MAGELLAN HEALTH SERVICES INC (Form: 10-Q, Received: 10/26/2006 16:10:43)

ATTEND/WITNESS

MAGELLAN HEALTH SERVICES, INC.

/s/ Caskie Lewis-Clapper

/s/ Daniel Gregoire

Caskie Lewis-Clapper

Print Name:

Daniel Gregoire

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(MarkOne)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2006

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File No. 1-6639

MAGELLAN HEALTH SERVICES, INC.

(Exact name of registrant as specified in its charter)

Delaware	58-1076937
(State of other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)
55 Nod Road, Avon, Connecticut	06001
(Address of principal executive offices)	(Zip code)

(860) 507-1900

(Registrant’s telephone number, including area code)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes o No x

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

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

Large accelerated filer x Accelerated filer o Non-accelerated filer o

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

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
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 x No o

The number of shares of the registrant’s Ordinary Common Stock outstanding as of September 30, 2006 was 37,759,332.

FORM 10-Q

MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES

INDEX

		Page No.
PART I—Financial Information:
Item 1:	Financial Statements	3
	Condensed Consolidated Balance Sheets—December 31, 2005 and September 30, 2006	3
	Condensed Consolidated Statements of Income—For the Three Months and Nine Months Ended September 30, 2005 (restated) and 2006	4
	Condensed Consolidated Statements of Cash Flows—For the Nine Months Ended September 30, 2005 (restated) and 2006	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
Item 3:	Quantitative and Qualitative Disclosures About Market Risk	45
Item 4:	Controls and Procedures	45
PART II—Other Information:
Item 1:	Legal Proceedings	46
Item 1A :	Risk Factors	46
Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds	50
Item 3:	Defaults Upon Senior Securities	50
Item 4:	Submission of Matters to a Vote of Security Holders	50
Item 5:	Other Information	50
Item 6:	Exhibits	51
Signatures		52

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,				September 30,
	2005				2006
					(unaudited)
ASSETS
Current Assets:
Cash and cash equivalents		$	81,039			$	128,286
Restricted cash		149,723				127,732
Accounts receivable, less allowance for doubtful accounts of $2,442 and $1,567 at December 31, 2005 and September 30, 2006, respectively		42,428				59,245
Short-term investments (restricted investments of $42,976 and $28,859 at December 31, 2005 and September 30, 2006, respectively)		236,153				38,855
Other current assets (restricted deposits of $16,498 and $19,665 at December 31, 2005 and September 30, 2006, respectively)		31,434				36,435
Total Current Assets		540,777				390,553
Property and equipment, net		102,898				96,466
Long-term investments - restricted		2,897				2,996
Investments in unconsolidated subsidiaries		15,339				—
Deferred income taxes		76,023				79,046
Other long-term assets		10,948				4,994
Goodwill		290,192				504,683
Other intangible assets, net		30,412				76,984
Total Assets		$	1,069,486			$	1,155,722
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable		$	14,834			$	17,256
Accrued liabilities		62,327				77,835
Medical claims payable		164,013				139,801
Other medical liabilities		45,557				30,168
Current maturities of long-term debt and capital lease obligations		25,194				25,197
Total Current Liabilities		311,925				290,257
Long-term debt and capital lease obligations		37,890				18,958
Deferred credits and other long-term liabilities		84,832				119,008
Minority interest		1,762				174
Total Liabilities		436,409				428,397
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, 2005 and September 30, 2006—Issued and outstanding—36,584 shares and 37,759 shares at December 31, 2005 and September 30, 2006, respectively		366				378
Multi-Vote common stock, par value $.01 per share
Authorized—40,000 shares—Issued and outstanding—none		—				—
Other Stockholders’ Equity:
Additional paid-in capital		429,933				462,937
Retained earnings		194,904				258,679
Warrants outstanding		8,489				5,384
Accumulated other comprehensive loss		(615		)		(53		)
Total Stockholders’ Equity		633,077				727,325
Total Liabilities and Stockholders’ Equity		$	1,069,486			$	1,155,722

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 September 30,						Nine Months Ended September 30,
	2005			2006			2005			2006
	(restated)						(restated)
Net revenue	$	454,266		$	429,487		$	1,371,564		$	1,229,016
Cost and expenses:
Cost of care	299,134			271,905			920,263			804,446
Cost of goods sold	—			15,212			—			15,212
Direct service costs and other operating expenses(1)	91,867			96,661			278,958			276,827
Equity in earnings of unconsolidated subsidiaries	(1,759		)	—			(4,711		)	(390		)
Depreciation and amortization	12,161			13,096			36,952			35,086
Interest expense	8,711			1,807			25,961			5,497
Interest income	(4,995		)	(4,280		)	(11,927		)	(13,418		)
Gain on sale of assets	—			—			—			(5,148		)
Special charges (benefits)	(556		)	—			(556		)	—
	404,563			394,401			1,244,940			1,118,112
Income from continuing operations before income taxes and minority interest	49,703			35,086			126,624			110,904
Provision for income taxes	16,828			13,890			49,696			47,169
Income from continuing operations before minority interest	32,875			21,196			76,928			63,735
Minority interest, net	(25		)	(40		)	47			(40		)
Income from continuing operations	32,900			21,236			76,881			63,775
Income from discontinued operations(2)	696			—			1,526			—
Net income	33,596			21,236			78,407			63,775
Other comprehensive (loss) income	44			186			(428		)	562
Comprehensive income	$	33,640		$	21,422		$	77,979		$	64,337
Weighted average number of common shares outstanding—basic (See Note D)	36,436			37,096			35,795			36,925
Weighted average number of common shares outstanding—diluted (See Note D)	37,605			39,023			37,200			38,569
Income per common share—basic:
Income from continuing operations	$	0.90		$	0.57		$	2.15		$	1.73
Income from discontinued operations	$	0.02		$	—		$	0.04		$	—
Net income	$	0.92		$	0.57		$	2.19		$	1.73
Income per common share—diluted:
Income from continuing operations	$	0.87		$	0.54		$	2.07		$	1.65
Income from discontinued operations	$	0.02		$	—		$	0.04		$	—
Net income	$	0.89		$	0.54		$	2.11		$	1.65

(1) Includes stock compensation expense of $3,855, and $8,939 for the three months ended September 30, 2005 and 2006, respectively, and $12,024 and $21,033 for the nine months ended September 30, 2005 and 2006, respectively.

(2) Net of income tax provision of $28 and $1,073 for the three months and nine months ended September 30, 2005, respectively.

See accompanying notes to condensed consolidated financial statements.

MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30,

(Unaudited)

(In thousands)

	2005			2006
	(restated)
Cash flows from operating activities:
Net income	$	78,407		$	63,775
Adjustments to reconcile net income to net cash from operating activities:
Gain on sale of assets	—			(5,148		)
Depreciation and amortization	36,952			35,086
Equity in earnings of unconsolidated subsidiaries	(4,711		)	(390		)
Non-cash interest expense	1,042			1,042
Non-cash stock compensation expense	12,024			21,033
Non-cash income tax expense	45,393			42,232
Cash flows from changes in assets and liabilities, net of effects from acquisitions of businesses:
Restricted cash	(41,121		)	22,241
Accounts receivable, net	(2,787		)	11,125
Other assets	4,604			(384		)
Accounts payable and accrued liabilities	68			(19,013		)
Medical claims payable and other medical liabilities	12,804			(39,602		)
Other	1,767			(39		)
Net cash provided by operating activities	144,442			131,958
Cash flows from investing activities:
Capital expenditures	(14,384		)	(14,999		)
Proceeds from sale of assets	—			22,200
Purchase of investments	(462,011		)	(29,589		)
Maturity of investments	331,642			227,534
Acquisitions and investments in businesses, net of cash acquired	—			(282,806		)
Proceeds from note receivable	7,000			3,000
Net cash used in investing activities	(137,753		)	(74,660		)
Cash flows from financing activities:
Payments on long-term debt and capital lease obligations	(19,266		)	(18,929		)
Proceeds from exercise of stock options and warrants	12,787			8,878
Net cash used in financing activities	(6,479		)	(10,051		)
Net increase in cash and cash equivalents	210			47,247
Cash and cash equivalents at beginning of period	45,390			81,039
Cash and cash equivalents at end of period	$	45,600		$	128,286

See accompanying notes to condensed consolidated financial statements.

MAGELLAN HEALTH SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2006

(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 three months and nine months ended September 30, 2006 are not necessarily indicative of the results to be expected for the full year. All intercompany accounts and transactions have been eliminated in consolidation.

These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2005 and the notes thereto, which are included in the Company’s Annual Report on Form 10-K filed with the SEC on March 8, 2006.

Restatements of Previously Issued Unaudited Condensed Consolidated Financial Statements

On March 7, 2006, the Company announced that it was restating previously filed financial statements to correct the Company’s accounting for reversals of valuation allowances pertaining to deferred tax assets (excluding deferred tax assets related to the Company’s net operating loss carryforwards) that existed prior to the Company’s emergence from bankruptcy on January 5, 2004. The Company had recorded the reversals of valuation allowances for such deferred tax assets as reductions to the Company’s income tax provision. In accordance with American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) 90-7, “Financial Reporting by Entities in Reorganization Under the Bankruptcy Code” (“SOP 90-7”), and the Financial Accounting Standard Board’s Emerging Issues Task Force (“EITF”) Topic No. D-33, “Timing of Recognition of Tax Benefits for Pre-Reorganization Temporary Differences and Carryforwards” (“EITF D-33”), such reversals of valuation allowances should be recorded as reductions to goodwill. Accordingly, the Company has restated its consolidated financial statements for the fiscal year ended December 31, 2004, and for the quarters ended March 31, 2004, June 30, 2004, September 30, 2004, December 31, 2004, March 31, 2005, June 30, 2005 and September 30, 2005. All applicable financial information contained in this Form 10-Q gives effect to these restatements.

The quarterly impacts of the restatement adjustments for the three months and nine months ended September 30, 2005 are reflected below (in thousands, except per share amounts):

	Three months ended			Nine months ended
	September 30,			September 30,
	2005			2005
Net revenue		$ —			$ —
Cost and expenses:
Cost of care		—			—
Direct service costs and other operating expenses		—			—
Equity in earnings of unconsolidated subsidiaries		—			—
Depreciation and amortization		—			—
Interest expense		—			—
Interest income		—			—
Gain on sale of assets		—			—
Special charges (benefits)		—			—
		—			—
Income from continuing operations before income taxes and minority interest		—			—
Provision for income taxes		595			1,517
Income (loss) from continuing operations before minority interest		(595	)		(1,517	)
Minority interest, net		—			—
Income (loss) from continuing operations		(595	)		(1,517	)
Income (loss) from discontinued operations, net of income taxes		(208	)		(746	)
Net income (loss)		(803	)		(2,263	)
Income (loss) available to common stockholders		$ (803	)		$(2,263	)
Weighted average number of common shares outstanding—basic		36,436			35,795
Weighted average number of common shares outstanding—diluted		37,605			37,200
Income per common share—basic:
Income (loss) from continuing operations		$ (0.02	)		$ (0.04	)
Income (loss) from discontinued operations		$ —			$ (0.02	)
Net income (loss)		$ (0.02	)		$ (0.06	)
Income per common share—diluted:
Income (loss) from continuing operations		$ (0.02	)		$ (0.04	)
Income (loss) from discontinued operations		$ —			$ (0.02	)
Net income (loss)		$ (0.02	)		$ (0.06	)

The weighted average number of common shares outstanding, both basic and diluted, are not affected by the restatement.

Summary of Significant Accounting Policies

Use of Estimates

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 is recognized over the applicable coverage period on a per member basis for covered members. Managed care risk revenues approximated $405.5 million and $1,221.1 million for the three months and nine months ended September 30, 2005, respectively, and $360.9 million and $1,063.4 million for the three months and nine months ended September 30, 2006, respectively.

Performance-based Revenue

The Company has the ability to earn performance-based revenue under certain risk and non-risk contracts included in the managed behavioral healthcare and radiology benefits management lines of business. Performance-based revenue generally is based on either the ability of the Company to manage care for its clients below specified targets, or on other operating metrics. For each such contract, the Company estimates and records performance-based revenue after considering the relevant contractual terms and the data available for the performance-based revenue calculation. Pro-rata performance-based revenue is recognized on an interim basis pursuant to the rights and obligations of each party upon termination of the contracts. Performance-based revenues were $2.9 million and $9.8 million for the three months and nine months ended September 30, 2005, respectively, and $3.9 million and $11.0 million for the three months and nine months ended September 30, 2006, respectively.

Significant Customers

Managed Behavioral Healthcare

The Company’s contracts with the State of Tennessee’s TennCare program (“TennCare”) and with subsidiaries of WellPoint, Inc. (“WellPoint”), each generated revenues that exceeded, in the aggregate, ten percent of managed behavioral healthcare net revenues for each of the three months and nine months ended September 30, 2005 and 2006. The Company also has a significant concentration of business from individual counties which are part of the Pennsylvania Medicaid program.

The Company provides managed behavioral healthcare services for TennCare, through contracts held by the Company’s wholly owned subsidiaries Tennessee Behavioral Health, Inc. (“TBH”) and Premier Behavioral Health Systems of Tennessee, LLC (“Premier”). Prior to April 11, 2006 Premier was a joint venture in which the Company owned a fifty percent interest; however the Company consolidated the results of operations of Premier, the joint venture, in the Company’s consolidated statements of income. On April 11, 2006, the Company purchased the other fifty percent interest in Premier for $1.5 million, so that Premier is now a wholly-owned subsidiary of the Company. TennCare has divided its program into three regions, and the Company’s TennCare contracts, which extend through September 30, 2007, currently encompass all of the TennCare membership for all three regions. The Company recorded revenue of $108.1 million and $334.8 million during the three months and nine months ended September 30, 2005, respectively, and $101.8 million and $312.1 million during the three months and nine months ended September 30, 2006, respectively, from its TennCare contracts.

On April 7, 2006, TennCare issued a Request for Proposals (“RFP”) for the management of the integrated delivery of behavioral and physical medical care to TennCare enrollees in the Middle region by managed care organizations. On July 26, 2006, TennCare announced the two winning bidders to the RFP process, neither of which had partnered with the Company, and a start date of April 1, 2007 at which time the Company’s contracts with TennCare will be amended to remove the Middle region enrollees. For the

three months and nine months ended September 30, 2006, revenue derived from TennCare enrollees residing in the Middle region amounted to $36.7 million and $113.9 million, respectively.

Total revenue from the Company’s contracts with WellPoint was $51.3 million and $155.7 million during the three months and nine months ended September 30, 2005, respectively, and $49.9 million and $148.3 million during the three months and nine months ended September 30, 2006, respectively. Included in the revenue amount for the three months and nine months ended September 30, 2006 is revenue of $3.2 million and $9.4 million from contracts that National Imaging Associates, Inc. (“NIA”) has with WellPoint (see Note B for discussion of the Company’s acquisition of NIA).

On September 6, 2006, the Company announced that it was notified by WellPoint of its intent to terminate its contract with the Company for the management of behavioral healthcare services for its commercial members in Indiana, Kentucky and Ohio (the “Midwest contract”), effective March 31, 2007. The Midwest contract had been set to expire on December 31, 2007; however, WellPoint notified the Company of its intent to exercise its right under the Midwest contract to terminate without cause with six months’ notice. For the nine months ended September 30, 2006, the Midwest contract generated revenue of $73.4 million. The Company has two other managed behavioral healthcare contracts with WellPoint that generated revenue of $65.5 million for the nine months ended September 30, 2006. Each of these contracts has a term expiring on December 31, 2007, neither contract has an early termination provision similar to that contained in the Midwest contract and the Company has not received notice of a change in the status of these contracts. The contracts with respect to the management of radiology benefits through the Company’s NIA subsidiary are unrelated to and unaffected by WellPoint’s decision regarding behavioral healthcare management for the Midwest contract.

The Company derives a significant portion of its revenue from contracts with various counties in the State of Pennsylvania (the “Pennsylvania Counties”). Although these are separate contracts with individual counties, they all pertain to the Pennsylvania Medicaid program. Revenues from the Pennsylvania Counties in the aggregate totaled $54.2 million and $159.7 million in the three months and nine months ended September 30, 2005, respectively, and $62.1 million and $186.1 million in the three months and nine months ended September 30, 2006, respectively.

The Company recorded net revenue from Aetna, Inc. (“Aetna”) of $61.8 million and $184.5 million for the three months and nine months ended September 30, 2005, respectively, which represented in excess of ten percent of the managed behavioral healthcare net revenues of the Company for such periods. The Company’s contract with Aetna terminated on December 31, 2005. During the three months and nine months ended September 30, 2006, the Company recognized $0.6 million and $6.0 million of revenue related to the performance of one-time, transitional activities associated with the contract termination.

Radiology Benefits Management and Specialty Pharmaceutical Management

Included in the Company’s Radiology Benefits Management line of business are three customers that each exceeds 10 percent of the net revenues for this line of business. The three customers represent 30.7 percent, 12.0 percent and 11.1 percent, respectively, of the net revenues for Radiology Benefits Management for the year to date period through September 30, 2006. The second customer discussed above has contracts with the Company for three geographical markets, and such customer has informed the Company that the contracts for two of these markets will terminate effective December 31, 2006.

Included in the Company’s Specialty Pharmaceutical Management line of business are three customers that each exceeds 10 percent of the net revenues for this line of business. The three customers represent 49.4 percent, 17.2 percent and 14.8 percent, respectively, of the net revenues for Specialty Pharmaceutical Management for the year to date period through September 30, 2006.

Cash and Cash Equivalents

Cash equivalents are short-term, highly liquid interest-bearing investments with maturity dates of three months or less when purchased, consisting primarily of money market instruments. Included in cash and cash equivalents are excess capital and undistributed earnings for its regulated subsidiaries, which as of September 30, 2006 was $47.4 million.

Restricted Assets

The Company has certain assets which are considered restricted for: (i) the payment of claims under the terms of certain managed behavioral healthcare contracts; (ii) regulatory purposes related to the payment of claims in certain jurisdictions; and (iii) the maintenance of minimum required tangible net equity levels for certain of the Company’s subsidiaries. Significant restricted assets of the Company as of December 31, 2005 and September 30, 2006 were as follows (in thousands):

	December 31, 2005		September 30, 2006
Restricted cash		$ 149,723		$ 127,732
Restricted short-term investments		42,976		28,859
Restricted deposits (included in other current assets)		16,498		19,665
Restricted long-term investments		2,897		2,996
Total		$ 212,094		$ 179,252

Investments

The Company accounts for its investments in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”).

As of September 30, 2006, there were no unrealized losses that the Company believed to be other-than-temporary, because the Company believes it is probable that: (i) all contractual terms of each investment will be satisfied, (ii) the decline in fair value is due primarily to changes in interest rates (and not because of increased credit risk), and (iii) the Company intends and has the ability to hold each investment for a period of time sufficient to allow a market recovery. Unrealized losses related to investments greater and less than one year are not material. No realized gains or losses were recorded for the three months and nine months ended September 30, 2005 and 2006. The following is a summary of short-term and long-term investments at December 31, 2005 and September 30, 2006 (in thousands):

	December 31, 2005
		Gross		Gross
	Amortized	Unrealized		Unrealized			Estimated
	Cost	Gains		Losses			Fair Value
U.S. Government and agency securities	$ 63,783		$—		$(158	)	$ 63,625
Corporate debt securities	175,580		—		(457	)	175,123
Certificates of deposit	302		—		—		302
Total investments at December 31, 2005	$ 239,665		$—		$(615	)	$ 239,050

	September 30, 2006
			Gross		Gross
	Amortized		Unrealized		Unrealized			Estimated
	Cost		Gains		Losses			Fair Value
U.S. Government and agency securities		$ 24,657		$—		$(12	)		$24,645
Corporate debt securities		17,000		—		(41	)		16,959
Certificates of deposit		247		—		—			247
Total investments at September 30, 2006		$ 41,904		$—		$(53	)		$41,851

The maturity dates of the Company’s investments as of September 30, 2006 are summarized below (in thousands):

	Amortized			Estimated
	Cost			Fair Value
Due prior to October 1, 2007		$	38,900		$	38,855
Due October 1, 2007 to April 30, 2008		3,004			2,996
Total investments at September 30, 2006		$	41,904		$	41,851

Goodwill

Goodwill is accounted for in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). Pursuant to SFAS 142, the Company is required to test its goodwill for impairment on at least an annual basis. The Company has selected October 1 as the date of its annual impairment test. The balance of goodwill has been allocated as follows (in thousands):

	December 31,			September 30,
	2005			2006
Health Plan segment (defined below)		$	290,192		$	254,090
Radiology Benefits Management segment (defined below)		—			105,854
Specialty Pharmaceutical Management segment (defined below)		—			144,739
Total		$	290,192		$	504,683

The changes in the carrying amount of Company goodwill for the nine months ended September 30, 2006 are reflected in the table below (in thousands):

Balance as of December 31, 2005	$	290,192
Adjustment to goodwill as a result of the projected realization of net operating loss carryforwards subsequent to fresh-start reporting(1)	(36,102		)
Adjustment to goodwill as a result of the acquisition of National Imaging Associates, Inc. (“NIA”)—See Note B	105,854
Adjustment to goodwill as a result of the acquisition of ICORE Healthcare LLC (“ICORE”)—See Note B	144,739
Balance as of September 30, 2006	$	504,683

(1) During fiscal 2006, the Company recorded tax benefits from the utilization of deferred tax assets, including net operating loss carryforwards (“NOLs”), that existed prior to the Company’s emergence from bankruptcy on January 5, 2004. These tax benefits have been reflected as reductions of goodwill in accordance with SOP 90-7.

Intangible Assets

At December 31, 2005 and September 30, 2006, the Company had net identifiable intangible assets (primarily customer agreements and lists and provider networks) of approximately $30.4 million and $77.0 million, respectively, net of accumulated amortization of approximately $17.3 million and $25.7 million, respectively. Intangible assets are amortized over their estimated useful lives, which range from approximately three to sixteen years. Amortization expense was $3.4 million and $10.4 million for the three months and nine months ended September 30, 2005, respectively, and $3.5 million and $8.5 million for the three months and nine months ended September 30, 2006, respectively.

Cost of Care, Medical Claims Payable and Other Medical Liabilities

Cost of care is recognized in the period in which members received managed healthcare services. In addition to actual benefits paid, cost of care includes the impact of accruals for estimates of medical claims payable. Medical claims payable represents the liability for healthcare claims reported but not yet paid and claims incurred but not yet reported (“IBNR”) related to the Company’s managed healthcare businesses. The IBNR portion of medical claims payable is estimated based on past claims payment experience for member groups, enrollment data, utilization statistics, authorized healthcare services and other factors. This data is incorporated into contract-specific actuarial reserve models. Although considerable variability is inherent in such estimates, management believes the liability for medical claims payable is adequate. Medical claims payable balances are continually monitored and reviewed. Changes in assumptions for cost of care caused by changes in actual experience could cause the estimates to change in the near term. The Company believes that the amount of medical claims payable is adequate to cover its ultimate liability for unpaid claims as of September 30, 2006; however, actual claims payments and other items may differ from established estimates.

Other medical liabilities consist primarily of “reinvestment” payables under certain managed behavioral healthcare contracts with Medicaid customers. Under this type of contract, if the cost of care is less than certain minimum amounts specified in the contract (usually as a percentage of revenue), the Company is required to “reinvest” such difference in behavioral healthcare programs when and as specified by the customer or to pay the difference to the customer for their use in funding such programs.

Cost of Goods Sold

Cost of goods sold represents the net purchase cost of specialty pharmaceutical medicines and related medical supplies distributed to customers related to the Company’s Specialty Pharmaceutical Management segment (see Note F). Inventories of $3.7 million at September 30, 2006 consist of pharmaceutical medicines and related medical supplies, stated at lower of cost or market, and are included in other current assets within the accompanying condensed consolidated balance sheet. The Company accounts for such inventory on the first-in, first-out method.

Income Taxes

The Company’s effective income tax rate was 33.9 percent and 39.2 percent for the three months and nine months ended September 30, 2005 (restated), respectively, and 39.6 percent and 42.5 percent for the three months and nine months ended September 30, 2006, respectively. The effective rates for such periods differ from federal statutory income tax rates primarily due to state income taxes and permanent differences between book and tax income.

Stock Compensation

At December 31, 2005 and September 30, 2006, the Company had equity-based employee incentive plans, which are described below.

Stock Option Awards

On January 5, 2004, (the “Effective Date”), the Company established the 2003 Management Incentive Plan (“2003 MIP”) which allows for the issuance of up to 6,373,689 shares of common stock pursuant to stock options or stock grants. During fiscal 2004, the Company granted options for the purchase of 4.4 million shares of common stock at a weighted average grant date fair value of approximately $14.61 per share. These options vest ratably on each anniversary date over the three to four years subsequent to grant, and have a 10 year life. During fiscal 2005, the Company granted options for the purchase of 1.1 million shares of common stock at a weighted average grant date fair value of

approximately $10.90 per share. These options vest ratably on each anniversary date over the four years subsequent to grant, and have a 10 year life. Other than the 2004 Options (defined below) and certain options granted under the 2006 MIP (defined below), options granted by the Company have exercise prices equal to the fair market value on the date of grant.

Summarized information relative to the Company’s stock options issued under the 2003 MIP for the years ended December 31, 2004 and 2005 is as follows:

	2004					2005
	Options		Weighted Average Exercise Price			Options		Weighted Average Exercise Price
Balance, beginning of period	—			$	—	4,220,222			$	13.34
Granted	4,402,522			13.34		1,115,185			34.28
Cancelled	(182,300	)		16.10		(255,947	)		27.58
Exercised	—			—		(1,064,749	)		12.48
Balance, end of period	4,220,222			$	13.34	4,014,711			$	18.50
Exercisable, end of period	—			$	—	30,045			$	33.05

The fair values of the stock options granted were estimated on the date of their grant using the Black-Scholes-Merton option pricing model based on the following weighted average assumptions for the years ended December 31, 2004 and 2005:

	2004
	Senior Executive Options			Other Options		2005
Risk-free interest rate		3.35	%	2.97	%	4.00	%
Expected life		5 years		4 years		4 years
Expected volatility		39.10	%	37.80	%	32.50	%
Expected dividend yield		0.00	%	0.00	%	0.00	%

The following table illustrates pro forma net income and pro forma net income per share as if the fair value-based method of accounting for stock options under SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) had been applied in measuring stock compensation expense for all awards for the three months and nine months ended September 30, 2005 (in thousands, except per share data):

	Three Months Ended				Nine Months Ended
	September 30, 2005
	(restated)
Net income, as reported		$	33,596			$	78,407
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects		3,626				10,901
Deduct: Total stock-based employee compensation expense determined under fair value method, net of related tax effects		(5,371		)		(15,622		)
Pro forma net income		$	31,851			$	73,686
Income per common share:
Basic—as reported		$	0.92			$	2.19
Basic—pro forma		$	0.87			$	2.06
Diluted—as reported		$	0.89			$	2.11
Diluted—pro forma		$	0.85			$	1.98

On February 24, 2006, the board of directors of the Company approved three equity plans and recommended they be submitted for approval by the Company’s shareholders at the 2006 Annual Meeting of Shareholders. The board approved the 2006 Management Incentive Plan (“2006 MIP”), the 2006 Director Equity Compensation Plan (“Director Plan”) and the 2006 Employee Stock Purchase Plan (“ESPP”). All three of these plans were approved by the Company’s shareholders at the 2006 Annual Meeting of Shareholders on May 16, 2006.

The 2006 MIP, which is similar to the Company’s 2003 MIP, authorizes the issuance of equity awards covering a total of 2,750,000 shares of the Company’s common stock, no more than 300,000 shares of which may be restricted stock or restricted stock units. A restricted stock unit is a notional account representing the right to receive a share of Ordinary Common Stock (or, at the Company’s option, cash in lieu thereof) at some future date. Under the 2006 MIP, the exercisability of certain options and the vesting of certain restricted stock units is subject to certain performance targets. The Director Plan covers 120,000 shares of the Company’s common stock, no more than 15,000 of which may be restricted stock or restricted stock units, and provides for the issuance of options and restricted stock or restricted stock units to directors immediately following each annual meeting of shareholders in 2006 and 2007. The ESPP is a noncompensatory plan and covers 100,000 shares of the Company’s common stock and permits employees of the Company to purchase Common Stock at a 5 percent discount. The initial period of activity for the ESPP is August 1, 2006 through December 31, 2006.

Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123 (revised 2004) “Share-Based Payment” (“SFAS 123R”), using the modified prospective transition method and therefore has not restated results for prior periods. Under this transition method, stock compensation expense for the three months and nine months ended September 30, 2006 includes stock compensation expense for all awards granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123. Stock compensation expense for all awards granted after January 1, 2006 is based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. The Company recognizes stock compensation expense on a straight-line basis over the requisite service period, which is generally the option vesting term ranging from three to four years. Prior to the adoption of SFAS 123R, the Company recorded stock compensation expense under Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”).

The Company uses the Black-Scholes-Merton formula to estimate the fair value of stock options granted to employees and recorded stock compensation expense of $8.9 million and $21.0 million for the three months and nine months ended September 30, 2006, respectively. As stock compensation expense recognized in the condensed consolidated statements of income for the three months and nine months ended September 30, 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures, currently estimated at four percent, as required by SFAS 123R. In the Company’s pro forma information that was required under SFAS 123 for the periods prior to January 1, 2006, the Company accounted for its forfeitures as they occurred. The impact of adopting SFAS 123R to the condensed consolidated financial statements for the three months and nine months ended September 30, 2006 was a reduction to net income of $1.8 million and $4.1 million, respectively, or a decrease of $0.05 and $0.11, respectively, on both basic and fully-diluted income per common share.

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 months and nine months ended September 30, 2006, 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.

The weighted average grant date fair value of the stock options granted during the nine months ended September 30, 2006 was $14.20 as estimated using the Black-Scholes-Merton option-pricing model based on the following weighted average assumptions:

Risk-free interest rate	4.83	%
Expected life	4 years
Expected volatility	29.90	%
Expected dividend yield	0.00	%

As part of its SFAS 123R adoption, management determined that volatility based on actively traded equities of companies that are similar to the Company is a better indicator of expected volatility and future stock price trends than the Company’s historical volatility, due to the lack of sufficient history of the Company subsequent to the Company’s emergence from bankruptcy on the Effective Date.

Summarized information related to the Company’s stock options for the nine months ended September 30, 2006 is as follows:

						Weighted
			Weighted			Average		Aggregate
			Average			Remaining		Intrinsic
			Exercise			Contractual		Value
	Options		Price			Term (in years)		(in thousands)
Outstanding, beginning of period	4,014,711			$	18.50
Granted	1,620,484			37.10
Cancelled	(198,928	)		24.57
Exercised	(481,757	)		18.39
Outstanding, end of period	4,954,510			$	24.35		6.97		$	91,780
Vested and expected to vest at end of period	4,778,185			$	24.11		0.87		$	89,639
Exercisable, end of period	190,979			$	32.70		8.23		$	1,921

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (based upon the difference between the Company’s closing stock price on the last trading day of the fiscal 2006 third quarter of $42.60 and the exercise price) for all in-the-money options as of September 30, 2006. This amount changes based on the fair market value of the Company’s stock. The total pre-tax intrinsic value of options exercised (based on the difference between the Company’s closing stock price on the day the option was exercised and the exercise price) during the nine months ended September 30, 2006 was $9.9 million.

As of September 30, 2006, there was $33.0 million of total unrecognized stock compensation expense related to nonvested stock options that is expected to be recognized over a weighted average remaining recognition period of 2.56 years. The total fair value of shares vested during the three months and nine months ended September 30, 2006 was $0 million and $9.4 million, respectively.

During the nine months ended September 30, 2006, the Company granted 956,002 options to members of management at a weighted average grant date fair value of approximately $13.35 and at an exercise price of $38.52, which was equal to the price of the Company’s stock on February 24, 2006, the date that the option grants were approved by the board of directors of the Company.

The Company granted an additional 199,463 options pursuant to the January 31, 2006 acquisition of NIA (see Note B below), including 99,463 Incentive Stock Options (“ISOs”). The weighted average grant date fair value of the 100,000 options, other than ISOs, granted to NIA employees was approximately $11.01. The 99,463 ISOs were granted to three employees previously employed by NIA in exchange for

outstanding NIA incentive stock options held by such individuals and were granted at exercise prices that ranged from $4.44 to $7.66 per share, which prices were determined based on the exercise price of the NIA options exchanged times the exchange ratio equal to the price of the Company’s stock at closing to the purchase price per share of NIA paid by the Company in the acquisition. The options had a weighted average grant date fair value of approximately $32.24. Stock compensation expense related to the ISOs for the three months and nine months ended September 30, 2006 was approximately $0.3 million and $0.7 million, respectively. The remaining 465,019 options granted to management in the nine months ended September 30, 2006 were granted at exercise prices which equaled the fair market value of the Company’s Ordinary Common Stock on the respective grant dates, which included options to purchase 222,319 shares granted upon exercise of 2004 Options (defined below) pursuant to the amendments as described below.

Substantially all of the Company’s options granted during the nine months ended September 30, 2006 vest ratably on each anniversary date over the three years subsequent to grant, and all have a ten year life.

At September 30, 2006, 2,508,691 shares of the Company’s common stock remain available for future grant under the Company’s 2003 MIP and the 2006 MIP. At September 30, 2006, 73,758 shares of the Company’s common stock remain available for future grant under the 2006 Director Plan.

Restricted Stock Awards

During the year ended December 31, 2005, the Company granted 140,636 shares of restricted stock pursuant to the 2003 MIP, 14,507 of which were vested and 126,129 of which vest ratably on each anniversary date over the four years subsequent to grant. Of these grants, 10,872 shares were cancelled pursuant to terminations of employment, resulting in a total of 115,257 outstanding unvested shares of restricted stock at December 31, 2005.

Summarized information related to the Company’s nonvested restricted stock awards for the nine months ended September 30, 2006 is as follows:

			Weighted Average
			Grant Date
	Shares		Fair Value
Outstanding, beginning of period	115,257			$	34.06
Awarded	550,629			$	44.06
Vested	(25,493	)		$	34.57
Forfeited	(8,243	)		$	34.57
Outstanding, end of period	632,150			$	42.74

On July 31, 2006, pursuant to the Company’s purchase of ICORE, the Company granted to the unitholders of ICORE, 543,879 shares of restricted stock of the Company valued at $24.0 million, which stock will vest over three years, provided that the unitholders do not earlier terminate their employment with the Company or any subsidiary of the Company. The remaining 6,750 restricted stock awards granted in the nine months ended September 30, 2006 vest ratably on each anniversary date over the three years subsequent to grant. As of September 30, 2006, there was $23.1 million of unrecognized stock compensation expense related to nonvested restricted stock awards. This cost is expected to be recognized over a weighted-average period of 2.78 years

Restricted Stock Units

During the nine months ended September 30, 2006, the Company granted 121,080 restricted stock units pursuant to the 2006 MIP which vest ratably on each anniversary date over the three years subsequent to grant. As of September 30, 2006, there was $4.1 million of unrecognized stock compensation expense related to nonvested restricted stock units. This cost is expected to be recognized over a weighted-average period of 2.42 years.

Option Modification

On January 3, 2006, the Company amended certain stock options outstanding under the 2003 MIP. The amendments, as further described below, were intended primarily to bring the features of such options into compliance with certain requirements established by Section 409A of the Internal Revenue Code of 1986, as amended (the “Code”), which was added to the Code by the American Jobs Creation Act of 2004 and governs as a general matter the federal income tax treatment of deferred compensation. The amended options were originally issued in connection with the consummation of the Plan, which occurred on the Effective Date (the “2004 Options”). Because the exercise price of such 2004 Options may be considered to have been less than the fair market value of the shares that may be acquired upon exercise of such options as determined by the market trading in such shares following the consummation of the Plan, such options might be subject to the provisions of Section 409A, including certain penalty tax provisions on the option holders.

The amendments in each case reduced the period in which the 2004 Options, once vested, could be exercised from the tenth anniversary of the date of grant to the end of the calendar year in which each option first becomes exercisable. The vesting schedule of the options was not changed and no change was made in the exercise price or other material terms.

In addition, the 2004 Options issued to the Company’s Chief Executive Officer, Chief Operating Officer and Chief Financial Officer (the “Senior Executives”) were also amended to defer until January 5, 2007 the exercisability of all but 137,398 of their options that vest in January 2006. This deferral was agreed upon in connection with the waiver by the Company of the restriction on sale before January 5, 2007 of 413,003 shares held by the Senior Executives, that they had previously acquired upon exercise of a portion of their 2004 Options that vested in January 2005.

In connection with these amendments, the Company agreed to grant new options to option holders, other than the Senior Executives, upon exercise of their 2004 Options. The new options will be in an amount equal to the number of options exercised, will have exercise prices equal to the market price on the date of grant and will vest ratably on each anniversary date over the three years subsequent to grant. In the nine months ended September 30, 2006, options to purchase 222,319 shares were granted pursuant to these amendments upon exercise of 2004 Options during this period.

Common Stock Warrants

On the Effective Date, Magellan and 88 of its subsidiaries consummated their Third Joint Amended Plan of Reorganization, as modified and confirmed (the “Plan”). Under the Plan, the Company issued 570,825 warrants to purchase common stock of the Company at a purchase price of $30.46 per share at anytime until January 5, 2011. As of September 30, 2006, 570,381 of these warrants remain outstanding. Also on the Effective Date and pursuant to the Plan, the Company entered into a warrant agreement with Aetna whereby Aetna had the option to purchase, between January 1, 2006 and January 5, 2009, 230,000 shares of Ordinary Common Stock at a purchase price of $10.48 per share. On January 30, 2006, Aetna effected a cashless exercise for all of their warrants, which resulted in 150,815 shares being issued to Aetna.

Recent Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109” (“FIN 48”), which prescribes a minimum recognition threshold and measurement methodology for tax positions taken or expected to be taken in a tax return. FIN 48 will be effective beginning January 1, 2007. The Company has not yet evaluated the impact of implementation of FIN 48 on its consolidated financial statements.

Reclassifications

Certain amounts previously reported for the three months and nine months ended September 30, 2005 have been reclassified to conform to the presentation of amounts reported for the three months and nine months ended September 30, 2006.

NOTE B—Acquisitions

Acquisition of National Imaging Associates

On January 31, 2006, the Company acquired all of the outstanding stock of NIA, a privately held radiology benefits management (“RBM”) firm headquartered in Hackensack, New Jersey, for approximately $121 million in cash, after giving effect to cash acquired in the transaction, and NIA became a wholly owned subsidiary of Magellan.

NIA manages diagnostic imaging services on a non-risk basis for its health plans to ensure that such services are clinically appropriate and cost effective. NIA has approximately 17.3 million covered lives under contract as of September 30, 2006. The Company reports the results of operations of NIA as a separate segment entitled Magellan Radiology Benefits Management (“Radiology Benefits Management”). See Note F—Business Segment Information.

The estimated fair values of NIA assets acquired and liabilities assumed at the date of the acquisition are summarized as follows (in thousands):

Assets acquired:
Current assets	$	9,927
Property and equipment, net	5,998
Other assets	85
Goodwill	105,854
Other identified intangible assets	13,530
Total assets acquired	135,394
Liabilities assumed:
Current liabilities	5,626
Total liabilities assumed	5,626
Net assets acquired	$	129,768

The purchase price has been allocated based upon the estimated fair value of net assets acquired at the date of acquisition. A portion of the excess purchase price over tangible net assets acquired has been allocated to identified intangible assets totaling $13.5 million, consisting of customer contracts in the amount of $12.6 million, which is being amortized over 10 years, and developed software in the amount of $0.9 million, which is being amortized over 5 years. In addition, the excess of purchase price over tangible net assets and identified intangible assets acquired resulted in $105.9 million of non-tax deductible goodwill.

As a result of the acquisition of NIA, the Company approved an exit plan for certain NIA operations and activities. The Company’s plan to exit certain facilities of NIA resulted in assumed liabilities of $0.7 million to terminate an initial estimate of 25 employees and $0.4 million to close excess facilities, which were recorded based on EITF No. 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination.” Such assumed liabilities are reflected in accrued liabilities in the condensed consolidated financial statements. Additional liabilities may be recognized in future periods as the Company completes its analysis of this acquisition. A rollforward of exit plan liabilities assumed is as follows (in thousands):

	Balance										Balance
	January 31, 2006			Additions			Payments				September 30, 2006
Type of Cost
Employee severance and termination benefits		$	654		$	—		$	(311	)		$	343
Lease termination and other costs		362			—			(60		)		302
		$	1,016		$	—		$	(371	)		$	645

Acquisition of ICORE Healthcare, LLC

On July 31, 2006, pursuant to the Agreement and Plan of Merger (the “Merger Agreement”), dated as of June 27, 2006, among Magellan Health Services, Inc. (“Magellan”), Green Spring Health Services Inc. (a wholly-owned subsidiary of Magellan) (“Green Spring”), Magellan Sub Co. II, Inc. (a wholly-owned subsidiary of Green Spring), ICORE Healthcare LLC (“ICORE”), a Delaware limited liability company, and Raju Mantena as representative of the unitholders of ICORE, Magellan Sub Co. II, Inc. merged with and into ICORE (the “Merger”). As a result of the Merger, Magellan became the owner of all outstanding units of membership interest of ICORE, which will now operate as an indirect wholly-owned subsidiary of Magellan.

As consideration for the Merger, the Company paid or agreed to pay to the previous unitholders of ICORE, all of whom are members of ICORE’s management team, (i) $161 million of cash at closing; (ii) $24 million of restricted stock of Magellan with such restricted stock vesting over three years, provided the unitholders do not earlier terminate their employment with Magellan; (iii) $25 million plus accrued interest (the “Deferred Payment”) on the third anniversary of the Closing, subject to any indemnity claims Magellan may have under the agreement; (iv) the amount of positive working capital that existed at ICORE on the closing date (the “Working Capital Payments”), which is currently estimated to be $19.7 million and which is payable in installments ending 30 days after the final reconciliation of working capital is determined on the first anniversary of the closing; and (v) a potential earn-out of up to $75 million (the “Earn-Out”). The $161 million of cash paid at closing, the $25 million Deferred Payment and $19.7 of estimated Working Capital Payments were recorded as purchase price. The $24 million of restricted stock is being recognized as stock compensation expense over the three year vesting period. The Deferred Payment and the remaining estimated Working Capital Payments are included in Deferred Credits and Other Long-Term Liabilities and in Accrued liabilities, respectively, on the Company’s accompanying condensed consolidated balance sheet as of September 30, 2006. The earn-out has two parts: (i) up to $25 million based on earnings for the 18 month period ending December 31, 2007 and (ii) up to $50 million based on earnings in 2008. The earn-out, if earned, is payable 33 percent in cash and 67 percent in restricted stock of Magellan that vests over two years after issuance. Any earn-out earned will be recognized as compensation expense over the applicable reporting period.

ICORE is engaged in providing specialty pharmaceutical services to managed care organizations. 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 storage needs. ICORE’s specialty pharmaceutical services include (i) the distribution of 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. ICORE holds contracts with approximately 29 health plans, after

consolidating health plans under common control, and 9 pharmaceutical manufacturers as of September 30, 2006.

The Company reports the results of operations of ICORE as a separate segment entitled Magellan Specialty Pharmaceutical Management (“Specialty Pharmaceutical Management”). See Note F—Business Segment Information.

The estimated fair values of ICORE assets acquired and liabilities assumed at the date of the acquisition are summarized as follows (in thousands):

Assets acquired:
Current assets	$	31,920
Property and equipment, net	752
Other assets	31
Goodwill	144,739
Other identified intangible assets	41,500
Total assets acquired	218,942
Liabilities assumed:
Current liabilities	12,238
Total liabilities assumed	12,238
Net assets acquired	$	206,704

The purchase price has been allocated based upon the estimated fair value of net assets acquired at the date of acquisition. A portion of the excess purchase price over tangible net assets acquired has been allocated to identified intangible assets totaling $41.5 million, consisting of customer contracts which are being amortized over 3 to 10 years. In addition, the excess of purchase price over tangible net assets and identified intangible assets acquired resulted in $144.7 million of tax deductible goodwill. The Company’s tax provision will not be impacted by the tax deductible goodwill from the ICORE transaction.

Pro Forma Financial Information

The following unaudited supplemental pro forma information represents the Company’s consolidated results of operations for the three and nine months ended September 30, 2005 as if the acquisitions of NIA and ICORE had occurred on January 1, 2005 and for the three and nine months ended September 30, 2006 as if the acquisition of ICORE had occurred on January 1, 2006, in all cases after giving effect to certain adjustments including interest income, depreciation and amortization, and stock compensation expense. The results of NIA have been included in the Company’s consolidated financial statements since January 31, 2006, the date of acquisition. Had NIA’s results of operations been included in the Company’s results of operations since January 1, 2006, there would have been no material effect on the Company’s consolidated results of operations.

Such pro forma information does not purport to be indicative of operating results that would have been reported had the acquisitions of NIA and ICORE occurred on January 1, 2005 and 2006 (in thousands):

	Pro Forma
	(unaudited)
	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2005		2006		2005		2006
Net revenue	$	479,202	$	438,936	$	1,440,103	$	1,296,053
Net income	33,221		21,097		77,294		63,721
Income per common share—basic:	$	0.91	$	0.57	$	2.16	$	1.72
Income per common share—diluted:	$	0.88	$	0.54	$	2.08	$	1.64

NOTE C—Long Term Debt and Capital Lease Obligations

Information with regard to the Company’s long-term debt and capital lease obligations at December 31, 2005 and September 30, 2006 is as follows (in thousands):

	December 31,				September 30,
	2005				2006
Credit Agreement:
Revolving Loan Facility due through 2008		$	—			$	—
Term Loan Facility (7.17% at September 30, 2006) due through 2008		62,500				43,750
4.36% to 6.00% capital lease obligations due through 2008		584				405
		63,084				44,155
Less current maturities of long-term debt and capital lease obligations		(25,194		)		(25,197		)
		$	37,890			$	18,958

NOTE D—Income per Common Share

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

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2005			2006		2005			2006
	(restated)					(restated)
Numerator:
Income from continuing operations—basic and diluted		$	32,900	$	21,236		$	76,881	$	63,775
Denominator:
Weighted average number of common shares outstanding—basic		36,436		37,096			35,795		36,925
Common stock equivalents—stock options		912		1,672			1,170		1,480
Common stock equivalents—warrants		247		186			229		146
Common stock equivalents—restricted stock		10		47			6		8
Common stock equivalents—restricted stock units		—		22			—		10
Weighted average number of common shares outstanding—diluted		37,605		39,023			37,200		38,569
Income from continuing operations per common share— basic		$	0.90	$	0.57		$	2.15	$	1.73
Income from continuing operations per common share—diluted		$	0.87	$	0.54		$	2.07	$	1.65

The weighted average number of common shares outstanding for the three months and nine months ended September 30, 2005 and 2006 was calculated using outstanding shares of the Company’s Ordinary Common Stock and Multi-Vote Common Stock. Common stock equivalents included in the calculation of diluted weighted average common shares outstanding for the three months and nine months ended September 30, 2005 and 2006 represent stock options to purchase shares of the Company’s Ordinary Common Stock, restricted stock awards and restricted stock units, and shares of Ordinary Common Stock related to certain warrants issued on the Effective Date.

NOTE E—Commitments and Contingencies

Insurance

The Company maintains a program of insurance coverage for a broad range of risks in its business. As part of this program of insurance, the Company is self-insured for a portion of its general, professional and managed care liability risks.

The Company has renewed its general, professional and managed care liability insurance policies with unaffiliated insurers for a one-year period from June 17, 2006 to June 17, 2007. The general liability policies are written on an “occurrence” basis, subject to a $0.1 million per claim un-aggregated self-insured retention. The professional liability and managed care errors and omissions liability policies are written on a “claims-made” basis, subject to a $1.0 million per claim ($10.0 million per class action claim) un-aggregated self-insured retention for managed care liability, and a $0.1 million per claim un-aggregated self-insured retention for professional liability. The Company is responsible for claims within its self-insured retentions, including portions of claims reported after the expiration date of the policies if they are not renewed, or if policy limits are exceeded. The Company also purchases excess liability coverage in an amount that management believes to be reasonable for the size and profile of the organization.

Legal

The Company is subject to or party to certain litigation and claims relating to its operations and business practices. Except as otherwise provided under the Plan, litigation asserting claims against the Company and its subsidiaries that were parties to the chapter 11 proceedings for pre-petition obligations (the “Pre-petition Litigation”) was enjoined as of the Effective Date as a consequence of the confirmation of the Plan and may not be pursued over the objection of Magellan or such subsidiary unless relief is provided from the effect of the injunction. The Company believes that the Pre-petition Litigation claims with respect to which distributions have been provided for under the Plan constitute general unsecured claims and, to the extent allowed by the Plan, would be resolved as other general unsecured creditor claims.

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

Operating Leases

The Company leases certain of its operating facilities. The leases, which expire at various dates through January 2013, generally require the Company to pay all maintenance, property tax and insurance costs.

NOTE F—Business Segment Information

The Company is engaged in the specialty healthcare management services business. It currently provides managed behavioral healthcare services, radiology benefits management, and specialty pharmaceutical management as a result of its acquisition of ICORE.

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 six segments, based on the services it provides and/or the customers that it serves, as described below.

Managed Behavioral Healthcare. The Company’s Managed Behavioral Healthcare business is composed of three of the Company’s segments, each as described further below. 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, however, generally does not directly provide, or own any provider of, treatment services. The Managed Behavioral Healthcare business is managed based on the services provided and/or the customers served, through the following three segments:

Health Plan. The Managed Behavioral Healthcare Health Plan segment (“Health Plan”) generally reflects managed behavioral healthcare services provided under contracts with managed care companies, health insurers and other health plans. Health Plan’s contracts encompass both risk-based and administrative services only (“ASO”) contracts for commercial, Medicaid and Medicare members of the health plan.

Employer. The Managed Behavioral Healthcare Employer segment (“Employer”) generally reflects the provision of employee assistance program (“EAP”) services, managed behavioral healthcare services and integrated products under contracts with employers, including corporations and governmental agencies, and labor unions. Employer managed behavioral healthcare services are primarily ASO products.

Public Sector. The Managed Behavioral Healthcare Public Sector segment (“Public Sector”) generally reflects managed behavioral healthcare services provided to Medicaid recipients under contracts with state and local governmental agencies. Public Sector contracts encompass both risk-based and ASO contracts.

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

The accounting policies of these segments are the same as those described in Note A—“General—Summary of Significant Accounting Policies.” 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):

										Corporate
	Health						Public			and
	Plan			Employer			Sector			Other			Consolidated
Three Months Ended September 30, 2005
Net revenue	$	228,849		$	31,437		$	193,980		$	—			$	454,266
Cost of care	(128,674		)	(7,477		)	(162,983		)	—				(299,134		)
Direct service costs	(39,747		)	(15,727		)	(7,074		)	—				(62,548		)
Other operating expenses	—			—			—			(29,319		)		(29,319		)
Stock compensation expense(1)	130			21			83			3,621				3,855
Equity in earnings of unconsolidated subsidiaries	1,759			—			—			—				1,759
Segment profit (loss)	$	62,317		$	8,254		$	24,006		$	(25,698	)		$	68,879

											Radiology				Specialty				Corporate
	Health							Public			Benefits				Pharmaceutical				and
	Plan			Employer				Sector			Management				Management				Other				Consolidated
Three Months Ended September 30, 2006
Net revenue	$	164,479			$	32,079		$	201,586			$	10,648			$	20,695			$	—			$	429,487
Cost of care	(95,404		)		(6,875		)	(169,626		)		—				—				—				(271,905		)
Cost of goods sold	—				—			—				—				(15,212		)		—				(15,212		)
Direct service costs	(25,754		)		(16,605		)	(8,928		)		(9,845		)		(2,631		)		—				(63,763		)
Other operating expenses	—				—			—				—				—				(32,898		)		(32,898		)
Stock compensation expense(1)	391				94			242				353				1,308				6,551				8,939
Segment profit (loss)	$	43,712			$	8,693		$	23,274			$	1,156			$	4,160			$	(26,347	)		$	54,648

										Corporate
	Health						Public			and
	Plan			Employer			Sector			Other			Consolidated
Nine Months Ended September 30, 2005
Net revenue	$	687,244		$	94,839		$	589,481		$	—			$	1,371,564
Cost of care	(382,545		)	(23,122		)	(514,596		)	—				(920,263		)
Direct service costs	(121,898		)	(47,908		)	(22,452		)	—				(192,258		)
Other operating expenses	—			—			—			(86,700		)		(86,700		)
Stock compensation expense(1)	405			66			259			11,294				12,024
Equity in earnings of unconsolidated subsidiaries	4,711			—			—			—				4,711
Segment profit (loss)	$	187,917		$	23,875		$	52,692		$	(75,406	)		$	189,078

											Radiology				Specialty				Corporate
	Health							Public			Benefits				Pharmaceutical				and
	Plan			Employer				Sector			Management				Management				Other				Consolidated
Nine Months Ended September 30, 2006
Net revenue	$	481,648			$	97,316		$	598,551			$	30,806			$	20,695			$	—			$	1,229,016
Cost of care	(271,577		)		(21,942		)	(510,927		)		—				—				—				(804,446		)
Cost of goods sold	—				—			—				—				(15,212		)		—				(15,212		)
Direct service costs	(78,169		)		(50,879		)	(26,269		)		(26,760		)		(2,631		)		—				(184,708		)
Other operating expenses	—				—			—				—				—				(92,119		)		(92,119		)
Stock compensation expense(1)	957				246			603				887				1,308				17,032				21,033
Equity in earnings of unconsolidated subsidiaries	390				—			—				—				—				—				390
Segment profit (loss)	$	133,249			$	24,741		$	61,958			$	4,933			$	4,160			$	(75,087	)		$	153,954

(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						Nine Months Ended
	September 30,						September 30,
	2005			2006			2005			2006
Segment profit	$	68,879		$	54,648		$	189,078		$	153,954
Stock compensation expense	(3,855		)	(8,939		)	(12,024		)	(21,033		)
Depreciation and amortization	(12,161		)	(13,096		)	(36,952		)	(35,086		)
Interest expense	(8,711		)	(1,807		)	(25,961		)	(5,497		)
Interest income	4,995			4,280			11,927			13,418
Gain on sale of assets	—			—			—			5,148
Special (charges) benefits	556			—			556			—
Income from continuing operations before income taxes and minority interest	$	49,703		$	35,086		$	126,624		$	110,904

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, 2005, which was filed with the Securities and Exchange Commission (“SEC”) on March 8, 2006.

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, including National Imaging Associates (“NIA”) and ICORE Healthcare LLC (“ICORE”) (each as discussed below), 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 managed behavioral healthcare customers that have already done so with a portion of their membership, including 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 impact of healthcare costs on fixed fee contracts;

· the Company’s dependence on government spending for managed healthcare, including changes in federal, state and local healthcare policies;

· restricted 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 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 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, 2005. 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.

Overview

The Company is engaged in the specialty healthcare management services business . Through fiscal 2005, the Company predominantly operated in the managed behavioral healthcare business. During fiscal 2006, the Company has expanded into radiology benefits management and specialty pharmaceutical management as a result of its acquisitions of NIA and ICORE, respectively, as discussed further below.

Managed Behavioral Healthcare

The Company, directly and through its subsidiaries, coordinates and manages 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, however, generally does not directly provide, or own any provider of, treatment services. The Company provides its management services primarily through: (i) risk-based products, where the Company assumes all or a 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, (iii) employee assistance programs (“EAPs”) where the Company provides short-term outpatient counseling and (iv) products that combine features of some or all of the Company’s risk-based, ASO or EAP products. At September 30, 2006, the Company managed the behavioral healthcare of approximately 43.0 million individuals.

The following table sets forth the approximate number of managed behavioral healthcare covered lives as of September 30, 2005 and 2006. The table also shows revenue for the three months and nine months ended September 30, 2005 and 2006, for the types of managed behavioral healthcare programs offered by the Company:

Programs

	Covered
	Lives		Percent			Revenue			Percent
	(in millions, except percentages)
Three Months Ended September 30, 2005
Risk-Based products		14.1		25.5	%		$	378.1		83.2	%
EAP products		13.5		24.5	%		27.4			6.0	%
ASO products		27.6		50.0	%		48.8			10.8	%
Total		55.2		100.0	%		$	454.3		100.0	%

	Covered
	Lives		Percent			Revenue			Percent
	(in millions, except percentages)
Three Months Ended September 30, 2006
Risk-Based products		9.4		21.9	%		$	334.1		83.9	%
EAP products		13.7		31.9	%		26.7			6.7	%
ASO products		19.9		46.2	%		37.3			9.4	%
Total		43.0		100.0	%		$	398.1		100.0	%

	Covered
	Lives		Percent			Revenue		Percent
	(in millions, except percentages)
Nine Months Ended September 30, 2005
Risk-Based products		14.1		25.5	%	$	1,138.2		83.0	%
EAP products		13.5		24.5	%	82.9			6.0	%
ASO products		27.6		50.0	%	150.5			11.0	%
Total		55.2		100.0	%	$	1,371.6		100.0	%

	Covered
	Lives		Percent			Revenue		Percent
	(in millions, except percentages)
Nine Months Ended September 30, 2006
Risk-Based products		9.4		21.9	%	$	982.2		83.4	%
EAP products		13.7		31.9	%	81.2			6.9	%
ASO products		19.9		46.2	%	114.1			9.7	%
Total		43.0		100.0	%	$	1,177.5		100.0	%

Acquisition of National Imaging Associates

NIA manages diagnostic imaging services for health plans to ensure that such services are clinically appropriate and cost effective. Currently, all of NIA’s management services are on a non-risk, ASO basis. The Company believes that NIA is the largest RBM manager in the country with approximately 17.3 million covered lives under contract as of September 30, 2006. The Company reports the results of operations of NIA as a separate segment entitled Radiology Benefits Management.

Acquisition of ICORE Healthcare, LLC

The Company reports the results of operations of ICORE as a separate segment entitled Specialty Pharmaceutical Management.

Business Segments

Health Plan. The Managed Behavioral Healthcare Health Plan segment (“Health Plan”) generally reflects managed behavioral healthcare services provided under contracts with managed care companies, health insurers and other health plans. Health Plan’s contracts encompass both risk-based and ASO contracts for commercial, Medicaid and Medicare members of the health plan. Health Plan managed the behavioral health benefits of approximately 27.1 million covered lives as of September 30, 2006.

Employer. The Managed Behavioral Healthcare Employer segment (“Employer”) generally reflects the provision of EAP services, managed behavioral healthcare services and integrated products under contracts with employers, including corporations and governmental agencies, and labor unions. Employer managed behavioral healthcare services are primarily ASO products. Employer provided these services for approximately 13.9 million covered lives as of September 30, 2006.

Radiology Benefits Mangagement. The Radiology Benefits Management segment generally reflects the management of diagnostic imaging services on a non-risk basis for health plans to ensure that such services are clinically appropriate and cost effective. The Company’s Radiology Benefits Management segment managed the benefits of approximately 17.3 million covered lives as of September 30, 2006.

Specialty Pharmaceutical Management. The Specialty Pharmaceutical Management segment generally reflects the management and distribution of specialty drugs used in the treatment of cancer, multiple sclerosis, hemophilia, infertility, rheumatoid arthritis, chronic forms of hepatitis and other diseases, under contracts with health plans in commercial, Medicare and Medicaid programs. The Company’s Specialty Pharmaceutical Management segment had contracts with 29 health plans, after consolidating health plans under common control, and 9 pharmaceutical manufacturers as of September 30, 2006

Significant Customers

Managed Behavioral Healthcare

The Company’s contracts with the State of Tennessee’s TennCare program (“TennCare”) and with subsidiaries of WellPoint, each generated revenues that exceeded, in the aggregate, ten percent of managed behavioral healthcare net revenues for each of the three months and nine months ended September 30, 2005 and 2006. The Company also has a significant concentration of business from individual counties which are part of the Pennsylvania Medicaid program.

managed care organizations. On July 26, 2006, TennCare announced the two winning bidders to the RFP process, neither of which had partnered with the Company, and a start date of April 1, 2007 at which time the Company’s contracts with TennCare will be amended to remove the Middle region enrollees. For the three months and nine months ended September 30, 2006, revenue derived from TennCare enrollees residing in the Middle region amounted to $36.7 million and $113.9 million, respectively.

Radiology Benefits Management and Specialty Pharmaceutical Management

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 March 8, 2006.

Stock Compensation

Effective January 1, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004) “Share-Based Payment” (“SFAS 123R”), using the modified prospective transition method and therefore has not restated results for prior periods. Under this transition method, stock compensation expense for the nine months ended September 30, 2006 includes stock compensation expense for all awards granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). Stock compensation expense for all awards granted after January 1, 2006 is based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. The Company recognizes stock compensation expense on a straight-line basis over the requisite service period, which is generally the vesting term ranging from three to four years. Prior to the adoption of SFAS 123R, the Company recorded stock compensation expense under Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”).

The Company estimates the fair value of stock options using the Black-Scholes-Merton option pricing model that employs the following key assumptions: Expected volatility is based on the annualized daily historical volatility of the Company’s stock price, over the expected life of the option. Management determined that volatility based on actively traded equities of companies that are similar to the Company is a better indicator of expected volatility and future stock price trends than historical Company volatility, due to the lack of sufficient history of the Company subsequent to the Company’s emergence from bankruptcy. Expected term of the option is based on historical employee stock option exercise behavior and the vesting terms of the respective option. Risk-free interest rates are based on the U.S. Treasury yield in effect at the time of grant.

SFAS 123R also requires the Company to recognize stock compensation expense for only the portion of options, restricted stock or restricted stock units that are expected to vest. Therefore, estimated forfeiture rates are derived from historical employee termination behavior. The Company’s estimated forfeiture rate for the nine months ended September 30, 2006 is four percent. If the actual number of forfeitures differs from those estimated, additional adjustments to stock compensation expense may be required in future periods. If vesting of such an award is conditioned upon the achievement of performance goals, stock compensation expense during the performance period is estimated using the most probable outcome of the performance goals, and adjusted as the expected outcome changes.

Goodwill

	December 31,			September 30,
	2005			2006
Health Plan segment (defined above)		$	290,192		$	254,090
Radiology Benefits Management segment (defined above)		—			105,854
Specialty Pharmaceutical Management segment (defined above)		—			144,739
Total		$	290,192		$	504,683

Factors Affecting Comparability

As a result of the Company’s January 31, 2006 acquisition of NIA and July 31, 2006 acquisition of ICORE, the Company’s results of operations for the three months and nine months ended September 30, 2005 are not comparable to the three months and nine months ended September 30, 2006.

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):

										Corporate
	Health						Public			and
	Plan			Employer			Sector			Other			Consolidated
Three Months Ended September 30, 2005
Net revenue	$	228,849		$	31,437		$	193,980		$	—			$	454,266
Cost of care	(128,674		)	(7,477		)	(162,983		)	—				(299,134		)
Direct service costs	(39,747		)	(15,727		)	(7,074		)	—				(62,548		)
Other operating expenses	—			—			—			(29,319		)		(29,319		)
Stock compensation expense(1)	130			21			83			3,621				3,855
Equity in earnings of unconsolidated subsidiaries	1,759			—			—			—				1,759
Segment profit (loss)	$	62,317		$	8,254		$	24,006		$	(25,698	)		$	68,879

											Radiology				Specialty				Corporate
	Health							Public			Benefits				Pharmaceutical				and
	Plan			Employer				Sector			Management				Management				Other				Consolidated
Three Months Ended September 30, 2006
Net revenue	$	164,479			$	32,079		$	201,586			$	10,648			$	20,695			$	—			$	429,487
Cost of care	(95,404		)		(6,875		)	(169,626		)		—				—				—				(271,905		)
Cost of goods sold	—				—			—				—				(15,212		)		—				(15,212		)
Direct service costs	(25,754		)		(16,605		)	(8,928		)		(9,845		)		(2,631		)		—				(63,763		)
Other operating expenses	—				—			—				—				—				(32,898		)		(32,898		)
Stock compensation expense(1)	391				94			242				353				1,308				6,551				8,939
Segment profit (loss)	$	43,712			$	8,693		$	23,274			$	1,156			$	4,160			$	(26,347	)		$	54,648

										Corporate
	Health						Public			and
	Plan			Employer			Sector			Other			Consolidated
Nine Months Ended September 30, 2005
Net revenue	$	687,244		$	94,839		$	589,481		$	—			$	1,371,564
Cost of care	(382,545		)	(23,122		)	(514,596		)	—				(920,263		)
Direct service costs	(121,898		)	(47,908		)	(22,452		)	—				(192,258		)
Other operating expenses	—			—			—			(86,700		)		(86,700		)
Stock compensation expense(1)	405			66			259			11,294				12,024
Equity in earnings of unconsolidated subsidiaries	4,711			—			—			—				4,711
Segment profit (loss)	$	187,917		$	23,875		$	52,692		$	(75,406	)		$	189,078

											Radiology				Specialty				Corporate
	Health							Public			Benefits				Pharmaceutical				and
	Plan			Employer				Sector			Management				Management				Other				Consolidated
Nine Months Ended September 30, 2006
Net revenue	$	481,648			$	97,316		$	598,551			$	30,806			$	20,695			$	—			$	1,229,016
Cost of care	(271,577		)		(21,942		)	(510,927		)		—				—				—				(804,446		)
Cost of goods sold	—				—			—				—				(15,212		)		—				(15,212		)
Direct service costs	(78,169		)		(50,879		)	(26,269		)		(26,760		)		(2,631		)		—				(184,708		)
Other operating expenses	—				—			—				—				—				(92,119		)		(92,119		)
Stock compensation expense(1)	957				246			603				887				1,308				17,032				21,033
Equity in earnings of unconsolidated subsidiaries	390				—			—				—				—				—				390
Segment profit (loss)	$	133,249			$	24,741		$	61,958			$	4,933			$	4,160			$	(75,087	)		$	153,954

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

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2005			2006			2005			2006
Segment profit	$	68,879		$	54,648		$	189,078		$	153,954
Stock compensation expense	(3,855		)	(8,939		)	(12,024		)	(21,033		)
Depreciation and amortization	(12,161		)	(13,096		)	(36,952		)	(35,086		)
Interest expense	(8,711		)	(1,807		)	(25,961		)	(5,497		)
Interest income	4,995			4,280			11,927			13,418
Gain on sale of assets	—			—			—			5,148
Special (charges) benefits	556			—			556			—
Income from continuing operations before income taxes and minority interest	$	49,703		$	35,086		$	126,624		$110,904

Quarter ended September 30, 2006 (“Current Year Quarter”), compared to the quarter ende d September 30, 2005 (“Prior Year Quarter”)

Health Plan

Net Revenue

Net revenue related to Health Plan decreased by 28.1 percent or $64.4 million from the Prior Year Quarter to the Current Year Quarter. The decrease in revenue is mainly due to terminated contracts of $83.2 million and other net unfavorable decreases of $1.4 million, which decreases were partially offset by new business of $12.3 million, increased membership from existing contracts of $7.1 million and other net increases of $0.8 million.

Cost of Care

Cost of care decreased by 25.9 percent or $33.3 million from the Prior Year Quarter to the Current Year Quarter. The decrease in cost of care is primarily due to terminated contracts of $50.7 million, favorable care development for the Prior Year Quarter which was recorded after the Prior Year Quarter of $4.1 million, and unfavorable prior period medical claims development recorded in the Prior Year Quarter of $3.1 million, which decreases were partially offset by new risk business of $10.7 million, care trends, change in mix of products and other net variances of $8.3 million, increased membership from existing customers of $4.3 million and unfavorable prior period medical claims development recorded in the Current Year Quarter of $1.3 million. Cost of care increased as a percentage of risk revenue to 71.8 percent in the Current Year Quarter from 69.6 percent in the Prior Year Quarter, mainly due to care trends and changes in business mix resulting primarily from terminated contracts. For further discussion of Health Plan care trends, see “Outlook—Results of Operations” below.

Direct Service Costs

Direct service costs decreased by 35.2 percent or $14.0 million from the Prior Year Quarter to the Current Year Quarter. The decrease in direct service costs is primarily due to terminated contracts and cost-cutting and operating efficiency efforts by the Company. Direct service costs decreased as a percentage of revenue from 17.4 percent in the Prior Year Quarter to 15.7 percent for the Current Year Quarter, mainly due to the cost-cutting and operating efficiency efforts of the Company.

Equity in Earnings of Unconsolidated Subsidiaries

The Company recorded approximately $1.8 million of equity in earnings of unconsolidated subsidiaries in the Prior Year Quarter, which consisted entirely of earnings of Royal Health Care, LLC (“Royal”). The Company sold its equity interest in Royal effective February 6, 2006.

Employer

Net Revenue

Net revenue related to Employer increased by 2.0 percent or $0.6 million from the Prior Year Quarter to the Current Year Quarter. The increase in revenue is mainly due to revenue from new customers of $1.1 million, increased membership from existing customers of $0.6 million, and other net increases of $1.5 million, which increases were partially offset by terminated contracts of $2.6 million.

Cost of Care

Cost of care decreased by 8.1 percent or $0.6 million from the Prior Year Quarter to the Current Year Quarter. The decrease in cost of care is mainly due to favorable prior period medical claims development recorded in the Current Year Quarter of $0.4 million and terminated contracts of $0.5 million, which decreases were partially offset by care trends and other net variances of $0.3 million. Cost of care decreased as a percentage of risk revenue from 27.1 percent in the Prior Year Quarter to 24.6 percent in the Current Year Quarter, mainly due to favorable prior period medical claims development recorded in the Current Year Quarter.

Direct Service Costs

Direct service costs increased by 5.6 percent or $0.9 million from the Prior Year Quarter to the Current Year Quarter. The increase is primarily due to expense related to services and support required for Hurricane Katrina victims and related activities in the Current Year Quarter, which also caused direct service costs to increase as a percentage of revenue from 50.0 percent for the Prior Year Quarter to 51.8 percent in the Current Year Quarter.

Public Sector

Net Revenue

Net revenue related to Public Sector increased by 3.9 percent or $7.6 million from the Prior Year Quarter to the Current Year Quarter. This increase is primarily due to favorable rate changes of $7.2 million and new business of $6.0 million, partially offset by contract changes of $3.2 million, terminated contracts of $0.9 million, and other net decreases of $1.5 million, mainly due to membership decreases.

Cost of Care

Cost of care increased by 4.1 percent or $6.6 million from the Prior Year Quarter to the Current Year Quarter. This increase is primarily due to care associated with a Prior Year Quarter change in estimate related to a potential contractual liability of $9.8 million, care associated with favorable rate changes for contracts that have minimum cost of care requirements of $5.4 million, new business of $5.1 million, and care trends and other net variances of $0.9 million, which increases were partially offset by a reduction in care requirements associated with contract changes of $7.8 million, favorable prior period medical claims development recorded in the Current Year Quarter of $2.8 million, terminated contracts of $0.8 million, and membership decreases of $3.2 million. Cost of care increased as a percentage of risk revenue from 84.5

percent in the Prior Year Quarter to 84.8 percent in the Current Year Quarter mainly due to contract changes.

Direct Service Costs

Direct service costs increased by 26.2 percent or $1.9 million from the Prior Year Quarter to the Current Year Quarter. The increase in direct service costs was primarily due to costs associated with new business opportunities. As a percentage of revenue, direct service costs increased from 3.6 percent in the Prior Year Quarter to 4.4 percent in the Current Year Quarter primarily due to a ramp-up of costs required to support new business opportunities.

Radiology Benefits Management

Net Revenue

Net revenue related to the Radiology Benefits Management segment was $10.6 million for the Current Year Quarter. As discussed above, the acquisition of NIA closed on January 31, 2006 and thus the Prior Year Quarter does not include any operating results for this segment of the Company.

Direct Service Costs

Direct service costs were $9.8 million for the Current Year Quarter. As a percentage of revenue, direct service costs were 92.5 percent.

Specialty Pharmaceutical Management

Net Revenue

Net revenue related to the Specialty Pharmaceutical Management segment was $20.7 million for the Current Year Quarter. As discussed above, the acquisition of ICORE closed on July 31, 2006 and thus the Prior Year Quarter does not include any operating results for this segment of the Company.

Cost of Goods Sold

Cost of goods sold were $15.2 million for the Current Year Quarter. As a percentage of the revenue derived from the distribution of specialty drugs, cost of goods sold were 88.1 percent.

Direct Service Costs

Direct service costs were $2.6 million for the Current Year Quarter. As a percentage of net revenue, direct service costs were 12.7 percent.

Corporate and Other

Other Operating Expenses

Other operating expenses related to the Corporate and Other segment increased by 12.2 percent or $3.6 million from the Prior Year Quarter to the Current Year Quarter. The increase resulted primarily from higher stock compensation expense of $2.9 million, corporate costs related to NIA and inflationary increases, with such increases being partially offset by efficiency improvements and terminated contracts. The increase in stock compensation expense is due primarily to the adoption of SFAS 123R effective January 1, 2006. See discussion of stock compensation expense in “Outlook—Results of Operations” below. As a percentage of total net revenue, other operating expenses increased from 6.5 percent for the Prior Year Quarter to 7.7 percent for the Current Year Quarter primarily due to the reduction in revenue from lost business and the impact of higher stock compensation expense.

Depreciation and Amortization

Depreciation and amortization expense increased by 7.7 percent or $0.9 million from the Prior Year Quarter to the Current Year Quarter, primarily due to asset additions since the prior year period, inclusive of assets related to the acquisitions of NIA and ICORE.

Interest Expense

Interest expense decreased by 79.3 percent or $6.9 million from the Prior Year Quarter to the Current Year Quarter, mainly due to the redemption of the Senior Notes and the Aetna Notes in the fourth quarter of 2005.

Interest Income

Interest income decreased by $0.7 million from the Prior Year Quarter to the Current Year Quarter, mainly due to a decrease in investments due to cash utilized in the redemption of the Senior Notes and in the acquisitions of NIA and ICORE, partially offset by cash provided by operating activities and an increase in yields on investments.

Other Items

The Company recorded special benefits of $0.6 million in the Prior Year Quarter relating to the reversal of previously recorded lease run-out costs for which a buyout was negotiated in the Prior Year Quarter.

Income Taxes

The Company’s effective income tax rate was 33.9 percent in the Prior Year Quarter (restated) and 39.6 percent in the Current Year Quarter. In accordance with American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) 90-7, “Financial Reporting by Entities in Reorganization Under the Bankruptcy Code” (“SOP 90-7”), subsequent (post-bankruptcy) utilization by the Company of deferred tax assets including NOLs, which existed at January 5, 2004 are accounted for as reductions to goodwill rather than income tax provision and, therefore, only benefit cash flows due to reduced tax payments. The Prior Year Quarter and Current Year Quarter effective income tax rates differ from the federal statutory income tax rates primarily due to state income taxes and permanent differences between book and tax income. The effective income tax rate will vary between periods mainly due to the impact of permanent differences in each period.

Discontinued Operations

The income in discontinued operations in the Prior Year Quarter is attributable to the reduction in estimates of certain reserves.

Nine months ended September 30, 2006 (“Current Year Period”), compared to the nine months ende d September 30, 2005 (“Prior Year Period”)

Health Plan

Net Revenue

Net revenue related to Health Plan decreased by 29.9 percent or $205.6 million from the Prior Year Period to the Current Year Period. The decrease in revenue is mainly due to terminated contracts of $256.3 million, which decrease was partially offset by new business of $26.0 million, increased membership from existing contracts of $17.2 million, revenue in the Current Year Period of $6.0 million related to

one-time transitional activities associated with the termination of the Aetna contract and other net increases of $1.5 million.

Cost of Care

Cost of care decreased by 29.0 percent or $111.0 million from the Prior Year Period to the Current Year Period. The decrease in cost of care is primarily due to terminated contracts of $151.3 million, favorable care development for the Prior Year Period which was recorded after the Prior Year Period of $4.3 million, favorable prior period medical claims development recorded in the Current Year Period of $4.1 million and unfavorable prior period medical claims development recorded in the Prior Year Period of $1.9 million, which decreases were partially offset by new risk business of $23.4 million, care trends, change in mix of products and other net increases of $16.7 million and increased membership from existing customers of $10.5 million. Cost of care increased as a percentage of risk revenue to 70.7 percent in the Current Year Period from 69.4 percent in the Prior Year Period, mainly due to care trends and changes in business mix resulting primarily from terminated contracts. For further discussion of Health Plan care trends, see “Outlook—Results of Operations” below.

Direct Service Costs

Direct service costs decreased by 35.9 percent or $43.7 million from the Prior Year Period to the Current Year Period. The decrease in direct service costs is primarily due to terminated contracts and cost-cutting and operating efficiency efforts by the Company. Direct service costs decreased as a percentage of revenue from 17.7 percent in the Prior Year Period to 16.2 percent for the Current Year Period, mainly due to the cost-cutting and operating efficiency efforts of the Company.

Equity in Earnings of Unconsolidated Subsidiaries

The Company recorded approximately $4.7 million and $0.4 million of equity in earnings of unconsolidated subsidiaries in the Prior Year Period and Current Year Period, respectively, which consisted entirely of earnings of Royal Health Care LLC (“Royal”). The Company sold its equity interest in Royal effective February 6, 2006, accordingly, the Current Year Period includes only one month of earnings in equity of Royal.

Employer

Net Revenue

Net revenue related to Employer increased by 2.6 percent or $2.5 million from the Prior Year Period to the Current Year Period. The increase in revenue is mainly due to increased membership from existing customers of $2.4 million, revenue from new customers of $1.7 million, increased revenue related to services and support required for Hurricane Katrina victims and related activities of $1.5 million and other net favorable increases of $4.3 million, which increases were partially offset by terminated contracts of $7.4 million.

Cost of Care

Cost of care decreased by 5.1 percent or $1.2 million from the Prior Year Period to the Current Year Period. The decrease in cost of care is mainly due to terminated contracts of $1.4 million and favorable prior period medical claims development recorded in the Current Year Period of $0.7 million, which decrease was partially offset by care trends and other net increases of $0.9 million. Cost of care decreased as a percentage of risk revenue from 27.7 percent in the Prior Year Period to 25.9 percent in the Current Year Period, mainly due to changes in business mix.

Direct Service Costs

Direct service costs increased by 6.2 percent or $3.0 million from the Prior Year Period to the Current Year Period. The increase is primarily due to expense related to services and support required for Hurricane Katrina victims and related activities in the Current Year Period, which also caused direct service costs to increase as a percentage of revenue from 50.5 percent for the Prior Year Period to 52.3 percent in the Current Year Period.

Public Sector

Net Revenue

Net revenue related to Public Sector increased by 1.5 percent or $9.1 million from the Prior Year Period to the Current Year Period. This increase is primarily due to favorable rate changes of $25.0 million, retrospective adjustments mainly related to membership recorded in the Current Year Period of $11.9 million, and new business of $6.0 million, which increases were partially offset by net membership decreases of $23.4 million (mainly related to TennCare disenrollment that occurred in late fiscal 2005), contract changes of $6.7 million, terminated contracts of $2.8 million, and other unfavorable changes of $0.9 million.

Cost of Care

Cost of care decreased by 0.7 percent or $3.7 million from the Prior Year Period to the Current Year Period. This decrease is primarily due to a reduction in care requirements associated with contract changes of $20.8 million, decreases in membership of $21.8 million, terminated contracts of $2.4 million, and favorable prior period medical claims development recorded in the Current Year Period of $1.1 million, which decreases were partially offset by care associated with favorable rate changes for contracts that have minimum cost of care requirements of $15.9 million, retrospective membership adjustments recorded in the Current Year Period of $7.6 million, new business of $5.1 million, care associated with a Prior Year Period change in estimate related to a potential contratual liability of $2.8 million, and care trends and other net variances of $11.0 million. Cost of care decreased as a percentage of risk revenue from 87.7 percent in the Prior Year Period to 85.9 percent in the Current Year Period mainly due to contract changes and rate increases in excess of the care trend.

Direct Service Costs

Direct service costs increased by 17.0 percent or $3.8 million from the Prior Year Period to the Current Year Period. The increase in direct service costs was primarily due to costs associated with new business opportunities. As a percentage of revenue, direct service costs increased from 3.8 percent in the Prior Year Period to 4.4 percent in the Current Year Period, primarily due to a ramp-up of costs required to support new business opportunities.

Radiology Benefits Management

Net Revenue

Net revenue related to the Radiology Benefits segment was $30.8 million for the Current Year Period. As discussed above, the acquisition of NIA closed on January 31, 2006 and thus the Current Year Period includes eight months of operating results and the Prior Year Period does not include any operating results for this segment of the Company.

Direct Service Costs

Direct service costs were $26.8 million for the Current Year Period. As a percentage of revenue, direct service costs were 86.9 percent.

Specialty Pharmaceutical Management

Net Revenue

Net revenue related to the Specialty Pharmaceutical Management segment was $20.7 million for the Current Year Period. As discussed above, the acquisition of ICORE closed on July 31, 2006 and thus the Prior Year Period does not include any operating results for this segment of the Company.

Cost of Goods Sold

Cost of goods sold were $15.2 million for the Current Year Period. As a percentage of the revenue derived from the distribution of specialty drugs, cost of goods sold were 88.1 percent.

Direct Service Costs

Direct service costs were $2.6 million for the Current Year Period. As a percentage of net revenue, direct service costs were 12.7 percent.

Corporate and Other

Other Operating Expenses

Other operating expenses related to the Corporate and Other segment increased by 6.2 percent or $5.4 million from the Prior Year Period to the Current Year Period. The increase resulted primarily from higher stock compensation expense of $5.7 million, corporate costs related to NIA and inflationary increases, with such increases being partially offset by efficiency improvements and terminated contracts. The increase in stock compensation expense is due primarily to the adoption of SFAS 123R effective January 1, 2006. As a percentage of total net revenue, other operating expenses increased from 6.3 percent for the Prior Year Period to 7.5 percent for the Current Year Period primarily due to the reduction in revenue from lost business, and the impact of higher stock compensation expense.

Depreciation and Amortization

Depreciation and amortization expense decreased by 5.1 percent or $1.9 million from the Prior Year Period to the Current Year Period, primarily due to certain assets becoming fully depreciated prior to the Current Year Period and intangible assets related to the Aetna contract being fully amortized at December 31, 2005, which decreases were partially offset by asset additions since the prior year period, inclusive of assets related to the acquisitions of NIA and ICORE.

Interest Expense

Interest expense decreased by 78.8 percent or $20.5 million from the Prior Year Period to the Current Year Period, mainly due to the redemption of the Senior Notes and the Aetna Notes in the fourth quarter of 2005.

Interest Income

Interest income increased by $1.5 million from the Prior Year Period to the Current Year Period, mainly due to an increase in yields on investments and an increase in cash provided by operating activities,

partially offset by a decrease in investments due to cash utilized in the redemption of Senior Notes and in the acquisitions of NIA and ICORE.

Other Items

The Company recorded special benefits of $0.6 million in the Prior Year Period relating to the reversal of previously recorded lease run-out costs for which a buyout was negotiated in the Prior Year Period.

A gain on the disposition of assets of $5.1 million was recognized in the Current Year Period mainly as a result of the Company’s sale of its equity interest in Royal.

Income Taxes

The Company’s effective income tax rate was 39.2 percent in the Prior Year Period (restated) and 42.5 percent in the Current Year Period. In accordance with SOP 90-7, subsequent (post-bankruptcy) utilization by the Company of deferred tax assets including NOLs, which existed at January 5, 2004 are accounted for as reductions to goodwill rather than income tax provision and, therefore, only benefit cash flows due to reduced tax payments. The Prior Year Period and Current Year Period effective income tax rates differ from the federal statutory income tax rates primarily due to state income taxes and permanent differences between book and tax income. The effective income tax rate will vary between periods mainly due to the impact of permanent differences in each period.

Discontinued Operations

The income in discontinued operations in the Prior Year Period is attributable to favorable settlements received in the Prior Year Period and changes in estimated reserves for various accrued liabilities.

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 award and implementation of new contracts; (v) enrollment changes; (vi) contract terminations; (vii) pricing adjustments upon contract renewals (and price competition in general) and (viii) changes in estimates regarding medical costs and incurred but not yet reported medical claims.

Care Trends. The Company expects that the Health Plan care trend factor for fiscal 2006 will be 6 to 8 percent. The Company estimates that the Public Sector care trend factor for fiscal 2006 will be 4 to 6 percent.

Stock compensation expense. On January 1, 2006, the Company adopted SFAS 123R. Under SFAS 123R, the Company uses the Black-Scholes-Merton formula to estimate the value of stock options granted to employees. The Company estimates that stock compensation expense for fiscal 2006 will be approximately $30.0 million to $32.0 million.

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 credit agreement with Deutsche Bank AG dated January 5, 2004, as amended (the “Credit Agreement”). Based on the amount of cash equivalents and investments and the borrowing levels under the Credit Agreement as of September 30, 2006, 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. Net cash provided by operating activities decreased by approximately $12.5 million from the Prior Year Period to the Current Year Period, primarily due to a decrease in segment profit between periods of $35.1 million, and payments of $26.3 million in the Current Year Period associated with claims run-out for terminated contracts, with such unfavorable variances partially offset by net positive working capital changes of $33.8 million (which mainly relates to favorable timing of cash flows from Public Sector segment regulated entities), and lower interest payments of $15.1 million in the Current Year Period.

Investing Activities. The Company utilized $14.4 million and $15.0 million during the Prior Year Period and Current Year Period, respectively, for capital expenditures. The majority of capital expenditures for both periods related to management information systems and related equipment.

During the Current Year Period, the Company received proceeds of $22.2 million related to the sale of assets, mainly for the sale of its investment in Royal. Additionally, during the Current Year Period, the Company used net cash of $120.8 million related to the acquisition of NIA and $162.0 million related to the acquisition of ICORE.

During the Prior Year Period, the Company utilized net cash of $130.4 million for the purchase of “available-for-sale” investments and during the Current Year Period, the Company received net cash of $197.9 million from the net maturity of “available-for-sale” investments, a portion of which was utilized to fund the NIA and ICORE acquisitions. The Company’s investments consist of U.S. government and agency securities, corporate debt securities and certificates of deposit.

During the Prior Year Period and the Current Year Period, the Company received proceeds of $7.0 million and $3.0 million, respectively, related to a previously outstanding $10.0 million note receivable, which was fully paid in June 2006

Financing Activities. During the Prior Year Period, the Company repaid $16.9 million of indebtedness outstanding under the Credit Agreement and made payments on capital lease obligations of $2.4 million. In addition, the Company received $12.8 million from the exercise of stock options and warrants. During the Current Year Period, the Company repaid $18.7 million of indebtedness outstanding under the Credit Agreement and made payments on capital lease obligations of $0.2 million. In addition, the Company received $8.9 million from the exercise of stock options and warrants.

Outlook—Liquidity and Capital Resources

Liquidity. During fiscal 2006, the Company expects to fund its capital expenditures with cash from operations. The Company estimates that it will spend approximately $6 million to $12 million of additional funds in fiscal 2006 for capital expenditures. The Company does not anticipate that it will need to draw on amounts available under the revolving loan facility of the Credit Agreement for its operations, capital needs or debt service in fiscal 2006. The Company also currently expects to have adequate liquidity to satisfy its existing financial commitments over the periods in which they will become due.

Off-Balance Sheet Arrangements. As of September 30, 2006, the Company has no off-balance sheet arrangements of a material significance.

Restrictive Covenants in Debt Agreements. The Credit Agreement contains covenants that limit management’s discretion in operating the Company’s business by restricting or limiting the Company’s ability, among other things, to:

· incur or guarantee additional indebtedness or issue preferred or redeemable stock;

· pay dividends and make other distributions;

· repurchase equity interests;

· make certain other payments;

· 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 Credit Agreement also requires the Company to comply with specified financial ratios and tests. Failure to do so, unless waived by the lenders under the Credit Agreement pursuant to its terms, would result in an event of default under the Credit Agreement. The Credit Agreement 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, as of December 2005, it had approximately $467 million of reportable NOLs. These estimated NOLs expire in 2011 through 2020 and are subject to examination and adjustment by the IRS. The Company’s utilization of NOLs became subject to limitation under Internal Revenue Code Section 382 upon emergence from bankruptcy, which affects the timing of the use of NOLs. At this time, the Company does not believe these limitations will materially limit the Company’s ability to use any NOLs before they expire. In accordance with SOP 90-7, subsequent (post-bankruptcy) utilization by the Company of NOLs that existed prior to the Company’s emergence from bankruptcy on January 5, 2004 will be accounted for as reductions to goodwill rather than income tax provision and, therefore, only benefit cash flows due to reduced tax payments. Although the Company has NOLs that may be available to offset future taxable income, the Company may be subject to Federal alternative minimum tax.

Deferred Taxes. The Company’s lack of a sufficient history of profitable operations subsequent to its emergence from bankruptcy has created uncertainty as to the Company’s ability to realize its deferred tax assets, inclusive of NOLs. Accordingly, as of December 31, 2005 and September 30, 2006, the Company’s valuation allowances were $167.2 million and $123.2 million, respectively, covering substantially all of its deferred tax assets , net of deferred tax liabilities and other tax contingencies . As of December 31, 2005 and September 30, 2006, net deferred tax assets, after reduction for valuation allowance, represent the Company’s estimate of those net tax assets which are “more likely than not” to be realizable. The Company continues to assess its position relative to the potential future realization of the deferred tax assets for which valuation allowances have been recorded. If the Company subsequently determines that such deferred tax assets are more likely than not realizable, then the valuation allowances recorded for such deferred tax assets will be reversed . The reversal of valuation allowances for deferred tax assets that existed prior to the Company’s emergence from bankruptcy on January 5, 2004 would be recorded as a reduction to goodwill.

Recent Accounting Pronouncements

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 Credit Agreement. Based on the Company’s investment balances, and the borrowing levels under the Credit Agreement as of September 30, 2006, 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.

Evaluation of Disclosure Controls and Procedures

The Company’s management evaluated, with the participation of the Company’s principal executive and principal financial officers, the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of September 30, 2006. 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 September 30, 2006.

Changes in Internal Control over Financial Reporting

The Company had incorrectly reported the reversal of all valuation allowances for the use of deferred tax assets, other than NOLs, as a reduction of income tax expense for the year ended December 31, 2004, the nine months ended September 30, 2005, and each of the quarters in those periods. As a result, the Company has restated its consolidated financial statements for those periods. This restatement resulted in the reporting of a material weakness in internal controls over financial reporting in the Company’s 2005 Annual Report on Form 10-K. Management believes that the error was the result of an incorrect interpretation of very complex accounting guidance. Management has since reviewed and corrected its accounting policy for income taxes to accurately track and record the reversal of valuation allowances established under fresh start reporting prior to its emergence from bankruptcy with respect to deferred tax assets other than NOLs.

There has been no change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the Company’s fiscal quarter ended September 30, 2006, 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 managed healthcare services entail significant risks of liability. From time to time, the Company is subject to various actions and claims arising from the acts or omissions of its employees, network providers or other parties. In the normal course of business, the Company receives reports relating to deaths and other serious incidents involving patients enrolled in its programs. 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 defendant to incur significant fees and costs related to their defense. To date, claims and actions against the Company alleging professional negligence have not resulted in material liabilities and the Company does not believe that any such pending action against it will have a material adverse effect on the Company. However, there can be no assurance that pending or future actions or claims for professional liability (including any judgments, settlements or costs associated therewith) will not have a material adverse effect on the Company.

The Company is subject to or party to certain litigation and claims relating to its operations and business practices. Except as otherwise provided under the Third Joint Amended Plan of Reorganization, as modified and confirmed (the “Plan”), litigation asserting claims against the Company and its subsidiaries that were parties to the chapter 11 proceedings for pre-petition obligations (the “Pre-petition Litigation”) was enjoined as of January 5, 2005 (“the Effective Date”) as a consequence of the confirmation of the Plan and may not be pursued over the objection of Magellan or such subsidiary unless relief is provided from the effect of the injunction. The Company believes that the Pre-petition Litigation claims with respect to which distributions have been provided for under the Plan constitute general unsecured claims and, to the extent allowed by the Plan, would be resolved as other general unsecured creditor claims.

In the opinion of management, the Company has recorded reserves that are adequate to cover litigation, claims or assessments that have been or may be asserted against the Company, and for which the outcome is probable and reasonably estimable. Management believes that the resolution of 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 1A. Risk Factors.

The managed healthcare services industry and the provision of managed healthcare services are subject to extensive and evolving federal and state regulation, as discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 (Item 1 under “Regulation” and Item 1A under “Government Regulation”). Such laws and regulations cover, but are not limited to, matters such as licensure, accreditation, government healthcare program participation requirements, information privacy and security, reimbursement for patient services, and Medicare and Medicaid fraud and abuse. The Company is also subject to certain state laws and regulations and federal laws as a result of the Company’s role in management of customers’ employee benefit plans.

With the Company’s acquisition of ICORE additional federal and state regulations became applicable to the Company. Various aspects of ICORE’s specialty pharmaceutical management business are governed by federal and state laws and regulations not previously applicable to the Company or which may now be applicable in different ways. Significant sanctions may be imposed for violations of these laws and compliance programs are a significant operational requirement of ICORE’s business. There are, however, significant uncertainties involving the application of many of these legal requirements to ICORE. Accordingly, ICORE may be required to incur additional administrative and compliance expenses in determining the applicable requirements and in adapting its compliance practices, or modifying its business

practices, in order to satisfy changing interpretations and regulatory policies. In addition, there are numerous proposed health care laws and regulations at the federal and state levels, many of which, if adopted, could adversely affect ICORE’s business.

Federal Anti-Remuneration/Fraud And Abuse Laws.

The federal healthcare Anti-Kickback Statute prohibits, among other things, an entity from paying or receiving, subject to certain exceptions and “safe harbors,” any remuneration, directly or indirectly, to induce the referral of individuals covered by federally funded health care programs, or the purchase, or the arranging for or recommending of the purchase, of items or services for which payment may be made in whole, or in part, under Medicare, Medicaid, CHAMPUS or other federally funded health care programs. Sanctions for violating the Anti-Kickback Statute may include imprisonment, criminal and civil fines and exclusion from participation in the federally funded health care programs. The Anti-Kickback Statute has been interpreted broadly by courts, the Office of Inspector General (“OIG”) within the U.S. Department of Health & Human Services (“DHHS”), and other administrative bodies. It also is a crime under the Public Contractor Anti-Kickback Statute, for any person to knowingly and willfully offer or provide any remuneration to a prime contractor to the United States, including a contractor servicing federally funded health programs, in order to obtain favorable treatment in a subcontract. Violators of this law also may be subject to civil monetary penalties.

In April 2003, the OIG published “Final OIG Compliance Program Guidance for Pharmaceutical Manufacturers,” referred to as “Compliance Guidance.” The Compliance Guidance is voluntary and is directly aimed at the compliance efforts of pharmaceutical manufacturers. This Compliance Guidance highlights several transactions as potential “risks,” including transactions and relationships with pharmacy benefit managers (“PBMs”), some of which are similar to transactions and/or relationships that ICORE enters into with its customers. As pharmaceutical manufacturers’ business practices evolve in compliance with the Compliance Guidelines, ICORE’s relationships with pharmaceutical manufacturers may be affected.

Federal Statutes Prohibiting False Claims.

The Federal False Claims Act imposes civil penalties for knowingly making or causing to be made false claims with respect to governmental programs, such as Medicare and Medicaid, for services not rendered, or for misrepresenting actual services rendered, in order to obtain higher reimbursement. Private individuals may bring qui tam or whistle blower suits against providers under the Federal False Claims Act, which authorizes the payment of a portion of any recovery to the individual bringing suit. A few federal district courts recently have interpreted the Federal False Claims Act as applying to claims for reimbursement that violate the Anti-Kickback Statute under certain circumstances. The Federal False Claims Act generally provides for the imposition of civil penalties and for treble damages, resulting in the possibility of substantial financial penalties for small billing errors. Criminal provisions that are similar to the Federal False Claims Act provide that a corporation may be fined if it is convicted of presenting to any federal agency a claim or making a statement that it knows to be false, fictitious or fraudulent to any federal agency. While ICORE does not directly provide services to beneficiaries of federally funded health programs and, accordingly, does directly submit claims to the federal government, it does provide services to federal government contractors, such as Part D Plans, and it is possible that ICORE could become involved in a situation where false claim issues are raised based on allegations that it caused or assisted a government contractor in making a false claim.

Medicare Prescription Drug, Improvement, and Modernization Act of 2003.

The Medicare Prescription Drug, Improvement, and Modernization Act of 2003, referred to as “MMA” that took effect on January 1, 2006, among other things, created a new voluntary outpatient

prescription drug benefit for Medicare enrollees on an insured basis through Prescription Drug Plans, “PDPs,” and by Medicare Advantage Plans, in various regions across the United States. If the federal Centers for Medicare & Medicaid Services (“CMS”) determines that ICORE has not performed satisfactorily as a subcontractor, CMS may request a PDP or a Medicare Advantage Plan customer of ICORE to revoke its Part D activities or responsibilities under the subcontract. Among other things, PDPs and Medicare Advantage Plans are subject to provisions of the MMA intended to deter fraud, waste and abuse and are monitored strictly by CMS and its contracted Medicare Drug Integrity Contractors (“MEDICs”) to ensure that Part D program funds are not spent inappropriately. The practices that are subject to regulation under these provisions are evolving and future applications or interpretations of these provisions could affect ICORE’s operations.

FDA Regulation.

The U.S. Food and Drug Administration, the “FDA,” generally has authority to regulate drug promotional materials that are disseminated “by or on behalf of” a drug manufacturer. ICORE’s business includes the provision of educational seminars for prescribers and other ICORE customers on behalf of manufacturer clients and thus is subject to the federal laws applicable to the promotion of prescription drugs.

State Anti-Remuneration/False Claims Laws.

Several states have laws and/or regulations similar to the federal anti-remuneration and Federal False Claims Act described above. Sanctions for violating these state anti-remuneration and false claims laws may include injunction, imprisonment, criminal and civil fines and exclusion from participation in the state Medicaid programs.

State Comprehensive PBM Regulation.

States continue to introduce broad legislation to regulate PBM activities. Some of this legislation would encompass the activities of ICORE. In particular, such legislation seeks to impose fiduciary duties or disclosure obligations on entities that provide certain types of pharmacy management services. Both Maine and the District of Columbia have enacted statutes imposing fiduciary obligations on entities providing pharmacy management services. Regulation of this nature could affect the services ICORE provides its customers.

State Legislation Affecting Plan Or Benefit Design.

Some states have enacted legislation that prohibits certain types of managed care plan sponsors from implementing certain restrictive formulary and network design features, and many states have legislation regulating various aspects of managed care plans, including provisions relating to the pharmacy benefits. Other states mandate coverage of certain benefits or conditions and require health plan coverage of specific drugs, if deemed medically necessary by the prescribing physician. Such legislation does not generally apply to ICORE directly, but may apply to certain clients of ICORE, such as HMOs and health insurers. If legislation of this nature were to become widely adopted and were applied to services ICORE provides , it could have the effect of limiting the economic benefits achievable by ICORE customers through the use of ICORE’s services, adversely affecting the demand for ICORE’s services.

Legislation Affecting Drug Prices.

Under MMA, Part B drugs generally are reimbursed on an average sales price, “ASP,” methodology. This ASP methodology may create an incentive for some drug manufacturers to reduce the levels of

discounts or rebates available to purchasers, including ICORE, or their clients with respect to Medicare Part B drugs.

The federal Medicaid rebate statute provides that pharmaceutical manufacturers of brand-name outpatient prescription drugs must provide the Medicaid program a rebate in accordance with certain requirements. Investigations have been commenced by certain government agencies which question whether Medicaid rebates were properly calculated in accordance with such requirements, reported and paid by the manufacturers to the Medicaid programs. ICORE is not responsible for such calculations, reports or payments. Some pharmaceutical manufacturers may view the Medicaid rebate statute and/or the associated investigations as a disincentive to offer rebates and discounts to private parties, including in the context of ICORE’s business.

Regulations Affecting ICORE Pharmacies

ICORE owns two mail order pharmacies that provide services to certain of ICORE health plan customers. The activities undertaken by ICORE pharmacies subject the pharmacies to state and federal statutes and regulations governing, among other things, the operation of mail order pharmacies, repackaging of drug products, stocking of prescription drug products and dispensing of prescription drug products, including controlled substances. ICORE’s mail order pharmacy facilities are located in Florida and New York and are duly licensed to conduct business in those states. Many states, however, require out-of-state mail order pharmacies to register with the state board of pharmacy or similar governing body when pharmaceuticals are delivered by mail into the state and some states require that an out-of-state pharmacy employ a pharmacist that is licensed in the state into which pharmaceuticals are shipped. Additional regulation of this nature may require ICORE to expend additional funds to satisfy such regulatory requirements and could make it impractical for ICORE to undertake certain business opportunities it may otherwise be interested in pursuing.

Regulation of Controlled Substances

ICORE pharmacies must register with the United States Drug Enforcement Administration, the “DEA,” and individual state controlled substance authorities in order to dispense controlled substances. Federal law requires ICORE to comply with the DEA’s security, recordkeeping, inventory control, and labeling standards in order to dispense controlled substances. State controlled substance law requires registration and compliance with state pharmacy licensure, registration or permit standards promulgated by the state pharmacy licensing authority.

Some of the state regulatory requirements described above may be preempted in whole or in part by the federal Employee Retirement Income Security Act of 1974, as amended, “ERISA,” which provides for comprehensive federal regulation of employee benefit plans. However, the scope of ERISA preemption is uncertain and is subject to conflicting court rulings. As a result, ICORE could be subject to overlapping federal and state regulatory requirements in respect of certain of its operations and may need to implement compliance programs that satisfy multiple regulatory regimes.

Other

Most of ICORE’s distribution contracts with its customers use “average wholesale price” (“AWP”) as a benchmark for establishing pricing. As part of a proposed settlement in the case of New England Carpenters Health Benefit Fund, et. al. v. First Data Bank, et. al., Civil Action No. 1:05-CV-11148-PBS (D. Mass.), a case brought against First Data Bank, one of several companies that report data on prescription drug prices, First Data Bank has agreed to reduce the AWP of over 8,000 specific pharmaceutical products by four percent. The proposed settlement has not received preliminary or final approval of the court, and we cannot predict whether or when the court will approve the settlement or the timing of any changes to the AWP.

In the absence of any action on the part of ICORE to renegotiate with its customers the pricing of those pharmacy distribution contracts that use AWP, the proposed reduction in First Data Bank’s AWP could materially reduce the margin earned by Icore on such Pharmaceutical distribution contracts. While this change to AWP may adversely affect the margin earned by ICORE on those distribution contracts that use AWP, it is not expected to have a material adverse affect on the Company’s results of operations.

General

The Company believes its operations, including those of ICORE, are structured to comply in all material respects with applicable laws and regulations and that it has received all licenses and approvals that are material to the operation of its businesses. However, regulation of the managed healthcare services industry is constantly evolving, with new legislative enactments and regulatory initiatives at the state and federal levels being implemented on a regular basis. Consequently, it is possible that a court or regulatory agency may take a position under existing or future laws or regulations, or as a result of a change in the interpretation thereof, that such laws or regulations apply to the Company in a different manner than the Company believes such laws or regulations apply. Moreover, any such position may require significant alterations to the Company’s business operations in order to comply with such laws or regulations, or interpretations thereof.

In addition, government investigations and allegations have become more frequent concerning possible violations of fraud and abuse and false claims statutes and regulations by healthcare organizations. Violators may be excluded from participating in government healthcare programs, subject to fines or penalties or required to repay amounts received from the government for previously billed services. A violation of such laws and regulations may have a material adverse effect on the Company.

The imposition of additional licensing and other regulatory requirements may, among other things, increase the Company’s equity requirements, increase the cost of doing business or force significant changes in the Company’s operations to comply with these requirements.

The costs associated with compliance with government regulation as describe above may adversely affect the Company’s financial condition and results of operations.

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.

None.

Item 5. Other Information.

On February 24, 2006, the board of directors of the Company approved the Amended and Restated Supplemental Accumulation Plan (“SAP”). The SAP which was originally approved in 2000 is a deferred compensation plan designed to promote the retention of key executives. The SAP is a calendar year based plan that is funded by the Company through a fixed percentage of an executive’s base salary. Annually, the Management Compensation Committee of the board approves the percentage contribution for the executive officers. The SAP may also be funded by each executive officer through voluntary deferrals of compensation. Both company and voluntary contributions are paid to a trust and invested in one or more

mutual funds selected by each executive officer. The SAP was amended and restated to comply with the provisions of Internal Revenue Code Section 409A relating to deferred compensation.

Item 6. Exhibits


10.1		Magellan Health Services, Inc. Amended and Restated Supplemental Accumulation Plan.
10.2		Amendment to Employment Agreement between the Company and Jeffrey West, dated July 28, 2006.
10.3		Amendment to Employment Agreement between the Company and Eric Reimer, dated July 28, 2006.
10.4		Amendment to Employment Agreement between the Company and Daniel Gregoire, dated July 28, 2006.
10.5		Amendment to Employment Agreement between the Company and Michael Majerik, dated July 28, 2006.
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: October 26, 2006	MAGELLAN HEALTH SERVICES, INC.
	(Registrant)
	/s/ MARK S. DEMILIO
	Mark S. Demilio
	Executive Vice President and Chief Financial Officer (Principal Financial Officer and Duly Authorized Officer)

Exhibit 10.1

MAGELLAN HEALTH SERVICES, INC,

SUPPLEMENTAL ACCUMULATION PLAN

As Amended and Restated

Effective January 1, 2005

MAGELLAN HEALTH SERVICES, INC.

SUPPLEMENTAL ACCUMULATION PLAN

TABLE OF CONTENTS

		Page

ARTICLE 1 DEFINITIONS		1

1.1	ACCOUNT	1

1.2	ADMINISTRATOR	1

1.3	BENEFICIARY	1

1.4	CODE	2

1.5	COMPANY	1

1.6	COMPENSATION	2

1.7	COMPENSATION DEFERRAL ACCOUNT	2

1.8	COMPENSATION DEFERRALS	2

1.9	DESIGNATION DATE	2

1.10	DISCRETIONARY CONTRIBUTIONS	2

1.11	DISCRETIONARY CONTRIBUTIONS ACCOUNT	2

1.12	EFFECTIVE DATE	2

1.13	ELIGIBLE EMPLOYEE	2

1.14	EMPLOYER	3

1.15	ENTRY DATE	3

1.16	KEY EMPLOYEE	3

1.17	PARTICIPANT	3

1.18	PAYMENT DATE	3

1.19	PLAN	3


1.20	PLAN YEAR	3

1.21	TRUST	3

1.22	TRUSTEE	3

1.23	VALUATION DATE	3

ARTICLE 2 ELIGIBILITY AND PARTICIPATION		4

2.1	REQUIREMENTS	4

2.2	RE-EMPLOYMENT	4

2.3	CHANGE OF EMPLOYMENT CATEGORY	4

ARTICLE 3 CONTRIBUTIONS AND CREDITS		4

3.1	EMPLOYER CONTRIBUTIONS	4

3.2	PARTICIPANT COMPENSATION DEFERRALS	5

3.3	CONTRIBUTIONS TO THE TRUST	7

ARTICLE 4 ALLOCATION OF FUNDS		7

4.1	ALLOCATION OF EARNINGS OR LOSSES ON ACCOUNTS	7

4.2	ACCOUNTING FOR DISTRIBUTIONS	7

4.3	SEPARATE ACCOUNTS	7

4.4	INTERIM VALUATIONS	7

4.5	DEEMED INVESTMENT DIRECTIONS OF PARTICIPANTS	8

4.6	EXPENSES	9

4.7	TAXES	9

ARTICLE 5 ENTITLEMENT TO BENEFITS		9

5.1	PAYMENT DATE; SEPARATION FROM SERVICE	9

5.2	SEPARATION FROM SERVICE UPON DISPOSITION OF ASSETS OR SUBSIDIARIES	10

5.3	HARDSHIP DISTRIBUTIONS	10


5.4	APPLICATION TO TRUSTEE	11

5.5	TREATMENT OF FORFEITURES	11

5.6	RE-EMPLOYMENT OF RECIPIENT	11

ARTICLE 6 DISTRIBUTION OF BENEFITS		11

6.1	DISTRIBUTABLE AMOUNT	11

6.2	METHOD OF PAYMENT	11

6.3	DEATH BENEFITS	12

ARTICLE 7 BENEFICIARIES; PARTICIPANT DATA		13

7.1	DESIGNATION OF BENEFICIARIES	13

7.2	INFORMATION TO BE FURNISHED BY PARTICIPANTS AND BENEFICIARIES; INABILITY TO LOCATE PARTICIPANTS OR BENEFICIARIES	13

ARTICLE 8 ADMINISTRATION		14

8.1	ADMINISTRATIVE AUTHORITY	14

8.2	UNIFORMITY OF DISCRETIONARY ACTS	15

8.3	LITIGATION	15

8.4	CLAIMS PROCEDURE	15

8.5	ACTION BY THE ADMINISTRATOR	16

8.6	PARTICIPATION BY ADMINISTRATORS	16

8.7	ALLOCATION OF DUTIES	17

ARTICLE 9 AMENDMENT		17

9.1	RIGHT TO AMEND	17

9.2	AMENDMENTS TO ENSURE PROPER CHARACTERIZATION OF PLAN	17

ARTICLE 10 TERMINATION		17

10.1	TERMINATION OF SUSPENSION OF PLAN	17

iii


10.2	AUTOMATIC TERMINATION OF PLAN	17

10.3	SUSPENSION OF DEFERRALS	18

10.4	ALLOCATION AND DISTRIBUTION	18

10.5	SUCCESSOR TO EMPLOYER	18

ARTICLE 11 THE TRUST		18

11.1	ESTABLISHMENT OF TRUST	18

11.2	UNFUNDED STATUS OF PLAN	18

ARTICLE 12 MISCELLANEOUS		19

12.1	LIMITATIONS ON LIABILITY OF EMPLOYER	19

12.2	CONSTRUCTION	19

12.3	SPENDTHRIFT PROVISION	20

12.4	NO EMPLOYMENT CONTRACT	20

12.5	NOTICES	20

12.6	CONSENT TO PLAN	20

12.7	BINDING ON SUCCESSORS	21

MAGELLAN HEALTH SERVICES, INC.

SUPPLEMENTAL ACCUMULATION PLAN

As Amended and Restated

Effective as of January 1, 2005

RECITALS

The Magellan Health Services, Inc. Supplemental Accumulation Plan (the “Plan”) is adopted by Magellan Health Services, Inc. (the “Company”) for the benefit of the directors, officers and certain executive, management and other highly compensated employees of the Company and its subsidiaries and affiliates. The purpose of the Plan is to offer those directors and employees an opportunity to elect to defer the receipt of compensation in order to provide deferred compensation benefits taxable pursuant to section 451 of the Internal Revenue Code of 1986, as amended (the “Code”). The Plan is intended to be a “top-hat” plan (i.e., an unfunded deferred compensation plan maintained for a select group of management or highly-compensated employees) under sections 201(2), 301(a)(3) and 401(a)(1) of the Employee Retirement Income Security Act of 1974 (“ERISA”).

Accordingly, the following Plan is adopted.

ARTICLE 1

DEFINITIONS

1.1 ACCOUNT . Account means the balance credited to a Participant’s or Beneficiary’s Plan account, including contribution credits and income, gains and losses (as determined by the Administrator, in its discretion) credited thereto. A Participant’s or Beneficiary’s Account shall be determined as of the Valuation Date.

1.2 ADMINISTRATOR . Administrator means the committee described in Article 8, which is responsible for the administration of this Plan.

1.3 BENEFICIARY . Beneficiary means any person or persons so designated in accordance with the provisions of Article 7.

1.4 CODE . Code means the Internal Revenue Code of 1986 and the regulations thereunder, as amended from time to time.

1.5 COMPANY . Company means Magellan Health Services, Inc. and its successors and assigns.

1.6 COMPENSATION . Compensation means the total current cash remuneration that would be payable in a Plan Year by the Employer to an Eligible Employee with respect to his or her service for the Employer as an employee, ignoring any election to make Compensation Deferrals under this Plan. In the case of a director, “Compensation” means the compensation which would otherwise have been payable currently for services as a member of the Board of Directors of the Company or any other Employer, including fees payable for services as a member of a committee of the Board.

1.7 COMPENSATION DEFERRAL ACCOUNT . Compensation Deferral Account is defined in Section 3.2.

1.8 COMPENSATION DEFERRALS . Compensation Deferrals is defined in Section 3.2.

1.9 DESIGNATION DATE . Designation Date means the date or dates as of which a designation of deemed investment directions by an individual pursuant to Section 4.5, or any change in a prior designation of deemed investment directions by an individual pursuant to Section 4.5, shall become effective. The Designation Dates in any Plan Year shall be the first day of each calendar quarter or such other dates as may be designated by the Administrator.

1.10 DISCRETIONARY CONTRIBUTIONS . Discretionary Contributions mean the contributions made by an Employer, as described in Section 3.1(a).

1.11 DISCRETIONARY CONTRIBUTIONS ACCOUNT . Discretionary Contributions Account means the account established to record the Discretionary Contributions credited to a Participant each Plan Year and the earnings, losses and expenses attributable thereto, as described in Section 3.1.

1.12 EFFECTIVE DATE . Effective Date means the effective date of the Plan, which, as amended and restated, shall be January 1, 2005.

1.13 ELIGIBLE EMPLOYEE . Eligible Employee means, for any Plan Year (or applicable portion thereof), a director of the Company or another Employer or a person regularly employed by an Employer, who is paid through a U.S. payroll system, and who is determined by the Administrator to be a member of a select group of management or highly compensated employees and who is designated by the Company’s Board of Directors or the Company’s Chief Executive Officer to be an Eligible Employee under the Plan. The Company shall notify those individuals, if any, who will be Eligible Employees for the next Plan Year, typically by October 1 of the preceding calendar year. If the Company determines that an individual first becomes an Eligible Employee during a Plan Year, the Company shall notify such individual of its determination and of the date during the Plan Year on which the individual shall first become an Eligible Employee. Solely for the purposes of this Plan, a director of the Company or another Employer shall be deemed to be in the employment of the Company or any other Employer so long as he or she serves in the capacity of a director by the Company or any other Employer.

1.14 EMPLOYER . Employer means the Company and its successors unless otherwise herein provided or any subsidiary of the Company (or its successors) which, with the consent of the Company’s Board of Directors or the Company’s Chief Executive Officer, assumes the obligations of an Employer hereunder.

1.15 ENTRY DATE . Entry Date with respect to an individual means the first day of the first pay period following the date on which the individual (i) first becomes an Eligible Employee and (ii) with respect to Compensation Deferrals has made an election to defer within thirty (30) days after such date.

1.16 KEY EMPLOYEE . Key Employee means “key employee” as defined in Section 416(i) of the Code, disregarding Section 416(i)(5). Key Employees shall be determined as of December 31 of each Plan Year, based upon compensation received in such Plan Year, and designation of an individual as a Key Employee shall be effective as of the immediately following April 1.

1.17 PARTICIPANT . Participant means any person so designated in accordance with the provisions of Article 2, including, where appropriate according to the context of the Plan, any former employee or director who is or may become (or whose Beneficiaries may become) eligible to receive a benefit under the Plan.

1.18 PAYMENT DATE . Payment Date means the fixed date, as selected by the Administrator, as of which a Participant’s Plan benefits are to be paid or commence to be paid to the Participant. The Payment Date shall be a date which is as soon as administratively practical following the Participant’s separation from service with all Employers, provided it shall not be later than the later of (i) the end of the calendar year in which the Participant separates from service with all Employers, or (ii) the 15 th day of the third month following the date of the Participant’s separation from service, and provided further that a Participant who is a Key Employee on the date of separation from service shall not receive any payment on account of such separation from service until six (6) months after such separation from service.

1.19 PLAN . Plan means this Magellan Health Services, Inc. Supplemental Accumulation Plan, as amended from time to time.

1.20 PLAN YEAR . Plan Year means the calendar year.

1.21 TRUST . Trust means the Trust, if any, established pursuant to Article 11.

1.22 TRUSTEE . Trustee means the trustee of the Trust established pursuant to Article 11.

1.23 VALUATION DATE . Valuation Date means the last day of each calendar month or any other date that the Administrator, in its sole discretion, designates as a Valuation Date.

ARTICLE 2

ELIGIBILITY AND PARTICIPATION

2.1 REQUIREMENTS . Every Eligible Employee on the Effective Date shall be eligible to become a Participant on the Effective Date. Every other Eligible Employee shall be eligible to become a Participant on the first Entry Date occurring on or after the date on which he or she becomes an Eligible Employee. No individual shall become a Participant, however, if he or she is not an Eligible Employee on the date his or her participation is to begin. No Eligible Employee may become a Participant on a date other than January 1 unless the Eligible Employee does not participate in any other account balance deferred compensation plan that would be aggregated with this Plan under Section 409A of the Code.

Participation in the Plan is voluntary. In order to participate in the Plan, an otherwise Eligible Employee must make written application in such manner as may be required by Section 3.2 and by the Company.

2.2 RE-EMPLOYMENT . If a Participant whose employment with the Employer is terminated is subsequently re-employed, he or she shall become a Participant in accordance with the provisions of Section 2.1, provided he or she then qualifies as an Eligible Employee. A Participant who terminates employment with all of the Employers and is reemployed by an Employer within the same Plan Year shall not be eligible to make Compensation Deferrals again prior to January 1 of the following Plan Year.

2.3 CHANGE OF EMPLOYMENT CATEGORY . During any period in which a Participant remains in the employ of the Employer, but ceases to be an Eligible Employee, he or she shall not be eligible to make Compensation Deferrals hereunder. A Participant who ceases to be an Eligible Employee and again becomes an Eligible Employee within the same Plan Year shall not be eligible to make Compensation Deferrals again hereunder until January 1 of the following Plan Year.

ARTICLE 3

CONTRIBUTIONS AND CREDITS

3.1 EMPLOYER CONTRIBUTIONS . The following contributions shall be made by each Employer each Plan Year:

(a) Discretionary Contributions : The Discretionary Contributions credited to a Participant for each Plan Year shall be an amount (if any) determined by the Employer, in its sole and absolute discretion, and contributed by the Employer to the Plan as a Discretionary Contribution on the Participant’s behalf. The Employer may make Discretionary Contributions for any Plan Year in a different amount for each Participant or for any group of Participants and may choose to make no Discretionary Contributions for any Participant or for any group of Participants, in its absolute discretion. The Discretionary Contributions credited to a Participant for each Plan year and the subsequent earnings, losses and expenses attributable to those contributions shall be

separately accounted for in a Discretionary Contribution Account in the Participant’s name. Whenever the Discretionary Contributions for the Plan Year are so credited, they shall be credited to the Participant’s Discretionary Contribution Account and subject to the Participant’s deemed investment directions.

(b) Earnings, Losses and Expenses : The Participant’s Discretionary Contributions Account shall be credited or debited, as applicable, as of each Valuation Date, with the deemed earnings or losses, as applicable, and expenses attributable to that account, as determined by the Administrator hereunder, in its sole and absolute discretion. The Administrator shall have the sole and absolute discretion to allocate such deemed earnings or losses and expenses among the Participants’ Discretionary Contributions Accounts pursuant to such allocation rules as the Administrator deems to be reasonable and administratively practicable.

3.2 PARTICIPANT COMPENSATION DEFERRALS .

(a) In General . In accordance with rules established by the Administrator, a Participant may elect to defer Compensation which is due to be earned and which would otherwise be paid to the Participant; provided, however, that (1) the Participant’s deferrals from his or her base salary shall not exceed fifty percent (50%) of base salary, (2) the Participant’s deferrals from sales commissions and bonuses and incentive compensation may be up to one hundred percent (100%) of those compensation items, and (3) the minimum amount projected to be deferred pursuant to the Participant’s deferral election(s) for any Plan Year shall be five thousand dollars ($5,000), pro-rated on a monthly basis in any case where the Participant’s period of participation in the Plan for the Plan Year is less than twelve (12) months. Notwithstanding the foregoing, in no event shall the Compensation Deferral for any pay period during which a Participant’s deferral election is in effect reduce the Participant’s net Compensation (determined after subtraction of the Compensation Deferral amount) below the amount necessary to satisfy for that pay period the aggregate employment and withholding taxes, as well as deductions, withholdings and/or salary reductions with respect to any employee benefit, that are applicable to the Participant’s Compensation for that pay period. Amounts so deferred will be considered a Participant’s “Compensation Deferrals.”

(b) Timing of Election . A Participant shall make such an election with respect to a coming twelve (12) month Plan Year by (i) no later than December 31 st of the prior Plan Year in the case of deferrals from regular salary, and sales bonuses and commissions (which the Participant may earn in the subsequent Plan Year by reason of the Employer receiving payment for such sales in the subsequent Plan Year), and (ii) no later than June 30 of that prior Plan Year in the case of annual incentive compensation (other than sales bonuses or commissions) earned over a period of at least twelve (12) months, such as the Short-Term Incentive Plan (or, if earlier, a date prior to the date such performance compensation has become both substantially certain to be paid and readily ascertainable), or (iii) during such other period prior to the beginning of the coming Plan

Year designated by the Administrator. In the first year in which an individual becomes an Eligible Employee (and was not previously eligible to participate in any other account balance plan of deferred compensation aggregated with this Plan under Section 409A of the Code), such newly Eligible Employee may make a Compensation Deferral election within thirty (30) days after the date the individual becomes eligible, provided such election applies only with respect to Compensation to be paid for services to be performed subsequent to the election.

(c) Election Procedure . Compensation Deferrals shall be made (i) through regular payroll deductions from salary (and sales bonuses and commissions), and/or (ii) through an election by the Participant to defer the payment of an annual bonus not yet paid and payable no sooner than the following Plan Year. A deferral election may not be made with respect to a bonus payment that is payable in the year the deferral election is made, except to the extent permitted by Section 409A of the Code. All deferral elections shall be made in writing on a form provided by or acceptable to the Administrator and filed with the Administrator by no later than the date designated by the Administrator as the due date for that election (which date shall be, for deferral of salary, sales bonuses and sales commissions, a date occurring before the beginning of the Plan Year to which the election applies or, in the case of a new Participant, a date occurring before his or her Entry Date). Except to the extent the Administrator otherwise provides, all Compensation Deferral elections shall be stated as a whole percentage of the Compensation item to which it applies. The Participant may not terminate his or her Compensation Deferral election at any time during the Plan Year to which it applies unless the Participant qualifies for a hardship distribution under Section 5.3. In the case of a Compensation Deferral election for annual incentive compensation (other than sales bonuses and commissions), except to the extent the Administration otherwise provides, the Participant may file a written deferral election with the Employer on or before June 30 of the Plan Year preceding the Plan Year in which that annual incentive payment first would become payable. Once made, a Compensation Deferral election (whether for regular payroll or annual incentive pay) shall continue in force indefinitely until affirmatively changed. A Participant may change a Compensation Deferral for future years by filing a revised written deferral election in accordance with this Section 3.2(c); for example, by filing an election with respect to regular salary prior to the first day of the next Plan Year, in accordance with the procedures specified above. Compensation Deferrals shall be deducted by the Employer from the pay of a deferring Participant and shall be credited to the Account of the deferring Participant within a reasonable time of the date that the deferral amount would otherwise have been paid to the Participant.

(d) Suspension of Contributions . Notwithstanding anything to the contrary, in any case where a Participant receives a hardship withdrawal under Section 5.3, the Participant’s Compensation Deferrals shall be suspended for Compensation earned in the remainder of the Plan Year following the Plan Year in which that withdrawal was made (including annual incentive Compensation earned in such Plan Year but payable in the next Plan Year).

(e) Compensation Deferral Account . There shall be established and maintained by the Employer a Compensation Deferral Account in the name of each

Participant to which shall be credited or debited: (a) amounts equal to the Participant’s Compensation Deferrals; (b) amounts equal to any deemed earnings or losses (as determined by the Administrator, in its sole and absolute discretion) attributable or allocable thereto; and (c) expenses charged to that Account.

(f) Vesting . A Participant shall at all times be fully vested in amounts credited to his or her Participant Compensation Deferral Account.

3.3 CONTRIBUTIONS TO THE TRUST . An amount shall be contributed by the Employer to the Trust, if any, maintained under Section 11.1 equal to the amount(s) required to be credited to the Participant’s Account under Sections 3.1 and 3.2.

ARTICLE 4

ALLOCATION OF FUNDS

4.1 ALLOCATION OF EARNINGS OR LOSSES ON ACCOUNTS . Subject to Section 4.5, each Participant shall have the right to direct the Administrator as to how amounts in his or her Plan Account shall be deemed to be invested among the investment funds made available by the Administrator in its absolute discretion. Subject to such limitations as may from time to time be required by law, imposed by the Administrator or contained elsewhere in the Plan, and subject to such operating rules and procedures as may be imposed from time to time by the Administrator, prior to the date on which a direction will become effective, the Participant shall have the right to direct the Administrator as to how amounts in his or her Account shall be deemed to be invested. The Administrator shall direct the Trustee to invest the account maintained in the Trust, if any, with respect to the Participant pursuant to the deemed investment directions the Administrator properly has received from the Participant. As of each Valuation Date, each Participant’s Account will be credited or debited with earnings or losses of the designated deemed investments in an amount equal to that determined by multiplying the balance credited to such designated deemed investment for the Participant’s Account as of the prior Valuation Date by the net rate of gain or loss on the assets of such designated deemed investment since the last Valuation Date.

4.2 ACCOUNTING FOR DISTRIBUTIONS . As of the date of any distribution hereunder, the distribution made hereunder to the Participant or his or her Beneficiary or Beneficiaries shall be charged to such Participant’s Account. Such amounts generally shall be charged on a pro rata basis against the investments in which the Participant’s Account is deemed to be invested.

4.3 SEPARATE ACCOUNTS . A separate account under the Plan shall be established and maintained by the Administrator to reflect the Account for each Participant with sub-accounts to show separately the deemed earnings and losses credited or debited to such Account, and the applicable deemed investments of the Account.

4.4 INTERIM VALUATIONS . If it is determined by the Administrator that the value of the Participant’s Account as of any date on which distributions are to be

made differs materially from the value of the Participant’s Account on the prior Valuation Date upon which the distribution is to be based, the Administrator, in its sole and absolute discretion, shall have the right to designate any date in the interim as a Valuation Date for the purpose of revaluing the Participant’s Account so that the Account will, prior to the distribution, reflect its share of such material difference in value.

4.5 DEEMED INVESTMENT DIRECTIONS OF PARTICIPANTS . Subject to such limitations as may from time to time be required by law, imposed by the Administrator or contained elsewhere in the Plan, and subject to such operating rules and procedures as may be imposed from time to time by the Administrator, prior to and effective for each Designation Date, each Participant may communicate to the Administrator a direction as to how his or her Account should be deemed to be invested among such deemed investment funds as may be made available by the Administrator hereunder. The Administrator may, in its absolute discretion, select the investment funds to be made available from time to time as deemed investments under the Plan and may add or remove investment funds as it deems appropriate, provided that the Administrator generally shall give at least thirty (30) days’ advance notice to the participant before any investment fund is removed or made unavailable. Such direction shall designate the percentage (in whole percentages or such other increments permitted by the Administrator) of each portion of the Participant’s Account which is requested to be deemed to be invested in such deemed investment funds, and shall be subject to the following rules:

(a) Any initial or subsequent deemed investment direction shall be made in the manner designated by the Administrator, and shall be effective as of the next Designation Date which is at least ten (10) business days (or such lesser number of days permitted by the Administrator) after such filing.

(b) All amounts credited to the Participant’s account shall be deemed to be invested in accordance with the then effective deemed investment direction; and as of the effective date of any new deemed investment direction, all or a portion of the Participant’s Account at that date shall be reallocated among the designated deemed investment funds according to the percentages specified in the new deemed investment direction unless and until a subsequent deemed investment direction shall be filed and become effective. An election concerning deemed investment choices shall continue indefinitely as provided in the Participant’s most recent election form, or other form specified by the Administrator.

(c) If the Administrator receives an initial or revised deemed investment direction which it deems to be incomplete, unclear or improper, the Participant’s investment direction then in effect shall remain in effect (or, in the case of a deficiency in an initial deemed investment direction, the Participant shall be deemed to have filed no deemed investment direction) until the next Designation Date, unless the Administrator provides for, and permits the application of, corrective action prior thereto.

(d) If the Administrator possesses (or is deemed to possess as provided in (c), above) at any time directions as to the deemed investment of less than all of a

Participant’s Account, the Participant shall be deemed to have directed that the undersigned portion of the Account be deemed to be invested in a money market, fixed income or similar fund made available under the Plan as determined by the Administrator in its discretion.

(e) Each Participant hereunder, as a condition to his or her participation hereunder, agrees to indemnify and hold harmless the Company, each Employer, the Administrator and their agents and representatives from any losses or damages of any kind relating to the deemed investment of the Participant’s Account hereunder.

(f) Each reference in this Section to a Participant shall be deemed to include, where applicable, a reference to any Beneficiary of the Participant.

4.6 EXPENSES . The Company anticipates that it will pay all expenses of administering the Plan and the Trust and all fees and expenses with respect to which the Trustee is entitled to compensation or reimbursement. If not so paid, the fees and expenses shall be paid from the Trust. If any fees or other expenses are paid from the Trust or if any assets of the Trust are distributed from the Trust other than for purposes of paying benefits under the Plan (e.g., are used to pay claims of the Employer’s general Insolvency creditors, such fees, expenses or other charges shall be charged against each Plan Participant’s interest in the Trust, pro rata based upon the relative value of each such Participant’s interest in the Trust as of the Valuation Date next preceding the applicable payment or charge. Taxes allocable to a particular Participant’s interest in the Trust shall be charged against that Participant’s interest.

4.7 TAXES . Any taxes allocable to an Account (or portion thereof) maintained under the Plan which are payable prior to the distribution of the Account (or portion thereof), as determined by the Administrator, in its sole and absolute discretion, shall be charged against that Account as an expense of the Account, in the manner provided in Section 4.6.

ARTICLE 5

ENTITLEMENT TO BENEFITS

5.1 PAYMENT DATE; SEPARATION FROM SERVICE .

(a) General Rule. The Payment Date applicable to the Participant’s Discretionary Contribution Account and the Participant’s Compensation Deferral Account shall be the Payment Date, as selected by the Administrator, which shall not be later than the later of (i) the end of the calendar year in which the Participant separates from service with all Employers or (ii) the 15 th day of the third month following the date on which the Participant separates from service with all Employers.

(b) Key Employees . Except to the extent permitted under Code Section 409A, a Participant who is a Key Employee on the date he or she separates from service with all the Employers shall not be entitled to a distribution on account of such separation from service until six months after such

separation from service (or if earlier, the date of the Participant’s death).

(c) Grandfathered Accounts . With respect to those Compensation Deferral Accounts credited under the Plan as of December 31, 2004 (“Grandfathered Account”), for which the Participant elected, prior to the Effective Date, a fixed payment date, such Grandfathered Account, as adjusted for subsequent earnings and losses therein (and specifically excluding any additional Compensation Deferral elections) shall be paid in the form of a lump sum as of such previously elected fixed payment date.

5.2 SEPARATION FROM SERVICE UPON DISPOSITION OF ASSETS OR SUBSIDIARIES . Upon the disposition of the stock of a subsidiary of the Company or substantially all of the assets of either the Company or a subsidiary of the Company, a Participant affected by that sale or disposition shall not be considered to have separated from service for purposes of this Plan if all of the following conditions are satisfied: (a) the Participant continues employment with either the Company or the subsidiary, as the case may be, or the entity acquiring such assets; (b) the purchaser agrees to assume responsibility for payment of the vested and unvested benefit obligations to the Participant and all other similarly situated Participants accrued hereunder as of the sale date; and (c) assets equal to the value of the Participant’s and all other similarly situated Participants benefits accrued hereunder as of the sale date are transferred from the Trust to a similar trust established or designated by the purchaser. If any of the foregoing conditions are not satisfied, then the Participant shall be deemed to have separated from service for purposes of this Plan upon the disposition of the stock of such subsidiary or substantially all of the assets of the Company or a subsidiary of the Company by which the Participant was employed.

5.3 HARDSHIP DISTRIBUTIONS . In the event of financial hardship of the Participant, as hereinafter defined, the Participant may apply to the Administrator for the distribution of all or any part of his or her Compensation Deferral Account and Discretionary Contribution Account. The Administrator shall consider the circumstances of each such case, and the best interests of the Participant and his or her family, and shall have the right, in its sole and absolute discretion, if applicable, to allow such distribution, or, if applicable, to direct a distribution of part of the amount requested, or to refuse to allow any distribution. Upon a finding of financial hardship, the Administrator shall make or cause the appropriate distribution to be made to the Participant from amounts held by the Administrator or the Trustee in respect of the Participant’s vested Compensation Deferral Account and Discretionary Contribution Account. In no event shall the aggregate amount of the distribution exceed either the full value of the Participant’s vested Compensation Deferral Account and Discretionary Contribution Account or the amount determined by the Administrator, in its sole and absolute discretion, to be necessary to alleviate the Participant’s financial hardship (which financial hardship may be considered to include any taxes due because of the distributions occurring because of this Section), and which is not reasonably available from other resources of the Participant. For purposes of this Section, the value of the Participant’s Compensation Deferral Account and Discretionary Contribution Account shall be determined as of the date of the distribution. “Financial hardship” means (a) a

severe financial hardship to the Participant resulting from a sudden and unexpected illness or accident of the Participant or of a dependent (as defined in Code section 152(a)) of the Participant, (b) loss of the Participant’s property due to casualty, or (c) other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the Participant, each as determined to exist by the Administrator. A distribution may be made under this Section only with the consent of the Administrator and only to the extent it satisfies the requirements for a distribution on account of an unforeseeable emergency, pursuant to Section 409A of the Code.

5.4 APPLICATION TO TRUSTEE . On the date or dates on which a Participant or Beneficiary is entitled to payment under Section 5.1, the Participant or Beneficiary need not make application for payment to the Administrator, but instead may make application for payment directly to the Trustee who shall, subject to any restrictions or limitations contained in the Trust, pay the Participant or Beneficiary the appropriate amount directly from the Trust without the consent of the Administrator. The Trustee shall report the amount of each such payment, and any withholding thereon, to the Administrator.

5.5 RE-EMPLOYMENT OF RECIPIENT . If a Participant receiving installment distributions pursuant to Section 6.2 is re-employed by the Employer, the remaining distributions due to the Participant shall continue without interruption.

ARTICLE 6

DISTRIBUTION OF BENEFITS

6.1 DISTRIBUTABLE AMOUNT . Upon the occurrence of a Payment Date applicable to any portion of a Participant’s Account, the vested portion of the Participant’s Account that is subject to that Payment Date (the “Distributable Amount”) shall be paid or commence to be paid to the Participant under Section 6.2. Any payment due hereunder from the Trust which is not paid by the Trust for any reason will be paid by the Employer from its general assets.

6.2 METHOD OF PAYMENT .

(a) Cash Or In-Kind Payments . Payments under the Plan shall generally be made in cash; provided, however, that to the extent payment is made directly from the Trust, payment may be made in cash or in-kind as elected by the Participant, as permitted by the Administrator in its sole and absolute discretion and subject to applicable restrictions on transfer as may be applicable legally and contractually.

(b) Timing and Manner of Payment .

(i) Minimum Distribution : If at the time a Participant separates from service with all of the Employers, the Participant’s entire Account balance under the Plan (and any other account balance plan that would be aggregated with the Plan under Section 409A of the Code) is less than $50,000, then, regardless of any method of payment that may have been elected by the Participant, the Distributable

Amount shall be paid in one lump sum payment to the Participant on the applicable Payment Date.

(ii) Election of Form of Distribution. If an Eligible Employee first becomes a Participant as a result of Compensation Deferrals, he or she shall file with the Administrator an election regarding the form of payment of his Accounts, at the same time as he or she files the initial deferral election. If an Eligible Employee first becomes a Participant as a result of a Discretionary Contribution, he or she shall file with the Administrator an election regarding the from of payment of his Accounts prior to the date such Discretionary Contribution is credited to his Account.

(iii) Alternative Forms of Distribution . A Participant may elect to have his or her Account distributed on the Payment Date in the form of: (a) a lump sum payment, (b) twenty (20) quarterly payments, commencing on the Payment Date, or (c) forty (40) quarterly payments, commencing on the Payment Date. Each quarterly payment shall equal a fraction of the Participant’s total accounts; the numerator of the fraction shall be 1, and the denominator shall be the remaining number of installments.

(iv) Changes in Payment Elections. A Participant may not change his or her election regarding the method of payment (i.e., a lump sum or installments).

(v) Investments . If the whole or any part of a payment hereunder is to be in installments, the total to be so paid shall continue to be deemed to be invested pursuant to Sections 4.1 and 4.5 under such procedures as the Administrator may establish, in which case any deemed income, gain, loss or expense attributable thereto (as determined by the Trustee, in its discretion) shall be reflected in the Account when the amount of each installment payment is determined.

(vi) Default : If the Distributable Amount equals or exceeds $50,000 at the Participant’s separation from service with all of the Employers and the Participant has not elected another method of payment under this Section, the Distributable Amount (as adjusted for subsequent gains, losses, expenses and required withholdings) shall be paid to the Participant in one lump sum cash payment on the applicable Payment Date.

6.3 DEATH BENEFITS . If a Participant dies before separating from service with all Employers, the entire undistributed value of the Participant’s Account shall be paid on the Payment Date, in the form of a lump sum payment, to the person or persons designated as the Participant’s Beneficiary(ies) in accordance with Section 7.1. If a Participant dies after separating from service and before he or she has received all payments to which he or she is entitled under the Plan, the entire undistributed value of the Participant’s Account shall be paid to the person or persons designated in accordance with Section 7.1, in the form of a lump sum no later than the later of (i) December 31 of the year in which the Participant died or (ii) March 15 of the year immediately succeeding the year in which the Participant died.

ARTICLE 7

BENEFICIARIES; PARTICIPANT DATA

7.1 DESIGNATION OF BENEFICIARIES . Each Participant from time to time may designate any person or persons (who may be named contingently or successively) to receive such benefits as may be payable under the Plan upon or after the Participant’s death, and such designation may be changed from time to time by the Participant by filing a new designation. Each designation will revoke all prior designations by the same Participant, shall be in a form prescribed by the Administrator, and will be effective only when filed in writing with the Administrator during the Participant’s lifetime.

In the absence of a valid Beneficiary designation, or if, at the time any benefit payment is due to a Beneficiary, there is no living Beneficiary validly named by the Participant, the Administrator shall cause the payment of any such benefit payment to be made to the Participant’s spouse, if then living, but otherwise to the Participant’s then living descendants, if any, per stirpes , but, if none, to the Participant’s estate. In determining the existence or identity of anyone entitled to a benefit payment, the Administrator may rely conclusively upon information supplied by the Participant’s personal representative, executor or administrator. If a question arises as to the existence or identity of anyone entitled to receive a benefit payment as aforesaid, or if a dispute arises with respect to any such payment, then, notwithstanding the foregoing, the Administrator, in its sole and absolute discretion, may direct the Employer to distribute such payment to the Participant’s estate without liability for any tax or other consequences which might flow therefrom, or may take such other action as the Administrator deems to be appropriate.

7.2 INFORMATION TO BE FURNISHED BY PARTICIPANTS AND BENEFICIARIES; INABILITY TO LOCATE PARTICIPANTS OR BENEFICIARIES . Any communication, statement or notice addressed to a Participant or to a Beneficiary at his or her last post office address as shown on the Employer’s records shall be binding on the Participant or Beneficiary for all purposes of the Plan. The Administrator shall not be obliged to search for any Participant or Beneficiary beyond the sending of a registered letter to such last know address. If the Administrator notifies any Participant or Beneficiary that he or she is entitled to an amount under the Plan and the Participant or Beneficiary fails to claim such amount or make his or her location known to the Administrator within three (3) years thereafter, then, except as otherwise required by law, if the location of one or more of the next of kin of the Participant is known to the Administrator, the Administrator may direct distribution of such amount to any one or more or all of such next of kin, and in such proportions as the Administrator determines. If the location of none of the foregoing persons can be determined, the Administrator shall have the right to direct that the amount payable shall be deemed to be a forfeiture and paid to the Employer, except that the dollar amount of the forfeiture, unadjusted for deemed gains or losses in the interim, shall be paid by the Employer if a claim for the benefit subsequently is made by the Participant or Beneficiary to whom it was payable. If a benefit payable to an unlocated Participant or Beneficiary is subject to escheat

pursuant to applicable state law, the Employer shall not be liable to any person for any payment made in accordance with such law.

ARTICLE 8

ADMINISTRATION

8.1 ADMINISTRATIVE AUTHORITY . The Company may appoint one or more persons to serve as Administrator at its pleasure from time to time. Persons appointed as Administrator may include employees of an Employer and Participants. During any period when no person is currently serving as Administrator, the Company is charged with the Administrator’s duties. Where two or more persons are concurrently serving as Administrator, they are jointly responsible for all of the Administrator’s duties, except to the extent specific duties may have been allocated between them pursuant to Section 8.7. A person serving as Administrator may resign at any time by giving advance written notice to the Company. The Company may, in its discretion, remove any person serving as Administrator, with or without cause, by giving that person written notice of his removal. Any individual who was an Employee when appointed as Administrator is automatically removed at termination of employment by all Employers, without the necessity of any notice, unless his or her continued appointment is expressly requested by the Company. Any successor Administrator succeeds to all rights and duties of the predecessor. The Company is to notify the Trustee of all appointments, resignations or removals of Administrators. Except as otherwise specifically provided herein, the Administrator, in its sole and absolute discretion, shall have the sole responsibility for and the sole control of the operation and administration of the Plan, and shall have the power and authority to take all action and to make all decisions and interpretations which may be necessary or appropriate in order to administer and operate the Plan, including, without limiting the generality of the foregoing, the power, duty and responsibility to:

(a) Resolve and determine all disputes or questions arising under the Plan, and to remedy any ambiguities, inconsistencies or omissions in the Plan;

(b) Adopt such rules of procedure and regulations as in its opinion may be necessary for the proper and efficient administration of the Plan and as are consistent with the Plan;

(d) Make determinations with respect to the eligibility of any Eligible Employee as a Participant and make determinations concerning the crediting of Plan Accounts; and

(e) Appoint any persons or firms, or otherwise act to secure specialized advice or assistance, as it deems necessary or desirable in connection with the administration and operation of the Plan, and the Administrator shall be entitled to rely conclusively upon, and shall be fully protected in any action or omission taken by it in

good faith reliance upon, the advice or opinion of such firms or persons. The Administrator shall have the power and authority to delegate from time to time by written instrument all or any part of its duties, powers or responsibilities under the Plan, both ministerial and discretionary, as it deems appropriate, to any person or committee, and in the same manner to revoke any such delegation of duties, powers or responsibilities. Any action of such person or committee in the exercise of such delegated duties, powers or responsibilities shall have the same force and effect for all purposes hereunder as if such action had been taken by the Administrator. Further, the Administrator may authorize one or more persons to execute any certificate or document on behalf of the Administrator, in which event any person notified by the Employer of such authorization shall be entitled to accept and conclusively rely upon any such certificate or document executed by such person as representing action by the Administrator until such notified person shall have been notified of the revocation of such authority.

8.2 UNIFORMITY OF DISCRETIONARY ACTS . Whenever in the administration or operation of the Plan discretionary actions by the Administrator are required or permitted, such actions shall be consistently and uniformly applied to all persons similarly situated, and no such action shall be taken which shall discriminate in favor of any particular person or group of persons.

8.3 LITIGATION . Except as may be otherwise required by law, in any action or judicial proceeding affecting the Plan, no Participant or Beneficiary shall be entitled to any notice or service of process, and any final judgment entered in such action shall be binding on all persons interested in, or claiming under, the Plan.

8.4 CLAIMS PROCEDURE . Any person claiming a benefit under the Plan (a “Claimant”) shall present the claim, in writing, to the Administrator, and the Administrator shall respond in writing. In the claim is denied, the written notice of denial shall state, in a manner calculated to be understood by the Claimant:

(a) The specific reason or reasons for the denial, with specific references to the Plan provisions on which the denial is based;

(b) A description of any additional material or information necessary for the Claimant to perfect his or her claim and an explanation of why such material or information is necessary; and

The written notice denying or granting the Claimant’s claim shall be provided to the Claimant within ninety (90) days after the Administrator’s receipt of the claim, unless special circumstances require an extension of time for processing the claim. If such an extension is required, written notice of the extension shall be furnished by the Administrator to the Claimant within the initial ninety (90) day period and in no event shall such an extension exceed a period of ninety (90) days from the end of the initial ninety (90) day period. Any extension notice shall indicate the special circumstances requiring the extension and the date on which the Administrator expects to render a

decision on the claim. Any claim not granted or denied within the period noted above shall be deemed to have been denied.

Any Claimant whose claim is denied, or deemed to have been denied under the preceding sentence (or such Claimant’s authorized representative), may, within sixty (60) days after the Claimant’s receipt of notice of the denial, or after the date of the deemed denial, request a review of the denial by notice given, in writing, to the Administrator. Upon such a request for review, the claim shall be reviewed by the Administrator (or its designated representative) which may, but shall not be required to, grant the Claimant a hearing. In connection with the review, the Claimant may have representation, may examine pertinent documents, and may submit issues and comments in writing.

The decision on review normally shall be made within sixty (60) days of the Administrator’s receipt of the request for review. If an extension of time is required due to special circumstances, the Claimant shall be notified, in writing, by the Administrator, and the time limit for the decision on review shall be extended to one hundred twenty (120) days. The decision on review shall be in writing and shall state, in a manner calculated to be understood by the Claimant, the specific reasons for the decision and shall include references to the relevant Plan provisions on which the decision is based. The written decision on review shall be given to the Claimant within the sixty (60) day (or, if applicable, the one hundred twenty (120) day) time limit discussed above. If the decision on review is not communicated to the Claimant within the sixty (60) day (or, if applicable, the one hundred twenty (120) day) period discussed above, the claim shall be deemed to have been denied upon review. All decisions on review shall be final and binding with respect to all concerned parties.

8.5 ACTION BY THE ADMINISTRATOR . If more than one Administrator has been appointed, they may elect a chairman and secretary and adopt rules for the conduct of their business. A majority of the persons then serving constitutes a quorum for the transaction of business. All action taken by the Administrator is to be by vote of a majority of those present at such meeting and entitled to vote or without a meeting upon written consent signed by at least a majority of the Administrators. All documents are to be executed on the Administrator’s behalf by either the chairman or the secretary, if any, except that any Administrator has the power to execute all documents necessary or required by an insurer in connection with the application for insurance policies, and the act of that Administrator is binding on all Administrators to the same extent as though that instrument had been executed by the chairman or the secretary.

8.6 PARTICIPATION BY ADMINISTRATORS . No Administrator shall be precluded from becoming a Plan Participant, if he or she would be otherwise eligible, but he may not vote or act upon matters relating specifically to his or her own participation under the Plan, except when such matters relate to benefits generally. If this disqualification results in the lack of a quorum, then the Company shall appoint a sufficient number of temporary Administrators to serve for the sole purpose of determining that question.

8.7 ALLOCATION OF DUTIES . The Administrator’s duties, powers and responsibilities may be allocated among its members so long as that allocation is pursuant to written procedures adopted by the Administrator, in which case, except as may be required by ERISA, no Administrator shall have any liability with respect to any duties, powers or responsibilities not allocated to him, or for the acts or omissions of any other Administrator.

ARTICLE 9

AMENDMENT

9.1 RIGHT TO AMEND . The Company, by written instrument executed by the Company, shall have the right to amend the Plan, at any time and with respect to any provisions hereof, and all parties hereto or claiming any interest hereunder shall be bound by such amendment; provided, however, that no such amendment shall deprive a Participant or a Beneficiary of a material right accrued hereunder prior to the date of the amendment.

9.2 AMENDMENTS TO ENSURE PROPER CHARACTERIZATION OF PLAN . Notwithstanding the provisions of Section 9.1, the Plan may be amended by the Company at any time, retroactively if required, if found necessary, in the opinion of the Company, in order to ensure that the Plan is characterized as “top-hat” plan of deferred compensation maintained for a select group of management or highly compensated employees as described under ERISA sections 201(2), 301(a)(3), an 401(a)(1), to comply with Section 409A of the Code, and to conform the Plan to the provisions and requirements of any applicable law (including ERISA and the Code). No such amendment shall be considered prejudicial to any interest of a Participant or a Beneficiary hereunder.

ARTICLE 10

TERMINATION

10.1 TERMINATION OF SUSPENSION OF PLAN . The Employer reserves the right to terminate the Plan as to some or all of its Eligible Employees and/or its obligation to make further credits to Plan Accounts. The Company reserves the right to suspend the operation of the Plan for a fixed or indeterminate period of time.

10.2 AUTOMATIC TERMINATION OF PLAN . The Plan automatically shall terminate upon the dissolution of the Company, or upon its merger into or consolidation with any other corporation or business organization if there is a failure by the surviving corporation or business organization to adopt specifically and agree to continue the Plan, provided that distributions of Accounts shall not be made to a Participant upon any such events if it would result in the Participant incurring a penalty under Section 409A of the Code.

10.3 SUSPENSION OF DEFERRALS . In the event of a suspension of the Plan, the Company and the Employer shall continue all aspects of the Plan, other than Compensation Deferrals and Employer Contribution Credits, during the period of the suspension, in which event payments hereunder will continue to be made during the period of the suspension in accordance with Articles 5 and 6.

10.4 ALLOCATION AND DISTRIBUTION . This Section shall become operative on a complete termination of the Plan. The provisions of this Section also shall become operative in the event of a partial termination of the Plan, as determined by the Administrator, in its sole and absolute discretion, but only with respect to that portion of the Plan attributable to the Participants to whom the partial termination is applicable. Upon the effective date of any such event, notwithstanding any other provisions of the Plan, no persons who were not theretofore Participants shall be eligible to become Participants, the value of the interest of all Participants and Beneficiaries shall be determined and, after deduction of estimated expenses in liquidating and, if applicable, paying Plan benefits, paid to them as soon as is practicable after such termination, provided such payment can be made in compliance with Section 409A of the Code.

10.5 SUCCESSOR TO EMPLOYER . Any corporation or other business organization which is a successor to an Employer by reason of a consolidation, merger or purchase of substantially all of the assets of an Employer shall have the right to become a party to the Plan by adopting the same by resolution of the entity’s board of directors or other appropriate governing body, subject to the approval by the Company in its role discretion. If, within ninety (90) days from the effective date of such consolidation, merger or sale of assets, such new entity does not become a party hereto, as above provided, the Plan automatically shall be terminated as to that Employer, and the provisions of Section 10.4 shall become operative.

ARTICLE 11

THE TRUST

11.1 ESTABLISHMENT OF TRUST . The Company may establish the Trust with the Trustee pursuant to such terms and conditions as are set forth in the Trust agreement to be entered into between the Company and the Trustee. The Trust is intended to be treated as a “grantor” trust under the Code; the establishment of the Trust is not intended to cause the Participant to realize current income on amounts contributed thereto; the Trust is not intended to cause the Plan to be “funded” under ERISA and the Code; and the Trust shall be so interpreted.

11.2 UNFUNDED STATUS OF PLAN . This Plan constitutes a mere contractual promise by the Company and the other Employers to make benefit payments in the future, and each Participant’s rights shall be those of a general, unsecured creditor of the Company and/or Employer. No Participant shall have any beneficial interest in any specific assets that an Employer may hold or set aside in connection with this Plan.

ARTICLE 12

MISCELLANEOUS

12.1 LIMITATIONS ON LIABILITY OF EMPLOYER . Neither the establishment of the Plan nor any modification thereof, nor the creation of any account under the Plan, nor the payment of any benefits under the Plan shall be construed as giving to any Participant or other person any legal or equitable right against the Employer, or any officer or employee thereof except as provided by law or by any Plan provision. Neither the Company nor any other Employer in any way guarantees any Participant’s Account from loss or depreciation, whether caused by poor investment performance or the inability to realize upon an investment due to an insolvency affecting an investment vehicle or any other reason. In no event shall the Company, an Employer, or any successor, employee, officer, director or stockholder of the Company or an Employer, be liable to any person on account of any claim arising by reason of the provisions of the Plan or of any instrument or instruments implementing its provisions, or for the failure of any Participant, Beneficiary or other persons to be entitled to any particular tax consequences with respect to the Plan, or any credit or distribution hereunder.

12.2 CONSTRUCTION . If any provision of the Plan is held to be illegal or void, such illegality or invalidity shall not affect the remaining provisions of the Plan, but shall be fully severable, and the Plan shall be construed and enforced as if said illegal or invalid provision had never been inserted herein. For all purposes of the plan, where the context admits, the singular shall include the plural, and the plural shall include the singular. Headings of Articles and Sections herein are inserted only for convenience of reference and are not to be considered in the construction of the Plan. The laws of the State of Maryland shall govern, control and determine all questions of law arising with respect to the Plan and the interpretation and validity of its respective provisions, except where those laws are preempted by the laws of the United States. Participation under the Plan will not give any Participant the right to be retained in the service of the Employer nor any right or claim to any benefit under the Plan unless such right or claim has specifically accrued hereunder.

The Plan is intended to be and at all times shall be interpreted and administered so as to comply with Section 409A of the Code, to qualify as an unfunded deferred compensation plan, and no provision of the Plan shall be interpreted so as to give any individual any right in any assets of the Employer which right is greater than the rights of a general unsecured creditor of the Employer.

This Plan is intended to be a “top-hat” plan under ERISA. In the event the Administrator determines that the participation of certain individuals as Eligible Employees under the Plan causes the Plan to fail to qualify as a “top-hat” plan, the Company, in its sole and absolute direction, is authorized to take whatever action it deems necessary to preserve the status of the Plan as a “top-hat” plan, including, but not limited to, termination of an otherwise eligible employee’s participation in the Plan and (notwithstanding any provisions of the Plan to the contrary) immediate distribution of

such individual’s Account, provided such distribution complies with Section 409A of the Code.

12.3 SPENDTHRIFT PROVISION . No amount payable to a Participant or a Beneficiary under the Plan shall, except as otherwise specifically provided by law, be subject in any manner to anticipation, alienation, attachment, garnishment, sale, transfer, assignment (either at law or in equity), levy, execution, pledge, encumbrance, charge or any other legal or equitable process, and any attempt to do so will be void; nor will any benefit be in any manner liable for or subject to the debts, contracts, liabilities, engagements or torts of the person entitled thereto. Further, none of the following shall be construed as an assignment or alienation: (i) the withholding of taxes from Plan benefit payments, (ii) the recovery under the Plan of overpayments of benefits previously made to a Participant or Beneficiary; (iii) if applicable, the transfer of benefit rights from the Plan to another plan, (iv) the direct deposit of benefit payments to an account in a banking or investment institution (if not actually part of an arrangement constituting an assignment or alienation), or (v) the segregation of all or a part of an Account in accordance with a court-approved domestic relations order.

In the event that any Participant’s or Beneficiary’s benefits hereunder are garnished or attached by order of any court, the Administrator or Trustee may bring an action or a declaratory judgment in a court of competent jurisdiction to determine the proper recipient of the benefits to be paid under the Plan. During the pendency of said action, any benefits that become payable shall be held as credits to the Participant’s or Beneficiary’s Account or, if the Administrator or Trustee prefers, paid into the court as they become payable, to be distributed by the court to the recipient as the court deems proper at the close of said action.

12.4 NO EMPLOYMENT CONTRACT . Neither this Plan nor a Participant’s Compensation Deferral election, either singly or collectively, shall in any way obligate any Employer to continue the employment of a Participant with the Employer, nor does either this Plan or a Compensation Deferral election limit the right of an Employer at any time and for any reason to terminate the Participant’s employment. In no event shall this Plan by its terms or implications constitute an employment contract of any nature whatsoever between the Company and a Participant.

12.5 NOTICES . Any written notice to the Company referred to herein shall be made by mailing or delivering such notice to the Company to the attention of Vice President, Human Resources at 6950 Columbia Gateway Drive, Suite 400, Columbia, Maryland 21046 or any other address designated by the Company. Any written notice to a Participant shall be made by delivery to the Participant in person, through electronic transmission, or by mailing such notice to the Participant at his place of residence or business address.

12.6 CONSENT TO PLAN . By electing to become a Participant hereunder, each Participant shall be deemed conclusively to have accepted and consented to all of the terms of this Plan and all actions or decisions made by the Administrator or the Employer.

12.7 BINDING ON SUCCESSORS . The provision of this Plan and the Compensation Deferral elections hereunder shall be binding upon and inure to the benefit of the Company, its successors, and its assigns, and to the Participants and their heirs, executors, administrators, and legal representatives.

IN WITNESS WHEREOF, the Company has caused the Plan to be executed and its seal to be affixed hereto, on this the 24th day of October, 2006.

Exhibit 10.2

AMENDMENT TO EMPLOYMENT AGREEMENT (TIER II)

This Amendment to Employment Agreement between Magellan Health Services, Inc. (“Employer”) and Jeffrey West entered into as of this 28th day of July, 2006 (“Employee”).

WHEREAS , Employer and Employee desire to amend the terms of the Employment Agreement currently in effect between Employer and Employee (the “Employment Agreement”).

NOW THEREFORE , Employer or Employee agree that the Employment Agreement is hereby amended as follows:

I. New Change in Control Provisions — Add the following new paragraphs:

1. Termination Without Cause by the Company or With Good Reason By Executive In connection With, Or Within Eighteen Months After, A Change In Control: If Employer terminates this Agreement and Employee’s employment without cause, or if Employee terminates this Agreement and Employee’s employment with Good Reason, in connection with a Change in Control (as defined below) (whether before or at the time of such Change in control) or within eighteen months after a change in Control, Employee shall receive the following, in lieu of the amounts and benefits described in Section 6:

(i) Base Salary through the date of termination;

(ii) pro-rata Target Bonus for the year in which termination occurs, payable in a single installment immediately after termination;

(iii) 1.5 times the sum of (a) Base Salary plus (b) Target bonus, payable in a single cash installment immediately after termination;

(iv) if employee elects COBRA coverage for health, dental and vision benefits, Employer shall pay Employer’s contributions for health insurance and Employee shall pay Employee’s contributions rate for health, dental and vision insurance for up to eighteen (18) months after termination.

(v) any other amounts earned, accrued or owing to Executive but not yet paid;

(vi) other payments, entitlements or benefits, if any, that are payable in accordance with applicable plans, programs, arrangements or other agreements of the company or any affiliate; and

(vii) all stock options granted to Employee from January 4, 2004 and prior to March 10, 2005 shall vest and become immediately exercisable.

2. Definitions:

A. Change in Control:

A “Change in Control” of the Company shall mean the first to occur after the date hereof of any of the following events:

(i) any “person,” as such term is used in Sections 3(a)(9) and 13(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), becomes a “beneficial owner,” as such term is used in Rule 13d-3 promulgated under the Exchange Act, of 51% or more of the Voting Stock (as defined below) of the Company;

(ii) the majority of the Board of Directors of the Company consists of individuals other than “Continuing Directors,” which shall mean the members of the Board on the date hereof, provided that any person becoming a director subsequent to the date hereof whose election or nomination for election was supported by a vote of the directors who then comprised the Continuing Directors, shall be considered to be a Continuing Director;

(iii) the Board of Directors of the Company adopts and, if required by law or the certificate of incorporation of the Corporation, the shareholders approve the dissolution of the Company or a plan of liquidation or comparable plan providing for the disposition of all or substantially all of the Company’s assets;

(iv) all or substantially all of the assets of the Company are disposed of pursuant to a merger, consolidation, share exchange, reorganization or other transaction unless the shareholders of the Company immediately prior to such merger, consolidation, share exchange, reorganization or other transaction beneficially own, directly or indirectly, in substantially the same proportion as they previously owned the Voting Stock or other ownership interests of the Company, 51% of the Voting Stock or other ownership interests of the entity or entities, if any, that succeed to the business of the Company; or

(v) the Company merges or combines with another company and, immediately after the merger or combination, the shareholders of the Company immediately prior to the merger or combination own, directly or indirectly, 50% or less of the Voting Stock of the successor company, provided that in making such determination there shall be excluded from the number of shares of Voting Stock held by such shareholders, but not from the Voting Stock of the successor company, any shares owned by Affiliates of such other company who were not also Affiliates of the Company prior to such merger or combination.

B. “Cause” in connection with a Change in Control shall mean:

(i) Employee is convicted of (or pleads guilty or nolo contendere to) a felony or a crime involving moral turpitude;

(ii) Employee’s commission of an act of fraud or dishonesty involving his or her duties on behalf of the Company;

(iii) Employee’s willful failure or refusal to faithfully and diligently perform duties lawfully assigned to Employee as an officer or employee of the Company or other willful breach of any material term of any employment agreement at the time in effect between the Company and Employee; or

(iv) Employee’s willful failure or refusal to abide by the Company’s policies, rules, procedures or directives, including any material violation of the Company’s Code of Ethics.

C. “Good Reason” shall mean:

(i) a reduction in Employee’s salary in effect at the time of a Change in Control, unless such reduction is comparable in degree to the reduction that takes place for all other employees of the Company of comparable rank, or a reduction in Employee’s target bonus opportunity for the year in which or any year after the year in which the Change of Control occurs from Employee’s target bonus opportunity for the year in which the Change in Control occurs (if any) as established under any employment agreement Employee has with the Company or any bonus plan of the Company applicable to Employee (or, if no such target bonus opportunity has yet been established for Employee under a bonus plan applicable to Employee for the year in which the Change of Control has occurred, the target bonus opportunity so established for Employee for the immediately preceding year, if any);

(iii) a material diminution in Employee’s position, duties or responsibilities as in effect at the time of a Change in Control, or the assignment to Employee of duties which are materially inconsistent with such position, duties and authority, unless in either case such change is made with the consent of the Employee; or

(iv) the relocation by more than 50 miles of the offices of the Company which constitute at the time of the Change in Control Employee’s principal location for the performance of his or her services to the Company;

provided that, in each such case, such event or condition continues uncured for a period of more than 15 days after Employee gives notice thereof to the Company.

D. “Company” shall include any entity that succeeds to all or substantially all of the business of the Company,

E. “Affiliate” of a person or other entity shall mean a person or other entity that directly or indirectly controls, is controlled by, or is under common control with the person or other entity specified,

F. “Voting Stock” shall mean any capital stock of any class or classes having general voting power under ordinary circumstances, in the absence of contingencies, to elect the directors of a corporation and reference to a percentage of Voting Stock shall refer to such percentage of the votes that all such Voting Stock is entitled to cast.

II. Other Changes

1. Amendment to Section 6(c)

Section 6 (c) in the Employment Agreement is hereby amended to change the reference in the fifth line from “35 miles” to “50 miles”.

2. Amendment to Section 7(b)(i):

Section 7(b)(i) is hereby amended to delete it and insert the following in place thereof:

(i) Employee covenants and agrees that during any period in which Base Salary is continued after termination of this Agreement (or in respect of which Base Salary is paid in a lump sum) or for one year after Employee’s voluntary termination of employment without Good Reason or termination of Employee’s employment for cause, he or she will not, on his or her own behalf or as a partner, officer, director, employee, agent, or consultant of any other person or entity, directly or indirectly, engage or attempt to engage in the business of providing or selling services in the United States that are services offered by Employer at the time of the termination of this Agreement, unless waived in writing by Employer in its sole discretion. Employee recognizes that the above restriction is reasonable and necessary to protect the interest of the Employer and its controller subsidiaries and affiliates.

IN WITNESS WHEREOF , Employer and Employee have executed this Amendment to Employment Agreement as of the date first above written.

Magellan Health Services, Inc.


By		/s/ Caskie Lewis-Clapper
		Duly Authorized


/s/ Jeffrey West
Employee

Exhibit 10.3

AMENDMENT TO EMPLOYMENT AGREEMENT (TIER I)

This Amendment to Employment Agreement between Magellan Health Services, Inc. (“Employer”) and Eric Reimer entered into as of this 28th day of July, 2006 (“Employee”).

WHEREAS , Employer and Employee desire to amend the terms of the Employment Agreement currently in effect between Employer and Employee (the “Employment Agreement”).

NOW THEREFORE , Employer or Employee agree that the Employment Agreement is hereby amended as follows:

I. New Change in Control Provisions — Add the following new paragraphs:

1. Termination Without Cause by the Company or With Good Reason By Executive In connection With, Or Within Two Years After, A Change In Control: If Employer terminates this Agreement and Employee’s employment without cause, or if Employee terminates this Agreement and Employee’s employment with Good Reason, in connection with a Change in Control (as defined below) (whether before or at the time of such Change in control) or within two years after a change in Control, Employee shall receive the following, in lieu of the amounts and benefits described in Section 6:

(i) Base Salary through the date of termination;

(ii) pro-rata Target Bonus for the year in which termination occurs, payable in a single installment immediately after termination;

(iii) 2 times the sum of (a) Base Salary plus (b) Target bonus, payable in a single cash installment immediately after termination;

(v) any other amounts earned, accrued or owing to Executive but not yet paid;

(vi) other payments, entitlements or benefits, if any, that are payable in accordance with applicable plans, programs, arrangements or other agreements of the company or any affiliate; and

(vii) all stock options granted to Employee from January 4, 2004 and prior to March 10, 2005 shall vest and become immediately exercisable.

2. Definitions:

A. Change in Control:

A “Change in Control” of the Company shall mean the first to occur after the date hereof of any of the following events:

(iii) the Board of Directors of the Company adopts and, if required by law or the certificate of incorporation of the Corporation, the shareholders approve the dissolution of the Company or a plan of liquidation or /comparable plan providing for the disposition of all or substantially all of the Company’s assets;

B. “Cause” in connection with a Change in Control shall mean:

(i) Employee is convicted of (or pleads guilty or nolo contendere to) a felony or a crime involving moral turpitude;

(ii) Employee’s commission of an act of fraud or dishonesty involving his or her duties on behalf of the Company;

(iv) Employee’s willful failure or refusal to abide by the Company’s policies, rules, procedures or directives, including any material violation of the Company’s Code of Ethics.

C. “Good Reason” shall mean:

provided that, in each such case, such event or condition continues uncured for a period of more than 15 days after Employee gives notice thereof to the Company.

D. “Company” shall include any entity that succeeds to all or substantially all of the business of the Company,

3 Tax Gross-Up. The following provisions shall apply with respect to any excise tax imposed under Section 4999 of the Internal Revenue Code as amended (the “Code”), (the “Excise Tax):

a. If any of the payments or benefits received or to be received by Employee in connection with a Change in Control or Employee’s termination of employee (whether pursuant to the terms of this Agreement or any other plan, arrangement of agreement with the Company, any person whose actions result in a Change on Control of the Company or any person affiliated with the Company or such person (the “Total Payments”)) will be subject to the Excise Tax, the Company shall pay to Employee an additional amount (the “Gross-Up Payment”) such that the net amount retained by Employee after payment of (a) the Excise Tax, if any, on the Total Payments and (b) any Excise Tax and income tax due in respect of the Gross-Up Payment, shall equal the Total Payments. Such payment shall be made in a single lump sum within 10 days following the date of a determination that only such payment is required.

b. For purposes of determining whether any of the Total payments will be subject to Excise Tax and the amount of such Excise Tax, (i) any Total Payments shall be treated as “parachute payments” (within the meaning of Section280G(b) (2) of the Code) unless, in the opinion of tax counsel selected by the Company and reasonably acceptable to Employee, such payments or benefits (in whole or in part) should not constitute parachute payments, including by reason of Section 280G (b) (4) (A) of the Code, and all “excess parachute payments” (within the meeting of Section 280G(b) (1) of the Code) shall be treated as subject to the Excise Tax unless, in the opinion of such tax counsel, such excess parachute payments (in whole or in part) represent reasonable compensation for services actually rendered (within the meaning of Section 280G(b) (4) (B) of the Code), or are otherwise not

subject to the Excise Tax, and (ii) the value of any noncash benefits or any deferred payment or benefit shall be determined by the Company’s independent auditors in accordance with the principles of Section 280G(d) (3) of the Code. For purposes of determining the amount of the Gross-Up payment, Employee shall be deemed to pay federal income and employment taxes at the highest marginal rate of federal income and employment taxation in the calendar year in which the Gross-Up Payment is to be made and state and local income and employment taxes at the highest marginal rate of taxation in the state and locality of Employee’s residence on the date of termination of employment (or such other time as hereinafter described), net of the maximum reduction in federal income or employment taxes which could be obtained from deduction of such state and local taxes.

In the event that the Excise Tax is subsequently determined to be less than the amount taken into account hereunder at the time of termination of Employee’s employment (or such other time as is hereinafter described), Employee shall repay to the Company, at the time that the amount of such reduction in Excise Tax is finally determined, the portion of the Gross-Up Payment attributable to such reduction plus interest on the amount of such repayment at the applicable federal rate, as defined in Section 1274(b) (2) (B) of the Code. In the event that the Excise Tax is determined to exceed the amount taken into account hereunder at the time of the termination of Employee’s employment (or such other time as is hereinafter described) (including by reason of any payment the existence or amount of which cannot be determined at the time of the Gross-Up Payment), the Company shall make an additional Gross-Up Payment in respect of such excess (plus any interest at the applicable federal rate, penalties or additions payable by Employee with respect to such excess) at the time that the amount of such excess is finally determined. Employee and the Company shall each reasonably cooperate with the other in connection with any administrative or judicial proceedings concerning the existence or amount of liability for Excise Tax with respect to the Total payments.

II. Other Changes

1. Amendment to Section 6(c)

Section 6 (c) in the Employment Agreement is hereby amended to change the reference in the fifth line from “35 miles” to “50 miles”.

2. Amendment to Section 7(b)(i):

Section 7(b)(i) is hereby amended to delete it and insert the following in place thereof:

IN WITNESS WHEREOF , Employer and Employee have executed this Amendment to Employment Agreement as of the date first above written.

Magellan Health Services, Inc.


By		/s/ Caskie Lewis-Clapper
		Duly Authorized


/s/ Eric Reimer
Employee

Exhibit 10.4

AMENDMENT TO EMPLOYMENT AGREEMENT (TIER I)

This Amendment to Employment Agreement between Magellan Health Services, Inc. (“Employer”) and Daniel Gregoire entered into as of this 28th day of July, 2006 (“Employee”).

WHEREAS , Employer and Employee desire to amend the terms of the Employment Agreement currently in effect between Employer and Employee (the “Employment Agreement”).

NOW THEREFORE , Employer or Employee agree that the Employment Agreement is hereby amended as follows:

I. New Change in Control Provisions — Add the following new paragraphs:

(i) Base Salary through the date of termination;

(ii) pro-rata Target Bonus for the year in which termination occurs, payable in a single installment immediately after termination;

(iii) 2 times the sum of (a) Base Salary plus (b) Target bonus, payable in a single cash installment immediately after termination;

(v) any other amounts earned, accrued or owing to Executive but not yet paid;

(vi) other payments, entitlements or benefits, if any, that are payable in accordance with applicable plans, programs, arrangements or other agreements of the company or any affiliate; and

(vii) all stock options granted to Employee from January 4, 2004 and prior to March 10, 2005 shall vest and become immediately exercisable.

2. Definitions:

A. Change in Control:

A “Change in Control” of the Company shall mean the first to occur after the date hereof of any of the following events:

B. “Cause” in connection with a Change in Control shall mean:

(i) Employee is convicted of (or pleads guilty or nolo contendere to) a felony or a crime involving moral turpitude;

(ii) Employee’s commission of an act of fraud or dishonesty involving his or her duties on behalf of the Company;

(iv) Employee’s willful failure or refusal to abide by the Company’s policies, rules, procedures or directives, including any material violation of the Company’s Code of Ethics.

C. “Good Reason” shall mean:

provided that, in each such case, such event or condition continues uncured for a period of more than 15 days after Employee gives notice thereof to the Company.

D. “Company” shall include any entity that succeeds to all or substantially all of the business of the Company,

3 Tax Gross-Up. The following provisions shall apply with respect to any excise tax imposed under Section 4999 of the Internal Revenue Code as amended (the “Code”), (the “Excise Tax):

(within the meaning of Section 280G(b) (4) (B) of the Code), or are otherwise not subject to the Excise Tax, and (ii) the value of any noncash benefits or any deferred payment or benefit shall be determined by the Company’s independent auditors in accordance with the principles of Section 280G(d) (3) of the Code. For purposes of determining the amount of the Gross-Up payment, Employee shall be deemed to pay federal income and employment taxes at the highest marginal rate of federal income and employment taxation in the calendar year in which the Gross-Up Payment is to be made and state and local income and employment taxes at the highest marginal rate of taxation in the state and locality of Employee’s residence on the date of termination of employment (or such other time as hereinafter described), net of the maximum reduction in federal income or employment taxes which could be obtained from deduction of such state and local taxes.

II. Other Changes

1. Amendment to Section 6(c)

Section 6 (c) in the Employment Agreement is hereby amended to change the reference in the fifth line from “35 miles” to “50 miles”.

2. Amendment to Section 7(b)(i):

Section 7(b)(i) is hereby amended to delete it and insert the following in place thereof:

IN WITNESS WHEREOF , Employer and Employee have executed this Amendment to Employment Agreement as of the date first above written.

Magellan Health Services, Inc.


By		/s/ Caskie Lewis-Clapper
		Duly Authorized


/s/ Daniel Gregoire
Employee

EXHIBIT 10.5

AMENDMENT TO EMPLOYMENT AGREEMENT (TIER I)

This Amendment to Employment Agreement between Magellan Health Services, Inc. (“Employer”) and Michael Majerik entered into as of this 28th day of July, 2006 (“Employee”).

WHEREAS , Employer and Employee desire to amend the terms of the Employment Agreement currently in effect between Employer and Employee (the “Employment Agreement”).

NOW THEREFORE , Employer or Employee agree that the Employment Agreement is hereby amended as follows:

I. New Change in Control Provisions — Add the following new paragraphs:

(i) Base Salary through the date of termination;

(ii) pro-rata Target Bonus for the year in which termination occurs, payable in a single installment immediately after termination;

(iii) 2 times the sum of (a) Base Salary plus (b) Target bonus, payable in a single cash installment immediately after termination;

(v) any other amounts earned, accrued or owing to Executive but not yet paid;

(vi) other payments, entitlements or benefits, if any, that are payable in accordance with applicable plans, programs, arrangements or other agreements of the company or any affiliate; and

(vii) all stock options granted to Employee from January 4, 2004 and prior to March 10, 2005 shall vest and become immediately exercisable.

2. Definitions:

A. Change in Control:

A “Change in Control” of the Company shall mean the first to occur after the date hereof of any of the following events:

B. “Cause” in connection with a Change in Control shall mean:

(i) Employee is convicted of (or pleads guilty or nolo contendere to) a felony or a crime involving moral turpitude;

(ii) Employee’s commission of an act of fraud or dishonesty involving his or her duties on behalf of the Company;

(iv) Employee’s willful failure or refusal to abide by the Company’s policies, rules, procedures or directives, including any material violation of the Company’s Code of Ethics.

C. “Good Reason” shall mean:

provided that, in each such case, such event or condition continues uncured for a period of more than 15 days after Employee gives notice thereof to the Company.

D. “Company” shall include any entity that succeeds to all or substantially all of the business of the Company,

3 Tax Gross-Up. The following provisions shall apply with respect to any excise tax imposed under Section 4999 of the Internal Revenue Code as amended (the “Code”), (the “Excise Tax):

II. Other Changes

1. Amendment to Section 6(c)

Section 6 (c) in the Employment Agreement is hereby amended to change the reference in the fifth line from “35 miles” to “50 miles”.

2. Amendment to Section 7(b)(i):

Section 7(b)(i) is hereby amended to delete it and insert the following in place thereof:

IN WITNESS WHEREOF , Employer and Employee have executed this Amendment to Employment Agreement as of the date first above written.

Magellan Health Services, Inc.


By		/s/ Caskie Lewis-Clapper
		Duly Authorized


/s/ Michael Majerik
Employee

Exhibit 31.1

CERTIFICATIONS

I, Steven J. Shulman, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Magellan Health Services, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: October 26, 2006	/s/ STEVEN J. SHULMAN
	Steven J. Shulman
	Chief Executive Officer

Exhibit 31.2

CERTIFICATIONS

I, Mark S. Demilio, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Magellan Health Services, Inc.;

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: October 26, 2006	/s/ MARK S. DEMILIO
	Mark S. Demilio
	Chief Financial Officer

Exhibit 32.1

Certification Required by Rule 13a-14(b) and 18 U.S.C. Section 1350 (as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002)

I, Steven J. Shulman, as Chief Executive Officer of Magellan Health Services, Inc (the “Company”), certify, pursuant to 18 U.S.C. Section 1350 (as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002), that to my knowledge:

(1) the accompanying Quarterly Report on Form 10-Q of the Company for the quarterly period ended September 30, 2006 (the “Report”), fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

(2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: October 26, 2006	/s/ STEVEN J. SHULMAN
	Steven J. Shulman
	Chief Executive Officer

Exhibit 32.2

Certification Required by Rule 13a-14(b) and 18 U.S.C. Section 1350 (as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002)

I, Mark S. Demilio, as Chief Financial Officer of Magellan Health Services, Inc (the “Company”), certify, pursuant to 18 U.S.C. Section 1350 (as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002), that to my knowledge:

(2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: October 26, 2006	/s/ MARK S. DEMILIO
	Mark S. Demilio
	Chief Financial Officer