Attached files

file filename
EX-32.2 - EXHIBIT 32.2 - HMS HOLDINGS CORPexh_322.htm
EX-32.1 - EXHIBIT 32.1 - HMS HOLDINGS CORPexh_321.htm
EX-31.2 - EXHIBIT 31.2 - HMS HOLDINGS CORPexh_312.htm
EX-31.1 - EXHIBIT 31.1 - HMS HOLDINGS CORPexh_311.htm
EX-10.1 - EXHIBIT 10.1 - HMS HOLDINGS CORPexh_101.htm
EX-2.1 - EXHIBIT 2.1 - HMS HOLDINGS CORPexh_21.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended March 31, 2017

 

Or

 

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

 

For the transition period from to

 

Commission File Number 000-50194

 

HMS HOLDINGS CORP.

(Exact name of registrant as specified in its charter)

 

Delaware 11-3656261
(State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification No.)
   
5615 High Point Drive, Irving, TX 75038
(Address of principal executive offices) (Zip Code)

 

(Registrant’s Telephone Number, Including Area Code)

(214) 453-3000

 

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 12 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for shorter period that the registrant was required to submit and post such files). x Yes  o No

 

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

 

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

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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

 

As of May 31, 2017, there were approximately 83,909,845 shares of the registrant’s common stock (par value $0.01 per share) outstanding.

 

 
 

 

HMS HOLDINGS CORP. AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q

FOR THE THREE MONTHS ENDED MARCH 31, 2017

INDEX

 

    Page
     
Glossary of Terms and Abbreviations 3
   
PART I – FINANCIAL INFORMATION  
   
Item 1. Financial Statements 6
     
  Consolidated Balance Sheets
March 31, 2017 (unaudited) and December 31, 2016
6
     
  Consolidated Statements of Income
Three Months Ended March 31, 2017 and 2016 (unaudited)
7
     
  Consolidated Statement of Shareholders’ Equity
Three Months Ended March 31, 2017 (unaudited)
8
     
  Consolidated Statements of Cash Flows
Three Months Ended March 31, 2017 and 2016 (unaudited)
9
     
  Notes to the Consolidated Financial Statements
Three Months Ended March 31, 2017 and 2016 (unaudited)
10
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 22
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 27
     
Item 4. Controls and Procedures 28
     
PART II – OTHER INFORMATION  
   
Item 1. Legal Proceedings 29
     
Item 1A. Risk Factors 29
     
Item 5. Other Information 29
     
Item 6. Exhibits 30
     
Signatures 31
   
Exhibit Index 32

 

2
 

 

Glossary of Terms and Abbreviations

 

2016 Form 10-K   Company's Annual Report on Form 10-K for the year ended December 31, 2016
ACA   Patient Protections and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010
ACO   Accountable Care Organizations
ADR   Additional Documentation Request
ALJ   Administrative Law Judges
ASC   Accounting Standards Codification
ASO   Administrative Service Only
CHIP   Children's Health Insurance Program
CMS   Centers for Medicare & Medicaid Services
CMS NHE Projections   Centers for Medicare & Medicaid Services National Health Expenditures
CMS Reserve   Estimated liability for appeals associated with our contract with CMS
COSO   Committee of Sponsoring Organizations of the Treadway Commission
DMD   Domestic Manufacturing Deduction
DRA   Deficit Reduction Act of 2005
DSO   Days Sales Outstanding
ERISA   Employment Retirement Income Security Act of 1974
Exchange Act   Securities Exchange Act of 1934, as amended
FASB   Financial Accounting Standards Board
FFS   Fee For Services
HIPAA   Health Insurance Portability and Accountability Act of 1996
HITECH   Health Information Technology for Economic and Clinical Health
IRS   U.S Internal Revenue Service
LIBOR   Intercontinental Exchange London Interbank Offered Rate
Medicare Advantage   Medicaid and Medicare managed care
MMIS   Medicaid Management Information Systems
PBM   Pharmacy Benefit Managers
PHI   Protected health information
PI   Payment Integrity
R&D Credits   Research and Development Tax Credits
RAC   Recovery Audit Contractor
RFI   Request for information
RFP   Request for proposals
SEC   U.S. Securities and Exchange Commission
Securities Act   Securities Act of 1933, as amended
Section 199 Deduction   U.S. Production activities deduction
SG&A   Selling, general and administrative expenses
TPL   Third-party liability
U.S. GAAP   United States Generally Accepted Accounting Principles
VHA   Veterans Health Administration
Credit Agreement   The Credit Agreement dated December 16, 2011 among HMS Holdings Corp., the Guarantor Party thereto, the Lenders party thereto and Citibank, N.A. as Administrative Agent, as amended and restated in its entirety by the Amended and Restated Credit Agreement dated as of May 3, 2013 among HMS Holdings Corp., the Guarantor Party thereto, the Lenders party thereto and Citibank, N. A. as Administrative Agent, as amended
2006 Stock Plan   HMS Holdings Corp. Fourth Amended and Restated 2006 Stock Plan
2011 HDI Plan   HDI Holdings, Inc. Amended 2011 Stock Option and Stock Issuance Plan
2016 Omnibus Plan   HMS Holdings Corp. 2016 Omnibus Incentive Plan
401(k) Plan   HMS Holdings Corp. 401(k) Plan

 

3
 

 

Cautionary Note Regarding Forward-Looking Statements

 

This Quarterly Report on Form 10-Q of HMS Holdings Corp. (together with its subsidiaries “HMS,” the “Company,” “we,” “our” or “us”) contains “forward-looking statements” within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. From time to time, we also provide forward-looking statements in other materials we release to the public, as well as oral forward-looking statements. Such statements give our current expectations or forecasts of future events; they do not relate strictly to historical or current facts.

 

We have tried, wherever possible, to identify such statements by using words such as “aim,” “anticipate,” “believe,” “estimate,” “expect,” “forecast,” “intend,” “likely,” “may,” “plan,” “project,” “seek,” “target,” “will,” “would,” “could,” “should,” and similar expressions and references to guidance, although some forward-looking statements may be expressed differently. In particular, these include statements relating to future actions, business plans, objectives and prospects, future operating or financial performance or results of current and anticipated services, the benefits and synergies to be obtained from completed and future acquisitions, the future performance of companies we have acquired, sufficiency of our appeals reserves, the future effect of different accounting determinations or remediation activities, our ability to successfully remediate material weaknesses in our internal control over financial reporting, our future expenses, interest rates and financial results, and the impact of changes to U.S. healthcare legislation or healthcare spending affecting Medicare, Medicaid or other publicly funded or subsidized health programs.

 

Forward-looking statements are not guarantees and involve risks, uncertainties and assumptions that are difficult to predict. Actual results may differ materially from past results and forward-looking statements if known or unknown risks or uncertainties materialize, or if underlying assumptions prove inaccurate. These risks and uncertainties include, among other things:

 

§our ability to execute our business plans or growth strategy;
§our ability to innovate, develop or implement new or enhanced solutions or services;
§the nature of investment and acquisition opportunities we are pursuing, and the successful execution of such investments and acquisitions;
§our ability to successfully integrate acquired businesses and realize synergies;
§variations in our results of operations;
§our ability to accurately forecast the revenue under our contracts and solutions;
§our ability to protect our systems from damage, interruption or breach, and to maintain effective information and technology systems and networks;
§our ability to protect our intellectual property rights, proprietary technology, information processes, and know-how;
§significant competition for our solutions and services;
§our failure to maintain a high level of customer retention or the unexpected reduction in scope or termination of key contracts with major customers;
§customer dissatisfaction, our non-compliance with contractual provisions or regulatory requirements;
§our failure to meet performance standards triggering significant costs or liabilities under our contracts;
§our inability to manage our relationships with information and data sources and suppliers;
§reliance on sub-contractors and other third party providers and parties to perform services;
§our ability to continue to secure contracts and favorable contract terms through the competitive bidding process and to prevail in protests or challenges to contract awards;
§pending or threatened litigation;
§unfavorable outcomes in legal proceedings;
§our success in attracting qualified employees and members of our management team;
§our ability to generate sufficient cash to cover our interest and principal payments under our credit facility or to borrow or use credit;
§unexpected changes in our effective tax rates;

 

4
 

 

§unanticipated increases in the number or amount of claims for which we are self-insured;
§changes in the U.S. healthcare environment or healthcare financing system, including regulatory, budgetary or political actions that affect procurement practices and healthcare spending;
§our failure to comply with applicable laws and regulations governing individual privacy and information security or to protect such information from theft and misuse;
§negative results of government or customer reviews, audits or investigations;
§state or federal limitations related to outsourcing or certain government programs or functions;
§restrictions on bidding or performing certain work due to perceived conflicts of interests;
§the market price of our common stock and lack of dividend payments; and
§anti-takeover provisions in our corporate governance documents.

 

These and other risks are discussed under the headings “Part I, Item 1. Business,” “Part I. Item 1A, Risk Factors,” “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Part II, Item 7A. Quantitative and Qualitative Disclosures About Market Risk,” of our 2016 Form 10-K and in other documents we file with the SEC.

 

Any forward-looking statements made by us in this Quarterly Report on Form 10-Q speak only as of the date on which they are made. We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required by law. We caution readers not to place undue reliance upon any of these forward-looking statements. You are advised, however, to consult any further disclosures we make on related subjects in our Form 10-Q and Form 8-K reports and our other filings with the SEC.

 

Market and Industry Data

 

This Quarterly Report on Form 10-Q contains market, industry and government data and forecasts that have been obtained from publicly available information, various industry publications and other published industry sources. We have not independently verified the information and cannot make any representation as to the accuracy or completeness of such information. None of the reports and other materials of third party sources referred to in this Quarterly Report on Form 10-Q were prepared for use in, or in connection with, this Quarterly Report.

 

 

 

 

 

5
 

 

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

 

HMS HOLDINGS CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)

 

   March 31,
2017
  December 31,
2016
Assets   (unaudited)      
Current assets:          
Cash and cash equivalents  $168,289   $175,999 
Accounts receivable, net of allowance of $9,985 and $10,772, at March 31, 2017 and December 31, 2016, respectively   166,604    173,582 
Prepaid expenses   16,376    13,699 
Income tax receivable   4,088    3,354 
Other current assets   568    1,001 
Total current assets   355,925    367,635 
Property and equipment, net   93,176    92,167 
Goodwill   379,716    379,716 
Intangible assets, net   33,470    37,797 
Deferred financing costs, net   2,269    2,790 
Other assets   2,566    2,650 
Total assets  $867,122   $882,755 
           
Liabilities and Shareholders' Equity          
Current liabilities:          
Accounts payable, accrued expenses and other liabilities  $38,593   $59,402 
Estimated liability for appeals   31,544    30,755 
Total current liabilities   70,137    90,157 
Long-term liabilities:          
Revolving credit facility   197,796    197,796 
Net deferred tax liabilities   22,965    22,717 
Deferred rent   5,265    5,427 
Other liabilities   10,127    10,048 
Total long-term liabilities   236,153    235,988 
Total liabilities   306,290    326,145 
Commitments and contingencies (Note 10)          
Shareholders' equity:          
Preferred stock -- $0.01 par value; 5,000,000 shares authorized; none issued        
Common stock -- $0.01 par value; 175,000,000 shares authorized; 96,299,517 shares issued and 83,885,439 shares outstanding at March 31, 2017; 95,966,852 shares issued and 83,552,774 shares outstanding at December 31, 2016   959    959 
Capital in excess of par value   347,805    345,025 
Retained earnings   327,552    326,110 
Treasury stock, at cost: 12,414,078 shares at March 31, 2017 and December 31, 2016   (115,484)   (115,484)
           
Total shareholders' equity   560,832    556,610 
           
Total liabilities and shareholders' equity  $867,122   $882,755 

 

See accompanying notes to unaudited consolidated financial statements.

 

6
 

 

HMS HOLDINGS CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share amounts)

(unaudited)

 

   Three Months Ended
March 31,
   2017  2016
Revenue  $113,733   $119,758 
Cost of services:          
Compensation   48,920    46,401 
Data processing   9,783    9,624 
Occupancy   3,547    3,627 
Direct project expenses   10,443    14,483 
Other operating expenses   7,203    5,776 
Amortization of acquisition related software and intangible assets   6,286    7,013 
Total cost of services   86,182    86,924 
Selling, general and administrative expenses   23,608    22,925 
Total operating expenses   109,790    109,849 
Operating income   3,943    9,909 
Interest expense   (2,286)   (2,091)
Interest income   155    47 
Income before income taxes   1,812    7,865 
Income taxes   370    3,305 
Net income  $1,442   $4,560 
           
Basic income per common share:          
Net income per common share -- basic  $0.02   $0.05 
Diluted income per common share:          
Net income per common share -- diluted  $0.02   $0.05 
Weighted average shares:          
Basic   83,617    84,033 
Diluted   85,580    84,479 

 

See accompanying notes to unaudited consolidated financial statements.

 

7
 

 

HMS HOLDINGS CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

(in thousands, except share amounts)

(unaudited)

 

 

   Common Stock        Treasury Stock   
                      
   # of Shares
Issued
  Par Value  Capital in
Excess of Par
Value
  Retained
Earnings
  # of Shares  Amount  Total
Shareholders'
Equity
Balance at December 31, 2016   95,966,852   $959   $345,025   $326,110    12,414,078   $(115,484)  $556,610 
Net income   -    -    -    1,442    -    -    1,442 
Stock-based compensation expense   -    -    5,386    -    -    -    5,386 
Exercise of stock options   677    -    2    -    -    -    2 
Vesting of restricted stock units, net of shares withheld for employee tax   331,988    -    (2,608)   -    -    -    (2,608)
                                    
Balance at March 31, 2017   96,299,517   $959   $347,805   $327,552    12,414,078   $(115,484)  $560,832 

 

See accompanying notes to the unaudited consolidated financial statements.

 

8
 

 

HMS HOLDINGS CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

 

   Three Months Ended
March 31,
   2017  2016
Operating activities:          
Net income  $1,442   $4,560 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation and amortization of property and equipment   6,235    6,577 
Amortization of intangible assets   4,327    5,043 
Amortization of deferred financing costs   521    521 
Stock-based compensation expense   5,386    4,240 
Deferred income taxes   248   1,308 
Loss on disposal of assets   -    10 
Changes in operating assets and liabilities:          
Accounts receivable   6,978    3,350 
Prepaid expenses   (2,677)   (2,362)
Other current assets   433    328 
Other assets   84    51 
Income taxes receivable / (payable)   (734)   (3,589)
Accounts payable, accrued expenses and other liabilities   (19,646)   (16,963)
Estimated liability for appeals   789    (2,465)
Net cash provided by operating activities   3,386    609 
Investing activities:          
Purchases of land, property and equipment   (6,282)   (570)
Investment in capitalized software   (2,206)   (1,185)
Net cash used in investing activities   (8,488)   (1,755)
Financing activities:          
Proceeds from exercise of stock options   2    26 
Payments of tax withholdings on behalf of employees for net-share settlement for stock-based compensation   (2,608)   (1,002)
Payments on capital lease obligations   (2)   (37)
Net cash used in financing activities   (2,608)   (1,013)
Net decrease in cash and cash equivalents   (7,710)   (2,159)
Cash and Cash Equivalents          
Cash and cash equivalents at beginning of year   175,999    145,610 
Cash and cash equivalents at end of period  $168,289   $143,451 
           
Supplemental disclosure of cash flow information:          
Cash paid for income taxes  $734   $5,052 
Cash paid for interest  $1,686   $1,446 
           
Supplemental disclosure of non-cash activities:          
Change in balance of accrued property and equipment purchases  $(1,244)  $122 

 

See accompanying notes to the unaudited consolidated financial statements.

 

9
 

 

HMS HOLDINGS CORP. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the Three Months Ended March 31, 2017 and 2016

(unaudited)

 

1.Business and Summary of Significant Accounting Policies

 

(a) Business

 

HMS is a leading provider of cost containment solutions in the U.S. healthcare marketplace. Using innovative technology as well as extensive data services and powerful analytics, the Company delivers coordination of benefits, payment integrity, and health management and engagement solutions through its operating subsidiaries to help healthcare payers improve performance and outcomes. The Company is managed and operates as one business segment with a single management team that reports to the Chief Executive Officer. The Company serves state Medicaid programs, commercial health plans, federal government health agencies, government and private employers, child support agencies, and other healthcare payers and sponsors. Together the various services help the Company’s customers recover improper payments; prevent future improper payments; reduce fraud, waste and abuse; better manage the care that members receive; and ensure regulatory compliance.

 

The consolidated financial statements and notes herein are unaudited. Accordingly, they do not include all of the information and notes required by U.S. GAAP for complete financial statements. These statements include all adjustments (consisting of normal recurring accruals) that management considers necessary to present a fair statement of the Company’s results of operations, financial position and cash flows. The results reported in these unaudited consolidated financial statements should not be regarded as necessarily indicative of results that may be expected for the entire year. It is suggested that these unaudited consolidated financial statements be read in conjunction with the Company’s consolidated financial statements as of and for the year ended December 31, 2016 which were filed with the SEC as part of the 2016 Form 10-K. The consolidated balance sheet as of December 31, 2016 included herein was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP.

 

The preparation of the Company’s unaudited consolidated financial statements requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, primarily accounts receivable, intangible assets, fixed assets, accrued expenses, estimated liability for appeals, the disclosure of contingent liabilities at the date of the unaudited consolidated financial statements and the reported amounts of revenue and expenses during the reporting periods. The Company’s actual results could differ from those estimates.

 

These unaudited consolidated financial statements include HMS accounts and transactions and those of the Company’s wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

 

10
 

 

(b) Summary of Significant Accounting Policies

 

There have been no material changes to the Company’s significant accounting policies that are referenced in the 2016 Form 10-K.

 

Recently Adopted Accounting Pronouncements

 

In March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, (“ASU 2016-09”) that changes the accounting for certain aspects of share-based payments to employees. The new guidance requires excess tax benefits and tax deficiencies to be recorded in the income statement when stock awards vest or are settled. In addition, cash flows related to excess tax benefits will no longer be separately classified as a financing activity apart from other income tax cash flows. The standard also allows Companies to repurchase more of an employee’s vesting shares for tax withholding purposes without triggering liability accounting, clarifies that all cash payments made to tax authorities on an employee’s behalf for withheld shares should be presented as a financing activity on the cash flows statement and provides an accounting policy election to account for forfeitures as they occur. ASU 2016-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within such annual reporting periods with early adoption permitted. The Company elected to early adopt the new guidance in the fourth quarter of fiscal year 2016 which requires us to reflect any adjustments as of January 1, 2016, the beginning of the annual period that includes the interim period of adoption. The primary impact of adoption was the recognition of excess tax benefits in the provision for income taxes rather than paid-in capital for all periods in fiscal year 2016. Additional amendments to the accounting for income taxes and minimum statutory withholding tax requirements had no impact to retained earnings as of January 1, 2016, where the cumulative effect of these changes are required to be recorded. The Company elected to continue to estimate forfeitures expected to occur to determine the amount of compensation cost to be recognized in each period. The Company elected to apply the presentation requirements for cash flows related to excess tax benefits retrospectively to all periods presented which resulted in an increase to both net cash from operations and net cash used in financing of $0.01 million for the three months ended March 31, 2016. Adoption of the new standard resulted in the recognition of net excess tax benefits in the provision for income taxes rather than paid-in capital of $0.1 million for the three months ended March 31, 2016. The presentation requirements for cash flows related to employee taxes paid for withheld shares had no impact to any of the periods presented on the consolidated statements of cash flow since such cash flows have historically been presented as a financing activity.

 

In November 2015, the FASB issued ASU 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes (“ASU 2015-17”). ASU 2015-17 simplifies the current presentation of separately classifying deferred tax assets and deferred tax liabilities as current and noncurrent in a classified balance sheet by requiring companies to present them as noncurrent. ASU 2015-17, as amended, is effective for annual reporting periods beginning after December 15, 2016, including interim periods within such annual reporting periods with early adoption permitted. The Company elected to early adopt the new guidance in the fourth quarter of fiscal year 2016. The Company elected to apply the presentation requirements for the balance sheet retrospectively to all periods presented which resulted in a decrease to total current assets and total long term liabilities of $7.5 million at December 31, 2016.

 

Recently Issued Accounting Pronouncements

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”), which is the new comprehensive revenue recognition standard that will supersede all existing revenue recognition guidance under U.S. GAAP. The FASB has recently issued several amendments to the standard, including: principal versus agent considerations; clarification on accounting for licenses of intellectual property and identifying performance obligations; narrow scope-improvements and practical expedients; and technical corrections and improvements. ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within such annual reporting periods with early adoption permitted. The Company does not plan to early adopt this guidance and therefore will adopt on January 1, 2018. The guidance permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (modified retrospective method). The Company is in the process of determining the adoption method but preliminarily expects to use the modified retrospective method. The Company, with the assistance of external consultants, has developed and is currently following a preliminary implementation plan. One major element of this plan involves reviewing historical contracts to quantify the impact that adoption will have on the Company’s operations. Depending on the results of the Company’s review, there could be material changes to the timing and recognition of revenues and certain associated expenses. The Company expects to complete the review of historical contracts and the overall assessment process, including selecting a transition plan and an assessment of the overall impact to the results of operations by the end of the third quarter of 2017.

 

11
 

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 will require most lessees to recognize a majority of the Company’s leases on the balance sheet, which will increase reported assets and liabilities. ASU 2016-02 is effective for annual reporting periods beginning after December 15, 2018 including interim periods within such annual reporting periods with early adoption permitted. The Company has not early adopted this guidance and is currently evaluating the impact on the Company’s consolidated financial statements.

 

In August 2016, the FASB issued ASU No. 2016-15, Statements of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). The amendment clarifies where certain cash receipts and cash payments are presented and classified in the statement of cash flows. Current guidance does not include specific guidance on the eight classification issues presented in the amendments, which are intended to reduce diversity in practice with respect to classification and presentation of such cash receipts and payments. The amendments are effective for annual reporting periods beginning after December 15, 2017, and for interim reporting periods within such annual periods. The Company is currently evaluating the impact on the Company’s financial statements.

 

In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805) – Clarifying the Definition of a Business (“ASU 2017-01”). ASU 2017-01 finalizes previous proposals regarding shareholder concerns that the definition of a business is applied too broadly. The guidance assists entities with evaluating whether transactions should be accounted for as acquisitions of assets or of businesses. The amendments are effective for annual periods beginning after December 15, 2017, including interim periods within those periods. The Company is currently evaluating the impact on the Company’s financial statements of adopting this guidance.

 

In January 2017, the FASB issued ASU No. 2017-04, Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (“ASU 2017-04”). This amendment simplifies the manner in which an entity is required to test for goodwill impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. The amendment simplifies this approach by having the entity (1) perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, and (2) recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, with the understanding that the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The amendment is effective for public entities that are SEC filers prospectively for their annual, or any interim, goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for all entities for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is currently evaluating the impact on the Company’s financial statements of adopting this guidance.

 

12
 

 

In May 2017, the FASB issued ASU No. 2017-09, Compensation – Stock Compensation (Topic 718) – Scope of Modification Accounting (“ASU 2017-09”). ASU 2017-09 finalizes previous proposals regarding the complexity around share-based payment awards for modifications. The amendment simplifies the terms or conditions for applying modification accounting unless all of the following are satisfied: (1) the fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the modified award is the same as the fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the original award immediately before the original award is modified; (2) the vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified; and (3) the classification of the modified award as an equity instrument or as a liability instrument is the same as the classification of the original award immediately before the original award is modified. The amendment is effective for public entities that are SEC filers for annual and interim periods beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period, for reporting periods for which financial statements have not yet been issued. The Company is currently evaluating the impact on the Company’s financial statements of adopting this guidance.

 

Other new pronouncements issued but not effective until after March 31, 2017, if any, are not expected to have a material impact on the Company’s financial position, results of operations or liquidity.

 

2.       Accounts Receivable and Allowance

 

The Company’s accounts receivable, net, consisted of the following (in thousands):

 

   March 31,
2017
  December 31,
2016
Accounts receivable  $176,589   $184,354 
Allowance   (9,985)   (10,772)
Accounts receivable, net  $166,604   $173,582 

 

A summary of the activity in the allowance was as follows (in thousands):

 

   March 31,
2017
Balance--beginning of period  $10,772 
Provision   4,038 
Charge-offs   (4,825)
Recoveries   - 
Balance--end of period  $9,985 

 

3.        Intangible Assets and Goodwill

 

Intangible assets consisted of the following (in thousands, except for useful life):

 

13
 

 

   Gross
Carrying
Amount
  Accumulated
Amortization
  Net Carrying
Amount
  Useful Life
(in years)
March 31, 2017                    
Customer relationships  $103,090   $(75,549)  $27,541   5-10
Trade name   15,936    (11,969)   3,967   3-5
Intellectual Property   2,100    (245)   1,855   3-7
Restrictive covenants   133    (26)   107   3-5
Total  $121,259   $(87,789)  $33,470      
                     
December 31, 2016                    
Customer relationships  $103,090   $(71,914)  $31,176   5-10
Trade name   15,936    (11,393)   4,543   3-5
Intellectual Property   2,100    (140)   1,960   3-7
Restrictive covenants   133    (15)   118   3-5
Total  $121,259   $(83,462)  $37,797      

 

Amortization expense of intangible assets is expected to approximate the following (in thousands):

 

Year ending December 31,   
Remainder of 2017  $12,979 
2018   16,685 
2019   2,245 
2020   791 
2021   463 
Thereafter   307 

 

For the three months ended March 31, 2017 and 2016 amortization expense related to intangible assets was $4.3 million and $5.0 million, respectively.

 

4.        Accounts Payable, Accrued Expenses and Other Liabilities

 

Accounts payable, accrued expenses and other liabilities consisted of the following (in thousands):

 

   March 31,
 2017
  December 31,
2016
Accounts payable, trade  $9,399   $13,847 
Accrued compensation and other   11,686    28,507 
Accrued operating expenses   17,508    17,048 
Total accounts payable, accrued expenses and other liabilities  $38,593   $59,402 

 

 

14
 

 

5.        Income Taxes

 

The Company’s effective tax rate decreased to 20.4% for the three months ended March 31, 2017 from 42.0% for the three months ended March 31, 2016. The decrease in the effective tax rate, for the three months ended March 31, 2017, is primarily due to discrete stock option excess tax benefits, partially offset by interest on unrecognized tax benefits. Excluding these discrete items, our annual effective tax rate would approximate 36.8%.

 

Included in Other Liabilities on the Consolidated Balance Sheets, are the total amount of unrecognized tax benefits of approximately $7.6 million and $7.4 million, as of March 31, 2017 and December 31, 2016, respectively, (net of the federal benefit for state issues) that, if recognized, would favorably affect the Company’s future effective tax rate. Also included in Other Liabilities on the Consolidated Balance Sheets, are accrued liabilities for interest expense and penalties related to unrecognized tax benefits of $0.7 million and $0.6 million as of March 31, 2017 and December 31, 2016, respectively. HMS includes interest expense and penalties in the provision for income taxes in the unaudited Consolidated Statements of Income. The amount of interest expense (net of federal and state income tax benefits) and penalties in the unaudited Consolidated Statements of Income for the three months ended March 31, 2017 and 2016 was $0.1 million and $0.2 million, respectively. The Company believes it is reasonably possible that the amount of unrecognized tax benefits may decrease by $1.0 million over the next twelve months, due to the expiration of the statute of limitations in various state jurisdictions.

 

HMS files income tax returns with the U.S. Federal government and various state and local jurisdictions. HMS is no longer subject to U.S. Federal income tax examinations for years before 2012. The Internal Revenue Service notified HMS that years 2013 and 2014 have been selected for audit. HMS operates in a number of state and local jurisdictions, most of which have never audited the Company’s records. Accordingly, HMS is subject to state and local income tax examinations based upon the various statutes of limitations in each jurisdiction. HMS recently closed an ongoing audit with the State of New York by accepting immaterial assessments.

 

6.       Estimated Liability For Appeals

 

The Company provides services under contracts that contain various fee structures, including contingency fee and fixed fee arrangements. Revenue is recognized when a contract exists, services have been provided to the customer, the fee is fixed and determinable, and collectability is reasonably assured. In addition, the Company has contracts with the federal government which are generally cost-plus or time and material based. Revenue on cost-plus contracts is recognized based on costs incurred plus the negotiated fee earned. Revenue on time and materials contracts is recognized based on hours worked and expenses incurred.

 

Under the Company’s Medicare RAC contract with the CMS, held by the Company’s wholly owned subsidiary HealthDataInsights, Inc. (“HDI”) and certain contracts for commercial health plan customers, HMS recognizes revenue when claims are sent to the customer for offset against future claims payments. Providers and health plan customers have the right to appeal a claim and may pursue additional appeals if the initial appeal is found in favor of the customer. HMS accrues an estimated liability for appeals based on the amount of revenue that is subject to appeals, closures or other adjustments and which HMS estimates are probable of being returned to providers following a successful appeal. The Company’s estimates are based on the Company’s historical experience with appeals. The estimated liability for appeals represents the Company’s estimate of the potential amount of repayments related to appeals of claims, closures and other adjustments for which revenue was previously collected.

 

15
 

 

A summary of the activity in the Estimated liability for appeals was as follows (in thousands):

 

   March 31,
2017
Balance--beginning of period  $11,126 
Provision   - 
Appeals found in providers favor   (521)
Balance--end of period  $10,605 

 

The above chart represents the CMS estimated reserve liability only. The liability for appeals is an offset to revenue to the Company’s unaudited Consolidated Statements of Income. The total liability for appeals balance of $31.5 million and $30.8 million as of March 31, 2017 and December 31, 2016, respectively, includes $17.9 million and $17.3 million of CMS liabilities, respectively, which represents findings which have been adjudicated in favor of providers and $10.6 million and $11.1 million, respectively, of CMS liabilities which represents an estimate of findings that are probable of being returned to providers following a successful appeal.

 

7.        Credit Agreement

 

During the years ended December 31, 2016 and 2015, no principal payments were made against the Company’s revolving credit facility. The $197.8 million principal balance of the revolving credit facility is due in May 2018. The Company has commenced discussions to extend or refinance the revolving credit facility.

 

The Credit Agreement provides for an initial $500 million revolving credit facility, and, under specified circumstances, the revolving credit facility can be increased or one or more incremental term loan facilities can be added, provided that the incremental credit facilities do not exceed in the aggregate the sum of (a) $75 million plus (b) an additional amount not less than $25 million, so long as the total secured leverage ratio, calculated giving pro forma effect to the requested incremental borrowing and other customary and appropriate pro forma adjustment events, including any permitted acquisitions, is no greater than 2.5:1.0. The Company’s obligations and any amounts due under the Credit Agreement are guaranteed by the Company’s material 100% owned subsidiaries and secured by a security interest in all or substantially all of the Company’s and the Company’s subsidiaries’ physical assets.

 

The Credit Agreement requires the Company to comply with certain principal financial covenants and other covenants, including a maximum consolidated leverage ratio at 3.25:1.00 and a minimum interest coverage ratio of 3.00:1.00.

 

The interest rates applicable to the revolving credit facility are, at the Company’s option, either:

 

a)the LIBOR multiplied by the statutory reserve rate plus an interest margin ranging from 1.50% to 2.25% based on the Company’s consolidated leverage ratio, or
b)a base rate (which is equal to the greatest of (i) Citibank’s prime rate, (ii) the federal funds effective rate plus 0.50% and (iii) the one-month LIBOR plus 1.00% plus an interest margin ranging from 0.50% to 1.25% based on the Company’s consolidated leverage ratio.

 

HMS pays an unused commitment fee on the revolving credit facility during the term of the Credit Agreement ranging from 0.375% to 0.50% per annum based on the consolidated leverage ratio.

 

16
 

 

Interest expense and the commitment fees on the unused portion of the Company’s revolving credit facility were as follows (in thousands):

 

   Three Months Ended
March 31,
   2017  2016
Interest expense  $1,374   $1,178 
Commitment fees  $378   $378 

 

As of March 31, 2016 and December 31, 2016, the unamortized balance of deferred origination fees and debt issuance costs were $2.3 million and $2.8 million, respectively, recorded in Other assets on the Consolidated Balance Sheets. For both the three month periods ended March 31, 2017 and 2016, HMS amortized $0.5 million of interest expense related to the Company’s deferred origination fees and debt issue costs.

 

Although HMS expects that operating cash flows will continue to be a primary source of liquidity for the Company’s operating needs, the revolving credit facility may be used for general corporate purposes, including, but not limited to acquisitions, if necessary.

 

As part of the Company’s contractual agreement with a customer, HMS has an outstanding irrevocable letter of credit for $3.0 million, which HMS established against the revolving credit facility. On May 1, 2017, the expiration date of the letter of credit was extended to April 26, 2018.

 

As previously disclosed, on March 8, 2017, Amendment No. 1 to the Credit Agreement was executed which amended, among other things, the Company’s requirement to furnish to Citibank, N.A., as administrative agent, and the lenders party to the Credit Agreement, financial statements and other information within 90 days of the fiscal year-end to 180 days for the fiscal year-ended December 31, 2016. These financial statements include the audited consolidated balance sheet and related statements of income, stockholders’ equity and cash flows of the Company and its subsidiaries.

 

As of March 31, 2017, the Company was in compliance with all terms of the Credit Agreement.

 

8. Earnings Per Share

 

Basic income per share is calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted income per share is calculated by dividing net income by the weighted average number of common shares and dilutive common share equivalents outstanding during the period. The Company’s dilutive common share equivalents consist of stock options and restricted stock units.

 

17
 

 

The following table reconciles the basic to diluted weighted average common shares outstanding using the treasury stock method (in thousands, except per share amounts):

 

   Three Months Ended
March 31,
   2017  2016
Net income  $1,442   $4,560 
           
Weighted average common shares outstanding-basic   83,617    84,033 
Plus: net effect of dilutive stock options and restricted stock units   1,963    446 
Weighted average common shares outstanding-diluted   85,580    84,479 
Net income per common share-basic  $0.02   $0.05 
Net income per common share-diluted  $0.02   $0.05 

 

For the three months ended March 31, 2017 and 2016, 2,106,397 and 4,321,528 stock options, respectively, were not included in the diluted earnings per share calculation because the effect would have been anti-dilutive. For the three months ended March 31, 2017 and 2016, restricted stock units representing 42,056 and 99,461 shares of common stock, respectively, were not included in the diluted earnings per share calculation because the effect would have been anti-dilutive.

 

9.       Stock-Based Compensation

 

(a) Stock-Based Compensation Expense

 

Total stock-based compensation expense in the Company’s Consolidated Statements of Income related to the Company’s long-term incentive award plans was as follows (in thousands):

 

   Three Months Ended
March 31,
   2017  2016
Cost of services-compensation  $2,040   $1,931 
Selling, general and administrative   3,346    2,309 
Total  $5,386   $4,240 

 

(b) Stock Options

 

Stock-based compensation expense related to stock options was approximately $2.1 million and $2.0 million for the three months ended March 31, 2017 and 2016, respectively.

 

18
 

 

Presented below is a summary of stock option activity for the three months ended March 31, 2017 (in thousands except for weighted average exercise price and weighted average remaining contractual terms):

 

   Number
of
Options
  Weighted
Average
Exercise
Price
  Weighted
Average
Remaining
Contractual
Terms
  Aggregate
Intrinsic
Value
Outstanding balance at December 31, 2016   5,191   $17.35           
Granted   -    -           
Exercised   1    2.71           
Forfeitures   (52)   18.88           
Expired   (16)   24.87           
Outstanding balance at March 31, 2017   5,124    17.32    4.76   $20,130 
                     
Expected to vest at March 31, 2017   1,540    15.01    5.52    8,431 
Exercisable at March 31, 2017   2,920   $18.99    4.21   $8,231 

 

The weighted-average grant date fair value per share of the stock options granted during the three months ended March 31, 2016 was $5.45. No stock options were issued during the three months ended March 31, 2017. HMS estimated the fair value of each stock option grant on the date of grant using a Black-Scholes option pricing model and weighted–average assumptions set forth in the following table:

 

   Three Months
Ended March 31,
   2017  2016
Expected dividend yield        
Risk-free interest rate       1.20%
Expected volatility       43.89%
Expected life (years)       4.9 

 

During the three months ended March 31, 2017 and 2016, the Company issued 677 and 9,975 shares, respectively, of the Company’s common stock upon the exercise of outstanding stock options and received proceeds of $1,836 and $26,425, respectively. The total intrinsic value of stock options exercised during the three months ended March 31, 2017 and 2016 was $10,903 and $100,815, respectively.

 

As of March 31, 2017, there was approximately $10.2 million of total unrecognized compensation cost related to stock options outstanding, which is expected to be recognized over a weighted average period of 1.11 years.

 

Excess tax benefit from the exercise of stock options for the three months ended March 31, 2017 and 2016 was $0.4 million and $0.01 million, respectively.

 

(c) Restricted Stock Units

 

Stock-based compensation expense related to restricted stock units was $3.3 million and $2.2 million for the three months ended March 31, 2017 and 2016, respectively.

 

19
 

 

Presented below is a summary of restricted stock units activity for the three months ended March 31, 2017 (in thousands, except for weighted average grant date fair value per unit):

 

   Number of
Units
  Weighted Average
Grant Date Fair
Value per Unit
Outstanding balance at December 31, 2016   1,413   $16.44 
Granted   4    20.33 
Vesting of restricted stock units, net of units withheld for taxes   (332)   16.27 
Units withheld for taxes   (140)   16.27 
Forfeitures   (28)   17.99 
Outstanding balance at March 31, 2017   917   $16.51 

 

As of March 31, 2017, 761,178 restricted stock units remained unvested and there was approximately $10.4 million of unrecognized compensation cost related to restricted stock units, which is expected to be recognized over a weighted average vesting period of 1.11 years.

 

10.       Commitments and Contingencies

 

Dennis Demetre and Lori Lewis: In July 2012, Dennis Demetre and Lori Lewis (the “Plaintiffs”), filed an action in the Supreme Court of the State of New York against HMS Holdings Corp., claiming an undetermined amount of damages alleging that various actions by HMS unlawfully deprived the Plaintiffs of the acquisition earn-out portion of the purchase price for Allied Management Group Special Investigation Unit (“AMG”) under the applicable Stock Purchase Agreement (the “SPA”) and that HMS had breached certain contractual provisions under the SPA. The Plaintiffs filed a second amended complaint with two causes of action for breach of contract and one cause of action for breach of implied covenant of good faith and fair dealing. HMS asserted a counterclaim against Plaintiffs for breach of contract based on contractual indemnification costs, including attorneys’ fees arising out of the Company’s defense of AMG in Kern Health Systems v. AMG, Dennis Demetre and Lori Lewis (the “California Action”), which are recoverable under the SPA. Mediation took place in September 2014 but the matter was not resolved. In June 2016, Kern Health Systems and AMG entered into a settlement agreement that resolved all claims in the California Action.

 

In January 2016, HMS moved for summary judgment on its counterclaim for breach of contract and for summary judgment on the Plaintiffs’ breach of contract causes of action against HMS (HMS did not move for summary judgment on Plaintiffs’ breach of implied covenant of good faith and fair dealing claim). The motions were argued on June 22, 2016. A decision on the motions has not yet been issued by the Court and a trial date has not been set. HMS continues to believe that the Plaintiffs’ claims are without merit and will continue to vigorously defend against them.

 

Shareholder Proceedings: On March 3, 2017, a putative securities class action was filed in the Federal District Court for the District of New Jersey, entitled Danahar v. HMS Holdings Corp., et al. The complaint names the Company, its Chief Executive Officer, and its Chief Financial Officer as defendants and arises out of the Company’s disclosure on March 2, 2017 that the filing of its 2016 Form 10-K would be delayed in order to permit the Company to complete the Company’s previously disclosed review of its Estimated liability for appeals and related internal control over financial reporting, and that the Company’s auditor had informed the Company that it had identified what it believed was a material weakness in the Company’s internal control over financial reporting related to the CMS reserves. The complaint alleges that the Company’s Form 10-K for the period ended December 31, 2015 and its quarterly reports on Form 10-Q for the period January 1, 2016 to September 30, 2016 were false and misleading for failing to disclose the matters set forth above. On May 19, 2017, the New Jersey District Court granted the defendants’ motion to transfer the action to the United States District Court for the Northern District of Texas. The action is at its early stages, and the Company has not yet responded to the complaint.

 

20
 

 

From time to time, HMS may be subject to investigations, legal proceedings and other disputes arising in the ordinary course of the Company’s business, including but not limited to regulatory audits, billing and contractual disputes, employment-related matters and post-closing disputes related to acquisitions. Due to the Company’s contractual relationships, including those with federal and state government entities, HMS’s operations, billing and business practices are subject to scrutiny and audit by those entities and other multiple agencies and levels of government, as well as to frequent transitions and changes in the personnel responsible for oversight of the Company’s contractual performance. HMS may have contractual disputes with its customers arising from differing interpretations of contractual provisions that define the Company’s rights, obligations, scope of work or terms of payment, and with associated claims of liability for inaccurate or improper billing for reimbursement of contract fees, or for sanctions or damages for alleged performance deficiencies. Resolution of such disputes may involve litigation or may require that HMS accept some amount of loss or liability in order to avoid customer abrasion, negative marketplace perceptions and other disadvantageous results that could affect the Company’s business, financial condition, results of operations and cash flows.

 

HMS records accruals for outstanding legal matters when it believes it is probable that a loss will be incurred and the amount can be reasonably estimated. The Company evaluates, on a quarterly basis, developments in legal matters that could affect the amount of any accrual and developments that would make a loss contingency both probable and reasonably estimable. If a loss contingency is not both probable and estimable, HMS does not establish an accrued liability.

 

11.       Subsequent Events

 

(a)Eliza Holding Acquisition

 

As previously disclosed, on April 17, 2017, the Company completed the acquisition of Eliza Holding Corp. for a cash purchase price of approximately $172.0 million, after adjustments for working capital, cash, transaction expenses and indebtedness. The acquisition was funded with available liquidity, consisting of approximately 75% cash on hand and approximately 25% of borrowings under the Company’s revolving credit facility. The purchase price is subject to certain post-closing purchase price adjustments.

 

(b)Annual Grants to Employees

 

On April 26, 2017, the Compensation Committee of the Board of Directors approved stock option and restricted stock unit awards of up to $16.6 million. The awards generally will vest over three years and will be issued three business days subsequent to the filing of this Quarterly Report on Form 10-Q.

 

In connection with the preparation of these unaudited Consolidated Financial Statements, an evaluation of subsequent events was performed through the date of issuance and, other than the events above, there were no other events that have occurred that would require adjustments to the financial statements or disclosure.

 

21
 

 

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

 

The following Management’s Discussion and Analysis should be read in conjunction with the other sections of this Quarterly Report on Form 10-Q, including the unaudited Consolidated Financial Statements, related Notes and other financial information appearing elsewhere in this Quarterly Report, and with our 2016 Form 10-K.

 

Business Overview

 

HMS is a leading provider of cost containment solutions in the U.S. healthcare marketplace. Using innovative technology as well as extensive data services and powerful analytics, we deliver coordination of benefits, payment integrity, and health management and engagement solutions through our operating subsidiaries to help healthcare payers improve performance and outcomes. We are managed and operate as one business segment with a single management team that reports to the Chief Executive Officer. We serve state Medicaid programs, commercial health plans, federal government health agencies, government and private employers, child support agencies, and other healthcare payers and sponsors. Together our various services help our customers recover improper payments; prevent future improper payments; reduce fraud, waste and abuse; better manage the care that members receive; and ensure regulatory compliance.

 

§We serve 46 state Medicaid programs and the District of Columbia, CMS and the VHA;
§We provide services to approximately 300 health plans in support of their multiple lines of business, including Medicaid managed care, Medicare Advantage and group and individual health; and
§We also serve as a sub-contractor for certain business outsourcing and technology firms.

 

Critical Accounting Policies

 

Since the date of our 2016 Form 10-K, there have been no material changes to our critical accounting policies. Refer to the items disclosed as our Critical Accounting Policies in Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 1 – “Business and Summary of Significant Accounting Policies” in our Notes to the Consolidated Financial Statements under Part II, Item 8 of our 2016 Form 10-K.

 

SUMMARY OF OPERATING RESULTS

 

Selected Operating Performance and Other Significant Items for the Three Months Ended March 31, 2017

 

§Revenue decreased $6.0 million, or 5.0% from the same quarter in 2016
§Operating income decreased $6.0 million, or 60.2% from the same quarter in 2016
§Net income decreased $3.2 million, or 68.4% from the same quarter in 2016
§Diluted earnings per share decreased $0.03 or 60% from the same quarter in 2016
§Shareholders’ equity increased $4.2 million since December 31, 2016
§First quarter 2017 cash flow from operations was $3.4 million

 

22
 

 

Comparison of Three Months Ended March 31, 2017 to March 31, 2016

 

The following table sets forth, for the periods indicated, certain items in our unaudited Consolidated Statements of Income expressed as a percentage of revenue:

 

   Three Months Ended
March 31,
   2017  2016
Revenue   100%   100%
Cost of services:          
Compensation   43.0    38.7 
Data processing   8.6    8.0 
Occupancy   3.1    3.0 
Direct project expenses   9.2    12.1 
Other operating expenses   6.4    4.8 
Amortization of acquisition related software and intangible assets   5.5    5.9 
Total cost of services   75.8    72.5 
Selling, general and administrative expenses   20.7    19.1 
Total operating expenses   96.5    91.6 
Operating income   3.5    8.3 
Interest expense   (2.0)   (1.7)
Interest income   0.1    0.0 
Income before income taxes   1.6    6.6 
Income taxes   0.3    2.8 
Net income   1.3%   3.8%

 

Revenue

 

Three Months Ended – 2017 vs. 2016

During the three months ended March 31, 2017 revenue was $113.7 million, a decrease of $6.0 million or 5.0% compared to prior year revenue of $119.8 million. The decrease was primarily due to no new Medicare RAC claims being processed under the HDI Medicare RAC contract as a result of the contract’s expiration in July 2016, however an administrative extension for certain appeal work was executed through January 2018. This decrease was partially offset by a slight increase in state government and commercial health plan revenue.

 

Total Cost of Services

 

Total cost of services consists of compensation, data processing, occupancy, direct project expenses, other operating expenses, and amortization of acquisition related software and intangible assets.

 

Three Months Ended – 2017 vs. 2016

During the three months ended March 31, 2017, total cost of services as a percentage of revenue was 75.8% compared to 72.5% for the three months ended March 31, 2016. Total cost of services for the three months ended March 31, 2017 was $86.2 million, a decrease of $0.7 million compared to $86.9 million for the three months ended March 31, 2016. This change resulted primarily from increases in compensation costs, data processing costs and other operating expenses. These increases were partially offset by decreases in occupancy costs, direct project expenses and amortization of certain intangible assets.

 

23
 

 

Compensation

 

Compensation expense is primarily composed of salaries and wages, which include overtime, health benefits, stock option expense, performance awards, commissions, employers share of FICA and fringe benefits.

 

Three Months Ended – 2017 vs. 2016

During the three months ended March 31, 2017, compensation expense as a percentage of revenue was 43.0% compared to 38.7% for the three months ended March 31, 2016. Compensation expense for the three months ended March 31, 2017 was $48.9 million, an increase of $2.5 million compared to $46.4 million for the three months ended March 31, 2016. This increase resulted from a $4.4 million total increase in salaries and stock-based compensation expense. These increases were partially offset by decreases in fringe benefits and net variable compensation.

 

Data Processing

 

Three Months Ended – 2017 vs. 2016

During the three months ended March 31, 2017, data processing expense as a percentage of revenue was 8.6% compared to 8.0% for the three months ended March 31, 2016. Data processing expense for the three months ended March 31, 2017 was $9.8 million, an increase of $0.2 million compared to $9.6 million for the three months ended March 31, 2016. This change resulted primarily from a $1.8 million increase in equipment maintenance and software maintenance costs. This increase was partially offset by a $1.7 million total decrease in data costs, depreciation expense and software expense.

 

Occupancy

 

Three Months Ended – 2017 vs. 2016

During the three months ended March 31, 2017, occupancy expenses as a percentage of revenue was 3.1% compared to 3.0% for the three months ended March 31, 2016. Occupancy expense was $3.5 million, a decrease of $0.1 million compared to $3.6 million for the three months ended March 31, 2016. This slight decrease was primarily a result of decreases in rental costs, utilities, and depreciation expenses.

 

Direct Project Expenses

 

Three Months Ended – 2017 vs. 2016

During the three months ended March 31, 2017, direct project expenses as a percentage of revenue was 9.2% compared to 12.1% for the three months ended March 31, 2016. Direct project expenses were $10.4 million for the three months ended March 31, 2017, a decrease of $4.1 million, compared to $14.5 million for the three months ended March 31, 2016. The decrease was primarily due to a $4.5 million decrease in sub-contractor fees, chart fees and data costs.

 

Other Operating Expenses

 

Three Months Ended – 2017 vs. 2016

During the three months ended March 31, 2017, other operating expenses as a percentage of revenue was 6.4% compared to 4.8% for the three months ended March 31, 2016. Other operating expenses for the three months ended March 31, 2017 were $7.2 million, an increase of $1.4 million compared to $5.8 million for the three months ended March 31, 2016. This increase primarily resulted from a $3.7 million total increase in sub-contractor fees, travel and entertainment, and consulting project expenses. These increases were partially offset by a $2.2 million decrease in temporary staffing. Additionally, during the quarter ended March 31, 2017, transaction costs related to a potential acquisition were $1.3 million.

 

24
 

 

Amortization of Acquisition Related Software and Intangible Assets

 

Three Months Ended – 2017 vs. 2016

During the three months ended March 31, 2017, amortization of acquisition related software and intangibles as a percentage of revenue was 5.5% compared to 5.9% for the three months ended March 31, 2016. Amortization of acquisition related software and intangible assets for the three months ended March 31, 2017 was $6.3 million, a decrease of $0.7 million compared to $7.0 million for the three months ended March 31, 2016. This decrease related to certain intangibles becoming fully amortized.

 

Selling, General and Administrative expenses

 

Three Months Ended – 2017 vs. 2016

During the three months ended March 31, 2017, SG&A expense as a percentage of revenue was 20.7% compared to 19.1% for the three months ended March 31, 2016. SG&A expense for the first quarter of 2017 was $23.6 million, an increase of $0.7 million compared to $22.9 million for the three months ended March 31, 2016. Increases were comprised of compensation expense, professional fees and consulting fees. These increases were partially offset by a reduction in legal fees.

 

Operating Income

 

Three Months Ended – 2017 vs. 2016

Operating income for the three months ended March 31, 2017 was $3.9 million, a decrease of $6.0 million, or 60.2% compared to operating income of $9.9 million for the three months ended March 31, 2016.

 

Interest Expense

 

Interest expense represents interest on borrowings under our revolving credit facility, amortization of deferred financing costs, commitment fees for our revolving credit facility and issuance fees for our letter of credit.

 

Three Months Ended – 2017 vs. 2016

During the three months ended March 31, 2017 interest expense was $2.3 million, an increase of $0.2 million compared to $2.1 million for the same period in the prior year. This increase resulted from an increase in the variable interest rate on our outstanding debt. Amortization of deferred financing costs of $0.5 million in both periods is included within interest expense.

 

Income Taxes

 

Three Months Ended – 2017 vs. 2016

During the three months ended March 31, 2017 we recorded income tax expense of $0.4 million, a decrease of $2.9 million compared to $3.3 million for the same period in 2016. Net income before taxes of $1.8 million decreased $6.1 million, compared to $7.9 million for the three months ended March 31, 2016. Additionally, our effective tax rate decreased to 20.4% for the three months ended March 31, 2017 compared to 42.0% for the three months ended March 31, 2016. The decrease in the effective tax rate for the period ended March 31, 2017, compared to March 31, 2016, is primarily due to a $0.4 million excess tax benefit related to stock option exercises recognized from the adoption of ASU 2016-09 in December 2016, partially offset by a $0.1 million tax expense related to interest on unrecognized tax benefits. The differences between the federal statutory rate and our effective tax rate are state taxes, unrecognized tax benefits and permanent differences including the U.S. production activities deduction and research and development tax credits.

 

25
 

 

Net Income

 

Three Months Ended – 2017 vs. 2016

During the three months ended March 31, 2017, net income was $1.4 million which represents a $3.2 million decrease compared to net income of $4.6 million for the same period in 2016.

 

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements.

 

Liquidity and Capital Resources

 

The following tables should be read in conjunction with the unaudited Consolidated Financial Statements and related Notes included in this Quarterly Report on Form 10-Q.

 

Our cash and cash equivalents, working capital and available borrowings under our credit facility (based upon the borrowing base and financial covenants in our Credit Agreement) were as follows:

 

(In thousands)  March 31,
2017
  December 31,
2016
Cash and cash equivalents  $168,289   $175,999 
Working capital  $285,788   $277,478 
Available borrowings under credit facility  $157,809   $183,913 

 

A summary of our cash flows was as follows:

 

   Three Months Ended
March 31,
(In thousands)  2017  2016
Net cash provided by operating activities  $3,386   $609 
Net cash used in investing activities   (8,488)   (1,755)
Net cash used in financing activities   (2,608)   (1,013)
Net decrease in cash and cash equivalents  $(7,710)  $(2,159)

 

Our principal source of cash has been our cash flow from operations and our $500 million five-year revolving credit facility. Other sources of cash include proceeds from exercise of stock options and tax benefits associated with stock option exercises. The primary uses of cash are compensation expenses, data processing, direct project costs and SG&A expenses and acquisitions. As previously disclosed, on April 17, 2017, the Company completed the acquisition of Eliza Holding Corp. for a cash purchase price of approximately $172.0 million, after adjustments for working capital, cash, transaction expenses and indebtedness. The acquisition was funded with available liquidity, consisting of approximately 75% cash on hand and approximately 25% of borrowings under the Company’s revolving credit facility. The purchase price is subject to certain post-closing purchase price adjustments.

 

26
 

 

We believe that expected cash flows from operations, available cash and cash equivalents, and funds available under our revolving credit facility will be sufficient to meet our liquidity requirements for the following year, which include:

 

§the working capital requirements of our operations;
§investments in our business;
§business development activities;

§repurchases of common stock; and
§repayment of our revolving credit facility.

 

Any projections of future earnings and cash flows are subject to substantial uncertainty. We may need to access debt and equity markets in the future if unforeseen costs or opportunities arise, to fund acquisitions or to repay indebtedness under the Credit Agreement, which matures in May 2018. If we need to obtain new debt or equity financing in the future, the terms and availability of such financing may be impacted by economic and financial market conditions as well as our financial condition and results of operations at the time we seek additional financing.

 

Cash Flows from Operating Activities

 

Net cash provided by operating activities for the three months ended March 31, 2017 was $3.4 million, an increase of $2.8 million as compared to net cash provided by operating activities of $0.6 million for the three months ended March 31, 2016. The increase in operating cash flow is primarily attributable to accounts receivable and decreases in amortization of certain intangibles, partially offset by a decrease in net income.

 

Cash Flows from Investing Activities

 

Net cash used in investing activities for the three months ended March 31, 2017 was $8.5 million, a $6.7 million increase compared to net cash used in investing activities of $1.8 million for the three months ended March 31, 2016. The increase primarily related to an increase in purchases of property and equipment and investment in capitalized software.

 

Cash Flows from Financing Activities

 

Net cash used in financing activities for the three months ended March 31, 2017 was $2.6 million, a $1.6 million increase compared to net cash used in financing activities of $1.0 million for the three months ended March 31, 2016. This increase was primarily related to the payment of tax withholdings on behalf of employees for net-share settlement for stock-based compensation.

 

Contractual Obligations

 

There have been no material changes in our contractual obligations as presented in our 2016 Form 10-K except as disclosed in Note 11 – “Subsequent Events” in our Notes to the unaudited Consolidated Financial Statements of the Quarterly Report on Form 10-Q.

 

Recently Issued Accounting Pronouncements

 

See “Recently Issued Accounting Pronouncements” in Note 1 of the unaudited Consolidated Financial Statements.

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

 

There have been no material changes to the market risks discussed in Item 7A to Part II of our 2016 Form 10-K.

 

27
 

 

Item 4.  Controls and Procedures

 

We are responsible for maintaining disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

 

As required by Rule 13a-15(b) under the Exchange Act, management, with the participation of our Chief Executive Officer and Chief Financial Officer, performed an evaluation of the effectiveness of our disclosure controls and procedures as of March 31, 2017. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective because of the material weaknesses in our internal control over financial reporting, as described in Management’s Report on Internal Control Over Financial Reporting in Item 9A of our Annual Report on Form 10-K for the year ended December 31, 2016, which continue to exist at March 31, 2017.

 

During the preparation of the annual consolidated financial statements for 2016, we identified material weaknesses in our internal control over financial reporting. We did not maintain an effective control environment based on lack of established reporting lines and defined authorities and responsibilities for financial reporting at our wholly owned subsidiary, HDI, and did not have an effective risk assessment process on a periodic basis to assess the effects of changes in business operations and turnover of our employees that significantly impact our financial processes and internal control over financial reporting related to (i) our Estimated liability for appeals associated with our contract with CMS (the “CMS Reserve”) and (ii) the valuation of our accounts receivable allowance (the “Allowance”). As a result, we did not design and implement effective process level control activities, specifically management review controls over the measurement and disclosure of the CMS Reserve and the Allowance and controls over the completeness and accuracy of data used to calculate the CMS Reserve and the Allowance.

 

To remediate the material weaknesses described above, we have redesigned the review controls over both the CMS Reserve and the Allowance, and have refined the calculations utilized, including additional controls over the completeness and accuracy of data used, to determine the CMS Reserve and the Allowance. We have also enhanced the use of higher level compensating controls in the near term to monitor the design and operating effectiveness of the revised controls and calculation of the liability related to the CMS Reserve and of the estimate of our Allowance. Our enhanced calculations and review procedures were in place during the first quarter of 2017; however, we cannot verify that the material weaknesses have been fully remediated until the applicable remedial controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively. Except as noted above, there have been no changes in the Company's internal control over financial reporting as of March 31, 2017, that has materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

28
 

 

PART II — OTHER INFORMATION

 

Item 1. Legal Proceedings

 

The information set forth under the caption “Commitments and Contingencies” in Note 10 of the Notes to the unaudited Consolidated Financial Statements of this Quarterly Report on Form 10-Q is incorporated herein by reference.

 

Item 1A. Risk Factors

 

In addition to the information set forth in this Quarterly Report on Form 10-Q, the risks that are discussed in the 2016 Form 10-K, under the headings “Part I, Item 1. Business,” “Part I, Item 1A. Risk Factors” and “Part II, Item 7A. Quantitative and Qualitative Disclosures About Market Risk,” should be carefully considered as such risks could materially affect the Company’s business, financial conditions or future results. There has been no material change in the Company’s risk factors from those described in the 2016 Form 10-K.

 

These risks are not the only risks facing the Company. Additional risks and uncertainties not currently known to the Company or that it currently deems to be immaterial also may have a material adverse effect on the Company’s business, financial condition or future results.

 

Item 5. Other Information

 

The Board of Directors has set the date of our 2017 Annual Meeting of Shareholders (the “2017 Annual Meeting”) as August 21, 2017. Because the date of the 2017 Annual Meeting has been changed by more than 30 days from the date of our previous annual meeting of shareholders, the Company has established a new deadline for the receipt of shareholder proposals intended to be included in our proxy materials for the 2017 Annual Meeting pursuant to Rule 14a-8 under the Exchange Act (“Rule 14a-8”).

 

Shareholders of the Company who wish to have a proposal considered for inclusion in the Company’s proxy materials for the 2017 Annual Meeting pursuant to Rule 14a-8 must ensure that such proposal is received in writing at our principal executive offices located at 5615 High Point Drive, Irving, Texas 75038, Attention: Meredith W. Bjorck, no later than June 16, 2017, which we have determined to be a reasonable time before we begin to print and mail our proxy materials. Any such proposal must also comply with the requirements of Rule 14a-8 to be eligible for inclusion in our proxy materials.

 

With regard to any proposal by a shareholder not seeking to have such proposal included in the proxy statement, but seeking to have such proposal considered at the 2017 Annual Meeting or seeking to nominate a candidate for director at the 2017 Annual Meeting, the deadline for timely notice as set forth in on page 9 of our proxy statement for our 2016 Annual Meeting of Shareholders has not changed since, pursuant to our Bylaws, the date of our 2017 Annual Meeting has not been delayed by more than 60 calendar days, from the first anniversary of the preceding year’s annual meeting.

 

29
 

 

Item 6. Exhibits

 

Pursuant to the rules and regulations of the SEC, the Company has filed, furnished or incorporated by reference the documents referenced in the accompanying Index to Exhibits as exhibits to this Quarterly Report on Form 10-Q. The Exhibits include agreements to which the Company is a party or has a beneficial interest. The agreements have been filed to provide investors with information regarding their respective terms. The agreements are not intended to provide any other actual information about the Company or its business or operations. In particular, the assertions embodied in any representations, warranties, and covenants contained in the agreements may be subject to qualifications with respect to knowledge and materiality different from those applicable to investors and may be qualified by information in confidential disclosure schedules not included with the exhibits. These disclosure schedules may contain information that modifies, qualifies and creates exceptions to the representations, warranties and covenants set forth in the agreements. Moreover, certain representations, warranties, and covenants in the agreements may have been used for the purpose of allocating risk between parties, rather than establishing matters as facts. In addition, information concerning the subject matter of the representations, warranties and covenants may have changed after the date of the respective agreement, which subsequent information may or may not be fully reflected in the Company’s public disclosures. Accordingly, investors should not rely on the representations, warranties and covenants in the agreements as characterizations of the actual state of facts about the Company or its business or operations on the date hereof.

 

(a) Exhibits

 

Exhibit
Number
  Description
2.1†*   Agreement and Plan of Merger, dated March 10, 2017, by and among the HMS Holdings Corp., Echo Acquisition Sub, Inc., Eliza Holding Corp., and Parthenon Investors III, L.P.,  solely in its capacity as the representative for equity holders of Eliza Holding Corp.
3.1   Conformed copy of Certificate of Incorporation of the Company, as amended through July 9, 2015 (incorporated by reference to Exhibit 3.1 to Company’s Quarterly Report on Form 10-Q (File No. 000-50194) as filed with the SEC on August 10, 2015)
3.2   Amended and Restated Bylaws of the Company dated May 4, 2016 (incorporated by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K (File No. 000- 50194) as filed with the SEC on May 5, 2016)
10.1*   Amendment No. 1 to the Amended and Restated Credit Agreement, dated March 8, 2017, among HMS Holdings Corp., the Guarantors Party thereto, the Lenders party thereto and Citibank, N.A. as Administrative Agent
31.1*   Rule 13a-14(a)/15d-14(a) Certification of the Principal Executive Officer of HMS Holdings Corp., as adopted pursuant to Section 302 of the Sarbanes- Oxley Act of 2002
31.2*   Rule 13a-14(a)/15d-14(a) Certification of the Principal Financial Officer of HMS Holdings Corp., as adopted pursuant to Section 302 of the Sarbanes- Oxley Act of 2002
32.1**   Section 1350 Certification of the Principal Executive Officer of HMS Holdings Corp., as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2**   Section 1350 Certification of the Principal Financial Officer of HMS Holdings Corp., as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS*   XBRL Instance Document
101.SCH*   XBRL Taxonomy Extension Schema Document
101.CAL*   XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*   XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*   XBRL Taxonomy Extension Label Linkbase Document
101.PRE*   XBRL Taxonomy Extension Presentation Linkbase Document

 

† Certain schedules and similar attachments to this agreement have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The Company agrees to furnish supplementally a copy of any omitted schedule or similar attachment to the SEC upon request.

 

* Filed herewith

** Furnished herewith

30
 

 

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: June 6, 2017 HMS HOLDINGS CORP.  
         
         
    By: /s/ WILLIAM C. LUCIA  
      William C. Lucia  
      President and Chief Executive Officer and Duly
      Authorized Officer  
      (Principal Executive Officer)  
         
         
    By: /s/ JEFFREY S. SHERMAN  
      Jeffrey S. Sherman  
      Executive Vice President, Chief Financial Officer and Treasurer
     

(Principal Financial Officer)

 
         
         
         
         
         
         

 

 

 

 

 

31
 

 

HMS Holdings Corp. and Subsidiaries

Exhibit Index

 

Exhibit
Number
  Description
2.1†*   Agreement and Plan of Merger, dated March 10, 2017, by and among the HMS Holdings Corp., Echo Acquisition Sub, Inc., Eliza Holding Corp., and Parthenon Investors III, L.P.,  solely in its capacity as the representative for equity holders of Eliza Holding Corp.
3.1   Conformed copy of Certificate of Incorporation of the Company, as amended through July 9, 2015 (incorporated by reference to Exhibit 3.1 to Company’s Quarterly Report on Form 10-Q (File No. 000-50194) as filed with the SEC on August 10, 2015)
3.2   Amended and Restated Bylaws of the Company dated May 4, 2016 (incorporated by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K (File No. 000- 50194) as filed with the SEC on May 5, 2016)
10.1*   Amendment No. 1 to the Amended and Restated Credit Agreement, dated March 8, 2017, among HMS Holdings Corp., the Guarantors Party thereto, the Lenders party thereto and Citibank, N.A. as Administrative Agent
31.1*   Rule 13a-14(a)/15d-14(a) Certification of the Principal Executive Officer of HMS Holdings Corp., as adopted pursuant to Section 302 of the Sarbanes- Oxley Act of 2002
31.2*   Rule 13a-14(a)/15d-14(a) Certification of the Principal Financial Officer of HMS Holdings Corp., as adopted pursuant to Section 302 of the Sarbanes- Oxley Act of 2002
32.1**   Section 1350 Certification of the Principal Executive Officer of HMS Holdings Corp., as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2**   Section 1350 Certification of the Principal Financial Officer of HMS Holdings Corp., as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS*   XBRL Instance Document
101.SCH*   XBRL Taxonomy Extension Schema Document
101.CAL*   XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*   XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*   XBRL Taxonomy Extension Label Linkbase Document
101.PRE*   XBRL Taxonomy Extension Presentation Linkbase Document

__________________________ 

† Certain schedules and similar attachments to this agreement have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The Company agrees to furnish supplementally a copy of any omitted schedule or similar attachment to the SEC upon request.

 

*Filed herewith

** Furnished herewith

 

 

 

32