NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
For
the Three and Six Months Ended June 30, 2018 and 2017
(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. We use innovative technology, extensive
data services and powerful analytics to deliver coordination of benefits, payment integrity and care management and consumer engagement
solutions to help healthcare payers improve financial performance and clinical outcomes. We provide coordination of benefits services
to government and commercial healthcare payers and sponsors to ensure that the responsible party pays healthcare claims. Our payment
integrity services ensure healthcare claims billed are accurate and appropriate, and our care management and consumer engagement
technology helps risk-bearing organizations to better engage with and manage the care delivered to their members. Together these
various services help customers recover erroneously paid amounts from liable third parties; prevent future improper payments;
reduce fraud, waste and abuse; better manage the care their members receive; engage healthcare consumers to improve clinical outcomes
while increasing member satisfaction and retention; and achieve regulatory compliance. We currently operate as one business segment
with a single management team that reports to our Chief Executive Officer.
The
accompanying consolidated financial statements and notes 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 (which include only
normal recurring adjustments, except as disclosed) 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, 2017 which were filed with the SEC as part of the 2017 Form 10-K. The consolidated balance
sheet as of December 31, 2017 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.
(b)
Summary of Significant Accounting Policies
There
have been no material changes to the Company’s significant accounting policies that are referenced in the 2017 Form 10-K
other than as described below with respect to revenue recognition.
Recently
Adopted 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 supersedes all existing revenue recognition guidance under U.S. GAAP.
The Company adopted ASU 2014-09 on January 1, 2018 as to all contracts using the modified retrospective method and the Company
recognized the cumulative effect of initially applying the new revenue standard as an adjustment to the opening balance of retained
earnings. The financial information for comparative prior periods has not been restated and continues to be reported under
the accounting standards in effect for those periods. The effect of adopting ASU 2014-09 in the current annual reporting period
as compared with the guidance that was in effect before the change is immaterial. The Company’s internal control framework
did not materially change, but existing internal controls were modified due to certain changes to business processes and systems
to support the new revenue recognition standard as necessary. The Company continues to expect the impact of the adoption of the
new standard to be immaterial to its net income and its internal control framework on an ongoing basis.
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”)
.
ASU 2016-15 clarifies where certain cash receipts and cash payments
are presented and classified in the statement of cash flows. The amendments are effective for annual reporting periods beginning
after December 15, 2017, and for interim reporting periods within such annual periods. The Company adopted this guidance on January
1, 2018. The adoption of this guidance did not have an effect on the Company’s consolidated 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 adopted this guidance on January 1, 2018. The adoption of this guidance
did not have a material effect on the Company’s consolidated financial statements.
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 requires entities to apply modification accounting to changes made to
a share-based payment award. The new guidance specifies that entities will apply modification accounting to changes to a share-based
payment award only if any of the following are not the same immediately before and after the change: 1) The award’s fair
value (or calculated value or intrinsic value, if those measurement methods are used), 2) the award’s vesting conditions,
and 3) the award’s classification as an equity or liability instrument. ASU 2017-09 is effective for annual reporting periods
beginning after December 15, 2017, including interim periods within such annual periods, with early adoption permitted. The Company
adopted this guidance on January 1, 2018. The adoption of this guidance did not have a material effect on the Company’s
consolidated financial statements.
Recently
Issued Accounting Pronouncements
In
February 2016, the FASB issued ASU No. 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. The Company
developed a preliminary implementation plan and is reviewing historical lease agreements to quantify the impact of adoption. Depending
on the results of the Company’s review, there could be material changes to the Company’s financial position and/or
results of operations. The Company expects to complete the initial analysis of all historical agreements and the overall assessment
process by the end of the third quarter of 2018 in anticipation of performing additional reviews and other implementation considerations
in the fourth quarter of 2018.
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 but this guidance is not expected to have a material impact on the Company’s financial
position, results of operations or internal control framework.
In June 2018, the FASB issued ASU No. 2018-07,
Compensation – Stock Compensation (Topic 718) – Improvements to Nonemployee Share-Based Payment Accounting,
(“ASU
2018-07”). ASU 2018-07 requires entities to apply similar accounting for share-based payment transactions with non-employees
as with share-based payment transactions with employees. ASU 2018-07 is effective for public entities for fiscal year beginning
after December 15, 2018, including interim periods within that fiscal year. Early adoption is permitted. The Company is currently
evaluating the impact on the Company’s financial statements of adopting this guidance but this guidance is not expected to
have a material impact on the Company’s financial position, results of operations or internal control framework.
2.
|
Fair Value of Financial Instruments
|
Financial
instruments (principally cash and cash equivalents, accounts receivable, accounts payable and accrued expenses) are carried at
cost, which approximates fair value due to the short-term maturity of these instruments. The Company’s long-term credit
facility is carried at cost, which, due to the variable interest rate associated with the revolving credit facility, approximates
its fair value. The Company has no Level 1 or Level 2 financial instruments and there were no transfers between Level 1 or Level
2 financial instruments. Included in Other liabilities on the unaudited Consolidated Balance Sheets at June 30, 2018 is a $35,000
contingent consideration liability classified as Level 3 which remains unchanged from December 31, 2017. The liability is valued
using a Monte Carlo simulation and includes unobservable inputs such as expected levels of revenues and discount rates. Changes
in the unobservable inputs of this instrument could result in a significant change in the fair value measurement.
The
Company’s revenue disaggregated by product for the three and six months ended June 30 is as follows
(in thousands)
:
|
|
Three
Months Ended
June 30
|
|
Six
Months Ended
June 30
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Coordination of benefits
|
|
$
|
100,754
|
|
|
$
|
98,454
|
|
|
$
|
192,507
|
|
|
$
|
186,946
|
|
Analytical
services
|
|
|
46,037
|
|
|
|
34,859
|
|
|
|
95,709
|
|
|
|
60,100
|
|
Total
|
|
$
|
146,791
|
|
|
$
|
133,313
|
|
|
$
|
288,216
|
|
|
$
|
247,046
|
|
Coordination
of benefits
Coordination of benefits revenue is derived
from contracts with state governments and Medicaid managed care plans that typically span 3 to 5 years with the option to renew.
Types of service contracts could include: (a) the identification of erroneously paid claims; (b) the delivery of verified commercial
insurance coverage information; (c) the identification of paid claims where another third party is liable; and (d) the identification
and enrollment of Medicaid members who have access to affordable employer insurance. Most of these types of service contracts contain
multiple promises, all of which are not distinct within the context of the contract. Therefore, the promises represent a single,
distinct performance obligation for the types of services we offer. Revenue derived from these performance obligations is largely
based on variable consideration where, based on the number of claims or amount of findings the Company identified, a contingent
or fixed transaction price/recovery percentage is allocated to each distinct performance obligation. The Company utilizes the expected
value method to estimate the variable consideration related to the transaction price for its service contracts. Key inputs and
assumptions in determining variable consideration includes identified pricing and expected recoveries and/or savings. The expected
recoveries and/or savings are based on historical experience of information received from our customers. Revenue is recognized
at a point in time when our customers realize economic benefits from our services when our services are completed. Generally, coordination
of benefit contract payment terms are not standardized within the respective contract; however, payment is typically due on demand
and there is a clear and distinct history of customers making consistent payments.
Analytical
services
The
Company’s analytical services revenue consists mostly of payment integrity services but also care management and consumer
engagement services.
Payment integrity services revenue is derived
from contracts with federal and state governments, commercial health plans and other at-risk entities that can span several years
with the option to renew. Types of service contracts could include: (a) services designed to ensure that healthcare payments are
accurate and appropriate; and (b) the identification of over/(under)payments or inaccurate charges based on a review of medical
records. Most of these types of service contracts contain multiple promises, all of which are not distinct within the context of
the contract. Therefore, the promises represent a single, distinct performance obligation for the types of services we offer. Revenue
derived from these performance obligations is largely based on variable consideration where, based on the number of claims or amount
of findings the Company identified, a contingent or fixed transaction price/recovery percentage is allocated to each distinct performance
obligation. The Company utilizes the expected value method to estimate the variable consideration related to the transaction price
for its service contracts. Key inputs and assumptions in determining variable consideration includes identified pricing and expected
recoveries and/or savings. The expected recoveries and/or savings are based on historical experience of information received from
our customers. Revenue is recognized at a point in time when our customers realize economic benefits from our services when our
services are completed. Generally, payment integrity contract payment terms are not standardized within the respective contract;
however, payment is typically due on demand and there is a clear and distinct history of customers making consistent payments.
Care
management and consumer engagement services revenue is derived from contracts with health plans and other risk-bearing
entities that can span several years with the option to renew. Types of service contracts could include: (a) programs
designed to improve member engagement; and (b) outreach services designed to improve clinical outcomes. Most of these types
of service contracts contain multiple promises, all of which are not distinct within the context of the contract. Therefore,
the promises represent a single, distinct performance obligation for the types of services we offer. Revenue derived from
these services is largely based on consideration associated with prices per order/transfer and PMPM/PMPY fees. The Company
believes the output method is a reasonable measure of progress for the satisfaction of our performance obligations, which are
satisfied over time, as it provides a faithful depiction of (1) our performance toward complete satisfaction of the
performance obligation under the contract and (2) the value transferred to the customer of the services performed under the
contract. The Company has elected the right to the invoice practical expedient for recognition of revenue related to its
performance obligations. Additionally, certain care management and consumer engagement services contracts have distinct
performance obligations related to software license and implementation fees which have historically been recognized as
revenue ratably over the life of the contract. However, upon adoption of ASC 606, revenue for software licenses is recognized
at the beginning of the license period when control is transferred as the license is installed and revenue for implementation
fees is recognized when control is transferred over time as the implementation is being performed. As the performance
obligation is deemed to have been satisfied and control transferred to our customers for software licenses and implementation
fees on or before December 31, 2017, the Company recorded a decrease to deferred revenue and an increase to opening retained
earnings of $1.4 million as of January 1, 2018 for the cumulative impact of adopting ASC 606. A portion
of the Company’s care management and consumer engagement services are deferred and revenue is recognized over time.
Deferred revenue of this nature was approximately $5.4 million and $6.4 million as of June 30, 2018 and December 31, 2017,
respectively, and is included in Accounts payable, accrued expenses and other liabilities in the Consolidated Balance Sheets.
Generally, care management and consumer engagement contract payment terms are stated within the contract and are due within
an explicitly stated time period (e.g., 30, 45, 60 days) from the date of invoice.
Contract
modifications are routine in nature and often done to account for changes in the contract specifications or requirements. In most
instances, contract modifications are for services that are not distinct, and, therefore, modifications are accounted for as part
of the existing contract.
4.
|
Accounts Receivable and Accounts Receivable Allowance
|
The
Company’s accounts receivable, net, consisted of the following
(in thousands)
:
|
|
June
30,
2018
|
|
December 31,
2017
|
Accounts
receivable
|
|
$
|
207,436
|
|
|
$204,259
|
Allowance
|
|
|
(14,322
|
)
|
|
(14,799)
|
Accounts
receivable, net
|
|
$
|
193,114
|
|
|
$189,460
|
We
record an accounts receivable allowance, based on historical patterns of billing adjustments, length of operating and collection
cycle and customer negotiations, behaviors and payment patterns. Changes in these estimates are recorded to revenue in the period
of change. A summary of the activity in the accounts receivable allowance was as follows
(in thousands)
:
|
|
June
30,
2018
|
|
December 31,
2017
|
Balance--beginning of period
|
|
$
|
14,799
|
|
|
$
|
10,772
|
|
Provision
|
|
|
10,332
|
|
|
|
20,233
|
|
Charge-offs
|
|
|
(10,809
|
)
|
|
|
(16,206
|
)
|
Balance--end
of period
|
|
$
|
14,322
|
|
|
$
|
14,799
|
|
On April 17, 2017, the Company completed the acquisition of
100% of the outstanding capital stock of Eliza Holding Corp. (“Eliza”), for a preliminary purchase price of $171.6
million funded with available liquidity of approximately 75% cash on hand and 25% from the Company’s existing credit line.
The allocation of the purchase price to
the fair value of the assets acquired and the liabilities assumed as of April 17, 2017, the effective date of the acquisition,
is as follows (
in thousands
):
Cash
and cash equivalents
|
|
$
|
435
|
|
Accounts receivable
|
|
|
8,902
|
|
Prepaid expenses
|
|
|
1,427
|
|
Property and equipment
|
|
|
1,146
|
|
Intangible assets
|
|
|
76,240
|
|
Goodwill
|
|
|
107,754
|
|
Other assets
|
|
|
63
|
|
Accounts payable
|
|
|
(2,620
|
)
|
Deferred tax liability
|
|
|
(19,681
|
)
|
Other
liabilities
|
|
|
(2,057
|
)
|
Total
purchase price
|
|
$
|
171,609
|
|
The
purchase price allocated to the intangibles acquired was as follows (
in thousands
):
|
|
Useful
Life
|
|
|
Customer
relationships
|
|
15 years
|
|
$
|
56,200
|
|
Intellectual property
|
|
6 years
|
|
|
19,600
|
|
Trade name
|
|
1.5 years
|
|
|
310
|
|
Restrictive
covenants
|
|
1
year
|
|
|
130
|
|
Fair
value of intangibles acquired
|
|
|
|
$
|
76,240
|
|
Acquisition
costs recorded in the second quarter 2017 to selling, general and administrative expenses were as follows (
in thousands):
Other
operating expenses - consulting fees
|
|
$
|
3,515
|
|
Other operating expenses
- legal fees
|
|
|
832
|
|
Other
operating expenses - transaction costs
|
|
|
185
|
|
Acquisition-related
costs
|
|
$
|
4,532
|
|
The
financial results of Eliza have been included in the Company’s consolidated financial statements since the date of acquisition.
6.
|
Intangible
Assets and Goodwill
|
Intangible
assets consisted of the following (
in thousands, except for weighted average amortization period
):
|
|
Gross
Carrying
Amount
|
|
Accumulated
Amortization
|
|
Net
Carrying
Amount
|
|
Weighted
Average
Amortization
Period
|
June 30, 2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer
relationships
|
|
$
|
156,790
|
|
|
$
|
(96,249
|
)
|
|
$
|
60,541
|
|
|
11.8
years
|
Trade
names
|
|
|
16,246
|
|
|
|
(15,097
|
)
|
|
|
1,149
|
|
|
0.5 years
|
Intellectual
property
|
|
|
21,700
|
|
|
|
(4,733
|
)
|
|
|
16,967
|
|
|
4.5 years
|
Restrictive
covenants
|
|
|
263
|
|
|
|
(212
|
)
|
|
|
51
|
|
|
1.1
years
|
Total
|
|
$
|
194,999
|
|
|
$
|
(116,291
|
)
|
|
$
|
78,708
|
|
|
|
|
|
Gross
Carrying
Amount
|
|
Accumulated
Amortization
|
|
Net
Carrying
Amount
|
|
Weighted
Average
Amortization
Period
|
December 31, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer
relationships
|
|
$
|
159,290
|
|
|
$
|
(89,106
|
)
|
|
$
|
70,184
|
|
|
11.3
years
|
Trade
names
|
|
|
16,246
|
|
|
|
(13,916
|
)
|
|
|
2,330
|
|
|
1 year
|
Intellectual
property
|
|
|
21,700
|
|
|
|
(2,874
|
)
|
|
|
18,826
|
|
|
5.2 years
|
Restrictive
covenants
|
|
|
263
|
|
|
|
(121
|
)
|
|
|
142
|
|
|
1.3
years
|
Total
|
|
$
|
197,499
|
|
|
$
|
(106,017
|
)
|
|
$
|
91,482
|
|
|
|
Amortization
expense of intangible assets is expected to approximate the following
(in thousands):
Year
ending December 31,
|
|
|
2018
|
|
$
|
11,579
|
|
2019
|
|
|
9,183
|
|
2020
|
|
|
7,664
|
|
2021
|
|
|
7,197
|
|
2022
|
|
|
7,197
|
|
Thereafter
|
|
|
35,888
|
|
Total
|
|
$
|
78,708
|
|
For the three months ended June 30, 2018
and 2017, amortization expense related to intangible assets was $6.7 million and $4.5 million, respectively. For the six months
ended June 30, 2018 and 2017, amortization expense related to intangible assets was $12.8 million and $9.7 million, respectively.
The Company assesses goodwill for impairment
on an annual basis as of June 30th of each year or more frequently if an event occurs or changes in circumstances would more likely
than not reduce the fair value of a reporting unit below its carrying amount. Assessment of goodwill impairment is at the HMS Holdings
Corp. entity level as the Company operates as a single reporting unit. The Company completed the annual impairment test as of June
30, 2018 electing to perform the first step of the goodwill impairment test by comparing the fair value of the reporting unit with
its carrying value, including goodwill. In calculating the fair value of the reporting unit, the Company utilized a weighting across
three commonly accepted valuation approaches: an income approach, a guideline public company approach and a merger and acquisition
approach. The income approach to determining fair value computes projections of the cash flows that the reporting unit is expected
to generate converted into a present value equivalent through discounting. Significant assumptions in the income approach include
income projections, a discount rate and a terminal growth value which are all level 3 inputs. The income projections include assumptions
for revenue and expense growth which are based on internally developed business plans and largely reflect recent historical revenue
and expense trends. The discount rate was based on a risk free rate plus a beta adjusted equity risk premium and specific
company risk premium. The terminal growth value is Company specific and was determined analyzing inputs such as historical inflation
and the GDP growth rate. The guideline public company approach and merger and acquisition approach are based on pricing multiples
observed for similar publicly traded companies or similar market companies that were sold. The results of the annual impairment
assessment provide that the fair value of the reporting unit was significantly in excess of the Company’s carrying value,
including goodwill; therefore, no impairment was indicated and step two was not performed. If actual results are not consistent
with our estimates or assumptions, the Company may be exposed to an impairment charge that could materially adversely impact our
consolidated financial position and results of operations.
There
were no impairment charges related to goodwill during the years ended December 31, 2017, 2016 or 2015. There were no changes in
the carrying amount of goodwill for the six-months ended June 30, 2018.
7.
|
Accounts
Payable, Accrued Expenses and Other Liabilities
|
Accounts
payable, accrued expenses and other liabilities consisted of the following
(in thousands)
:
|
|
June
30,
2018
|
|
December
31,
2017
|
Accounts
payable, trade
|
|
$
|
10,741
|
|
|
$
|
19,330
|
|
Accrued compensation
and other
|
|
|
26,448
|
|
|
|
24,072
|
|
Accrued
operating expenses
|
|
|
19,498
|
|
|
|
18,498
|
|
Total
accounts payable, accrued expenses and other liabilities
|
|
$
|
56,687
|
|
|
$
|
61,900
|
|
The Company’s effective tax rate
increased to 47.7% for the six months ended June 30, 2018 from 42.6% for the six months ended June 30, 2017. The effective rate
for six months ended June 30, 2018 includes the discrete tax impact related to the settlement of the litigation described in Note
13, Commitments and Contingencies, interest on uncertain tax benefits and net stock compensation in addition to a net federal tax
reform benefit comprised of a federal tax rate decrease, net of state impact, offset by tax increases for officer compensation
deduction limits and loss of the domestic manufacturing deduction. For the six months ended June 30, 2018, the differences between
the federal statutory rate and our effective tax rate are discrete tax expense related to the settlement of the litigation described
in Note 13, Commitments and Contingencies, state taxes, equity compensation impacts, unrecognized tax benefits, including interest,
officer compensation deduction limits, research and development tax credits, and other permanent differences.
The
effective tax rate for the six months ended June 30, 2018 represents the Company’s best estimate using information available
to the Company as of August 6, 2018. The Company anticipates U.S. regulatory agencies will issue further regulations over the
next nine months which may alter this estimate. The Company is still evaluating, among other things, the application of limitations
for executive compensation related to contracts existing prior to November 2, 2017. The Company will refine its estimates to incorporate
new or better information as it becomes available through the filing date of its 2017 U.S. income tax returns in the fourth quarter
of 2018.
Included
in Other Liabilities on the Consolidated Balance Sheets, are the total amount of unrecognized tax benefits of approximately $8.7
million and $8.2 million, as of June 30, 2018 and December 31, 2017, 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 $0.9 million and $0.6 million as of June 30, 2018 and December 31, 2017, 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 six months ended June
30, 2018 and 2017 was $0.3 million and an immaterial amount, respectively. The Company believes it is reasonably possible that
the amount of unrecognized tax benefits may decrease by $1.9 million over the next twelve months, due to the expiration of the
statute of limitations in federal and 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 Company is currently under audit by the Internal Revenue Service
for years 2013 and 2014 and no assessments have been received. HMS operates in a number of state and local jurisdictions. Accordingly,
HMS is subject to state and local income tax examinations based on the various statutes of limitations in each jurisdiction. Previously
recognized Texas refund claims are currently being examined by the state.
9.
|
Estimated
Liability For Appeals
|
Under
the Company’s contracts with certain commercial health plan customers and its Medicare RAC contracts with CMS (included
within the Company’s analytical services product revenue), providers have the right to appeal HMS claim findings and to
pursue additional appeals if the initial appeal is found in favor of HMS’s customer. The appeal process established under
the Medicare RAC contract with CMS includes five levels of appeals, and resolution of appeals can take substantial time to resolve.
HMS records a) a return obligation liability for findings which have been adjudicated in favor of providers and b) an estimated
return obligation liability based on the amount of revenue that is subject to appeals and which are probable of being adjudicated
in favor of providers following their successful appeal. The Company’s estimate is based on the Company’s historical
experience. To the extent the amount to be returned to providers following a successful appeal exceeds or is less than the amount
recorded, revenue in the applicable period would be reduced or increased by such amount. Any future changes to any of the Company’s
customer contracts, including modifications to the Medicare RAC contract, may require the Company to apply different assumptions
that could materially affect both the Company’s revenue and estimated liability for appeals in future periods.
The
Company’s original Medicare RAC contract with CMS expired on January 31, 2018. As a result of the contract expiration, the
Company’s contractual obligation with respect to any appeals resolved in favor of providers subsequent to the expiration
date have ceased and therefore the Company released its estimated liability and increased revenue by $8.4 million during the first
quarter of 2018. The Company continues to assess the remaining Medicare RAC liability to determine management’s best estimate
of liability for any findings which have been previously adjudicated prior to the expiration of the contract.
The
total estimated liability for appeals balance of $22.3 million and $30.8 million as of June 30, 2018 and December 31, 2017, respectively,
includes $19.4 million and $19.3 million, respectively, of Medicare RAC claim findings which have been adjudicated in favor of
providers, and $0.0 million and $8.5 million, respectively, of the Company’s estimate of the potential amount of Medicare
RAC repayments that are probable of being adjudicated in favor of providers following a successful appeal. Additionally, the total
estimated liability for appeals balance includes $2.9 million and $3.2 million related to commercial customers claim appeals.
The provision included in the estimated liability for appeals is an offset to revenue in the Company’s Consolidated Statements
of Income.
A
summary of the activity in the estimated liability for appeals related to the Company’s original Medicare RAC contract was
as follows
(in thousands)
:
|
|
June
30, 2018
|
Balance--beginning of period
|
|
$
|
8,544
|
|
Provision
|
|
|
-
|
|
Appeals found in providers
favor
|
|
|
(108
|
)
|
Release
of liability
|
|
|
(8,436
|
)
|
Balance--end
of period
|
|
$
|
-
|
|
In
December 2017, the Company entered into an amendment to its Credit Agreement, which, among other things, extended the maturity
of its then existing $500 million revolving credit facility by five years to December 2022 (the “Amended Revolving Facility”).
The availability of funds under the Amended Revolving Facility includes sublimits for (a) up to $50 million for the issuance of
letters of credit and (b) up to $25 million for swingline loans. In addition, the Company may increase the commitments under the
Amended Revolving Facility and/or add one or more incremental term loan facilities, provided that such incremental facilities
do not exceed in the aggregate the sum of (i) the greater of $120 million and 100% of Consolidated EBITDA (as defined in the Credit
Agreement) and (ii) an additional amount so long as our first lien leverage ratio (as defined in the Credit Agreement) on a pro
forma basis is not greater than 3.00:1.00, subject to obtaining commitments from lenders therefor and meeting certain other conditions.
As
of June 30, 2018 and December 31, 2017, the outstanding principal balance due on the Amended Revolving Facility was $240.0 million.
No principal payments were made against the Company’s Amended Revolving Facility during the six months ended June 30, 2018.
Borrowings
under the Amended Revolving Facility bear interest at a rate equal to, at the Company’s election (except with respect to
swingline borrowings, which will accrue interest based only at the base rate), either:
|
▪
|
a base rate determined
by reference to the greatest of (a) the prime or base commercial lending rate of the administrative agent as in effect on
the relevant date, (b) the federal funds effective rate plus 0.50% and (c) the one-month LIBO Rate plus 1.00%,
plus
an interest margin ranging from 0.50% to 1.00% based on the Company’s consolidated leverage ratio for the applicable
period; or
|
|
▪
|
an adjusted LIBO
Rate, equal to the LIBO Rate for the applicable interest period multiplied by the statutory reserve rate (equal to (x) one
divided by (y) one minus the aggregate of the maximum reserve percentage (including any marginal, special, emergency or supplemental
reserves) established by the Board of Governors of the Federal Reserve System of the United States),
plus
an interest
margin ranging from 1.50% to 2.00% based on the Company’s consolidated leverage ratio for the applicable period.
|
In
addition to paying interest on the outstanding principal, the Company is required to pay unused commitment fees on the Amended
Revolving Facility during the term of the Credit Agreement ranging from 0.375% to 0.250% per annum based on the Company’s
consolidated leverage ratio and letter of credit fees equal to 0.125% per annum on the aggregate face amount of each letter of
credit, as well as customary agency fees.
The
Amended Revolving Facility is secured, subject to certain customary carve-outs and exceptions, by a first priority lien and security
interest in substantially all tangible and intangible assets of the Company and certain subsidiaries of the Company. The Amended
Revolving Facility contains certain restrictive covenants, which affect, among other things, the ability of the Company and its
subsidiaries to incur indebtedness, create liens, make investments, sell or otherwise dispose of assets, engage in mergers or
consolidations with other entities, and pay dividends or repurchase stock. The Company is also required to comply, on a quarterly
basis, with two financial covenants: (i) a minimum interest coverage ratio of 3:00:1:00, and (ii) a maximum consolidated leverage
ratio of 4.75:1.00 through December 2019 and 4.25:1.00 from and after January 2020. The consolidated leverage ratio is subject
to a step-up to 5.25:1.00 for four full consecutive fiscal quarters following a permitted acquisition or similar investment. As
of June 30, 2018, the Company was in compliance with all terms of the Credit Agreement.
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
June 30,
|
|
Six
Months Ended
June 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Interest
expense
|
|
$
|
2,627
|
|
|
$
|
1,469
|
|
|
$
|
4,697
|
|
|
$
|
2,843
|
|
Commitment
fees
|
|
|
239
|
|
|
|
333
|
|
|
|
477
|
|
|
|
711
|
|
As
of June 30, 2018 and December 31, 2017, the unamortized balance of deferred origination fees and debt issuance costs were $2.5
million and $2.8 million, respectively. For the six month periods ended June 30, 2018 and 2017, HMS amortized $0.3 million and
$1.0 million, respectively, 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 Amended Revolving Facility may be used for general corporate purposes, including, but not limited to acquisitions, if necessary.
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
June 30,
|
|
Six
Months Ended
June 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Net
income
|
|
$
|
(3,367
|
)
|
|
$
|
6,517
|
|
|
$
|
3,024
|
|
|
$
|
7,959
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding-basic
|
|
|
83,231
|
|
|
|
83,921
|
|
|
|
83,222
|
|
|
|
83,708
|
|
Plus:
net effect of dilutive stock options and restricted stock units
|
|
|
-
|
|
|
|
1,905
|
|
|
|
1,615
|
|
|
|
1,826
|
|
Weighted average common shares outstanding-diluted
|
|
|
83,231
|
|
|
|
85,826
|
|
|
|
84,837
|
|
|
|
85,534
|
|
Net
(loss)/income per common share-basic
|
|
$
|
(0.04
|
)
|
|
$
|
0.08
|
|
|
$
|
0.04
|
|
|
$
|
0.10
|
|
Net
(loss)/income per common share-diluted
|
|
$
|
(0.04
|
)
|
|
$
|
0.08
|
|
|
$
|
0.04
|
|
|
$
|
0.09
|
|
For
the three months ended June 30, 2018, the Company incurred a net loss; therefore, basic and dilutive earnings per share were the
same and 2,552,862 stock options and restricted stock units representing 626,341 shares of common stock were excluded from consideration
in the calculation of diluted net loss per share because the effect would have been anti-dilutive. For the three months ended
June 30, 2017, 1,804,272 stock options and restricted stock units representing 51,836 shares of common stock were not included
in the diluted earnings per share calculation because the effect would have been anti-dilutive.
For
the six months ended June 30, 2018 and 2017, 2,738,783 and 1,888,257 stock options, respectively, were not included in the diluted
earnings per share calculation because the effect would have been anti-dilutive. For the six months ended June 30, 2018 and 2017,
restricted stock units representing 106,501 and 63,247 shares of common stock, respectively, were not included in the diluted
earnings per share calculation because the effect would have been anti-dilutive.
12.
|
Stock-Based Compensation
|
(a)
|
Stock-Based Compensation Expense
|
Total
stock-based compensation expense in the Company’s unaudited Consolidated Statements of Income related to the Company’s
long-term incentive award plans was as follows
(in thousands)
:
|
|
Three
Months Ended June
30,
|
|
Six
Months Ended
June 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Cost of services-compensation
|
|
$
|
1,673
|
|
|
$
|
1,462
|
|
|
$
|
4,236
|
|
|
$
|
3,503
|
|
Selling,
general and administrative
|
|
|
3,041
|
|
|
|
2,532
|
|
|
|
9,972
|
|
|
|
5,877
|
|
Total
|
|
$
|
4,714
|
|
|
$
|
3,994
|
|
|
$
|
14,208
|
|
|
$
|
9,380
|
|
Stock-based
compensation expense related to stock options was approximately $2.1 million and $1.7 million for the three months ended June
30, 2018 and 2017, respectively. Stock-based compensation expense related to stock options was approximately $6.1 million and
$3.9 million for the six months ended June 30, 2018 and 2017, respectively.
Presented
below is a summary of stock option activity for the six months ended June 30, 2018 (
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, 2017
|
|
|
5,554
|
|
|
$
|
17.35
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
1,010
|
|
|
|
19.58
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(151
|
)
|
|
|
15.81
|
|
|
|
|
|
|
|
|
|
Forfeitures
|
|
|
(26
|
)
|
|
|
16.43
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
(27
|
)
|
|
|
22.14
|
|
|
|
|
|
|
|
|
|
Outstanding
balance at June 30, 2018
|
|
|
6,360
|
|
|
|
17.78
|
|
|
|
5.37
|
|
|
|
26,785
|
|
Expected to vest at
June 30, 2018
|
|
|
1,633
|
|
|
|
17.68
|
|
|
|
8.00
|
|
|
|
6,449
|
|
Exercisable
at June 30, 2018
|
|
|
3,877
|
|
|
$
|
17.87
|
|
|
|
3.72
|
|
|
|
16,929
|
|
During
the three months ended June 30, 2018 and 2017, the Company issued 87,230 and 132,128 shares, respectively, of the Company’s
common stock upon the exercise of outstanding stock options and received proceeds of $2.2 million and $2.0 million, respectively.
The total intrinsic value of stock options exercised during the three months ended June 30, 2018 and 2017 was $0.8 million and
$0.6 million, respectively. During the six months ended June 30, 2018 and 2017, the Company issued 151,034 and 132,805 shares,
respectively, of the Company’s common stock upon the exercise of outstanding stock options and received proceeds of $2.4
million and $2.0 million, respectively. The total intrinsic value of stock options exercised during the six months ended June
30, 2018 and 2017 was $0.8 million and $0.6 million, respectively.
As
of June 30, 2018, there was approximately $9.6 million of total unrecognized compensation cost related to stock options outstanding,
which is expected to be recognized over a weighted average period of 2.3 years.
The
weighted-average grant date fair value per share of the stock options granted during the six months ended June 30, 2018 and 2017
was $7.52 and $7.73, respectively. 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:
|
|
Six
Months Ended
June
30,
|
|
|
2018
|
|
2017
|
Expected dividend yield
|
|
|
0%
|
|
|
0%
|
Risk-free interest rate
|
|
|
2.68%
|
|
|
1.74%
|
Expected volatility
|
|
|
42.43%
|
|
|
44.23%
|
Expected
life (years)
|
|
|
6.00
|
|
|
|
5.00
|
|
The
total tax benefits recognized on stock-based compensation for the three and six months ended June 30, 2018 and 2017 was $2.5 million
and $3.6 million, respectively.
|
(c)
|
Restricted
Stock Units
|
Stock-based
compensation expense related to restricted stock units was approximately $2.6 million and $2.2 million for the three months ended
June 30, 2018 and 2017, respectively. Stock-based compensation expense related to restricted stock units was approximately $8.1
million and $5.5 million for the six months ended June 30, 2018 and 2017, respectively.
Presented
below is a summary of restricted stock units activity for the six months ended June 30, 2018
(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, 2017
|
|
|
1,346
|
|
|
$
|
17.65
|
|
Granted
|
|
|
761
|
|
|
|
16.72
|
|
Vesting of restricted
stock units, net of units withheld for taxes
|
|
|
(364
|
)
|
|
|
16.93
|
|
Units withheld for taxes
|
|
|
(161
|
)
|
|
|
16.93
|
|
Forfeitures
|
|
|
(26
|
)
|
|
|
16.89
|
|
Outstanding
balance at June 30, 2018
|
|
|
1,556
|
|
|
$
|
19.98
|
|
For
the three months ended June 30, 2018 and 2017, HMS granted 62,259 and 536,023 restricted stock units, respectively, with an aggregate
fair market value of $0.9 million and $10.2 million, respectively. For the six months ended June 30, 2018 and 2017, HMS granted
761,083 and 539,657 restricted stock units, respectively, with an aggregate fair market value of $12.7 million and $10.3 million,
respectively.
As
of June 30, 2018, 1,330,734 restricted stock units remained unvested and there was approximately $13.9 million of unrecognized
compensation cost related to restricted stock units, which is expected to be recognized over a weighted average vesting period
of 1.38 years.
13.
|
Commitments
and Contingencies
|
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. In June 2016, Kern Health Systems and AMG entered into a settlement agreement that resolved
all claims in the California Action. In July 2017, the Court issued a decision on the Company’s motion for partial summary
judgment and granted the motion in part, dismissing one of Plaintiffs’ breach of contract causes of action against HMS.
On November 3, 2017, following a jury trial, a verdict was returned in favor of the Plaintiffs on a breach of contract claim,
and the jury awarded $60 million in damages to the Plaintiffs. On March 14, 2018, the Court held a hearing on the Company’s
post-trial motion for an order granting it judgment notwithstanding the verdict or, alternatively, setting aside the jury’s
award of damages. On June 27, 2018, prior to the Court issuing a decision on the motion, the Company entered into a Settlement
Agreement (the “Settlement Agreement”) with the Plaintiffs, John Alfred Lewis and Christopher Brandon Lewis. Pursuant
to the terms of the Settlement Agreement, the Company paid $20 million to resolve all matters in controversy pertaining to the
lawsuit. On July 5, 2018, the Court entered an order to discontinue the lawsuit pursuant to the Stipulation of Discontinuance
with Prejudice filed by the parties.
In
February 2018, the Company received a Civil Investigative Demand (“CID”) from the Texas Attorney General, purporting
to investigate possible unspecified violations of the Texas Medicaid Fraud Prevention Act. The Company has provided certain documents
and information in March 2018 in response to the CID and continues to cooperate with the government. HMS has not received any
further requests for information in connection with this CID.
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.
In
connection with the preparation of these unaudited Consolidated Financial Statements, an evaluation of subsequent events was performed
through the date of filing and there were no events that have occurred that would require adjustments to the financial statements
or disclosure.