Edgar Filing: MAGELLAN HEALTH SERVICES INC

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q


(Mark One)
ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2008
Or
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to

Commission File No. 1-6639

MAGELLAN HEALTH SERVICES, INC.
(Exact name of registrant as specified in its charter)


Delaware (State or other jurisdiction of incorporation or organization)		58-1076937 (IRS Employer Identification No.)
55 Nod Road, Avon, Connecticut (Address of principal executive offices)		06001 (Zip code)
(860) 507-1900 (Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one):


Large accelerated filer ý		Accelerated filer o		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company o

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

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ý No o

The number of shares of the registrant's Ordinary Common Stock outstanding as of June 30, 2008 was 40,630,451.

FORM 10-Q

MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES

INDEX



PART I—Financial Information:
Item 1:	Financial Statements	3
	Condensed Consolidated Balance Sheets—December 31, 2007 and June 30, 2008	3
	Condensed Consolidated Statements of Income—For the Three Months and Six Months Ended June 30, 2007 and 2008	4
	Condensed Consolidated Statements of Cash Flows—For the Six Months Ended June 30, 2007 and 2008	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2:	Management's Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3:	Quantitative and Qualitative Disclosures About Market Risk	37
Item 4:	Controls and Procedures	37
PART II—Other Information:
Item 1:	Legal Proceedings	38
Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds	38
Item 3:	Defaults Upon Senior Securities	38
Item 4:	Submission of Matters to a Vote of Security Holders	38
Item 5:	Other Information	39
Item 6:	Exhibits	39
Signatures		40

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)

			December 31, 2007		June 30, 2008

					(unaudited)
ASSETS
Current Assets:
Cash and cash equivalents			$	312,372	$	266,253
Restricted cash				252,763		215,264
Accounts receivable, less allowance for doubtful accounts of $1,317 and $1,642 at December 31, 2007 and June 30, 2008, respectively				66,356		82,574
Short-term investments (restricted investments of $12,962 and $71,516 at December 31, 2007 and June 30, 2008, respectively)				54,145		184,939
Deferred income taxes				75,273		75,273
Other current assets (restricted deposits of $19,388 and $19,264 at December 31, 2007 and June 30, 2008, respectively)				42,183		41,970

	Total Current Assets			803,092		866,273
Property and equipment, net				105,735		97,705
Long-term investments—restricted				2,430		21,263
Deferred income taxes				90,618		75,000
Other long-term assets				6,197		5,048
Goodwill				367,872		367,826
Other intangible assets, net				59,179		54,897

	Total Assets		$	1,435,123	$	1,488,012

LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable			$	25,952	$	21,412
Accrued liabilities				79,699		83,826
Medical claims payable				162,666		164,363
Other medical liabilities				93,573		87,665
Current maturities of long-term debt and capital lease obligations				13,969		1,321

	Total Current Liabilities			375,859		358,587
Long-term debt and capital lease obligations				—		39
Deferred credits and other long-term liabilities				150,433		156,863
Minority interest				599		698

		Total Liabilities		526,891		516,187

Preferred stock, par value $.01 per share
Authorized—10,000 shares—Issued and outstanding—none				—		—
Ordinary common stock, par value $.01 per share
Authorized—100,000 shares at December 31, 2007 and June 30, 2008—Issued and outstanding—40,157 shares and 40,630 shares at December 31, 2007 and June 30, 2008, respectively				402		406
Multi-Vote common stock, par value $.01 per share
Authorized—40,000 shares—Issued and outstanding—none				—		—
Other Stockholders' Equity:
	Additional paid-in capital			539,374		564,107
	Retained earnings			363,047		402,179
	Warrants outstanding			5,384		5,384
	Accumulated other comprehensive income (loss)			25		(251	)

	Total Stockholders' Equity			908,232		971,825

		Total Liabilities and Stockholders' Equity	$	1,435,123	$	1,488,012

See accompanying notes to condensed consolidated financial statements.

MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(In thousands, except per share amounts)

		Three Months Ended June 30,						Six Months Ended June 30,

		2007			2008			2007			2008
Net revenue		$	452,868		$	656,858		$	939,872		$	1,307,148

Cost and expenses:
	Cost of care		279,218			458,090			588,037			912,164
	Cost of goods sold		36,594			43,413			70,711			90,237
	Direct service costs and other operating expenses(1)		98,139			106,483			196,014			216,231
	Depreciation and amortization		13,505			14,523			27,157			28,897
	Interest expense		1,604			1,017			3,456			2,232
	Interest income		(5,519	)		(3,716	)		(10,706	)		(9,209	)

			423,541			619,810			874,669			1,240,552

Income from continuing operations before income taxes and minority interest			29,327			37,048			65,203			66,596
Provision for income taxes			12,311			15,101			27,218			27,404

Income from continuing operations before
	minority interest		17,016			21,947			37,985			39,192
Minority interest, net			192			59			192			60

Net income			16,824			21,888			37,793			39,132
Other comprehensive loss			(13	)		(262	)		(8	)		(276	)

Comprehensive income		$	16,811		$	21,626		$	37,785		$	38,856

Weighted average number of common shares outstanding—basic (See Note B)			38,842			39,961			38,538			39,848

Weighted average number of common shares outstanding—diluted (See Note B)			39,838			40,307			39,553			40,323

Net income per common share—basic:		$	0.43		$	0.55		$	0.98		$	0.98

Net income per common share—diluted:		$	0.42		$	0.54		$	0.96		$	0.97

(1): Includes stock compensation expense of $7,703 and $6,499 for the three months ended June 30, 2007 and 2008, respectively, and $14,490 and $18,517 for the six months ended June 30, 2007 and 2008, respectively.
See accompanying notes to condensed consolidated financial statements.

MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30,

(Unaudited)

(In thousands)

	2007			2008

Cash flows from operating activities:
Net income	$	37,793		$	39,132
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		27,157			28,897
Non-cash interest expense		694			1,355
Non-cash stock compensation expense		14,490			18,517
Non-cash income tax expense		25,895			19,367
Cash flows from changes in assets and liabilities, net of effects from acquisitions of businesses:
Restricted cash		(22,203	)		37,500
Accounts receivable, net		3,233			(16,218	)
Other assets		(3,206	)		390
Accounts payable and accrued liabilities		(11,210	)		11
Medical claims payable and other medical liabilities		17,404			(4,212	)
Other		89			103

Net cash provided by operating activities		90,136			124,842

Cash flows from investing activities:
Capital expenditures		(12,675	)		(16,687	)
Acquisitions and investments in businesses, net of cash acquired		(5,277	)		(425	)
Purchase of investments		(45,665	)		(203,745	)
Maturity of investments		50,347			54,172

Net cash used in investing activities		(13,270	)		(166,685	)

Cash flows from financing activities:
Payments on long-term debt and capital lease obligations		(14,074	)		(12,668	)
Proceeds from exercise of stock options and warrants		23,762			5,603
Other		(333	)		2,789

Net cash provided by (used in) financing activities		9,355			(4,276	)

Net increase (decrease) in cash and cash equivalents		86,221			(46,119	)
Cash and cash equivalents at beginning of period		163,737			312,372

Cash and cash equivalents at end of period	$	249,958		$	266,253

See accompanying notes to condensed consolidated financial statements.

MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2008

(Unaudited)

NOTE A—General

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of Magellan Health Services, Inc., a Delaware corporation ("Magellan"), include the accounts of Magellan, its majority owned subsidiaries, and all variable interest entities ("VIEs") for which Magellan is the primary beneficiary (together with Magellan, the "Company"). The financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the Securities and Exchange Commission's (the "SEC") instructions to Form 10-Q. Accordingly, the financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring adjustments considered necessary for a fair presentation, have been included. The results of operations for the six months ended June 30, 2008 are not necessarily indicative of the results to be expected for the full year. All significant intercompany accounts and transactions have been eliminated in consolidation.

These unaudited condensed consolidated financial statements should be read in conjunction with the Company's audited consolidated financial statements for the year ended December 31, 2007 and the notes thereto, which are included in the Company's Annual Report on Form 10-K filed with the SEC on February 29, 2008.

Business Overview

The Company is engaged in the specialty managed healthcare business. Through 2005, the Company predominantly operated in the managed behavioral healthcare business. During 2006, the Company expanded into radiology benefits management and specialty pharmaceutical management as a result of certain acquisitions. The Company provides services to health plans, insurance companies, corporations, labor unions and various governmental agencies. The Company's business is divided into the following five segments, based on the services it provides and/or the customers that it serves, as described below.

Two of the Company's segments are in the managed behavioral healthcare business. This line of business generally reflects the Company's coordination and management of the delivery of behavioral healthcare treatment services that are provided through its contracted network of third-party treatment providers, which includes psychiatrists, psychologists, other behavioral health professionals, psychiatric hospitals, general medical facilities with psychiatric beds, residential treatment centers and other treatment facilities. The treatment services provided through the Company's provider network include outpatient programs (such as counseling or therapy), intermediate care programs (such as intensive outpatient programs and partial hospitalization services), inpatient treatment and crisis intervention services. The Company generally does not directly provide, or own any provider of, treatment services except as relates to the Company's contract to provide managed behavioral healthcare services to Medicaid recipients and other beneficiaries of the Maricopa County Regional Behavioral Health Authority (the "Maricopa Contract"). Under the Maricopa Contract, the Company was required to assume the operations of twenty-four behavioral health direct care facilities for a transitional period and to divest itself of these facilities over a two year period.

MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

June 30, 2008

(Unaudited)

NOTE A—General (Continued)

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

The managed behavioral healthcare business is managed based on the services provided and/or the customers served, through the following two segments:

Commercial. The Managed Behavioral Healthcare Commercial segment ("Commercial") generally reflects managed behavioral healthcare services and EAP services provided under contracts with managed care companies, health insurers and other health plans for some or all of their commercial, Medicaid and Medicare members, as well as with employers, including corporations and governmental agencies, and labor unions. Commercial's managed behavioral healthcare contracts encompass either risk-based or ASO arrangements or both. This segment contains the operating segments previously defined as the Managed Behavioral Healthcare Health Plan Segment ("Health Plan") and the Managed Behavioral Healthcare Employer segment ("Employer"). Prior period balances have been reclassified to reflect this change. The Company now considers Commercial as one segment and it is managed as such.

Specialty Pharmaceutical Management. The Company's Specialty Pharmaceutical Management segment generally reflects the management of specialty drugs used in the treatment of cancer, multiple sclerosis, hemophilia, infertility, rheumatoid arthritis, chronic forms of hepatitis and other diseases. Specialty pharmaceutical drugs represent high-cost injectible, infused, oral, or inhaled drugs which traditional retail pharmacies typically do not supply due to their high cost, sensitive handling, and

MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

June 30, 2008

(Unaudited)

NOTE A—General (Continued)

storage needs. The Company's specialty pharmaceutical management services are provided under contracts with managed care companies, health insurers and other health plans for some or all of their commercial, Medicare and Medicaid members. The Company's specialty pharmaceutical services include (i) distributing specialty pharmaceutical drugs on behalf of health plans, (ii) administering on behalf of health plans rebate agreements between health plans and pharmaceutical manufacturers, and (iii) providing consulting services to health plans and pharmaceutical manufacturers.

Corporate and Other. This segment of the Company is comprised primarily of operational support functions such as sales and marketing and information technology, as well as corporate support functions such as executive, finance, human resources and legal.

Summary of Significant Accounting Policies

Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 157 ("SFAS 157"), which provides guidance for using fair value to measure assets and liabilities. It also responds to investors' requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value and the effect of fair value measurements on earnings. SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value, and does not expand the use of fair value in any new circumstances. SFAS 157 is effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued FASB Staff Position No. 157-2, Effective Date of FASB Statement No. 157 ("FSP 157-2"), which delays the effective date of SFAS 157 by one year for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). On January 1, 2008, the Company adopted SFAS 157 for financial assets and liabilities. The adoption did not have a material impact on the consolidated financial statements. The Company has not yet determined the impact on its consolidated financial statements, if any, from the adoption of SFAS 157, as it pertains to non-financial assets and non-financial liabilities.

In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115" ("SFAS 159"). SFAS 159 permits entities to elect to measure financial instruments and certain other items at fair value. The objective is to improve financial reporting by allowing entities to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS 159 is effective as of the beginning of an entity's first fiscal year that begins after November 15, 2007. SFAS 159 was effective for the Company on January 1, 2008. The Company did not elect the fair value option for any of the Company's existing financial instruments on January 1, 2008 and has not determined whether or not the Company will elect this option for any eligible financial instruments the Company acquires in the future.

MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

June 30, 2008

(Unaudited)

NOTE A—General (Continued)

liabilities assumed at their respective acquisition-date fair values and changes other practices under SFAS 141, some of which could have a material impact on how the Company accounts for business combinations. SFAS 141(R) also requires additional disclosure of information surrounding a business combination, such that users of the entity's financial statements can fully understand the nature and financial impact of the business combination. SFAS 160 requires entities to report non-controlling (minority) interests in subsidiaries as equity in the consolidated financial statements. The Company is required to adopt SFAS 141(R) and SFAS 160 simultaneously in the Company's year beginning January 1, 2009. The Company is currently evaluating the effects, if any, that SFAS 141(R) and SFAS 160 may have on the Company's consolidated financial position and results of operations.

Use of Estimates

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

Managed Care Revenue

Managed care revenue, inclusive of revenue from the Company's risk, EAP and ASO contracts, is recognized over the applicable coverage period on a per member basis for covered members. The Company is paid a per member fee for all enrolled members, and this fee is recorded as revenue in the month in which members are entitled to service. The Company adjusts its revenue for retroactive membership terminations, additions and other changes, when such adjustments are identified, with the exception of retroactivity that can be reasonably estimated. Any fees paid prior to the month of service are recorded as deferred revenue. Managed care revenues approximated $409.3 million and $854.2 million for the three and six months ended June 30, 2007, respectively, and $602.4 million and $1,195.8 million for the three and six months ended June 30, 2008, respectively.

Cost-Plus Contracts

The Company has certain cost-plus contracts with customers in which the Company recognizes revenue as costs are incurred and as services are performed. Revenues from cost-plus contracts approximated $7.3 million and $15.0 million for the three and six months ended June 30, 2007, respectively, and $8.3 million and $15.5 million for the three and six months ended June 30, 2008, respectively.

MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

June 30, 2008

(Unaudited)

NOTE A—General (Continued)

Block Grant Revenues

The Maricopa Contract is partially funded by federal, state and county block grant money, which represents annual appropriations. The Company recognizes revenue from block grant activity ratably over the period to which the block grant funding applies. Block grant revenues were approximately $30.6 million and $61.2 million for the three and six months ended June 30, 2008, respectively.

Distribution Revenue

The Company recognizes distribution revenue, which includes the co-payments received from members of the health plans the Company serves, when the specialty pharmaceutical drugs are shipped. At the time of shipment, the earnings process is complete: the obligation of the Company's customer to pay for the specialty pharmaceutical drugs is fixed, and, due to the nature of the product, the member may not return the specialty pharmaceutical drugs nor receive a refund. Revenues from the distribution of specialty pharmaceutical drugs on behalf of health plans were $38.7 million and $76.6 million for the three and six months ended June 30, 2007, respectively, and $46.9 million and $96.9 million for the three and six months ended June 30, 2008, respectively.

Performance-based Revenue

The Company has the ability to earn performance-based revenue under certain risk and non-risk contracts. Performance-based revenue generally is based on either the ability of the Company to manage care for its clients below specified targets, or on other operating metrics. For each such contract, the Company estimates and records performance-based revenue after considering the relevant contractual terms and the data available for the performance-based revenue calculation. Pro-rata performance-based revenue is recognized on an interim basis pursuant to the rights and obligations of each party upon termination of the contracts. Performance-based revenues were $1.1million and $3.2 million for the three and six months ended June 30, 2007, respectively, and $2.4 million and $6.3 million for the three and six months ended June 30, 2008, respectively.

Significant Customers

Consolidated Company

The Company's contracts with the State of Tennessee's TennCare program ("TennCare") generated net revenues that exceeded, in the aggregate, ten percent of net revenues for the consolidated Company for the six months ended June 30, 2007. In addition to TennCare, the Company's Maricopa Contract generated net revenues that exceeded, in the aggregate, ten percent of net revenues for the consolidated Company for the six months ended June 30, 2008. The Company also has a significant concentration of business from contracts with subsidiaries of WellPoint, Inc. ("WellPoint") and from contracts with various counties in the State of Pennsylvania (the "Pennsylvania Counties") which are part of the Pennsylvania Medicaid program.

The Maricopa Contract, which began September 1, 2007 and which extends through June 30, 2010, generated net revenues of $303.1 million for the six months ended June 30, 2008.

MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

June 30, 2008

(Unaudited)

NOTE A—General (Continued)

The Company provides managed behavioral healthcare services for TennCare through contracts that extend through various dates. The TennCare program is divided into three regions, and through March 31, 2007 the Company's TennCare contracts encompassed all of the TennCare membership for all three regions. As of April 1, 2007 substantially all of the membership in the Middle Grand Region was re-assigned to managed care companies in accordance with contract awards by TennCare pursuant to its request for proposals for the management of the integrated delivery of behavioral and physical medical care to the region. Substantially all of the membership in the West Grand and East Grand Regions will similarly be re-assigned to managed care companies in accordance with contract awards by TennCare effective November 1, 2008 and January 1, 2009. The Company continues to manage behavioral healthcare services for children enrolled in TennCare's Select, DCS Custody and SSI Children categories, as well as for certain out-of-state TennCare members pursuant to contracts that extend through June 30, 2009. The Company recorded net revenues of $174.8 million and $142.1 million for the six months ended June 30, 2007 and 2008, respectively, from its TennCare contracts. The portion of the total net revenues associated with the programs for children and out-of-state members referred to above was $23.1 million and $22.8 million for the six months ended June 30, 2007 and 2008, respectively.

Total net revenues from the Company's contracts with WellPoint were $88.0 million and $100.6 million during the six months ended June 30, 2007 and 2008, respectively, including radiology benefits management revenue of $7.7 million and $84.1 million, respectively. One of the Company's managed behavioral healthcare contracts with WellPoint was terminated by WellPoint effective March 31, 2007, and generated net revenues of $26.0 million during 2007. A second managed behavioral healthcare contract with WellPoint expired December 31, 2007 and generated net revenues of $41.6 million during the six months ended June 30, 2007.

In July 2007, WellPoint acquired a radiology benefits management company, and has expressed its intent to in-source all of its radiology benefits management contracts when such contracts expire. The Company has several radiology benefits management contracts with WellPoint including one that converted from an ASO arrangement to a risk arrangement effective July 1, 2007. Such risk contract originally had a three-year term through June 30, 2010, and cannot be terminated early, except for cause, as defined in the agreement. The term of this risk contract has been extended through December 31, 2010. The Company's other radiology benefits management contracts with WellPoint generated $7.9 million of net revenues for the six months ended June 30, 2008. Substantially all of this revenue relates to contracts that have terms through various dates in 2008.

Net revenues from the Pennsylvania Counties in the aggregate totaled $131.1 million and $145.4 million for the six months ended June 30, 2007 and 2008, respectively.

By Segment

MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

June 30, 2008

(Unaudited)

NOTE A—General (Continued)

$104.5 million for the six months ended June 30, 2007 and 2008, respectively. The second customer has a contract that extends through June 30, 2009 and generated net revenues of $43.7 million and $44.4 million for the six months ended June 30, 2007 and 2008, respectively.

In addition to TennCare for the six months ended June 30, 2007, one other customer generated greater than ten percent of the net revenues for the Public Sector segment for such period. This customer has a contract that extends through June 30, 2009 and generated net revenues of $61.2 million and $71.2 million for the six months ended June 30, 2007 and 2008, respectively.

In addition to WellPoint, one other customer generated greater than ten percent of the net revenues for the Radiology Benefits Management segment for the six months ended June 30, 2007 and 2008. This customer has a contract that extends through May 31, 2011 and generated net revenues of $7.2 million and $50.2 million for the six months ended June 30, 2007 and 2008, respectively.

Included in the Company's Specialty Pharmaceutical Management segment are four customers that each exceeded ten percent of the net revenues for this segment for the six months ended June 30, 2007. The four customers generated $30.1 million, $16.1 million, $15.8 million and $12.1 million of net revenues during the six months ended June 30, 2007. For the six months ended June 30, 2008, five customers each exceeded ten percent of the net revenues for this segment. The five customers generated $33.8 million, $25.1 million, $15.4 million, $14.3 million and $13.4 million of net revenues during the six months ended June 30, 2008.

Fair Value Measurements

The Company adopted SFAS 157 on January 1, 2008. SFAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). The standard outlines a valuation framework and creates a fair value hierarchy in order to increase the consistency and comparability of fair value measurements and the related disclosures. Under generally accepted accounting practices, certain assets and liabilities must be measured at fair value, and SFAS 157 details the disclosures that are required for items measured at fair value.

The Company has various financial instruments that must be measured under the new fair value standard including investments, which consist primarily of U.S. Government securities, obligations of government-sponsored enterprises, corporate debt securities and certificates of deposit. Pursuant to SFAS 157, financial assets and liabilities are to be measured using inputs from the three levels of the fair value hierarchy, which are as follows:

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

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

MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

June 30, 2008

(Unaudited)

NOTE A—General (Continued)

Level 3—Unobservable inputs that reflect our 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 June 30, 2008 (in thousands):

	Fair Value Measurements at June 30, 2008

	Level 1		Level 2		Level 3		Total
Cash and Cash Equivalents(1)	$	—	$	191,998	$	—	$	191,998
Restricted Cash(2)		—		147,487		—		147,487
Investments:
U.S. Government and agency securities		682		—		—		682
Obligations of government-sponsored enterprises(3)		—		64,779		—		64,779
Corporate debt securities		—		134,521		—		134,521
Certificates of deposit		—		6,220		—		6,220

	$	682	$	545,005	$	—	$	545,687

(1): Excludes $74.3 million of cash held in bank accounts by the Company.
(2): Excludes $67.8 million of restricted cash held in bank accounts by the Company.
(3): Includes investments in notes issued by the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Bank.

Income Taxes

The Company's effective income tax rate was 41.7 percent and 41.1 percent for the six months ended June 30, 2007 and 2008, respectively. This rate differs from the federal statutory income tax rate primarily due to state income taxes and permanent differences between book and tax income. The Company also accrues interest and penalties related to unrecognized tax benefits in its provision for income taxes.

The Company files a consolidated federal income tax return for the Company and its eighty-percent or more owned subsidiaries, and the Company and its subsidiaries file income tax returns in various states and local jurisdictions. The Company is no longer subject to additional U.S. federal taxes for years ended prior to December 31, 2004, although the Company's federal net operating loss carryovers ("NOLs") from such prior years remain subject to examination by the Internal Revenue Service ("IRS"). With few exceptions, the Company is also no longer subject to additional state or local income taxes for years ended prior to December 31, 2004.

MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

June 30, 2008

(Unaudited)

NOTE A—General (Continued)

Stock Compensation

The Company measures stock compensation under SFAS No. 123 (revised 2004) "Share-Based Payment" ("SFAS 123R"). At December 31, 2007 and June 30, 2008, the Company had equity-based employee incentive plans, which are described more fully in Note 7 in the Company's Annual Report on Form 10-K for the year ended December 31, 2007. Under SFAS 123R, the Company recorded stock compensation expense of $7.7 million and $14.5 million for the three and six months ended June 30, 2007, respectively, and $6.5 million and $18.5 million for the three and six months ended June 30, 2008, respectively. Stock compensation expense recognized in the condensed consolidated statements of income for the three and six months ended June 30, 2007 and 2008 has been reduced for estimated forfeitures, estimated at two percent and four percent, respectively.

The weighted average grant date fair value of all stock options granted during the six months ended June 30, 2008 was $9.05 as estimated using the Black-Scholes-Merton option pricing model, which also assumed an expected volatility of 28.4 percent based on the historical volatility of the Company's stock price.

SFAS 123R also requires the benefits of tax deductions in excess of recognized stock compensation expense to be reported as a financing cash flow, rather than as an operating cash flow. In the three and six months ended June 30, 2007, the tax deductions related to stock compensation expense were not recognized because of the availability of NOLs, and thus there were no such financing cash flows reported. In the six months ended June 30, 2008, approximately $4.4 million of benefits of such tax deductions related to stock compensation expense were realized and as such were reported as financing cash flows. Most of this amount was reflected as an increase to additional paid in capital, with the remainder recorded as an increase to tax contingencies.

Summarized information related to the Company's stock options for the six months ended June 30, 2008 is as follows:

			Weighted Average Exercise Price

Outstanding, beginning of period	4,059,096		$	36.68
Granted	1,410,915			41.49
Cancelled	(66,064	)		40.72
Exercised	(354,000	)		15.83

Outstanding, end of period	5,049,947			39.44

Vested and expected to vest at end of period	4,861,625			39.38

Exercisable, end of period	2,135,340		$	37.78

All of the Company's options granted during the six months ended June 30, 2008 vest ratably on each anniversary date over the three years subsequent to grant, and all have a ten year life.

MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

June 30, 2008

(Unaudited)

NOTE A—General (Continued)

Summarized information related to the Company's nonvested restricted stock awards and nonvested restricted stock units for the six months ended June 30, 2008 is as follows:

	Restricted Stock Awards					Restricted Stock Units

	Shares			Weighted Average Grant Date Fair Value		Shares			Weighted Average Grant Date Fair Value
Outstanding, beginning of period		601,384		$	43.25		219,736		$	40.57
Awarded		41,190			37.10		112,874			37.14
Vested		(34,983	)		36.24		(115,541	)		40.45
Forfeited		(757	)		34.57		(2,198	)		40.45

Outstanding, ending of period		606,834		$	43.25		214,871		$	38.83

Restricted stock awards and restricted stock units granted during the six months ended June 30, 2008 vest ratably on each anniversary date over the three years subsequent to grant.

On February 27, 2008 the board of directors of the Company approved the 2008 Management Incentive Plan ("2008 MIP") and recommended it be submitted for approval by the Company's shareholders at the 2008 Annual Meeting of shareholders. The 2008 MIP is similar to the 2006 Management Incentive Plan ("2006 MIP") and the 2003 Management Incentive Plan ("2003 MIP"). The board of directors also authorized a total of up to 4.5 million shares of the Company's Common Stock (which amount will be increased by the amount of any future forfeitures under the 2006 MIP, the 2003 MIP and the Director Plan) to be available for issuance pursuant to the 2008 MIP. Each restricted stock unit or share of restricted stock issued under the 2008 MIP shall be counted as 1.9 option shares for the purpose of calculating shares awarded and shares remaining available for grant pursuant to the 2008 MIP. The 2008 MIP also provides that no further awards are to be made under the 2006 MIP, the 2003 MIP or the Director Plan, and any equity awards remaining available for issuance under such plans are no longer available for issuance except for any forfeitures or other recapture of equity awards previously made under such plans, which will be available for grant under the 2008 MIP. The 2008 MIP, unlike the 2006 MIP and the 2003 MIP, also permits the grant of performance based cash bonus awards to eligible employees and the grant of equity to directors of the Company.

On February 27, 2008, the Compensation Committee of the board of the Company authorized the grant of stock options and restricted stock units to members of management pursuant to the 2008 MIP with such options and restricted stock units to be issued on March 5, 2008 pursuant to the Company's equity award policy. The options granted to management have a ten year term and an exercise price equal to the closing price of a share of Common Stock of the Company on NASDAQ on March 5, 2008, the date of grant of annual equity awards under the Company's equity award policy. The options and restricted stock units granted to management vest ratably on each anniversary date over the three years subsequent to grant, except that the vesting of certain of the restricted stock units are subject to satisfaction of certain performance targets.

MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

June 30, 2008

(Unaudited)

NOTE A—General (Continued)

The Compensation Committee also granted to each independent member of the board on May 20, 2008 (the date of the 2008 Annual Meeting of Shareholders), that number of shares of restricted stock of the Company determined by dividing $125,000 by the closing price of a share of the Company's Common Stock on NASDAQ on May 20, 2008. In addition, the Compensation Committee granted to the chairman of the board on May 20, 2008, that number of shares of restricted stock of the Company determined by dividing $500,000 by the closing price of a share of the Company's Common Stock on NASDAQ on May 20, 2008. Such shares of restricted stock granted to directors will vest on May 20, 2009.

The options and restricted stock units awarded to members of management and the directors as described above were subject to and conditioned upon shareholder approval of the 2008 MIP which occurred at the 2008 Annual Meeting of Shareholders of the Company. As such, these awards were not effectively granted nor was any stock compensation expense recorded until May 20, 2008.

Long Term Debt and Capital Lease Obligations

On April 30, 2008, the Company entered into a credit facility with Deutsche Bank AG and Citigroup Global Markets Inc. that provides for a $100.0 million Revolving Loan Commitment for the issuance of letters of credit for the account of the Company with a sublimit of up to $30.0 million for revolving loans (the "New Credit Facility"). On April 30, 2008, the Company's credit agreement with Deutsche Bank AG dated January 5, 2004, as amended (the "Credit Agreement") was terminated. Borrowings under the New Credit Facility will mature on April 29, 2009. The New Credit Facility is guaranteed by substantially all of the subsidiaries of the Company and is secured by substantially all of the assets of the Company and the subsidiary guarantors.

Under the New Credit Facility, the annual interest rate on Revolving Loan borrowings bear interest at a rate equal to the sum of (i) a borrowing margin of 1.00 percent plus (ii) (A) in the case of U.S. dollar denominated loans, the higher of the prime rate or one-half of one percent in excess of the overnight "federal funds" rate, or (B) in the case of Eurodollar denominated loans, an interest rate which is a function of the Eurodollar rate for the selected interest period. The Company has the option to borrow in U.S. dollar denominated loans or Eurodollar denominated loans at its discretion. Letters of Credit issued under the Revolving Loan Commitment bear interest at the rate of 1.125 percent. The commitment commission on the New Credit Facility is 0.375 percent of the unused Revolving Loan Commitment.

At June 30, 2008, the annual interest rates on the Company's capital lease obligations due through 2008 were 4.36 percent to 7.17 percent. There were no Revolving Loan borrowings at June 30, 2008.

MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

June 30, 2008

(Unaudited)

NOTE B—Net Income per Common Share

The following tables reconcile income (numerator) and shares (denominator) used in the computations of net income per common share (in thousands, except per share data):

		Three Months Ended June 30,				Six Months Ended June 30,

		2007		2008		2007		2008
Numerator:
Net income		$	16,824	$	21,888	$	37,793	$	39,132

Denominator:
Weighted average number of common shares outstanding—basic			38,842		39,961		38,538		39,848
	Common stock equivalents—stock options		632		220		735		307
	Common stock equivalents—warrants		178		122		167		144
	Common stock equivalents—restricted stock		148		4		82		6
	Common stock equivalents—restricted stock units		38		—		31		18
	Common stock equivalents—employee stock purchase plan		—		—		—		—

Weighted average number of common shares outstanding—diluted			39,838		40,307		39,553		40,323

Net income per common share—basic		$	0.43	$	0.55	$	0.98	$	0.98

Net income per common share—diluted		$	0.42	$	0.54	$	0.96	$	0.97

The weighted average number of common shares outstanding for the three and six months ended June 30, 2007 and 2008 was calculated using outstanding shares of the Company's Ordinary Common Stock. Common stock equivalents included in the calculation of diluted weighted average common shares outstanding for the three and six months ended June 30, 2007 and 2008 represent stock options to purchase shares of the Company's Ordinary Common Stock, restricted stock awards and restricted stock units, stock to be purchased under the Employee Stock Purchase Plan and shares of Ordinary Common Stock related to certain warrants issued on January 5, 2004.

NOTE C—Business Segment Information

The accounting policies of the Company's segments are the same as those described in Note A—"General." The Company evaluates performance of its segments based on profit or loss from continuing operations before stock compensation expense, depreciation and amortization, interest expense, interest income, gain on sale of assets, special charges or benefits, income taxes and minority interest ("Segment Profit"). Management uses Segment Profit information for internal reporting and control purposes and considers it important in making decisions regarding the allocation of capital and other resources, risk assessment and employee compensation, among other matters. Intersegment sales and transfers are not significant.

MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

June 30, 2008

(Unaudited)

NOTE C—Business Segment Information (Continued)

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

	Commercial			Public Sector			Radiology Benefits Management			Specialty Pharmaceutical Management			Corporate and Other			Consolidated

Net revenue	$	189,039		$	201,819		$	18,461		$	43,549		$	—		$	452,868
Cost of care		(94,570	)		(178,343	)		(6,305	)		—			—			(279,218	)
Cost of goods sold		—			—			—			(36,594	)		—			(36,594	)
Direct service costs		(41,602	)		(10,589	)		(11,262	)		(5,607	)		—			(69,060	)
Other operating expenses		—			—			—			—			(29,079	)		(29,079	)
Stock compensation expense(1)		653			246			546			2,101			4,157			7,703

Segment profit (loss)	$	53,520		$	13,133		$	1,440		$	3,449		$	(24,922	)	$	46,620

	Commercial			Public Sector			Radiology Benefits Management			Specialty Pharmaceutical Management			Corporate and Other			Consolidated

Net revenue	$	163,949		$	362,772		$	75,699		$	54,438		$	—		$	656,858
Cost of care		(85,129	)		(319,721	)		(53,240	)		—			—			(458,090	)
Cost of goods sold		—			—			—			(43,413	)		—			(43,413	)
Direct service costs		(38,144	)		(16,845	)		(14,205	)		(6,130	)		—			(75,324	)
Other operating expenses		—			—			—			—			(31,159	)		(31,159	)
Stock compensation expense(1)		249			194			140			2,015			3,901			6,499

Segment profit (loss)	$	40,925		$	26,400		$	8,394		$	6,910		$	(27,258	)	$	55,371

	Commercial			Public Sector			Radiology Benefits Management			Specialty Pharmaceutical Management			Corporate and Other			Consolidated

Net revenue	$	398,852		$	426,193		$	29,192		$	85,635		$	—		$	939,872
Cost of care		(207,169	)		(374,563	)		(6,305	)		—			—			(588,037	)
Cost of goods sold		—			—			—			(70,711	)		—			(70,711	)
Direct service costs		(83,737	)		(20,548	)		(22,222	)		(10,226	)		—			(136,733	)
Other operating expenses		—			—			—			—			(59,281	)		(59,281	)
Stock compensation expense(1)		1,161			457			1,008			4,153			7,711			14,490

Segment profit (loss)	$	109,107		$	31,539		$	1,673		$	8,851		$	(51,570	)	$	99,600

MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

June 30, 2008

(Unaudited)

NOTE C—Business Segment Information (Continued)

	Commercial			Public Sector			Radiology Benefits Management			Specialty Pharmaceutical Management			Corporate and Other			Consolidated

Net revenue	$	323,552		$	721,010		$	151,198		$	111,388		$	—		$	1,307,148
Cost of care		(166,702	)		(642,895	)		(102,567	)		—			—			(912,164	)
Cost of goods sold		—			—			—			(90,237	)		—			(90,237	)
Direct service costs		(75,569	)		(33,468	)		(27,305	)		(12,050	)		—			(148,392	)
Other operating expenses		—			—			—			—			(67,839	)		(67,839	)
Stock compensation expense(1)		672			368			645			4,119			12,713			18,517

Segment profit (loss)	$	81,953		$	45,015		$	21,971		$	13,220		$	(55,126	)	$	107,033

(1): Stock compensation expense is included in direct service costs and other operating expenses, however this amount is excluded from the computation of Segment Profit since it is managed on a consolidated basis.

The following table reconciles Segment Profit to consolidated income from continuing operations before income taxes and minority interest (in thousands):

		Three Months Ended June 30,						Six Months Ended June 30,

		2007			2008			2007			2008
Segment profit		$	46,620		$	55,371		$	99,600		$	107,033
Stock compensation expense			(7,703	)		(6,499	)		(14,490	)		(18,517	)
Depreciation and amortization			(13,505	)		(14,523	)		(27,157	)		(28,897	)
Interest expense			(1,604	)		(1,017	)		(3,456	)		(2,232	)
Interest income			5,519			3,716			10,706			9,209

	Income from continuing operations before income taxes and minority interest	$	29,327		$	37,048		$	65,203		$	66,596

NOTE D—Commitments and Contingencies

Legal

MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

June 30, 2008

(Unaudited)

NOTE D—Commitments and Contingencies (Continued)

operations and business practices. In the opinion of management, the Company has recorded reserves that are adequate to cover litigation, claims or assessments that have been or may be asserted against the Company, and for which the outcome is probable and reasonably estimable. Management believes that the resolution of such litigation and claims will not have a material adverse effect on the Company's financial condition or results of operations; however, there can be no assurance in this regard.

NOTE E—Subsequent Event

On July 30, 2008 the Company's board of directors approved a stock repurchase plan which authorizes the Company to purchase up to $200 million of its outstanding common stock through January 31, 2010. Stock repurchases under the program may 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 deems appropriate. The stock repurchase program may be limited or terminated at any time without prior notice.

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

The following discussion and analysis of the financial condition and results of operations of Magellan Health Services, Inc. ("Magellan"), and its majority-owned subsidiaries and all variable interest entities ("VIEs") for which Magellan is the primary beneficiary (together with Magellan, the "Company") should be read together with the Condensed Consolidated Financial Statements and the notes to the Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q and the Company's Annual Report on Form 10-K for the year ended December 31, 2007, which was filed with the Securities and Exchange Commission ("SEC") on February 29, 2008.

Forward-Looking Statements

This Form 10-Q 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"). Although the Company believes that its plans, intentions and expectations as reflected in such forward-looking statements are reasonable, it can give no assurance that such plans, intentions or expectations will be achieved. Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements. Important factors currently known to management that could cause actual results to differ materially from those in forward-looking statements include:

•: the Company's inability to renegotiate or extend expiring customer contracts, or the termination of customer contracts;
•: the Company's inability to integrate acquisitions in a timely and effective manner;
•: changes in business practices of the industry, including the possibility that certain of the Company's managed care customers could seek to provide managed healthcare services directly to their subscribers, instead of contracting with the Company for such services, particularly as a result of further consolidation in the managed care industry and especially regarding managed behavioral healthcare customers which have already done so with a portion of their membership, such as WellPoint, Inc. (which is discussed further below);
•: the impact of changes in the contracting model for Medicaid contracts, including certain changes in the contracting model used by states for managed healthcare services contracts relating to Medicaid lives;
•: the Company's ability to accurately predict and control healthcare costs, and to properly price the Company's services;
•: the Company's dependence on government spending for managed healthcare, including changes in federal, state and local healthcare policies;
•: restrictive covenants in the Company's debt instruments;
•: present or future state regulations and contractual requirements that the Company provide financial assurance of its ability to meet its obligations;
•: the impact of the competitive environment in the managed healthcare services industry which may limit the Company's ability to maintain or obtain contracts, as well as to its ability to maintain or increase its rates;
•: the possible impact of healthcare reform;
•: government regulation;

•: the possible impact of additional regulatory scrutiny and liability associated with the Company's Specialty Pharmaceutical Management segment;
•: the inability to realize the value of goodwill and intangible assets;
•: future changes in the composition of the Company's stockholder population which could, in certain circumstances, limit the ability of the Company to utilize its Net Operating Losses ("NOLs");
•: pending or future actions or claims for professional liability;
•: claims brought against the Company that either exceed the scope of the Company's liability coverage or result in denial of coverage;
•: class action suits and other legal proceedings; and
•: the impact of governmental investigations.

Further discussion of factors currently known to management that could cause actual results to differ materially from those in forward-looking statements is set forth under the heading "Risk Factors" in Item 1A of Magellan's Annual Report on Form 10-K for the year ended December 31, 2007. When used in this Quarterly Report on Form 10-Q, the words "estimate," "anticipate," "expect," "believe," "should," and similar expressions are intended to be forward-looking statements. Magellan undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time.

Business Overview

the treatment services, and (iii) employee assistance programs ("EAPs") where the Company provides short-term outpatient behavioral counseling services.

The managed behavioral healthcare business is managed based on the services provided and/or the customers served, through the following two segments:

Public Sector. The Managed Behavioral Healthcare Public Sector segment ("Public Sector") generally reflects managed behavioral healthcare services provided to Medicaid recipients under contracts with state and local governmental agencies. Public Sector contracts encompass either risk-based or ASO arrangements. As of June 30, 2008, Public Sector's covered lives were 2.2 million and 0.2 million for risk-based and ASO products, respectively. For the six months ended June 30, 2008, Public Sector's revenue was $718.7 million and $2.3 million for risk-based and ASO products, respectively.

Radiology Benefits Management. The Company's Radiology Benefits Management segment generally reflects the management of the delivery of diagnostic imaging services to ensure that such services are clinically appropriate and cost effective. The Company's radiology benefits management services currently are provided under contracts with managed care companies, health insurers and other health plans for some or all of their commercial, Medicaid and Medicare members. The Company has bid and may bid in the future on contracts with state and local governmental agencies for the provision of such services to Medicaid recipients. The Company won one Medicaid contract last year; however, its implementation has been postponed by the agency. The Company offers its radiology benefits management services through ASO contracts, where the Company provides services such as utilization review and claims administration, but does not assume responsibility for the cost of the imaging services and through risk-based contracts, where the Company assumes all or a substantial portion of the responsibility for the cost of providing diagnostic imaging services. The Company's first two risk-based radiology benefits management contracts became effective June 1, 2007 and July 1, 2007. As of June 30, 2008, covered lives for Radiology Benefits Management were 2.6 million and 18.5 million for risk-based and ASO products, respectively. For the six months ended June 30, 2008, revenue for Radiology Benefits Management was $121.3 million and $29.9 million for risk-based and ASO products, respectively.

commercial, Medicare and Medicaid members. The Company's specialty pharmaceutical services include (i) distributing specialty pharmaceutical drugs on behalf of health plans, (ii) administering on behalf of health plans rebate agreements between health plans and pharmaceutical manufacturers, and (iii) providing consulting services to health plans and pharmaceutical manufacturers. The Company's Specialty Pharmaceutical Management segment had contracts with 31 health plans as of June 30, 2008.

Significant Customers

Consolidated Company

The Maricopa Contract, which began September 1, 2007 and which extends through June 30, 2010, generated net revenues of $303.1 million for the six months ended June 30, 2008.

converted from an ASO arrangement to a risk arrangement effective July 1, 2007. Such risk contract originally had a three-year term through June 30, 2010, and cannot be terminated early, except for cause, as defined in the agreement. The term of this risk contract has been extended through December 31, 2010. The Company's other radiology benefits management contracts with WellPoint generated $7.9 million of net revenues for the six months ended June 30, 2008. Substantially all of this revenue relates to contracts that have terms through various dates in 2008.

Net revenues from the Pennsylvania Counties in the aggregate totaled $131.1 million and $145.4 million for the six months ended June 30, 2007 and 2008, respectively.

By Segment

WellPoint generated greater than ten percent of net revenues for the Commercial segment for the six months ended June 30, 2007. Two other customers generated greater than ten percent of Commercial net revenues for the six months ended June 30, 2007 and 2008. The first customer has a contract that extends through December 31, 2010 and generated net revenues of $85.5 million and $104.5 million for the six months ended June 30, 2007 and 2008, respectively. The second customer has a contract that extends through June 30, 2009 and generated net revenues of $43.7 million and $44.4 million for the six months ended June 30, 2007 and 2008, respectively.

Off-Balance Sheet Arrangements

The Company does not maintain any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on the Company's finances that is material to investors.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Except as noted below, the Company's critical accounting policies are summarized in the Company's Annual Report on Form 10-K, filed with the SEC on February 29, 2008.

Income Taxes

The Company files a consolidated federal income tax return for the Company and its eighty-percent or more owned subsidiaries, and the Company and its subsidiaries file income tax returns in various states and local jurisdictions. The Company is no longer subject to additional U.S. federal taxes for years ended prior to December 31, 2004, although the Company's federal NOLs from such prior years remain subject to examination by the Internal Revenue Service ("IRS"). With few exceptions, the Company is also no longer subject to additional state or local income taxes for years ended prior to December 31, 2004.

Results of Operations

The Company evaluates performance of its segments based on profit or loss from continuing operations before stock compensation expense, depreciation and amortization, interest expense, interest income, gain on sale of assets, special charges or benefits, income taxes and minority interest ("Segment Profit"). Management uses Segment Profit information for internal reporting and control purposes and considers it important in making decisions regarding the allocation of capital and other resources, risk assessment and employee compensation, among other matters. Intersegment sales and transfers are not significant.

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

	Commercial			Public Sector			Radiology Benefits Management			Specialty Pharmaceutical Management			Corporate and Other			Consolidated

Net revenue	$	189,039		$	201,819		$	18,461		$	43,549		$	—		$	452,868
Cost of care		(94,570	)		(178,343	)		(6,305	)		—			—			(279,218	)
Cost of goods sold		—			—			—			(36,594	)		—			(36,594	)
Direct service costs		(41,602	)		(10,589	)		(11,262	)		(5,607	)		—			(69,060	)
Other operating expenses		—			—			—			—			(29,079	)		(29,079	)
Stock compensation expense(1)		653			246			546			2,101			4,157			7,703

Segment profit (loss)	$	53,520		$	13,133		$	1,440		$	3,449		$	(24,922	)	$	46,620

	Commercial			Public Sector			Radiology Benefits Management			Specialty Pharmaceutical Management			Corporate and Other			Consolidated

Net revenue	$	163,949		$	362,772		$	75,699		$	54,438		$	—		$	656,858
Cost of care		(85,129	)		(319,721	)		(53,240	)		—			—			(458,090	)
Cost of goods sold		—			—			—			(43,413	)		—			(43,413	)
Direct service costs		(38,144	)		(16,845	)		(14,205	)		(6,130	)		—			(75,324	)
Other operating expenses		—			—			—			—			(31,159	)		(31,159	)
Stock compensation expense(1)		249			194			140			2,015			3,901			6,499

Segment profit (loss)	$	40,925		$	26,400		$	8,394		$	6,910		$	(27,258	)	$	55,371

	Commercial			Public Sector			Radiology Benefits Management			Specialty Pharmaceutical Management			Corporate and Other			Consolidated

Net revenue	$	398,852		$	426,193		$	29,192		$	85,635		$	—		$	939,872
Cost of care		(207,169	)		(374,563	)		(6,305	)		—			—			(588,037	)
Cost of goods sold		—			—			—			(70,711	)		—			(70,711	)
Direct service costs		(83,737	)		(20,548	)		(22,222	)		(10,226	)		—			(136,733	)
Other operating expenses		—			—			—			—			(59,281	)		(59,281	)
Stock compensation expense(1)		1,161			457			1,008			4,153			7,711			14,490

Segment profit (loss)	$	109,107		$	31,539		$	1,673		$	8,851		$	(51,570	)	$	99,600

	Commercial			Public Sector			Radiology Benefits Management			Specialty Pharmaceutical Management			Corporate and Other			Consolidated

Net revenue	$	323,552		$	721,010		$	151,198		$	111,388		$	—		$	1,307,148
Cost of care		(166,702	)		(642,895	)		(102,567	)		—			—			(912,164	)
Cost of goods sold		—			—			—			(90,237	)		—			(90,237	)
Direct service costs		(75,569	)		(33,468	)		(27,305	)		(12,050	)		—			(148,392	)
Other operating expenses		—			—			—			—			(67,839	)		(67,839	)
Stock compensation expense(1)		672			368			645			4,119			12,713			18,517

Segment profit (loss)	$	81,953		$	45,015		$	21,971		$	13,220		$	(55,126	)	$	107,033

(1): Stock compensation expense is included in direct service costs and other operating expenses, however this amount is excluded from the computation of Segment Profit since it is managed on a consolidated basis.

The following table reconciles Segment Profit to consolidated income from continuing operations before income taxes and minority interest (in thousands):

		Three Months Ended June 30,						Six Months Ended June 30,

		2007			2008			2007			2008
Segment profit		$	46,620		$	55,371		$	99,600		$	107,033
Stock compensation expense			(7,703	)		(6,499	)		(14,490	)		(18,517	)
Depreciation and amortization			(13,505	)		(14,523	)		(27,157	)		(28,897	)
Interest expense			(1,604	)		(1,017	)		(3,456	)		(2,232	)
Interest income			5,519			3,716			10,706			9,209

	Income from continuing operations before income taxes and minority interest	$	29,327		$	37,048		$	65,203		$	66,596

Quarter ended June 30, 2008 ("Current Year Quarter"), compared to the quarter ended June 30, 2007 ("Prior Year Quarter")

Commercial

Net Revenue

Net revenue related to Commercial decreased by 13.3 percent or $25.1 million from the Prior Year Quarter to the Current Year Quarter. The decrease in revenue is mainly due to terminated contracts of $39.8 million and net favorable retroactive membership adjustments of $2.2 million recorded in the Prior Year Quarter, which decreases were partially offset by increased membership from existing customers of $7.7 million, favorable rate changes of $6.7 million, revenue from new contracts implemented after (or during) the Prior Year Quarter of $1.6 million, and other net favorable variances of $0.9 million.

Cost of Care

Cost of care decreased by 10.0 percent or $9.4 million from the Prior Year Quarter to the Current Year Quarter. The decrease in cost of care is primarily due to terminated contracts of $25.9 million and favorable medical claims development for the Prior Year Quarter which was recorded after the Prior Year Quarter of $3.6 million, which decreases were partially offset by favorable prior period medical claims development recorded in the Prior Year Quarter of $6.2 million, increased membership from existing customers of $4.4 million, unfavorable prior period medical claims development recorded in the Current Year Quarter of $0.5 million, and care trends and other net variances of $9.0 million. Cost of care increased as a percentage of risk revenue (excluding EAP business) from 69.7 percent in the Prior Year Quarter to 73.9 percent in the Current Year Quarter, mainly due to changes in business mix.

Direct Service Costs

Direct service costs decreased by 8.3 percent or $3.5 million from the Prior Year Quarter to the Current Year Quarter. The decrease in direct service costs is mainly attributable to terminated contracts. Direct service costs increased as a percentage of revenue from 22.0 percent in the Prior Year Quarter to 23.3 percent in the Current Year Quarter, mainly due to changes in business mix.

Public Sector

Net Revenue

Net revenue related to Public Sector increased by 79.8 percent or $161.0 million from the Prior Year Quarter to the Current Year Quarter. This increase is primarily due to revenue from the

Maricopa Contract which was implemented after the Prior Year Quarter of $153.5 million, net favorable rate changes of $8.6 million and other net favorable variances of $0.9 million, which increases were partially offset by profit share of $2.0 million recorded in Current Year Quarter for favorable prior period medical claims development.

Cost of Care

Cost of care increased by 79.3 percent or $141.4 million from the Prior Year Quarter to the Current Year Quarter. This increase is primarily due to care associated with the Maricopa Contract of $139.1 million, care associated with rate changes for contracts with minimum cost of care requirements of $5.5 million, favorable prior period medical claims development recorded in the Prior Year Quarter of $1.6 million, and care trends and other net variances of $1.9 million, which increases were partially offset by favorable prior period medical claims development recorded in the Current Year Quarter of $6.7 million. Cost of care decreased as a percentage of risk revenue from 88.9 percent in the Prior Year Quarter to 88.4 percent in the Current Year Quarter mainly due to favorable care development.

Direct Service Costs

Direct service costs increased by 59.1 percent or $6.3 million from the Prior Year Quarter to the Current Year Quarter. The increase in direct service costs is primarily due to costs associated with the Maricopa Contract. Direct service costs decreased as a percentage of revenue from 5.2 percent for the Prior Year Quarter to 4.6 percent in the Current Year Quarter mainly due to business mix.

Radiology Benefits Management

Net Revenue

Net revenue related to Radiology Benefits Management increased by 310.0 percent or $57.2 million from the Prior Year Quarter to the Current Year Quarter. This increase is primarily due to the conversion of an ASO contract to a risk contract of $38.2 million, revenue from new customers implemented after (or during) the Prior Year Quarter of $19.8 million, and net increased membership from existing customers of $1.6 million (which is net of a decrease in risk membership of $1.5 million), which increases were partially offset by terminated contracts of $1.0 million and other net unfavorable variances of $1.4 million.

Cost of Care

Cost of care increased by $46.9 million from the Prior Year Quarter to the Current Year Quarter. This increase is primarily due to the conversion of an ASO contract to a risk contract of $32.1 million and care associated with new customers implemented after (or during) the Prior Year Quarter of $17.8 million, which increases were partially offset by favorable prior period medical claims development recorded in the Current Year Quarter of $1.5 million, decreased membership from existing risk customers of $1.4 million, and care trends and other net unfavorable variances of $0.1 million. Cost of care decreased as a percentage of risk revenue from 94.2 percent in the Prior Year Quarter to 86.5 percent in the Current Year Quarter mainly due to favorable care development and business mix.

Direct Service Costs

Direct service costs increased by 26.1 percent or $2.9 million from the Prior Year Quarter to the Current Year Quarter. This increase is primarily attributed to additional costs incurred to support the new risk contract which was implemented in June 2007. As a percentage of revenue, direct service costs decreased from 61.0 percent in the Prior Year Quarter to 18.8 percent in the Current Year Quarter, mainly due to the additional revenue provided by the risk-based contracts in the Current Year Quarter.

Specialty Pharmaceutical Management

Net Revenue

Net revenue related to Specialty Pharmaceutical Management increased by 25.0 percent or $10.9 million from the Prior Year Quarter to the Current Year Quarter. This increase is primarily due to increased distribution activity from new and existing customers of $7.6 million, increased consulting and rebate revenue of $3.1 million (including $0.7 million of retroactive rebate revenue recorded in the Current Year Quarter) and other net favorable variances of $0.2 million.

Cost of Goods Sold

Cost of goods sold increased by 18.6 percent or $6.8 million from the Prior Year Quarter to the Current Year Quarter, primarily due to increased distribution activity from new and existing customers. As a percentage of the portion of net revenue that relates to distribution activity, cost of goods sold decreased from 94.4 percent in the Prior Year Quarter to 92.5 percent in the Current Year Quarter, mainly due to business mix.

Direct Service Costs

Direct service costs increased by 9.3 percent or $0.5 million from the Prior Year Quarter to the Current Year Quarter. This increase is primarily due to expenses required to support the aforementioned increases to revenue. As a percentage of revenue, direct service costs decreased from 12.9 percent in the Prior Year Quarter to 11.3 percent in the Current Year Quarter, mainly due to the increased distribution revenue.

Corporate and Other

Other Operating Expenses

Other operating expenses related to the Corporate and Other Segment increased by 7.2 percent or $2.1 million from the Prior Year Quarter to the Current Year Quarter. The increase results primarily from net one-time expenses incurred in the Current Year Quarter of $1.2 million and other net unfavorable variances of $0.9 million. As a percentage of total net revenue, other operating expenses decreased from 6.4 percent for the Prior Year Quarter to 4.7 percent for the Current Year Quarter, primarily due to business mix and the increased revenue from the radiology risk contracts and the Maricopa Contract.

Depreciation and Amortization

Depreciation and amortization expense increased by 7.5 percent or $1.0 million from the Prior Year Quarter to the Current Year Quarter, primarily due to asset additions since the Prior Year Quarter, inclusive of assets related to the Maricopa Contract, partially offset by a decrease in amortization expense due to an intangible asset which became fully amortized in the prior year.

Interest Expense

Interest expense decreased by 36.6 percent or $0.6 million from the Prior Year Quarter to the Current Year Quarter, mainly due to reductions in outstanding debt balances as a result of debt payments and lower interest rates.

Interest Income

Interest income decreased by $1.8 million from the Prior Year Quarter to the Current Year Quarter mainly due to lower yields.

Income Taxes

The Company's effective income tax rate was 42.0 percent in the Prior Year Quarter and 40.8 percent in the Current Year Quarter. The Prior Year Quarter and Current Year Quarter effective income tax rates differ from the federal statutory income tax rate primarily due to state income taxes and permanent differences between book and tax income.

Six months ended June 30, 2008 ("Current Year Period"), compared to the six months ended June 30, 2007 ("Prior Year Period")

Commercial

Net Revenue

Net revenue related to Commercial decreased by 18.9 percent or $75.3 million from the Prior Year Period to the Current Year Period. The decrease in revenue is mainly due to terminated contracts of $104.3 million and net favorable retroactive membership adjustments of $2.2 million recorded in the Prior Year Period, which decreases were partially offset by increased membership from existing customers of $14.2 million, favorable rate changes of $8.7 million, favorable retroactive membership and rate adjustments of $4.1 million recorded in the Current Year Period, revenue from new contracts implemented after (or during) the Prior Year Period of $3.1 million, and other net favorable variances of $1.1 million.

Cost of Care

Cost of care decreased by 19.5 percent or $40.5 million from the Prior Year Period to the Current Year Period. The decrease in cost of care is primarily due to terminated contracts of $67.9 million and favorable medical claims development for the Prior Year Period which was recorded after the Prior Year Period of $2.7 million, which decreases were partially offset by increased membership from existing customers of $7.2 million, unfavorable prior period medical claims development recorded in the Current Year Period of $5.2 million, favorable prior period medical claims development recorded in the Prior Year Period of $3.6 million, and care trends and other net variances of $14.1 million. Cost of care increased as a percentage of risk revenue (excluding EAP business) from 70.9 percent in the Prior Year Period to 73.9 percent in the Current Year Period, mainly due to changes in business mix.

Direct Service Costs

Direct service costs decreased by 9.8 percent or $8.2 million from the Prior Year Period to the Current Year Period. The decrease in direct service costs is mainly attributable to terminated contracts. Direct service costs increased as a percentage of revenue from 21.0 percent in the Prior Year Period to 23.4 percent in the Current Year Period, mainly due to changes in business mix.

Public Sector

Net Revenue

Net revenue related to Public Sector increased by 69.2 percent or $294.8 million from the Prior Year Period to the Current Year Period. This increase is primarily due to revenue from new customers implemented after (or during) the Prior Year Period of $309.2 million and net favorable rate changes of $18.1 million (including $3.6 million of retroactive rate changes recorded in the Current Year Period), which increases were partially offset by a net loss of membership in connection with the Middle Grand Region of TennCare of $32.2 million and other net unfavorable variances of $0.3 million.

Cost of Care

Cost of care increased by 71.6 percent or $268.3 million from the Prior Year Period to the Current Year Period. This increase is primarily due to care associated with new customers of $284.8 million, care associated with rate changes for contracts with minimum cost of care requirements of $15.1 million (including $3.1 million of care recorded in the Current Year Period associated with retroactive rate changes), and favorable prior period medical claims development recorded in the Prior Year Period of $1.9 million, which increases were partially offset by the net loss of membership in connection with the Middle Grand Region of TennCare of $26.5 million, favorable prior period medical claims development recorded in the Current Year Period of $5.0 million, and care trends and other net favorable variances of $2.0 million. Cost of care increased as a percentage of risk revenue from 88.4 percent in the Prior Year Period to 89.4 percent in the Current Year Period mainly due to business mix.

Direct Service Costs

Direct service costs increased by 62.9 percent or $12.9 million from the Prior Year Period to the Current Year Period. The increase in direct service costs is primarily due to costs associated with new business. Direct service costs decreased as a percentage of revenue from 4.8 percent for the Prior Year Period to 4.6 percent in the Current Year Period mainly due to business mix.

Radiology Benefits Management

Net Revenue

Net revenue related to Radiology Benefits Management increased by 417.9 percent or $122.0 million from the Prior Year Period to the Current Year Period. This increase is primarily due to the conversion of an ASO contract to a risk contract of $75.0 million, revenue from new customers implemented after (or during) the Prior Year Period of $45.2 million, net increased membership from existing customers of $2.6 million (which is net of a decrease in risk membership of $1.5 million), and other net favorable variances of $1.2 million, which increases were partially offset by terminated contracts of $2.0 million.

Cost of Care

Cost of care increased by $96.3 million from the Prior Year Period to the Current Year Period. This increase is primarily due to the conversion of an ASO contract to a risk contract of $62.6 million and care associated with new customers implemented after (or during) the Prior Year Period of $36.7 million, which increases were partially offset by favorable prior period medical claims development recorded in the Current Year Period of $1.4 million, decreased membership from existing risk customers of $1.4 million, and care trends and other net unfavorable variances of $0.2 million. Cost of care decreased as a percentage of risk revenue from 94.2 percent in the Prior Year Period to 84.6 percent in the Current Year Period mainly due to favorable care development and business mix.

Direct Service Costs

Direct service costs increased by 22.9 percent or $5.1 million from the Prior Year Period to the Current Year Period. This increase is primarily attributed to additional costs incurred to support the new risk contract which was implemented in June 2007. As a percentage of revenue, direct service costs decreased from 76.1 percent in the Prior Year Period to 18.1 percent in the Current Year Period, mainly due to the additional revenue provided by the risk-based contracts in the Current Year Period.

Specialty Pharmaceutical Management

Net Revenue

Net revenue related to Specialty Pharmaceutical Management increased by 30.1 percent or $25.8 million from the Prior Year Period to the Current Year Period. This increase is primarily due to increased distribution activity from new and existing customers of $20.3 million, increased consulting and rebate revenue of $5.0 million (including $0.5 million of retroactive rebate revenue recorded in the Current Year Period) and other net favorable variances of $0.5 million.

Cost of Goods Sold

Cost of goods sold increased by 27.6 percent or $19.5 million from the Prior Year Period to the Current Year Period, primarily due to increased distribution activity from new and existing customers. As a percentage of the portion of net revenue that relates to distribution activity, cost of goods sold increased from 92.3 percent in the Prior Year Period to 93.1 percent in the Current Year Period, mainly due to business mix.

Direct Service Costs

Direct service costs increased by 17.8 percent or $1.8 million from the Prior Year Period to the Current Year Period. This increase is primarily due to expenses required to support the aforementioned increases to revenue. As a percentage of revenue, direct service costs decreased from 11.9 percent in the Prior Year Period to 10.8 percent in the Current Year Period, mainly due to increased distribution revenue.

Corporate and Other

Other Operating Expenses

Other operating expenses related to the Corporate and Other Segment increased by 14.4 percent or $8.6 million from the Prior Year Period to the Current Year Period. The increase results primarily from current year expenses incurred pursuant to the former Chief Executive Officer's employment agreement in relation to his service to the Company ending of $10.1 million (includes $5.4 million of stock compensation expense related to the acceleration of vesting for certain equity awards) and net one-time expenses incurred in the Current Year Period of $1.5 million, which increases were partially offset by expenses in the Prior Year Period related to bid proposals of $2.0 million and other net favorable variances of $1.0 million. As a percentage of total net revenue, other operating expenses decreased from 6.3 percent for the Prior Year Period to 5.2 percent for the Current Year Period, primarily due to business mix and the increased revenue from the radiology risk contracts and the Maricopa Contract.

Depreciation and Amortization

Depreciation and amortization expense increased by 6.4 percent or $1.7 million from the Prior Year Period to the Current Year Period, primarily due to asset additions since the Prior Year Period, inclusive of assets related to the Maricopa Contract, partially offset by a decrease in amortization expense due to an intangible asset which became fully amortized in the prior year.

Interest Expense

Interest expense decreased by 35.4 percent or $1.2 million from the Prior Year Period to the Current Year Period, mainly due to reductions in outstanding debt balances as a result of debt payments and lower interest rates.

Interest Income

Interest income decreased by $1.5 million from the Prior Year Period to the Current Year Period mainly due to lower yields.

Income Taxes

The Company's effective income tax rate was 41.7 percent in the Prior Year Period and 41.1 percent in the Current Year Period. The Prior Year Period and Current Year Period effective income tax rates differ from the federal statutory income tax rate primarily due to state income taxes and permanent differences between book and tax income.

Outlook—Results of Operations

The Company's Segment Profit and net income are subject to significant fluctuations from period to period. These fluctuations may result from a variety of factors such as those set forth under Item 2—"Forward-Looking Statements" as well as a variety of other factors including: (i) changes in utilization levels by enrolled members of the Company's risk-based contracts, including seasonal utilization patterns; (ii) contractual adjustments and settlements; (iii) retrospective membership adjustments; (iv) timing of implementation of new contracts, enrollment changes and contract terminations; (v) pricing adjustments upon contract renewals (and price competition in general); and (vi) changes in estimates regarding medical costs and incurred but not yet reported medical claims.

Care Trends. The Company expects that the Commercial care trend factor for 2008 will be 5 to 7 percent, the Public Sector care trend factor for 2008 will be 3 to 5 percent and the Radiology Benefits Management care trend for 2008 will be 12 to 15 percent.

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 Company's credit agreement with Deutsche Bank AG and Citigroup Global Markets, Inc. dated April 30, 2008 (the "New Credit Facility"). Based on the amount of cash equivalents and investments and the borrowing levels under the New Credit Facility as of June 30, 2008, a hypothetical 10 percent increase or decrease in the interest rate associated with these instruments, with all other variables held constant, would not materially affect the Company's future earnings and cash outflows.

Historical—Liquidity and Capital Resources

Operating Activities. The Company reported net cash provided by operating activities of $90.1 million and $124.8 million for the Prior Year Period and Current Year Period, respectively. The $34.7 million increase in operating cash flows is primarily due to the year-over-year increase of $69.8 million in the shift of restricted cash to restricted investments, with $7.6 million and $77.4 million of restricted cash being shifted to restricted investments in the Prior Year Period and Current Year Period, respectively, and the increase in segment profit between periods of $7.4 million. Partially offsetting these items is the funding of restricted cash of $14.9 million during the Current Year Period for a risk radiology contract, the increase between periods in the run-out of net contract liabilities for terminated contracts of $7.5 million, the net increase between periods in restricted cash associated with the Company's regulated entities of $2.5 million and other net unfavorable items of $17.6 million, mainly due to timing and additional working capital requirements to support the Company's growth.

Investing Activities. The Company utilized $12.7 million and $16.7 million during the Prior Year Period and Current Year Period, respectively, for capital expenditures. The majority of the increase in capital expenditures of $4.0 million is attributable to capital expenditures incurred during the Current Year Period of $3.2 million associated with the Maricopa Contract that commenced in September 2007. Most of the remainder of the capital expenditures for the Current Year Period and the majority of capital expenditures for the Prior Year Period related to management information systems and related equipment.

The Company received net cash of $4.7 million in the Prior Year Period and used net cash of $149.6 million in the Current Year Period from the net maturity of "available-for-sale" investments.

The Company's investments consist of U.S. government and agency securities, obligations of government-sponsored enterprises, corporate debt securities, money market funds and certificates of deposit.

During the Prior Year Period and Current Year Period, the Company made payments of $5.3 million and $0.4 million, respectively, for the working capital received in the acquisition of ICORE Healthcare LLC ("ICORE"), with the payment made during the Current Year Period representing the final ICORE working capital payment.

Financing Activities. During the Prior Year Period, the Company had debt and capital lease payments of $14.1 million. In addition, the Company received $23.8 million from the exercise of stock options and warrants and had other financing related cash outflows of $0.3 million.

During the Current Year Period, the Company had debt and capital lease payments of $12.7 million. In addition, the Company received $5.6 million from the exercise of stock options and warrants and had other net favorable items of $2.8 million.

Outlook—Liquidity and Capital Resources

Liquidity. During 2008, the Company expects to fund its capital expenditures with cash from operations. The Company estimates that it will spend approximately $13 million to $23 million of additional funds in 2008 for capital expenditures. The Company does not anticipate that it will need to draw on amounts available under the Revolving Loan borrowing of the New Credit Facility (as defined below) for its operations, capital needs or debt service in 2008. The Company also currently expects to have adequate liquidity to satisfy its existing financial commitments over the periods in which they will become due.

Stock Repurchase. On July 30, 2008 the Company's board of directors approved a stock repurchase plan which authorizes the Company to purchase up to $200 million of its outstanding common stock through January 31, 2010. Stock repurchases under the program may 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 deems appropriate. The stock repurchase program may be limited or terminated at any time without prior notice. The Company expects to fund the repurchase using cash on hand.

Off-Balance Sheet Arrangements. As of June 30, 2008, the Company has no material off-balance sheet arrangements.

New Credit Facility. On April 30, 2008, the Company's credit agreement with Deutsche Bank AG dated January 5, 2004, as amended (the "Credit Agreement") was terminated, and the Company entered into the New Credit Facility which provides for a $100.0 million Revolving Loan Commitment for the issuance of letters of credit for the account of the Company with a sublimit of up to $30.0 million for revolving loans. Borrowings under the New Credit Facility will mature on April 29, 2009. The New Credit Facility is guaranteed by substantially all of the subsidiaries of the Company and is secured by substantially all of the assets of the Company and the subsidiary guarantors.

commitment commission on the New Credit Facility will be 0.375 percent of the unused Revolving Loan Commitment.

Restrictive Covenants in Debt Agreements. The New Credit Facility 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 New Credit Facility also requires the Company to comply with specified financial ratios and tests. Failure to do so, unless waived by the lenders under the New Credit Facility pursuant to its terms, would result in an event of default under the New Credit Facility. The New Credit Facility is guaranteed by most of the Company's subsidiaries and is secured by most of the Company's assets and the Company's subsidiaries' assets.

Net Operating Loss Carryforwards. The Company estimates that it had reportable federal NOLs as of December 31, 2007 of approximately $236.1 million available to reduce future federal taxable income. These estimated NOLs expire in 2011 through 2020 and are subject to examination and adjustment by the IRS. In addition, the Company's utilization of such NOLs is subject to limitation under Internal Revenue Code Section 382, which affects the timing of the use of these NOLs. At this time, the Company does not believe these limitations will limit the Company's ability to use any federal NOLs before they expire. Although the Company has NOLs that may be available to offset future taxable income, the Company may be subject to Federal Alternative Minimum Tax.

As of December 31, 2007, the Company's valuation allowances against deferred tax assets were $10.2 million, mostly for certain state NOLs and other state deferred tax assets. The amount of deferred tax assets considered realizable required significant judgment and estimation. Changes in these estimates in the future could materially affect the Company's financial condition and results of operations.

Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 157, "Fair Value Measurements" ("SFAS 157"). SFAS 157 provides guidance for using fair value to measure assets and liabilities. It also responds to investors' requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value and the effect of fair value measurements on earnings. SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value, and does not expand the use of fair value in any new circumstances. SFAS 157 is effective for fiscal years beginning after November 15, 2007. In

February 2008, the FASB issued FASB Staff Position No. 157-2, Effective Date of FASB Statement No. 157 ("FSP 157-2"), which delays the effective date of SFAS 157 by one year for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). On January 1, 2008, the Company adopted SFAS 157 for financial assets and liabilities. The adoption did not have a material impact on the consolidated financial statements. The Company has not yet determined the impact on its consolidated financial statements, if any, from the adoption of SFAS 157, as it pertains to non-financial assets and non-financial liabilities.

In December 2007, the FASB issued SFAS No. 141(R) "Business Combinations" ("SFAS 141(R)") and SFAS No. 160, "Non-controlling Interests in Consolidated Financial Statements" ("SFAS 160"). SFAS 141(R) requires the acquiring entity in a business combination to record all assets acquired and liabilities assumed at their respective acquisition-date fair values and changes other practices under SFAS 141, some of which could have a material impact on how the Company accounts for business combinations. SFAS 141(R) also requires additional disclosure of information surrounding a business combination, such that users of the entity's financial statements can fully understand the nature and financial impact of the business combination. SFAS 160 requires entities to report non-controlling (minority) interests in subsidiaries as equity in the consolidated financial statements. The Company is required to adopt SFAS 141(R) and SFAS 160 simultaneously in the Company's year beginning January 1, 2009. The Company is currently evaluating the effects, if any, that SFAS 141(R) and SFAS 160 may have on the Company's consolidated financial position and results of operations.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Changes in interest rates affect interest income earned on the Company's cash equivalents and restricted cash and investments, as well as interest expense on variable interest rate borrowings under the New Credit Facility. Based on the Company's investment balances, and the borrowing levels under the New Credit Facility as of June 30, 2008, a hypothetical 10 percent increase or decrease in the interest rate associated with these instruments, with all other variables held constant, would not materially affect the Company's future earnings and cash outflows.

Item 4. Controls and Procedures.

a) The Company's management evaluated, with the participation of the Company's principal executive and principal financial officers, the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) under the Exchange Act), as of June 30, 2008. Based on their evaluation, the Company's principal executive and principal financial officers concluded that the Company's disclosure controls and procedures were effective as of June 30, 2008.

b) Under the supervision and with the participation of management, including the Company's principal executive and principal financial officers, the Company has determined that there has been no change in the Company's internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the Company's quarter ended June 30, 2008 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

The management and administration of the delivery of specialty managed healthcare entails 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, litigation and claims relating to its operations and business practices. In the opinion of management, the Company has recorded reserves that are adequate to cover litigation, claims or assessments that have been or may be asserted against the Company, and for which the outcome is probable and reasonably estimable. Management believes that the resolution of such litigation and claims will not have a material adverse effect on the Company's financial condition or results of operations; however, there can be no assurance in this regard.

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

None.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Submission of Matters to a Vote of Security Holders.

The annual meeting of shareholders of the Company (the "Meeting") was held on May 20, 2008 in connection with which proxies were solicited pursuant to Regulation 14A under the Securities Exchange Act of 1934. Four proposals were scheduled and noticed to be acted upon at the Meeting: (a) the election of four directors ("Proposal Number 1"); (b) approval of the 2008 Management Incentive Plan ("2008 MIP") ("Proposal Number 2"); (c) a shareholder proposal requesting that the board of directors take the necessary actions to declassify the board of directors and require annual elections of directors ("Proposal Number 3"); and (d) ratification of the appointment of Ernst & Young as the Company's independent registered public accounting firm for the fiscal year 2008 ("Proposal Number 4").

(1): At the meeting, the three nominees of the Board of Directors (William J. McBride, Robert M. LeBlanc, and Allen F. Wise) were re-elected as directors, to serve for three year terms or until the election and qualification of their successors, and William D. Forrest, who served as a director by appointment of the board, was elected to a three year term until the election and qualification of his successor. The vote with respect to each nominee was as follows:

Nominee

William J. McBride	34,881,482	2,321,836
Robert M. LeBlanc	33,977,642	3,225,676
Allen F. Wise	33,307,521	3,895,797
William D. Forrest	33,046,688	4,156,630

Other directors whose terms of office continued after the annual meeting are: Barry M. Smith, Rene Lerer, M.D., Nancy L. Johnson, Steven J. Shulman, Michael P. Ressner and Michael Diament.

Proposal Number 2 was adopted with 29,948,428 votes cast for, and 3,890,131 votes cast against; in addition there were 7,518 abstentions on Proposal Number 2.

Proposal Number 3 was not presented by the proponent or a qualified representative at the meeting, and accordingly, was not voted upon.

Proposal Number 4 was adopted with 37,180,629 votes cast for, and 12,697 votes cast against; in addition there were 9,991 abstentions on Proposal Number 4.

Item 5. Other Information.

None.

Item 6. Exhibits.


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.

SIGNATURES

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


Date: July 31, 2008	MAGELLAN HEALTH SERVICES, INC. (Registrant)
	By:	/s/ MARK S. DEMILIO Mark S. Demilio Executive Vice President and Chief Financial Officer (Principal Financial Officer and Duly Authorized Officer)

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands, except per share amounts)
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (In thousands, except per share amounts)
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, (Unaudited) (In thousands)
MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2008 (Unaudited)

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

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Item 4. Controls and Procedures.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

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

Item 3. Defaults Upon Senior Securities.

Item 4. Submission of Matters to a Vote of Security Holders.

Item 5. Other Information.

Item 6. Exhibits.

SIGNATURES