes and optimize the cost of care for the customers Magellan serves. The Company provides services to health plans and other managed care organizations (“MCOs”), employers, labor unions, various military and governmental agencies and third-party administrators (“TPAs”). Magellan operates three segments: Healthcare, Pharmacy Management and Corporate.
Healthcare Segment
The Healthcare segment (“Healthcare”) previously consisted of
The Behavioral & Specialty Health reporting unit’s customers include health plans, accountable care organizations (“ACOs”), employers, the United States military and various federal government agencies for whom Magellan provides carve-out management services for (i) behavioral health, (ii) employee assistance plans (“EAP”) and (iii) other areas of specialty healthcare including diagnostic imaging, musculoskeletal management, cardiac and physical medicine. These management services can be applied broadly across commercial, Medicaid and Medicare populations, or on a more targeted basis for our health plans and ACO customers. The Behavioral & Specialty Health unit also includes Magellan’s carve-out behavioral health contracts with various state Medicaid agencies, as well as certain provider assets that deliver primary care and behavioral healthcare services through an integrated approach.
The MCC Business, which is now reflected as discontinued operations, contracts with state Medicaid agencies
F-9
and the Centers for Medicare and Medicaid Services (“CMS”) to manage care for beneficiaries under various Medicaid and Medicare programs. MCC manages a wide range of services from total medical cost to carve out long-term support services. MCC largely focuses on managing care for more acute special populations including individuals with serious mental illness (“SMI”), dual eligibles, aged, blind and disabled (“ABD”) and other populations with unique and often complex healthcare needs.
Magellan’s coordination and management of these healthcare and long-term support services are provided through its comprehensive network of medical and behavioral health professionals, clinics, hospitals, skilled nursing facilities, home care agencies and ancillary service providers. This network of credentialed 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. In addition to the Company’s provider assets where it provides treatment services in certain geographies, the Company also employs licensed behavioral health counselors to deliver non-medical counseling under certain government contracts.
The Company provides its Healthcare management services primarily through: (i) risk-based contractual arrangements, where the Company assumes all or a substantial portion of the responsibility for the cost of providing treatment services in exchange for a fixed per member per month (“PMPM”) fee, or (ii) administrative services only (“ASO”) contractual arrangements, where the Company provides services such as utilization review, claims administration and/or provider network management, but does not assume full responsibility for the cost of the treatment services, in exchange for an administrative fee and, in some instances, a gain share.
Pharmacy Management
The Pharmacy Management segment (“Pharmacy Management”) is comprised of services that provide clinical and financial management of pharmaceuticals paid under both the medical and the pharmacy benefit. Pharmacy Management’s customer solutions include: (i) pharmacy benefit management (“PBM”) services, including pharmaceutical dispensing operations and Medicare Part D; (ii) pharmacy benefit administration (“PBA”) for state Medicaid and other government sponsored programs; (iii) clinical and formulary management 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.
These services are available individually, in combination, or in a fully integrated manner. The Company markets its pharmacy management services to managed care organizations, employers, third party administrators, state governments, Medicare Part D, and other government agencies, exchanges, brokers and consultants. In addition, the Company will continue to upsell its pharmacy services to its existing customers and market its pharmacy solutions to the Healthcare customer base.
Pharmacy Management contracts with its customers for services using risk-based, gain share or ASO arrangements. In addition, Pharmacy Management provides services to the Healthcare segment for most of the MCC business.
On May 11, 2020, the Company announced its decision to exit the Medicare Part D business at the end of 2020. The Company will retain its Medicare Employer Group Waiver Plan as well as full capabilities to serve the PBM needs of its existing and prospective Medicare customers.
Corporate
This segment of the Company is comprised primarily of amounts not allocated to the Healthcare and Pharmacy Management segments that are largely associated with costs related to being a publicly traded company.
F-10
2. Summary of Significant Accounting Policies
Recent Accounting Pronouncements
In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13” or “ASC 326”). This ASU amends the accounting on reporting credit losses for assets held at amortized cost basis and available for sale debt securities. This guidance is effective for annual and interim periods of public entities beginning after December 15, 2019, with
In January 2017, the FASB issued ASU No. 2017-04, “Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment” (“ASU 2017-04”). The amendments in this ASU eliminate the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge. This guidance is effective for annual and interim periods of public entities beginning after December 15, 2019, and was
In August 2018, the FASB issued ASU No. 2018-15, “Intangibles-Goodwill and Other–Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract” (“ASU 2018-15”). This ASU aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. This guidance is effective for annual and interim periods of public entities beginning after December 15, 2019, and was
In December 2019, the FASB issued ASU 2019-12, “Income Taxes – Simplifying the Accounting for Income Taxes” (“ASU 2019-12”). ASU 2019-12 simplifies the accounting for income taxes by removing several exceptions in the current standard and adding guidance to reduce the complexity in certain areas, such as requiring that an entity reflect the effect of an enacted change in tax laws or rates in the annual effective tax rate computation in the interim period that includes the enactment date. The standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020, with
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Significant estimates of the Company can include, among other things, valuation of goodwill and intangible assets, medical claims payable, other medical liabilities, stock compensation assumptions, tax contingencies and legal liabilities. In addition, the Company also makes estimates in relation to revenue recognition under Accounting Standard Codification 606 (“ASC 606”) which are explained in more detail in “Revenue Recognition” below. Actual results could differ from those estimates.
F-11
Revenue Recognition
Virtually all of the Company’s revenues are derived from business in North America. The following tables disaggregate our revenue for the years ended December 31, 2018, 2019 and 2020 by major service line, type of customer and timing of revenue recognition (in thousands):
Year Ended December 31, 2018 | |||||||||||
Healthcare |
| Pharmacy Management |
| Elimination |
| Total | |||||
Major Service Lines | |||||||||||
Behavioral & Specialty Health | |||||||||||
Risk-based, non-EAP | $ | | $ | — | $ | ( | $ | | |||
EAP risk-based | | — | — | | |||||||
ASO | | | ( | | |||||||
PBM, including dispensing | — | | ( | | |||||||
Medicare Part D | — | | — | | |||||||
PBA | — | | — | | |||||||
Formulary management | — | | — | | |||||||
Other | — | | — | | |||||||
Total net revenue | $ | | $ | | $ | ( | $ | | |||
Type of Customer | |||||||||||
Government | $ | | $ | | $ | — | $ | | |||
Non-government | | | ( | | |||||||
Total net revenue | $ | | $ | | $ | ( | $ | | |||
Timing of Revenue Recognition | |||||||||||
Transferred at a point in time | $ | — | $ | | $ | ( | $ | | |||
Transferred over time | | | ( | | |||||||
Total net revenue | $ | | $ | | $ | ( | $ | | |||
F-12
Year Ended December 31, 2019 | |||||||||||
Healthcare |
| Pharmacy Management |
| Elimination |
| Total | |||||
Major Service Lines | |||||||||||
Behavioral & Specialty Health | |||||||||||
Risk-based, non-EAP | $ | | $ | — | $ | ( | $ | | |||
EAP risk-based | | — | — | | |||||||
ASO | | | ( | | |||||||
PBM, including dispensing | — | | ( | | |||||||
Medicare Part D | — | | — | | |||||||
PBA | — | | — | | |||||||
Formulary management | — | | — | | |||||||
Other | — | | — | | |||||||
Total net revenue | $ | | $ | | $ | ( | $ | | |||
Type of Customer | |||||||||||
Government | $ | | $ | | $ | — | $ | | |||
Non-government | | | ( | | |||||||
Total net revenue | $ | | $ | | $ | ( | $ | | |||
Timing of Revenue Recognition | |||||||||||
Transferred at a point in time | $ | — | $ | | $ | ( | $ | | |||
Transferred over time | | | ( | | |||||||
Total net revenue | $ | | $ | | $ | ( | $ | | |||
Year Ended December 31, 2020 | |||||||||||
Healthcare |
| Pharmacy Management |
| Elimination |
| Total | |||||
Major Service Lines | |||||||||||
Behavioral & Specialty Health | |||||||||||
Risk-based, non-EAP | $ | | $ | — | $ | ( | $ | | |||
EAP risk-based | | — | — | | |||||||
ASO | | | ( | | |||||||
PBM, including dispensing | — | | ( | | |||||||
Medicare Part D | — | | — | | |||||||
PBA | — | | — | | |||||||
Formulary management | — | | — | | |||||||
Other | — | | — | | |||||||
Total net revenue | $ | | $ | | $ | ( | $ | | |||
Type of Customer | |||||||||||
Government | $ | | $ | | $ | — | $ | | |||
Non-government | | | ( | | |||||||
Total net revenue | $ | | $ | | $ | ( | $ | | |||
Timing of Revenue Recognition | |||||||||||
Transferred at a point in time | $ | — | $ | | $ | ( | $ | | |||
Transferred over time | | | ( | | |||||||
Total net revenue | $ | | $ | | $ | ( | $ | | |||
F-13
Per Member Per Month (“PMPM”) Revenue. Almost all of the Healthcare revenue and a small portion of the Pharmacy Management revenue is paid on a PMPM basis. PMPM revenue is inclusive of revenue from the Company’s risk, EAP and ASO contracts and primarily relates to managed care contracts for services such as the provision of behavioral healthcare, specialty healthcare, pharmacy management, or fully integrated healthcare services. PMPM contracts generally have a term of
Pharmacy Benefit Management Revenue. The Company’s customers for PBM business, including pharmaceutical dispensing operations, are generally comprised of MCOs, employer groups and health plans. PBM relationships generally have an expected term of
Medicare Part D. The Company is contracted with CMS as a Prescription Drug Plan (“PDP”) to provide prescription drug benefits to Medicare beneficiaries. The accounting for Medicare Part D revenue is primarily the same as that for PBM, as previously discussed. However, there is certain variable consideration present only in Medicare Part D arrangements. The Company estimates the annual amount of variable consideration using a most likely amount methodology, which is allocated to each reporting period based upon actual utilization as a percentage of estimated utilization for the year. Amounts estimated throughout the year for interim reporting are substantially resolved and fixed as of December 31st, the end of the plan year. In May 2020, the Company announced its decision to exit the Part D business at the end of 2020.
Pharmacy Benefit Administration Revenue. The Company provides Medicaid pharmacy services to states and other government sponsored programs. PBA contracts are generally multi-year arrangements but include language regarding early termination for convenience without material penalty provisions that results in enforceable rights and obligations on a month-to-month basis. In PBA arrangements, the Company is generally paid a fixed fee per month to provide PBA services. In addition, some PBA contracts contain upfront fees that constitute a material right. For contracts without an upfront fee, there is a single performance obligation to stand ready to provide the PBA services required for the contracted period. The Company believes that the customer receives the PBA benefits each day from access to the claims processing activities, and has concluded that a time-based measure is appropriate for recognizing PBA revenue.
F-14
For contracts with an upfront fee, the material right represents an additional performance obligation. Amounts allocated to the material right are initially recorded as a contract liability and recognized as revenue over the anticipated period of benefit of the material right, which generally ranges from
Formulary Management Revenue. The Company administers formulary management programs for certain clients through which the Company coordinates the achievement, calculation and collection of rebates and administrative fees from pharmaceutical manufacturers on behalf of clients. Formulary management contracts generally have a term of
In relation to the Company’s PBM business, the Company administers rebate programs through which it receives rebates from pharmaceutical manufacturers that are shared with its customers. The Company recognizes rebates when the Company is entitled to them and when the amounts of the rebates are determinable. The amount recorded for rebates earned by the Company from the pharmaceutical manufacturers is recorded as a reduction of cost of goods sold.
Government EAP Risk-Based Revenue. The Company has certain contracts with federal customers for the provision of various managed care services, which are classified as EAP risk-based business. These contracts are generally multi-year arrangements. The Company’s federal contracts are reimbursed on either a fixed fee basis or a cost reimbursement basis. The performance obligation on a fixed fee contract is to stand ready to provide the staffing required for the contracted period. For fixed fee contracts, the Company believes the invoiced amount corresponds directly with the value to the customer of the Company’s performance completed to date; therefore, the Company is utilizing the “right to invoice” practical expedient, with revenue recognition in the amount for which the Company has the right to invoice.
The performance obligation on a cost reimbursement contract is to stand ready to provide the activity or services purchased by the customer, such as the operation of a counseling services group or call center. The performance obligation represents a series for the duration of the arrangement. The reimbursement rate is fixed per the contract; however, the level of activity (e.g., number of hours, number of counselors or number of units) is variable. A majority of the Company’s cost reimbursement transaction price relates specifically to its efforts to transfer the service for a distinct increment of the series (e.g. day or month) and is recognized as revenue when the portion of the series for which it relates has been provided (i.e. as the Company provides hours, counselors or units of service).
In accordance with ASC 606-10-50-13, the Company is required to include disclosure on its remaining performance obligations as of the end of the current reporting period. Due to the nature of the contracts in the Company’s PBM and Part D business, these reporting requirements are not applicable. The majority of the Company’s remaining contracts meet certain exemptions as defined in ASC 606-10-50-14 through 606-10-50-14A, including (i) performance obligation is part of a contract that has an original expected duration of one year or less; (ii) the right to invoice practical expedient; and (iii) variable consideration related to unsatisfied performance obligations that is allocated entirely to a wholly unsatisfied promise to transfer a distinct service that forms part of a single performance obligation, and the terms of that variable consideration relate specifically to our efforts to transfer the distinct service, or to a specific outcome from transferring the distinct service. For the Company’s contracts that pertain to these exemptions: (i) the remaining performance obligations primarily relate to the provision of managed healthcare services to the customers’ membership; (ii) the estimated remaining duration of these performance obligations ranges from the remainder of the current calendar year to three years; and (iii) variable consideration for these contracts primarily includes net per member per month fees associated with unspecified membership that fluctuates throughout the contract.
F-15
Accounts Receivable, Contract Assets and Contract Liabilities
Accounts receivable, contract assets and contract liabilities consisted of the following (in thousands, except percentages):
December 31, |
| December 31, |
|
|
| |||||||
2019 | 2020 | $ Change | % Change | |||||||||
Accounts receivable | $ | | $ | | $ | | ||||||
Contract assets | | | | |||||||||
Contract liabilities - current | | | | |||||||||
Contract liabilities - long-term | | | ( | ( | ||||||||
Accounts receivable, which are included in accounts receivable, other current assets and other long-term assets on the consolidated balance sheets, increased by $
During the year ended December 31, 2020, the Company recognized revenue of $
The Company’s accounts receivable consists of amounts due from customers throughout the United States. Collateral is generally not required. A majority of the Company’s contracts have payment terms in the month of service, or within a few months thereafter. The timing of payments from customers from time to time generates contract assets or contract liabilities, however these amounts are immaterial.
Significant Customers
Customers exceeding ten percent of the consolidated Company’s net revenues
The Company had no customers that exceeded ten percent of the Company’s net revenues from continuing operations for the years ended December 31, 2018, 2019 and 2020. The following MCC customers, which are included in discontinued operations, previously exceeded ten percent of the Company’s consolidated net revenues.
The Company had contracts with the Commonwealth of Virginia (the “Virginia Contracts”). The Company began providing Medicaid managed long-term services and supports to enrollees in the Commonwealth Coordinated Care Plus (“CCC Plus”) program on August 1, 2017. On August 1, 2018, the Company began providing integrated healthcare services to Medicaid enrollees in the Commonwealth of Virginia under the Medallion 4.0/FAMIS Managed Care Program (“Medallion”). The Virginia Contracts generated net revenues of $
The Company had a contract with the State of New York (the “New York Contract”) to provide integrated managed care services to Medicaid and Medicare enrollees in the State of New York. The New York Contracts generated net revenues of $
The Company had contracts with the Commonwealth of Massachusetts and CMS (the “Massachusetts Contracts”) to provide integrated managed care services to Medicaid and Medicare enrollees in the Commonwealth of Massachusetts. Medicaid services are provided under a Senior Care Options contract (“SCO Contract”) began on January 1, 2016. The Massachusetts Contracts generated net revenues of $
F-16
Customers exceeding ten percent of segment net revenues
In addition to the Massachusetts Contracts, New York Contract and Virginia Contracts previously discussed, the following customers generated in excess of ten percent of net revenues for the respective segment for the years ended December 31, 2018, 2019 and 2020 (in thousands):
Segment |
| Term Date |
| 2018 |
| 2019 |
| 2020 |
| |||
Healthcare | ||||||||||||
Customer A | December 31, 2021 | $ | | $ | | $ | | |||||
Customer B | December 31, 2022 | | * | | * | | ||||||
Pharmacy Management | ||||||||||||
Customer C | March 31, 2024 | | | | ||||||||
* | Revenue amount did not exceed 10 percent of net revenues for the respective segment for the year presented. Amount is shown for comparative purposes only. |
Concentration of Business
The Company also has a significant concentration of business with various counties in the State of Pennsylvania (the “Pennsylvania Counties”) which are part of the Pennsylvania Medicaid program, with members under its contract with CMS and with various agencies and departments of the United States federal government. Net revenues from the Pennsylvania Counties in the aggregate totaled $
The Company’s contracts with customers typically have stated terms of to
Income Taxes
The Company files a consolidated federal income tax return with its eighty-percent or more controlled subsidiaries. The Company and its subsidiaries also file income tax returns in various state and local jurisdictions.
The Company estimates income taxes for each of the jurisdictions in which it operates. This process involves determining both permanent and temporary differences resulting from differing treatment for tax and book purposes. Deferred tax assets and/or liabilities are determined by multiplying the temporary differences between the financial reporting and tax reporting bases for assets and liabilities by the enacted tax rates expected to be in effect when such differences are recovered or settled. The Company then assesses the likelihood that the deferred tax assets will be recovered from the reversal of temporary differences, the implementation of feasible and prudent tax planning strategies, and future taxable income. To the extent the Company cannot conclude that recovery is more likely than not, it establishes a valuation allowance. The effect of a change in tax rates on deferred taxes is recognized in income in the period that includes the enactment date. Reversals of both valuation allowances and unrecognized tax benefits are recorded in the period they occur, typically as reductions to income tax expense.
The Coronavirus Aid, Relief, and Economic Security Act was signed into law on March 27, 2020, and the Consolidated Appropriations Act, 2021 was signed into law on December 27, 2020. Both acts provide widespread
F-17
emergency relief for the economy and aid to corporations including several significant provisions related to taxes. As of December 31, 2020, the Company has not utilized any of the provisions that would result in a material impact on its results.
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. On January 23, 2018, the United States Congress passed the Continuing Resolution which imposed a one-year moratorium on the health insurance fee (“HIF”), suspending its application for 2019. For 2020 the HIF fee was $
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. Book overdrafts are reflected within accounts payable on the balance sheets. At December 31, 2019, the Company had $
Restricted Assets
The Company has certain assets which are considered restricted for: (i) the payment of claims under the terms of certain managed care 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 Company’s subsidiaries. Significant restricted assets of the Company as of December 31, 2019 and 2020 were as follows (in thousands):
| 2019 |
| 2020 |
| |||
Restricted cash and cash equivalents | $ | | $ | | |||
Restricted short-term investments |
| |
| | |||
Restricted deposits (included in other current assets) |
| |
| | |||
Restricted long-term investments |
| |
| | |||
Total | $ | | $ | | |||
The Company’s equity in restricted net assets of consolidated subsidiaries represented approximately
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
F-18
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 financial assets and liabilities that are required to be measured at fair value as of December 31, 2019 and 2020 (in thousands):
December 31, 2019 | |||||||||||||
| Level 1 |
| Level 2 |
| Level 3 |
| Total |
| |||||
Assets | |||||||||||||
Cash and cash equivalents (1) |
| $ | — |
| $ | |
| $ | — |
| $ | | |
Investments: | |||||||||||||
U.S. Government and agency securities |
| |
| — |
| — |
| | |||||
Corporate debt securities |
| — |
| |
| — |
| | |||||
Certificates of deposit |
| — |
| |
| — |
| | |||||
Total assets held at fair value | $ | | $ | | $ | — | $ | | |||||
December 31, 2020 | |||||||||||||
| Level 1 |
| Level 2 |
| Level 3 |
| Total |
| |||||
Assets | |||||||||||||
Cash and cash equivalents (2) |
| $ | — |
| $ | |
| $ | — |
| $ | | |
Investments: | |||||||||||||
U.S. Government and agency securities |
| |
| — |
| — |
| | |||||
Corporate debt securities |
| — |
| |
| — |
| | |||||
Certificates of deposit |
| — |
| |
| — |
| | |||||
Total assets held at fair value | $ | | $ | | $ | — | $ | | |||||
| (1) | Excludes $ |
| (2) | Excludes $ |
For the years ended December 31, 2019 and 2020, the Company did not transfer 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 fair value of the Notes (as defined below) of $
Investments
All of the Company’s investments are classified as “available-for-sale” and are carried at fair value. Securities which have been classified as Level 1 are measured using quoted market prices in active markets for identical assets or liabilities while those which have been classified as Level 2 are measured using quoted prices for identical assets and liabilities in markets that are not active. The Company’s policy is to classify all investments with contractual maturities within one year as current. Investment income is recognized when earned and reported net of investment expenses. Net unrealized holding gains or losses are excluded from earnings and are reported, net of tax, as “accumulated other comprehensive income (loss)” in the accompanying consolidated balance sheets and consolidated statements of
F-19
comprehensive income until realized, unless the losses are deemed to be other-than-temporary. Realized gains or losses, including any provision for other-than-temporary declines in value, are included in the consolidated statements of income.
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. 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 and the non-credit component of the other-than-temporary impairment is recognized in other comprehensive income.
The credit component of an other-than-temporary impairment is determined by comparing the net present value of projected future cash flows with the amortized cost basis of the debt security. The net present value is calculated by discounting the best estimate of projected future cash flows at the effective interest rate implicit in the debt security at the date of acquisition. Cash flow estimates are driven by assumptions regarding probability of default, including changes in credit ratings, and estimates regarding timing and amount of recoveries associated with a default. Furthermore, unrealized losses entirely caused by non-credit related factors related to debt securities for which the Company expects to fully recover the amortized cost basis continue to be recognized in accumulated other comprehensive income.
As of December 31, 2019 and 2020, there were no material unrealized losses that the Company believed to be other-than-temporary.
December 31, 2019 |
| ||||||||||||
Gross | Gross |
| |||||||||||
Amortized | Unrealized | Unrealized | Estimated |
| |||||||||
| Cost |
| Gains |
| Losses |
| Fair Value |
| |||||
U.S. Government and agency securities |
| $ | |
| $ | |
| $ | ( |
| $ | | |
Corporate debt securities |
| |
| |
| ( |
| | |||||
Certificates of deposit |
| |
| — |
| — |
| | |||||
Total investments at December 31, 2019 | $ | | $ | | $ | ( | $ | | |||||
December 31, 2020 |
| ||||||||||||
Gross | Gross |
| |||||||||||
Amortized | Unrealized | Unrealized | Estimated |
| |||||||||
| Cost |
| Gains |
| Losses |
| Fair Value |
| |||||
U.S. Government and agency securities |
| $ | |
| $ | |
| $ | ( |
| $ | | |
Corporate debt securities |
| |
| |
| ( |
| | |||||
Certificates of deposit | |
| — |
| — |
| | ||||||
Total investments at December 31, 2020 | $ | | $ | | $ | ( | $ | | |||||
The maturity dates of the Company’s investments as of December 31, 2020 are summarized below (in thousands):
| Amortized |
| Estimated |
| |||
| Cost |
| Fair Value |
| |||
2021 | $ | | $ | | |||
2022 | | | |||||
Total investments at December 31, 2020 |
| $ | |
| $ | | |
Concentration of Credit Risk
Accounts receivable subjects the Company to a concentration of credit risk with third party payors that include health insurance companies, managed healthcare organizations, healthcare providers and governmental entities.
F-20
The Company maintains cash and cash equivalents balances at financial institutions which are insured by the Federal Deposit Insurance Corporation (“FDIC”). At times, balances in certain bank accounts may exceed the FDIC insured limits.
Pharmaceutical Inventory
Pharmaceutical inventory consists solely of finished goods (primarily prescription drugs) and is stated at the lower of first-in first-out, cost, or market.
Long-lived Assets
Long-lived assets, including property and equipment and intangible assets to be held and used, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We group and evaluate these long-lived assets for impairment at the lowest level at which individual cash flows can be identified. Impairment is determined by comparing the carrying value of these long-lived assets to management’s best estimate of the future undiscounted cash flows expected to result from the use of the assets and their eventual disposition. The cash flow projections used to make this assessment are consistent with the cash flow projections that management uses internally in making key decisions. In the event an impairment exists, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the asset, which is generally determined by using quoted market prices or the discounted present value of expected future cash flows.
In the evaluation of indefinite-lived intangible assets for impairment, the Company first assesses qualitative factors to determine whether it is more likely than not that the fair value of the indefinite-lived intangible asset is less than its carrying value. If the Company determines that it is not more likely than not for the indefinite-lived intangible asset’s fair value to be less than its carrying value, a calculation of the fair value is not performed. If the Company determines that it is more likely than not that the indefinite-lived intangible asset’s fair value is less than its carrying value, a calculation is performed and compared to the carrying value of the asset. If the carrying amount of the indefinite-lived intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. The Company measures the fair value of its indefinite-lived intangible assets using the “relief from royalty” method. Significant estimates in this approach include projected revenues and royalty and discount rates for each trade name evaluated.
Property and Equipment
Property and equipment is stated at cost, except for assets that have been impaired, for which the carrying amount has been reduced to estimated fair value. Expenditures for renewals and improvements are capitalized to the property accounts. Replacements and maintenance and repairs that do not improve or extend the life of the respective assets are expensed as incurred. The Company capitalizes costs incurred to develop internal-use software during the application development stage. Capitalization of software development costs occurs after the preliminary project stage is complete, management authorizes the project, and it is probable that the project will be completed and the software will be used for the function intended. Amortization of capital lease assets is included in depreciation expense and is included in accumulated depreciation as reflected in the table below. Depreciation is provided on a straight-line basis over the estimated useful lives of the assets, which is generally to
F-21
Property and equipment, net, consisted of the following at December 31, 2019 and 2020 (in thousands):
| 2019 |
| 2020 |
| |||
Building improvements | $ | | $ | | |||
Equipment |
| |
| | |||
Finance leases - property |
| |
| | |||
Finance leases - equipment |
| |
| | |||
Capitalized internal-use software |
| |
| | |||
| |
| | ||||
Accumulated depreciation |
| ( |
| ( | |||
Property and equipment, net | $ | | $ | | |||
Goodwill
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 goodwill impairment test is a two-step process that requires management to make judgments in determining what assumptions to use in the calculation. The first step of the process consists of estimating the fair value of each reporting unit with goodwill based on various valuation techniques, with the primary technique being a discounted cash flow analysis, which requires the input of various assumptions with respect to revenues, operating margins, growth rates and discount rates. The estimated fair value for each reporting unit is compared to the carrying value of the reporting unit, which includes goodwill. If the estimated fair value is less than the carrying value, a second step is performed to compute the amount of the impairment by determining an “implied fair value” of goodwill. The determination of a reporting unit’s “implied fair value” of goodwill requires the Company to allocate the estimated fair value of the reporting unit to the assets and liabilities of the reporting unit. Any unallocated fair value represents the “implied fair value” of goodwill, which is compared to its corresponding carrying value.
Goodwill is tested for impairment at a level referred to as a reporting unit, with the Company’s reporting units with goodwill as of December 31, 2020 comprised of Behavioral & Specialty Health and Pharmacy Management. On December 31, 2020, the Company completed the sale of its MCC reporting unit to Molina.
The fair values of the Behavioral & Specialty Health and Pharmacy Management reporting units were determined using a discounted cash flow method. This method involves estimating the present value of estimated future cash flows utilizing a risk adjusted discount rate. Key assumptions for this method include cash flow projections, terminal growth rates and discount rates.
While no units were determined to be impaired at this time, reporting unit goodwill is at risk of future impairment in the event of significant unfavorable changes in the Company’s forecasted future results and cash flows. In addition, market factors utilized in the impairment analysis, including long-term growth rates or discount rates, could negatively impact the fair value of our reporting units. For testing purposes, management's best estimates of the expected future results are the primary driver in determining the fair value. Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions and factors. As a result, there can be no assurance that the estimates and assumptions made for purposes of the annual goodwill test will prove to be an accurate prediction of the future.
Examples of events or circumstances that could reasonably be expected to negatively affect the underlying key assumptions and ultimately impact the estimated fair value of our reporting units may include such items as: (i) a decrease in expected future cash flows, specifically, a decrease in membership or rates or customer attrition and increase in costs that could significantly impact our immediate and long-range results, unfavorable working capital changes and an inability to successfully achieve our cost savings targets, (ii) adverse changes in macroeconomic conditions or an economic recovery that significantly differs from our assumptions in timing and/or degree (such as a recession); and (iii) volatility in the equity and debt markets or other country specific factors which could result in a higher weighted average cost of capital.
Based on known facts and circumstances, we evaluate and consider recent events and uncertain items, as well as related potential implications, as part of our annual assessment and incorporate into the analyses as appropriate. These facts and circumstances are subject to change and may impact future analyses.
F-22
While historical performance and current expectations have resulted in fair values of our reporting units and indefinite-lived intangible assets in excess of carrying values, if our assumptions are not realized, it is possible that an impairment charge may need to be recorded in the future.
Goodwill for each of the Company’s reporting units with goodwill at December 31, 2019 and 2020 was as follows (in thousands):
|
|
| |||||
2019 | 2020 | ||||||
$ | | $ | | ||||
| |
| | ||||
Total | $ | | $ | | |||
The changes in the carrying amount of goodwill for the years ended December 31, 2019 and 2020 are reflected in the table below (in thousands):
|
|
| |||||
2019 | 2020 | ||||||
Balance as of beginning of period | $ | | $ | | |||
Acquisition of Bayless |
| — |
| | |||
Balance as of end of period | $ | | $ | | |||
Intangible Assets
The Company reviews other intangible assets for impairment when events or changes in circumstances occur which may potentially impact the estimated useful life of the intangible assets.
The following is a summary of intangible assets at December 31, 2019 and 2020, and the estimated useful lives for such assets (in thousands, except useful lives):
December 31, 2019 |
| |||||||||||||||||||
| Weighted Avg | Gross | Net |
| ||||||||||||||||
Original | Remaining | Carrying | Accumulated | Carrying |
| |||||||||||||||
Asset |
| Useful Life | Useful Life | Amount |
| Amortization |
| Amount |
| |||||||||||
Customer agreements and lists |
| to | years | years | $ | |
| $ | ( |
| $ | | ||||||||
Provider networks and other |
| to | years | years |
| |
| ( |
| | ||||||||||
$ | | $ | ( | $ | | |||||||||||||||
December 31, 2020 |
| |||||||||||||||||||
| Weighted Avg | Gross | Net |
| ||||||||||||||||
Original | Remaining | Carrying | Accumulated | Carrying |
| |||||||||||||||
Asset |
| Useful Life | Useful Life | Amount |
| Amortization |
| Amount |
| |||||||||||
Customer agreements and lists |
| to | years | years | $ | |
| $ | ( |
| $ | | ||||||||
Provider networks and other |
| to | years | years |
| |
| ( |
| | ||||||||||
Trade names and licenses | indefinite | indefinite | | — | | |||||||||||||||
$ | | $ | ( | $ | | |||||||||||||||
Amortization expense was $
Cost of Care, Medical Claims Payable and Other Medical Liabilities
Cost of care is recognized in the period in which members receive managed healthcare services. In addition to actual benefits paid, cost of care in a period also includes the impact of accruals for estimates of medical claims payable. Medical claims payable represents the liability for healthcare claims reported but not yet paid and claims incurred but not yet reported (“IBNR”) related to the Company’s managed healthcare businesses. Such liabilities are determined by
F-23
employing actuarial methods that are commonly used by health insurance actuaries and that meet actuarial standards of practice. Cost of care for the Company’s EAP contracts, which are mainly with the United States federal government, pertain to the costs to employ licensed behavioral health counselors to deliver non-medical counseling for these contracts.
The IBNR portion of medical claims payable is estimated based on past claims payment experience for member groups, enrollment data, utilization statistics, authorized healthcare services and other factors. This data is incorporated into contract-specific actuarial reserve models and is further analyzed to create “completion factors” that represent the average percentage of total incurred claims that have been paid through a given date after being incurred. Factors that affect estimated completion factors include benefit changes, enrollment changes, shifts in product mix, seasonality influences, provider reimbursement changes, changes in claims inventory levels, the speed of claims processing and changes in paid claim levels. Completion factors are applied to claims paid through the financial statement date to estimate the ultimate claim expense incurred for the current period. Actuarial estimates of claim liabilities are then determined by subtracting the actual paid claims from the estimate of the ultimate incurred claims. For the most recent incurred months (generally the most recent
Medical claims payable balances are continually monitored and reviewed. If it is determined that the Company’s assumptions in estimating such liabilities are significantly different than actual results, the Company’s results of operations and financial position could be impacted in future periods. Adjustments of prior period estimates may result in additional cost of care or a reduction of cost of care in the period an adjustment is made. Further, due to the considerable variability of healthcare costs, adjustments to claim liabilities occur each period and are sometimes significant as compared to the net income recorded in that period. Prior period development is recognized immediately upon the actuary’s judgment that a portion of the prior period liability is no longer needed or that additional liability needs to be accrued. The following table presents the components of the change in medical claims payable for the years ended December 31, 2018, 2019 and 2020 (in thousands):
| 2018 |
| 2019 |
| 2020 |
| ||||
Claims payable and IBNR, beginning of period | $ | | $ | | $ | | ||||
Cost of care: | ||||||||||
Current year |
| |
| |
| | ||||
Prior years(3) |
| ( |
| ( |
| ( | ||||
Total cost of care |
| |
| |
| | ||||
Claim payments and transfers to other medical liabilities(1): | ||||||||||
Current year |
| |
| |
| | ||||
Prior years |
| |
| |
| | ||||
Total claim payments and transfers to other medical liabilities |
| |
| |
| | ||||
Claims payable and IBNR, end of period |
| |
| |
| | ||||
Withhold payable, end of period(2) |
| |
| |
| | ||||
Medical claims payable, end of period | $ | | $ | | $ | | ||||
| (1) | For any given period, a portion of unpaid medical claims payable could be covered by risk share or reinvestment liabilities (discussed below) and may not impact the Company’s results of operations for such periods. |
| (2) | Medical claims payable is offset by customer withholds from capitation payments in situations in which the customer has the contractual requirement to pay providers for care incurred. |
| (3) | Favorable development in 2018, 2019 and 2020 was $ |
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Actuarial standards of practice require that claim liabilities be adequate under moderately adverse circumstances. Adverse circumstances are situations in which the actual claims experience could be higher than the otherwise estimated value of such claims. In many situations, the claims paid amount experienced will be less than the estimate that satisfies the actuarial standards of practice. Any prior period favorable cost of care development related to a lack of moderately adverse conditions is excluded from “Cost of Care – Prior Years” adjustments, as a similar provision for moderately adverse conditions is established for current year cost of care liabilities and therefore does not generally impact net income.
Due to the existence of risk sharing and reinvestment provisions in certain customer contracts, principally in the Government contracts, a change in the estimate for medical claims payable does not necessarily result in an equivalent impact on segment profit.
The Company believes that the amount of medical claims payable is adequate to cover its ultimate liability for unpaid claims as of December 31, 2020; however, actual claims payments may differ from established estimates.
Other medical liabilities consist primarily of amounts payable to pharmacies for claims that have been adjudicated by the Company but not yet paid and “profit share” payables under certain risk-based contracts. Under a contract with profit share provisions, if the cost of care is below certain specified levels, the Company will “share” the cost savings with the customer at the percentages set forth in the contract. In addition, certain contracts include provisions to provide the Company additional funding if the cost of care is above the specified levels. Other medical liabilities also include “reinvestment” payables under certain managed healthcare contracts with Medicaid customers. Under a contract with reinvestment features, if the cost of care is less than certain minimum amounts specified in the contract (usually as a percentage of revenue), the Company is required to “reinvest” such difference in behavioral healthcare programs when and as specified by the customer or to pay the difference to the customer for their use in funding such programs.
Leases
The Company leases certain office space, distribution centers, land and equipment. We assess our contracts to determine if they contain a lease. This assessment is based on (i) the right to control the use of an identified asset; (ii) the right to obtain substantially all of the economic benefits from the use of the identified asset; and (iii) the right to use the identified asset. The Company elected the short-term lease practical expedient; thus, leases with an initial term of twelve months or less are not capitalized and the expense is recognized on a straight-line basis. Most leases include
Operating leases are included in other long-term assets, accrued liabilities and deferred credits and other long-term liabilities in the consolidated balance sheets. Finance leases are included in property and equipment, current debt, capital lease deferred financing obligations and long-term debt, capital lease and deferred financing obligations in the consolidated balance sheets.
ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments per the lease. Operating lease ROU assets and liabilities are recognized at lease commencement date based on the present value of lease payments over the lease term. As the rate implicit in most of our leases is not readily determinable, the Company used its incremental borrowing rate to determine the present value of lease payments.
F-25
The following table shows the components of lease expenses for the year ended December 31, 2020 (in thousands):
Year Ended | ||
Operating lease cost | $ | |
Finance lease cost: | ||
Amortization of right-of-use asset | | |
Interest on lease liabilities | | |
Total finance lease cost | | |
Short-term lease cost | | |
Variable lease cost | | |
Total lease cost | | |
Sublease income | ( | |
Net lease cost | $ | |
The following table shows the components of the lease assets and liabilities as of December 31, 2020 (in thousands):
December 31, 2020 | ||
Operating leases: | ||
$ | | |
$ | | |
| ||
$ | | |
Finance leases: | ||
$ | | |
$ | | |
| ||
Total finance lease liabilities | $ | |
The maturity dates of the Company’s leases as of December 31, 2020 are summarized below (in thousands):
December 31, 2020 | ||
2020 | $ | |
2021 | | |
2022 | | |
2023 | | |
2024 | | |
2025 and beyond | | |
Total lease payments | | |
Less interest | ( | |
Present value of lease liabilities | $ | |
F-26
The following table shows the weighted average remaining lease term and discount rate as of December 31, 2020:
December 31, 2020 | ||
Weighted average remaining lease term | ||
Operating leases | ||
Finance leases | ||
Weighted average discount rate | ||
Operating leases | ||
Finance leases | ||
Supplemental cash flow information relating to leases is as follows (in thousands):
Year ended December 31, 2020 | ||
Cash paid for amounts included in the measurement of lease liabilities: | ||
Operating cash flows from operating leases | $ | |
Operating cash flows from finance leases | | |
Financing cash flows from finance leases | | |
Right-of-use asset obtained in exchange for new lease obligation | ||
Operating leases | | |
Finance leases | | |
Accrued Liabilities
As of December 31, 2019, the individual current liabilities that exceeded five percent of total current liabilities related to accrued customer settlement liabilities of $
Net Income per Common Share attributable to Magellan
Net income per common share attributable to Magellan is computed based on the weighted average number of shares of common stock and common stock equivalents outstanding during the period (see Note 6—“Stockholders’ Equity”).
Stock Compensation
At December 31, 2019 and 2020, the Company had equity-based employee incentive plans, which are described more fully in Note 6—“Stockholders’ Equity”. The Company recorded stock compensation expense of $
F-27
Redeemable Non-Controlling Interest
As of December 31, 2020, the Company held a
3. Acquisitions
Acquisition of Aurelia Health, LLC
Pursuant to the
The base purchase price for the Bayless Acquisition per the Bayless Agreement was $
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 $
F-28
The estimated fair value of Bayless’ assets acquired and liabilities assumed at the date of the acquisition are summarized as follows (in thousands):
Assets acquired: | |||
Current assets (includes $ | $ | | |
Property and equipment, net | | ||
Other assets | | ||
Identified intangible assets | | ||
Goodwill | | ||
Total assets acquired | | ||
Liabilities assumed: | |||
Current liabilities | | ||
Other liabilities | | ||
Total liabilities assumed | | ||
Net assets acquired | | ||
Redeemable non-controlling interest | | ||
Total Consideration | $ | |
The Company’s estimated fair values of Bayless’ assets acquired, liabilities assumed and the redeemable non-controlling interest at the date of acquisition are determined based on certain valuations and analyses that have yet to be finalized, and accordingly, the assets acquired, liabilities assumed, and non-controlling interest, as detailed above, are subject to adjustment once the analyses are completed. The Company will make appropriate adjustments to the purchase price allocation prior to the completion of the measurement period as required.
In connection with the Bayless acquisition, the Company incurred acquisition related costs of $
4. Benefit Plans
The Company has a defined contribution retirement plan (the “401(k) Plan”). Employee participants can elect to contribute up to
5. Long-Term Debt, Finance Lease and Deferred Financing Obligations
Senior Notes
On September 22, 2017, the Company completed the public offering of $
The Notes bear interest payable semiannually in cash in arrears on March 22 and September 22 of each year, commencing on March 22, 2018, which rate is subject to an interest rate adjustment upon the occurrence of certain credit rating events. The interest rate on the Notes on December 31, 2020 was 4.900%. The Notes mature on
F-29
The Indenture also contains certain covenants which restrict the Company’s ability to, among other things, create liens on its and its subsidiaries’ assets; engage in sale and lease-back transactions; and engage in a consolidation, merger or sale of assets.
Credit Agreement
On September 22, 2017, the Company entered into a credit agreement with various lenders that provides for a $
Under the 2017 Credit Agreement, the annual interest rate on the loan borrowing is equal to (i) in the case of base rate loans, the sum of an initial borrowing margin of
As of December 31, 2020, the contractual maturities of the term loan facility under the 2017 Credit Agreement were as follows: 2021 - $
The 2017 Credit Agreement contains covenants that limit management’s discretion in operating the Company’s business by restricting or limiting the Company’s ability, among other things, to:
| ● | incur or guarantee additional indebtedness or issue preferred or redeemable stock; |
| ● | pay dividends and make other distributions; |
| ● | repurchase equity interests; |
| ● | make certain advances, investments and loans; |
| ● | enter into sale and leaseback transactions; |
| ● | create liens; |
| ● | sell and otherwise dispose of assets; |
| ● | acquire or merge or consolidate with another company; and |
F-30
| ● | enter into some types of transactions with affiliates. |
Letter of Credit Agreement
On August 22, 2017, the Company entered into a Continuing Agreement for Standby Letters of Credit with The Bank of Tokyo-Mitsubishi UFJ, Ltd. (“BTMU”), as issuer (the “L/C Agreement”), under which BTMU, at its sole discretion, may provide stand-by letter of credit to the Company. The Company had $
Finance Lease and Deferred Financing Obligations
There were $
6. Stockholders’ Equity
Stock Compensation
At December 31, 2019 and 2020, the Company had equity-based employee incentive plans. Prior to May 18, 2016, the Company utilized the 2011 Management Incentive Plan (the “2011 MIP”), 2008 Management Incentive Plan (the “2008 MIP”) and 2006 Directors’ Equity Compensation Plan (collectively the “Preexisting Plans”) for grants of stock options, RSAs, RSUs, and stock appreciation rights, to provide incentives to officers, employees and non-employee directors.
On February 25, 2016, the board of directors of the Company approved the 2016 Management Incentive Plan (“2016 MIP”), and the 2016 MIP was approved by the Company’s shareholders at the 2016 Annual Meeting of Shareholders on May 18, 2016. The 2016 MIP provides for the delivery of up to a number of shares equal to (i)
The 2016 MIP provides for awards of stock options, RSAs, RSUs, performance-based restricted stock units (“PSUs”), stock appreciation rights, cash-denominated awards and any combination of the foregoing. A RSU is a notional account representing the right to receive a share of the Company’s Common Stock (or, at the Company’s option, cash in lieu thereof) at some future date. In general, stock options vest ratably on each anniversary over the
On February 27, 2014 the board of directors of the Company approved the 2014 Employee Stock Purchase Plan (“2014 ESPP”), and the 2014 ESPP was approved by the Company’s shareholders at the 2014 Annual Meeting of Shareholders on May 21, 2014. The 2014 ESPP provides for up to
F-31
Stock Options
Summarized information related to the Company’s stock options for the years ended December 31, 2018, 2019 and 2020 is as follows:
2018 | 2019 |
| |||||||||
Weighted | Weighted |
| |||||||||
Average | Average |
| |||||||||
Exercise | Exercise |
| |||||||||
| Options |
| Price |
| Options |
| Price |
| |||
Outstanding, beginning of period |
| |
| $ | |
| |
| $ | | |
Granted |
| |
| |
| |
| | |||
Forfeited |
| ( |
| |
| ( |
| | |||
Exercised |
| ( |
| |
| ( |
| | |||
Outstanding, end of period |
| | |
| | | |||||
2020 |
| ||||||||||
Weighted |
| ||||||||||
Average |
| ||||||||||
Weighted | Remaining | Aggregate | |||||||||
Average | Contractual | Intrinsic | |||||||||
Exercise | Term | Value |
| ||||||||
| Options |
| Price |
| (in years) |
| (in thousands) |
| |||
Outstanding, beginning of period |
| | $ | |
|
|
|
| |||
Granted |
| | | ||||||||
Forfeited |
| ( | | ||||||||
Exercised |
| ( |
| | |||||||
Outstanding, end of period |
| | $ | |
| $ | | ||||
Vested and expected to vest at end of period |
| | $ | |
| $ | | ||||
Exercisable, end of period |
| | $ | |
| $ | | ||||
The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (based upon the difference between the Company’s closing stock price on the last trading day of 2020 of $
The total pre-tax intrinsic value of options exercised during the years ended December 31, 2018, 2019 and 2020 was $
The weighted average grant date fair value per share of substantially all stock options granted during the years ended December 31, 2018, 2019 and 2020 was $
| 2018 |
| 2019 |
| 2020 |
| |
Risk-free interest rate |
| | % | | % | | % |
Expected life |
| years | years | years | |||
Expected volatility |
| | % | | % | | % |
Expected dividend yield |
| | % | | % | | % |
For the years ended December 31, 2018, 2019 and 2020, expected volatility was based on the historical volatility of the Company’s stock price.
As of December 31, 2020, there was $
F-32
In the year ended December 31, 2018, the tax benefit from excess tax deductions included in continuing operations was $
Restricted Stock Awards
Summarized information related to the Company’s nonvested RSAs for the years ended December 31, 2018, 2019 and 2020 is as follows:
2018 | 2019 | 2020 |
| |||||||||||||
Weighted | Weighted | Weighted |
| |||||||||||||
Average | Average | Average |
| |||||||||||||
Grant Date | Grant Date | Grant Date |
| |||||||||||||
| Shares |
| Fair Value |
| Shares |
| Fair Value |
| Shares |
| Fair Value |
| ||||
Outstanding, beginning of period |
| |
| $ | |
| |
| $ | |
| | $ | | ||
Awarded |
| |
| |
| |
| |
| |
| | ||||
Vested |
| ( |
| |
| ( |
| |
| ( |
| | ||||
Forfeited |
| — |
| — |
| — |
| — |
| — |
| — | ||||
Outstanding, ending of period |
| | |
| | |
| | | |||||||
As of December 31, 2020, there was $
Restricted Stock Units
Summarized information related to the Company’s nonvested RSUs for the years ended December 31, 2018, 2019 and 2020 is as follows:
2018 | 2019 | 2020 |
| |||||||||||||
Weighted | Weighted | Weighted |
| |||||||||||||
Average | Average | Average |
| |||||||||||||
Grant Date | Grant Date | Grant Date |
| |||||||||||||
| Shares |
| Fair Value |
| Shares |
| Fair Value |
| Shares |
| Fair Value |
| ||||
Outstanding, beginning of period |
| |
| $ | |
| |
| $ | |
| | $ | | ||
Awarded |
| |
| |
| |
| |
| |
| | ||||
Vested |
| ( |
| |
| ( |
| |
| ( |
| | ||||
Forfeited |
| ( |
| |
| ( |
| |
| ( |
| | ||||
Outstanding, ending of period | | |
| | |
| | | ||||||||
As of December 31, 2020, there was $
F-33
Performance-Based Restricted Stock Units
Summarized information related to the Company’s nonvested PSUs for the years ended December 31, 2018, 2019 and 2020 is as follows:
|
| 2018 |
|
| 2019 |
|
| 2020 |
| ||||||||||
Weighted | Weighted | Weighted | |||||||||||||||||
| Average |
| Average |
| Average |
| |||||||||||||
| Grant Date |
| Grant Date |
| Grant Date |
| |||||||||||||
| Shares | Fair Value |
| Shares | Fair Value |
| Shares | Fair Value |
| ||||||||||
Outstanding, beginning of period |
| | $ |
| | $ |
| | $ | ||||||||||
Awarded |
| |
|
| |
|
| |
| ||||||||||
Vested |
| ( |
| |
| ( |
|
| ( |
| |||||||||
Forfeited |
| ( |
|
| ( |
|
| ( |
| ||||||||||
Outstanding, end of period |
| |
|
| |
|
| |
| ||||||||||
The PSUs will entitle the grantee to receive a number of shares of the Company’s Common Stock determined over a
The weighted average estimated fair value of the PSUs granted in the year ended December 31, 2018 was $
The weighted average estimated fair value of the PSUs granted in the year ended December 31, 2019 was $
The weighted average estimated fair value of the PSUs granted in the year ended December 31, 2020 was $
As of December 31, 2020, there was $
F-34
Net Income per Common Share Attributable to Magellan
The following table reconciles income (numerator) and shares (denominator) used in the Company’s computations of net income per share for the years ended December 31, 2018, 2019 and 2020 (in thousands, except per share data):
| 2018 |
| 2019 |
| 2020 | |||||
Numerator: | ||||||||||
Net income from continuing operations | $ | | $ | | $ | | ||||
Income from discontinued operations, net of tax | | | | |||||||
Net income | $ | | $ | | $ | | ||||
Denominator: | ||||||||||
Weighted average number of common shares outstanding—basic |
| |
| |
| | ||||
Common stock equivalents—stock options |
| |
| |
| | ||||
Common stock equivalents—RSAs |
| |
| |
| | ||||
Common stock equivalents—RSUs |
| |
| |
| | ||||
Common stock equivalents—PSUs | | | | |||||||
Common stock equivalents—employee stock purchase plan |
| |
| |
| | ||||
Weighted average number of common shares outstanding—diluted |
| |
| |
| | ||||
Net income per common share—basic: | ||||||||||
Continuing operations | $ | | $ | | $ | | ||||
Discontinued operations | | | | |||||||
Consolidated operations | $ | | $ | | $ | | ||||
Net income per common share—diluted: | ||||||||||
Continuing operations | $ | | $ | | $ | | ||||
Discontinued operations | | | | |||||||
Consolidated operations | $ | | $ | | $ | | ||||
The weighted average number of common shares outstanding for the years ended December 31, 2018, 2019 and 2020 was calculated using outstanding shares of the Company’s common stock. Common stock equivalents included in the calculation of diluted weighted average common shares outstanding for the years ended December 31, 2018, 2019 and 2020 represent stock options to purchase shares of the Company’s common stock, restricted stock awards, restricted stock units and stock purchased under the 2014 ESPP.
For the years ended December 31, 2018, 2019 and 2020, the Company had additional potential dilutive securities outstanding representing
Stock Repurchases
The Company’s board of directors has previously authorized a series of stock repurchase plans. Stock repurchases for each such plan could be executed through open market repurchases, privately negotiated transactions, accelerated share repurchases or other means. The board of directors authorized management to execute stock repurchase transactions from time to time and in such amounts and via such methods as management deemed appropriate. Each stock repurchase program could be limited or terminated at any time without prior notice. Pursuant to the terms of the Merger Agreement the Company suspended its stock repurchase programs on January 4, 2021, the date we announced our planned merger with Centene.
The Company’s board of directors approved, and subsequently amended, a stock repurchase plan which authorizes the Company to purchase up to $
F-35
under the programs may be carried out from time to time in open market transactions (including blocks) or in privately negotiated transactions. The timing of repurchases and the actual amount purchased will depend on a variety of factors including the market price of the Company’s shares, general market and economic conditions, and other corporate considerations. Repurchases may be made pursuant to plans intended to comply with Rule 10b5-1 under the Securities Exchange Act of 1934, which could allow the Company to purchase its shares during periods when it otherwise might be prevented from doing so under insider trading laws or because of self-imposed trading blackout periods. Repurchases are expected to be funded from working capital and anticipated cash from operations. The repurchase authorization does not require the purchase of a specific number of shares and is subject to suspension or termination by the Company’s board of directors at any time.
Pursuant to this program, the Company made purchases as follows (aggregate cost excludes broker commissions and is reflected in millions):
Total Number | Average | ||||||||
of Shares | Price Paid | Aggregate | |||||||
Period |
| Purchased |
| per Share |
| Cost |
| ||
October 26, 2015 - December 31, 2015 | | $ | | $ | | ||||
January 1, 2016 - December 31, 2016 | | | | ||||||
January 1, 2017 - December 31, 2017 | | | | ||||||
January 1, 2018 - December 31, 2018 | | | | ||||||
January 1, 2019 - December 31, 2019 | | | | ||||||
January 1, 2020 - December 31, 2020 | — | — | — | ||||||
| $ | | |||||||
The Company made no share repurchases from January 1, 2021 through February 19, 2021.
7. Income Taxes
Income Tax Expense
The components of income tax expense (benefit) in continuing operations for the following years ended December 31 were as follows (in thousands):
| 2018 |
| 2019 |
| 2020 |
| ||||
Income taxes currently payable: | ||||||||||
Federal | $ | | $ | | $ | ( | ||||
State |
| |
| |
| ( | ||||
| |
| |
| ( | |||||
Deferred income taxes (benefits): | ||||||||||
Federal |
| ( |
| |
| ( | ||||
State |
| |
| |
| ( | ||||
| ( |
| |
| ( | |||||
Total income tax expense (benefit) | $ | | $ | | $ | ( | ||||
F-36
Total income tax expense in continuing operations for the years ended December 31 was different from the amount computed using the statutory federal income tax rate in effect for each respective year for the following reasons (in thousands):
| 2018 |
| 2019 |
| 2020 |
| ||||
Income tax expense (benefit) at federal statutory rate | $ | | $ | | $ | ( | ||||
State income taxes (benefit), net of federal income tax benefit |
| |
| |
| ( | ||||
State contingencies added | | | | |||||||
Tax contingencies reversed due to statute closings |
| ( |
| ( |
| ( | ||||
Change in valuation allowances | ( | | ( | |||||||
Share-based compensation | ( | | | |||||||
Qualified research credit | ( | ( | ( | |||||||
Non-deductible executive compensation | | | | |||||||
Non-deductible HIF fees | | — | | |||||||
Sale of MCC Business | — | — | ( | |||||||
Other-net |
| |
| |
| | ||||
Total income tax expense | $ | | $ | | $ | ( | ||||
Deferred Income Taxes
The significant components of deferred tax assets and liabilities at December 31 were as follows (in thousands):
| 2019 |
| 2020 | ||||
Deferred tax assets: | |||||||
Net operating loss carryforwards | $ | | $ | | |||
Share-based compensation |
| |
| | |||
Other accrued compensation |
| |
| | |||
Claims reserves |
| |
| | |||
Deferred revenue | | | |||||
Accrued severance | | | |||||
Other non-deductible accrued liabilities |
| |
| | |||
Indirect tax benefits | | | |||||
Operating lease--right-of-use liabilities | | | |||||
Other deferred tax assets |
| |
| | |||
Total deferred tax assets |
| |
| | |||
Valuation allowances |
| ( |
| ( | |||
Deferred tax assets after valuation allowances |
| |
| | |||
Deferred tax liabilities: | |||||||
Depreciation |
| ( |
| ( | |||
Amortization of goodwill and intangible assets | ( | ( | |||||
Operating lease--right-of-use assets | ( | ( | |||||
Other deferred tax liabilities |
| ( |
| ( | |||
Total deferred tax liabilities |
| ( |
| ( | |||
Net deferred tax liabilities from continued operations | $ | ( | $ | ( | |||
As a result of the MCC Sale, $
The Company and its subsidiaries have $
F-37
Company’s ability to use any of these state and local NOLs before they expire.
The Company’s valuation allowances against deferred tax assets were $
Reversals of valuation allowances are recorded in the period they occur, typically as reductions to income tax expense. Determination of the amount of deferred tax assets considered realizable requires significant judgment and estimation regarding the forecasts of future taxable income which are consistent with the plans and estimates the Company uses to manage the underlying businesses. Although consideration is also given to potential tax planning strategies which might be available to improve the realization of deferred tax assets, none were identified which were both prudent and reasonable. The Company believes taxable income expected to be generated in the future will be sufficient to support realization of the Company’s deferred tax assets, as reduced by valuation allowances. This determination is based upon earnings history and future earnings expectations.
Other than deferred tax benefits attributable to operating loss carryforwards, there are no time constraints within which the Company’s deferred tax assets must be realized. Future changes in the estimated realizability of deferred tax assets could materially affect the Company’s financial condition and results of operations.
Uncertain Tax Positions
A reconciliation of the beginning and ending amount of gross unrecognized tax benefits is as follows (in thousands):
| 2018 |
| 2019 |
| 2020 |
| ||||
Balance as of beginning of period | $ | | $ | | $ | | ||||
Additions for current year tax positions |
| |
| |
| | ||||
Additions for tax positions of prior years |
| |
| |
| | ||||
Reductions for tax positions of prior years |
| ( |
| ( |
| ( | ||||
Reductions due to lapses of applicable statutes of limitations |
| ( |
| ( |
| ( | ||||
Changes due to Tax Act | | — | — | |||||||
Reductions due to settlements with taxing authorities |
| ( |
| ( |
| — | ||||
Balance as of end of period | $ | | $ | | $ | | ||||
If these unrecognized tax benefits had been realized as of December 31, 2019 and 2020, $
The Company continually performs a comprehensive review of its tax positions and accrues amounts for tax contingencies related to uncertain tax positions. Based upon these reviews, the status of ongoing tax audits and the expiration of applicable statutes of limitations, accruals are adjusted as necessary. The tax benefit from an uncertain tax position is recognized when it is more likely than not that, based on the technical merits, the position will be sustained upon examination, including resolution of any related appeals or litigation processes.
The Company also adjusts these liabilities for unrecognized tax benefits when its judgment changes as a result of the evaluation of new information not previously available. However, the ultimate resolution of a disputed tax position following an examination by a taxing authority could result in a payment that is materially different from that accrued by the Company. These differences are typically reflected as increases or decreases to income tax expense in the period in which they are determined.
The statutes of limitations regarding the assessment of federal and most state and local income taxes for 2016 expired during 2020. As a result, $
F-38
The statutes of limitations regarding the assessment of federal and most state and local income taxes for 2015 expired during 2019. As a result, $
The statutes of limitations regarding the assessment of federal and most state and local income taxes for 2014 expired during 2018. As a result, $
With few exceptions, the Company is no longer subject to income tax assessments by tax authorities for years ended prior to 2017. Further, it is reasonably possible the statutes of limitations regarding the assessment of federal and most state and local income taxes for 2017 could expire during 2021. Up to $
8. Supplemental Cash Flow Information
Supplemental cash flow information for the years ended December 31, 2018, 2019 and 2020 is as follows (in thousands):
| 2018 |
| 2019 |
| 2020 |
| ||||
Income taxes paid, net of refunds | $ | | $ | | $ | | ||||
Interest paid | $ | | $ | | $ | | ||||
Assets acquired through finance leases and deferred financing | $ | | $ | | $ | | ||||
9. Discontinued Operations
Magellan Complete Care – Stock and Asset Purchase Agreement
As discussed in Note 1— “General”, on December 31, 2020, the Company completed the sale of its MCC Business to Molina, pursuant to a Stock and Asset Purchase Agreement, dated as of April 30, 2020, by and between the Company and Molina, for cash in the amount of $
In connection with the MCC Sale, the Company and Molina are entering into commercial agreements for certain behavioral health, utilization management and related services to be provided by the Company to Molina and the MCC business. In addition, the parties will enter into a transition services agreement pursuant to which the Company and certain of its affiliates will provide, or cause third parties to provide, certain services to accommodate the transition of the MCC business to Molina.
The foregoing description of the Purchase Agreement and the MCC Sale does not purport to be complete and is qualified in its entirety by the terms and conditions of the Purchase Agreement, which was filed as Exhibit 2.1 to the Company’s Quarterly Report on Form 10-Q which was filed with the SEC on May 11, 2020, and any related agreements.
F-39
The accounting requirements for reporting a business to be divested as a discontinued operation were met during the second quarter of 2020. Accordingly, the accompanying consolidated financial statements for all periods presented reflect the MCC business as a discontinued operation.
The following table summarizes the major classes of assets and liabilities held for sale that were included in the Company’s consolidated balance sheets as of December 31, 2019 (in thousands):
December 31, | ||||
2019 |
| |||
Assets Held For Sale | ||||
Cash and cash equivalents ($ | $ | | ||
Accounts receivable, net |
| | ||
Short-term and long-term investments ($ |
| | ||
Property and equipment, net |
| | ||
Goodwill |
| | ||
Other intangible assets, net |
| | ||
Other current and long-term assets ($ | | |||
Total Assets Held For Sale | | |||
Less: current portion | | |||
Total Assets Held For Sale, Less Current Portion | $ | | ||
Liabilities Held For Sale | ||||
Accounts payable | $ | | ||
Accrued liabilities |
| | ||
Medical claims payable |
| | ||
Other medical liabilities |
| | ||
Deferred income taxes | | |||
Tax contingencies |
| | ||
Deferred credits and other long-term liabilities |
| | ||
Total Liabilities Held For Sale |
| | ||
Less: current portion |
| | ||
Total Liabilities Held For Sale, Less Current Portion | $ | | ||
F-40
The following table summarizes the components of income from discontinued operations that is included in the Company’s consolidated income statements for the years ended December 31, 2018, 2019 and 2020 (in thousands):
| Year Ended | |||||||||
December 31, | ||||||||||
| 2018 |
| 2019 |
| 2020 | |||||
Managed care and other revenue | $ | | $ | | $ | | ||||
Costs and expenses: | ||||||||||
Cost of care |
| |
| |
| | ||||
Direct service costs and other operating expenses (1)(2)(3) |
| |
| |
| | ||||
Depreciation and amortization |
| |
| |
| | ||||
Interest expense |
| |
| |
| | ||||
Interest and other income |
| ( |
| ( |
| ( | ||||
Gain on sale | — | — | ( | |||||||
Total costs and expenses |
| |
| |
| | ||||
Income from discontinued operation before income taxes |
| |
| |
| | ||||
Provision for income taxes |
| |
| |
| | ||||
Net income from discontinued operations | $ | | $ | | $ | | ||||
| (1) | Includes stock compensation expense of $ |
| (2) | Includes changes in fair value of contingent consideration of $ |
| (3) | Includes divestiture related expenses of $ |
The Company has retained corporate overhead expenses previously allocated to MCC of $
10. Special Charges
In 2020, the Company established a transformation office which has an initiative (the “Transformation Initiative”) to lower our operating costs and reinvest in our business by improving and automating processes, leveraging technology, consolidating platforms and reducing any friction our customers, providers and members experience when doing business with us. As part of the Transformation Initiative, the Company is in the process of restructuring certain operating activities which has resulted in the Company recording severance of $
In addition, the Company reevaluated its current office lease footprint. Recoverability of existing operating right-of-use lease assets, and the related fixed assets held at the office locations, to be held and used are measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds the fair value of the asset. Any lease terminations or abandonments initiated as a result of the Transformation Initiative that result in an impairment of such right-of-use assets and the location’s related fixtures will be reported as special charges. For the year ended December 31, 2020, lease terminations and abandonments resulted in the recognition of non-cash pre-tax impairment of $
F-41
The following table summarizes the components of special charges that are included in the Company’s consolidated income statements for the year ended December 31, 2020 (in thousands):
| Year Ended | ||
| December 31, 2020 | ||
Non-cash related special charges | |||
Right-of-use assets | $ | | |
Fixed assets | | ||
Total non-cash related special charges |
| | |
Cash related special charges | |||
Employee severance and termination benefits | | ||
Lease shutdown costs | | ||
Total cash related special charges | | ||
Total special charges | $ | | |
A roll-forward of the Transformation Initiative liabilities is as follows (in thousands):
Balance | Balance | |||||||||||
| December 31, |
|
|
| December 31, | |||||||
| 2019 |
| Additions |
| Payments |
| 2020 | |||||
Employee severance and termination benefits | $ | | $ | | $ | ( | $ | | ||||
Lease shutdown costs | | | ( | | ||||||||
| $ | |
| $ | | $ | ( | $ | | |||
11. Commitments and Contingencies
Insurance
The Company maintains a program of insurance coverage for a broad range of risks in its business. The Company has renewed its general, professional and managed care liability insurance policies with unaffiliated insurers for a period from June 17, 2020 to June 17, 2021. The general liability policy is written on an “occurrence” basis, subject to a $
The Company maintains a separate general and professional liability insurance policy with an unaffiliated insurer for its specialty pharmaceutical dispensing operations. The specialty pharmaceutical dispensing operations insurance policy has a term for the period June 17, 2020 to June 17, 2021. The general liability policy is written on an “occurrence” basis and the professional liability policy is written on a “claims-made” basis, subject to a $
The Company is responsible for claims within its self-insured retentions, and for 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.
Regulatory Issues
The managed healthcare industry is subject to numerous laws and regulations. The subjects of such laws and regulations cover, but are not limited to, matters such as licensure, accreditation, government healthcare program participation requirements, information privacy and security, reimbursement for patient services, and Medicare and Medicaid fraud and abuse. Over the past several years, government activity has increased with respect to investigations and/or allegations concerning possible violations of fraud and abuse and false claims statutes and/or regulations by
F-42
healthcare organizations and insurers. Entities that are found to have violated these laws and regulations may be excluded from participating in government healthcare programs, subjected to fines or penalties or required to repay amounts received from the government for previously billed patient services. Compliance with such laws and regulations can be subject to future government review and interpretation, as well as regulatory actions unknown or unasserted at this time.
In addition, regulators of certain of the Company’s subsidiaries may exercise certain discretionary rights under regulations including increasing their supervision of such entities, requiring additional restricted cash or other security or seizing or otherwise taking control of the assets and operations of such subsidiaries.
The Company is subject to certain federal laws and regulations in connection with its contracts with the federal government. These laws and regulations affect how the Company conducts business with its federal agency customers and may impose added costs on its business. The Company’s failure to comply with federal procurement laws and regulations could cause it to lose business, incur additional costs and subject it to a variety of civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, harm to reputation, suspension of payments, fines, and suspension or debarment from doing business with federal government agencies. The Company’s wholly owned subsidiary, Armed Forces Services Corporation (“AFSC”), conducts business with federal agency customers and federal contractors to such agencies. The Company investigated, with the assistance of outside counsel, matters relating to compliance by AFSC with Small Business Administration ( “SBA”) regulations and other federal laws applicable to government contractors and reported findings to the SBA and the Department of Defense, including facts indicating violations of SBA regulations and other federal laws, such as the Anti-Kickback Act, by former AFSC executives, none of which was disclosed to Magellan prior to its acquisition of AFSC. The Company voluntarily responded to government requests for further information regarding the Company’s investigation. As a result of the Company's disclosure and the ensuing government investigation, a former AFSC executive pleaded guilty in the United States District Court for the Eastern District of Virginia to one count of honest services fraud, and at sentencing in September 2020, the Court ordered the former AFSC executive to pay restitution to AFSC as the victim of that offense. In June 2020, the United States Attorney’s Office for the Eastern District of Virginia (“U.S. Attorney’s Office”) informed the Company of a civil investigation regarding the Company and AFSC related to potential violations of the False Claims Act and/or the Anti-Kickback Act also stemming from the matters self-disclosed by the Company. While the Company believes that it has responded appropriately by self-reporting findings regarding matters that incepted prior to its acquisition of AFSC in order to mitigate the risk of adverse consequences, should the Company or AFSC be held responsible for the reported conduct in a proceeding initiated by the U.S. Attorney’s Office, SBA, Department of Defense and/or other federal agencies, we may be required to pay damages and/or penalties and AFSC could be suspended or debarred from government contracting. Management believes that the resolution of such investigations will not have a material adverse effect on the Company’s financial condition or results of operations; however, there can be no assurance in this regard. AFSC generated approximately
Legal
The Company’s operating activities entail significant risks of liability. From time to time, the Company is subject to various actions and claims arising from the acts or omissions of its employees, network providers or other parties. In the normal course of business, the Company receives reports relating to deaths and other serious incidents involving patients whose care is being managed by the Company. Such incidents occasionally give rise to malpractice, professional negligence and other related actions and claims against the Company or its network providers. Many of these actions and claims received by the Company seek substantial damages and therefore require the Company to incur significant fees and costs related to their defense.
The Company is also subject to or party to certain class actions and other litigation and claims relating to its operations or business practices, including network provider reimbursement, employment practices and privacy and data protection. The Company has recorded reserves that, in the opinion of management, are adequate to cover litigation, claims or assessments that have been or may be asserted against the Company, and for which the outcome is probable and reasonably estimable. Management believes that the resolution of such litigation and claims will not have a material adverse effect on the Company’s financial condition or results of operations; however, there can be no assurance in this regard.
F-43
Leases
The Company leases certain office space, distribution centers, land and equipment. These leases expire at various dates through August 2029. See Note 2—“Summary of Significant Accounting Policies—Leases” for a discussion of the Company’s leases.
12. Business Segment Information
The accounting policies of the Company’s segments are the same as those described in Note 2—“Summary of Significant Accounting Policies.” The Company evaluates performance of its segments based on profit or loss from operations before stock compensation expense, depreciation and amortization, interest expense, interest and other income, changes in the fair value of contingent consideration recorded in relation to acquisitions, gain on sale of assets, special charges or benefits, and income taxes (“Segment Profit”). Management uses Segment Profit information for internal reporting and control purposes and considers it important in making decisions regarding the allocation of capital and other resources, risk assessment and employee compensation, among other matters. Healthcare subcontracts with Pharmacy Management to provide pharmacy benefits management services for certain of Healthcare’s customers. In addition, Pharmacy Management provides pharmacy benefits management for the Company’s employees covered under its medical plan. As such, revenue, cost of goods sold and direct service costs and other related to these arrangements are eliminated. The Company’s segments are defined in Note 1—“General.”
The following tables summarize, for the periods indicated, operating results by business segment for the years ended December 31, 2018, 2019 and 2020 (in thousands):
|
|
| Corporate |
|
| ||||||||
Pharmacy | and |
| |||||||||||
| Healthcare |
| Management |
| Elimination |
| Consolidated |
| |||||
Year Ended December 31, 2018 | |||||||||||||
Managed care and other revenue | $ | | $ | | $ | ( | $ | | |||||
PBM and dispensing revenue |
| — |
| |
| ( |
| | |||||
Cost of care |
| ( |
| — |
| — |
| ( | |||||
Cost of goods sold |
| — |
| ( |
| |
| ( | |||||
Direct service costs and other |
| ( |
| ( |
| ( |
| ( | |||||
Stock compensation expense (1) | | | | | |||||||||
Changes in fair value of contingent consideration (1) | | — | — | | |||||||||
Segment profit (loss) | $ | | $ | | $ | ( | $ | | |||||
Identifiable assets by business segment (2) | |||||||||||||
Restricted cash | $ | | $ | | $ | | $ | | |||||
Net accounts receivable |
| |
| |
| |
| | |||||
Investments |
| |
| |
| — |
| | |||||
Pharmaceutical inventory |
| — |
| |
| — |
| | |||||
Goodwill |
| |
| |
| — |
| | |||||
Other intangible assets, net |
| |
| |
| |
| | |||||
F-44
|
|
| Corporate |
|
| ||||||||
Pharmacy | and |
| |||||||||||
| Healthcare |
| Management |
| Elimination |
| Consolidated |
| |||||
Year Ended December 31, 2019 | |||||||||||||
Managed care and other revenue | $ | | $ | | $ | ( | $ | | |||||
PBM revenue |
| — |
| |
| ( |
| | |||||
Cost of care |
| ( |
| — |
| — |
| ( | |||||
Cost of goods sold |
| — |
| ( |
| |
| ( | |||||
Direct service costs and other |
| ( |
| ( |
| ( |
| ( | |||||
Stock compensation expense (1) |
| |
| |
| |
| | |||||
Segment Profit (Loss) | $ | | $ | | $ | ( | $ | | |||||
Identifiable assets by business segment (2) | |||||||||||||
Restricted cash | $ | | $ | | $ | — | $ | | |||||
Net accounts receivable |
| |
| |
| |
| | |||||
Investments |
| |
| |
| — |
| | |||||
Pharmaceutical inventory |
| — |
| |
| — |
| | |||||
Goodwill |
| |
| |
| — |
| | |||||
Other intangible assets, net |
| |
| |
| |
| | |||||
|
|
| Corporate |
|
| ||||||||
Pharmacy | and |
| |||||||||||
| Healthcare |
| Management |
| Elimination |
| Consolidated |
| |||||
Year Ended December 31, 2020 | |||||||||||||
Managed care and other revenue | $ | | $ | | $ | ( | $ | | |||||
PBM revenue |
| — |
| |
| ( |
| | |||||
Cost of care |
| ( |
| — |
| — |
| ( | |||||
Cost of goods sold |
| — |
| ( |
| |
| ( | |||||
Direct service costs and other |
| ( |
| ( |
| ( |
| ( | |||||
Stock compensation expense (1) |
| |
| |
| |
| | |||||
Segment Profit (Loss) | $ | | $ | | $ | ( | $ | | |||||
Identifiable assets by business segment (2) | |||||||||||||
Restricted cash | $ | | $ | | $ | | $ | | |||||
Net accounts receivable |
| |
| |
| |
| | |||||
Investments |
| |
| |
| — |
| | |||||
Pharmaceutical inventory |
| — |
| |
| — |
| | |||||
Goodwill |
| |
| |
| — |
| | |||||
Other intangible assets, net |
| |
| |
| — |
| | |||||
| (1) | Stock compensation expense, changes in the fair value of contingent consideration recorded in relation to the acquisitions and impairment of intangible assets are included in direct service costs and other operating expenses; however, these amounts are excluded from the computation of Segment Profit. |
| (2) | Identifiable assets by business segment are those assets that are used in the operations of each segment. The remainder of the Company’s assets cannot be specifically identified by segment. |
F-45
The following table reconciles consolidated income before income taxes to Segment Profit for the years ended December 31, 2018, 2019 and 2020 (in thousands):
2018 |
| 2019 |
| 2020 | |||||
Income (loss) from continuing operations before income taxes | $ | | $ | | $ | ( | |||
Stock compensation expense |
| |
| |
| | |||
Changes in fair value of contingent consideration | | — | — | ||||||
Depreciation and amortization |
| |
| |
| | |||
Interest expense |
| |
| |
| | |||
Interest and other income |
| ( |
| ( |
| ( | |||
Special charges | — | — | | ||||||
Segment Profit from continuing operations | $ | | $ | | $ | | |||
F-46
13. Selected Quarterly Financial Data (Unaudited)
The following is a summary of the unaudited quarterly results of operations for the years ended December 31, 2019 and 2020 (in thousands, except per share amounts):
For the Quarter Ended |
| ||||||||||||
March 31, | June 30, | September 30, | December 31, |
| |||||||||
| 2019 |
| 2019 |
| 2019 |
| 2019 |
| |||||
Year Ended December 31, 2019 |
|
|
|
|
|
|
|
| |||||
Net revenue: | |||||||||||||
Managed care and other | $ | | $ | | $ | | $ | | |||||
PBM and dispensing |
| |
| |
| |
| | |||||
Total net revenue |
| |
| |
| |
| | |||||
Costs and expenses: | |||||||||||||
Cost of care |
| |
| |
| |
| | |||||
Cost of goods sold |
| |
| |
| |
| | |||||
Direct service costs and other operating expenses (1) |
| |
| |
| |
| | |||||
Depreciation and amortization |
| |
| |
| |
| | |||||
Interest expense |
| |
| |
| |
| | |||||
Interest and other income |
| ( |
| ( |
| ( |
| ( | |||||
Special charges | — | — | — | — | |||||||||
Total costs and expenses |
| |
| |
| |
| | |||||
Income (loss) from continuing operations before income taxes |
| ( |
| |
| |
| | |||||
Provision (benefit) for income taxes |
| ( |
| |
| |
| | |||||
Net income (loss) from continuing operations | ( | | | | |||||||||
Income from discontinued operations, net of tax | | | | | |||||||||
Net Income | $ | | $ | | $ | | $ | | |||||
Weighted average number of common shares outstanding—basic |
| | | | | ||||||||
Weighted average number of common shares outstanding—diluted |
| | | | | ||||||||
Net income (loss) per common share—basic: | |||||||||||||
Continuing operations | $ | ( | $ | | $ | | $ | | |||||
Discontinued operations | | | | | |||||||||
Consolidated operations | $ | | $ | | $ | | $ | | |||||
Net income (loss) per common share—diluted: | |||||||||||||
Continuing operations | $ | ( | $ | | $ | | $ | | |||||
Discontinued operations | | | | | |||||||||
Consolidated operations | $ | | $ | | $ | | $ | | |||||
F-47
For the Quarter Ended |
| ||||||||||||
March 31, | June 30, | September 30, | December 31, |
| |||||||||
| 2020 |
| 2020 |
| 2020 |
| 2020 |
| |||||
Year Ended December 31, 2020 |
|
|
|
|
|
|
|
| |||||
Net revenue: | |||||||||||||
Managed care and other | $ | | $ | | $ | | $ | | |||||
PBM and dispensing |
| |
| |
| |
| | |||||
Total net revenue |
| |
| |
| |
| | |||||
Costs and expenses: | |||||||||||||
Cost of care |
| |
| |
| |
| | |||||
Cost of goods sold |
| |
| |
| |
| | |||||
Direct service costs and other operating expenses (2) |
| |
| |
| |
| | |||||
Depreciation and amortization |
| |
| |
| |
| | |||||
Interest expense |
| |
| |
| |
| | |||||
Interest and other income |
| ( |
| ( |
| ( |
| ( | |||||
Special charges | — | | | | |||||||||
Total costs and expenses |
| |
| |
| |
| | |||||
Income (loss) from continuing operations before income taxes |
| |
| |
| ( |
| ( | |||||
Provision (benefit) for income taxes |
| |
| ( |
| ( |
| ( | |||||
Net income (loss) from continuing operations | ( | | ( | ( | |||||||||
Income from discontinued operations, net of tax | | | | | |||||||||
Net Income | $ | | $ | | $ | | $ | | |||||
. | |||||||||||||
Weighted average number of common shares outstanding—basic |
| | | | | ||||||||
Weighted average number of common shares outstanding—diluted |
| | | | | ||||||||
Net income (loss) per common share—basic: | |||||||||||||
Continuing operations | $ | ( | $ | | $ | ( | $ | ( | |||||
Discontinued operations | | | | | |||||||||
Consolidated operations | $ | | $ | | $ | | $ | | |||||
Net income (loss) per common share—diluted: | |||||||||||||
Continuing operations | $ | ( | $ | | $ | ( | $ | ( | |||||
Discontinued operations | | | | | |||||||||
Consolidated operations | $ | | $ | | $ | | $ | | |||||
| (1) | Includes stock compensation expense of $ |
| (2) | Includes stock compensation expense of $ |
14. Subsequent Events
On January 4, 2021, the Company and Centene Corporation (“Centene”) entered into an Agreement of Plan of Merger (the “Merger Agreement”) by and among the Company, Centene, and Mayflower Merger Sub, Inc., a Delaware corporation and a wholly owned subsidiary of Centene (“Merger Sub”), pursuant to which, subject to the terms and conditions set forth therein, Merger Sub will merge with and into the Company, with the Company surviving such merger as a wholly-owned subsidiary of Centene.
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