NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 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 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 has reviewed historical lease agreements in order to quantify the impact
of adoption. Based upon the Company’s on-going analysis to date, the Company currently expects that there will be a material
increase to total assets and total liabilities on the Company’s consolidated balance sheet upon adoption; however, the Company
continues to perform the necessary additional reviews and other implementation considerations in order to appropriately quantify
the changes. The Company has elected to use the FASB’s optional transition method.The Company expects to complete the on-going
analysis and quantification by the end of 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.
On August 17, 2018 the SEC issued SEC Final Rule Release No. 33-10532,
Disclosure Update and Simplification
(“Final Rule”). The final rule amends certain disclosure requirements to facilitate the disclosure of information to
investors and simplify compliance without significantly altering the total mix of information provided to investors. The final
rule is effective for public entities that are SEC filers on November 5, 2018. The Company is currently evaluating the impact of
adopting this guidance but this guidance is not expected to have a material impact on the Company’s disclosures.
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. The Company’s contingent consideration liability of $35,000 at June 30, 2018 was reduced to zero
at September 30, 2018 and is included in Other liabilities on the unaudited Consolidated Balance Sheets. 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 nine months ended September 30 is as follows
(in thousands)
:
|
|
Three
Months Ended
September 30
|
|
|
Nine
Months Ended
September 30
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Coordination of benefits
|
|
$
|
105,694
|
|
|
$
|
90,073
|
|
|
$
|
298,201
|
|
|
$
|
277,018
|
|
Analytical
services
|
|
|
48,552
|
|
|
|
35,600
|
|
|
|
144,261
|
|
|
|
95,701
|
|
Total
|
|
$
|
154,246
|
|
|
$
|
125,673
|
|
|
$
|
442,462
|
|
|
$
|
372,719
|
|
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 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 $5.2 million and $6.4 million as of September 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)
:
|
|
September
30,
2018
|
|
|
December
31,
2017
|
|
Accounts
receivable
|
|
$
|
218,737
|
|
|
$
|
204,259
|
|
Allowance
|
|
|
(16,239
|
)
|
|
|
(14,799
|
)
|
Accounts
receivable, net
|
|
$
|
202,498
|
|
|
$
|
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)
:
|
|
September
30,
2018
|
|
|
December
31,
2017
|
|
Balance--beginning of period
|
|
$
|
14,799
|
|
|
$
|
10,772
|
|
Provision
|
|
|
16,107
|
|
|
|
20,233
|
|
Charge-offs
|
|
|
(14,667
|
)
|
|
|
(16,206
|
)
|
Balance--end
of period
|
|
$
|
16,239
|
|
|
$
|
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
(in years)
|
|
|
|
Customer
relationships
|
|
15
|
|
$
|
56,200
|
|
Intellectual property
|
|
6
|
|
|
19,600
|
|
Trade name
|
|
1.5
|
|
|
310
|
|
Restrictive
covenants
|
|
1
|
|
|
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. Eliza contributed approximately $37.4 million in revenue to HMS results of operations for the nine
months ended September 30, 2018. Eliza contributed approximately $17.5 million in revenue to HMS results of operations from the
date of acquisition through September 30, 2017.
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 (in years)
|
September 30, 2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer
relationships
|
|
$
|
156,790
|
|
|
$
|
(100,758
|
)
|
|
$
|
56,032
|
|
|
12.4
|
Trade
names
|
|
|
16,246
|
|
|
|
(15,724
|
)
|
|
|
522
|
|
|
0.3
|
Intellectual
property
|
|
|
21,700
|
|
|
|
(5,701
|
)
|
|
|
15,999
|
|
|
4.3
|
Restrictive
covenants
|
|
|
263
|
|
|
|
(223
|
)
|
|
|
40
|
|
|
0.9
|
Total
|
|
$
|
194,999
|
|
|
$
|
(122,406
|
)
|
|
$
|
72,593
|
|
|
|
|
|
Gross
Carrying
Amount
|
|
|
Accumulated
Amortization
|
|
|
Net
Carrying
Amount
|
|
|
Weighted
Average
Amortization
Period (in years)
|
December 31, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer
relationships
|
|
$
|
159,290
|
|
|
$
|
(89,106
|
)
|
|
$
|
70,184
|
|
|
11.3
|
Trade
names
|
|
|
16,246
|
|
|
|
(13,916
|
)
|
|
|
2,330
|
|
|
1
|
Intellectual
property
|
|
|
21,700
|
|
|
|
(2,874
|
)
|
|
|
18,826
|
|
|
5.2
|
Restrictive
covenants
|
|
|
263
|
|
|
|
(121
|
)
|
|
|
142
|
|
|
1.3
|
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
|
|
$
|
5,452
|
|
2019
|
|
|
9,195
|
|
2020
|
|
|
7,664
|
|
2021
|
|
|
7,197
|
|
2022
|
|
|
7,197
|
|
Thereafter
|
|
|
35,888
|
|
Total
|
|
$
|
72,593
|
|
For the
three months ended September 30, 2018 and 2017, amortization expense related to intangible assets was $6.1 million and $6.2 million,
respectively. For the nine months ended September 30, 2018 and 2017, amortization expense related to intangible assets was $18.9
million and $15.9 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; 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 nine-months ended September 30, 2018.
7.
|
|
Accounts
Payable, Accrued Expenses and Other Liabilities
|
Accounts payable, accrued expenses
and other liabilities consisted of the following
(in thousands)
:
|
|
September
30,
2018
|
|
|
December
31,
2017
|
|
Accounts
payable, trade
|
|
$
|
13,850
|
|
|
$
|
19,330
|
|
Accrued compensation
and other
|
|
|
32,372
|
|
|
|
24,072
|
|
Accrued
operating expenses
|
|
|
18,073
|
|
|
|
18,498
|
|
Total
accounts payable, accrued expenses and other liabilities
|
|
$
|
64,295
|
|
|
$
|
61,900
|
|
The Company’s effective tax rate decreased to 21.3% for the nine months ended September 30, 2018 from
39.4% for the nine months ended September 30, 2017. The nine months ended September 30, 2018 effective tax rate includes discrete
tax expense items related to a previously disclosed legal settlement, interest on uncertain tax benefits, state tax refunds 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 nine
months ended September 30, 2018, the differences between the federal statutory rate and our effective tax rate are discrete tax
expense items related to the previously disclosed legal settlement, 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 nine months ended September 30, 2018 represents the Company’s best estimate using information available
to the Company as of November 5, 2018. The Company anticipates U.S. regulatory agencies will issue further regulations over the
next three 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 $8.9 million and $8.2 million, as of September 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 $1.0 million and $0.6 million as of September 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 nine months ended September 30, 2018 and 2017 was $0.4 million and an immaterial amount, respectively. The Company believes
it is reasonably possible that the amount of unrecognized tax benefits may decrease by $3.5 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, territory, 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 adjustments have been received to date. 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 state apportionment benefits were adjusted by the state resulting in
additional benefits, net of federal tax, of $0.5 million relating to the current period and $2.4 million relating to prior periods.
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 $22.2 million and $30.8 million as of September 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 $2.8 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)
:
|
|
September
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
September 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 nine months ended September
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 September 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
September 30,
|
|
|
Nine
Months Ended
September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Interest
expense
|
|
$
|
2,527
|
|
|
$
|
2,230
|
|
|
$
|
7,224
|
|
|
$
|
5,072
|
|
Commitment
fees
|
|
|
211
|
|
|
|
325
|
|
|
|
688
|
|
|
|
1,036
|
|
As of
September 30, 2018 and December 31, 2017, the unamortized balance of deferred origination fees and debt issuance costs was $2.4
million and $2.8 million, respectively. For the nine month periods ended September 30, 2018 and 2017, HMS amortized $0.4 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
September 30,
|
|
|
Nine
Months Ended
September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Net
income
|
|
$
|
18,574
|
|
|
$
|
6,372
|
|
|
$
|
21,598
|
|
|
$
|
14,331
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding-basic
|
|
|
83,509
|
|
|
|
83,923
|
|
|
|
83,373
|
|
|
|
83,778
|
|
Plus:
net effect of dilutive stock options and restricted stock units
|
|
|
1,635
|
|
|
|
1,807
|
|
|
|
1,868
|
|
|
|
1,808
|
|
Weighted average common shares outstanding-diluted
|
|
|
85,144
|
|
|
|
85,730
|
|
|
|
85,241
|
|
|
|
85,586
|
|
Net
income per common share-basic
|
|
$
|
0.22
|
|
|
$
|
0.08
|
|
|
$
|
0.26
|
|
|
$
|
0.17
|
|
Net
income per common share-diluted
|
|
$
|
0.22
|
|
|
$
|
0.07
|
|
|
$
|
0.25
|
|
|
$
|
0.17
|
|
For the three months ended September 30, 2018 and 2017, 21,105 and 2,642,548 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 September 30, 2018 and 2017, restricted stock units representing 202 and 84,360 shares of common stock, respectively,
were not included in the diluted earnings per share calculation because the effect would have been anti-dilutive.
For the nine months ended September 30, 2018 and 2017, 531,378 and 2,132,017 stock options, respectively,
were not included in the diluted earnings per share calculation because the effect would have been anti-dilutive. For the nine
months ended September 30, 2018 and 2017, restricted stock units representing 595 and 63,452 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
September 30,
|
|
|
Nine
Months Ended
September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Cost of services-compensation
|
|
$
|
1,537
|
|
|
$
|
1,851
|
|
|
$
|
5,802
|
|
|
$
|
5,353
|
|
Selling,
general and administrative
|
|
|
1,900
|
|
|
|
5,531
|
|
|
|
11,843
|
|
|
|
11,408
|
|
Total
|
|
$
|
3,437
|
|
|
$
|
7,382
|
|
|
$
|
17,645
|
|
|
$
|
16,761
|
|
Stock-based
compensation expense related to stock options was approximately $1.6 million and $3.2 million for the three months ended September
30, 2018 and 2017, respectively. Stock-based compensation expense related to stock options was approximately $7.6 million and
$7.1 million for the nine months ended September 30, 2018 and 2017, respectively.
Presented below is a summary
of stock option activity for the nine months ended September 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
|
|
|
(686
|
)
|
|
|
21.13
|
|
|
|
|
|
|
|
|
|
Forfeitures
|
|
|
(100
|
)
|
|
|
17.64
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
(30
|
)
|
|
|
22.21
|
|
|
|
|
|
|
|
|
|
Outstanding
balance at September 30, 2018
|
|
|
5,748
|
|
|
|
17.33
|
|
|
|
5.41
|
|
|
$
|
88,909
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expected to vest at
September 30, 2018
|
|
|
1,561
|
|
|
|
17.65
|
|
|
|
7.79
|
|
|
$
|
23,669
|
|
Exercisable
at September 30, 2018
|
|
|
3,373
|
|
|
$
|
17.13
|
|
|
|
3.76
|
|
|
$
|
52,900
|
|
During
the three months ended September 30, 2018 and 2017, the Company issued 535,077 and 40,734 shares, respectively, of the Company’s
common stock upon the exercise of outstanding stock options and received proceeds of $12.1 million and $0.8 million, respectively.
The total intrinsic value of stock options exercised during the three months ended September 30, 2018 and 2017 was $4.0 million
and $0.3 million, respectively. During the nine months ended September 30, 2018 and 2017, the Company issued 686,111 and 173,539
shares, respectively, of the Company’s common stock upon the exercise of outstanding stock options and received proceeds
of $13.7 million and $2.7 million, respectively. The total intrinsic value of stock options exercised during the nine months ended
September 30, 2018 and 2017 was $4.7 million and $0.6 million, respectively.
As of
September 30, 2018, there was approximately $7.6 million of total unrecognized compensation cost related to stock options outstanding,
which is expected to be recognized over a weighted average period of 2.1 years.
The weighted-average
grant date fair value per share of the stock options granted during the nine months ended September 30, 2018 and 2017 was $7.52
and $7.68, 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:
|
|
Nine
Months
Ended September 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 nine months ended September 30, 2018 was $1.0 million and
$3.5 million, respectively. The total tax benefits recognized on stock-based compensation for the three and nine months
ended September 30, 2017 was $0.0 and $3.6 million, respectively.
(c)
|
|
Restricted
Stock Units
|
Stock-based
compensation expense related to restricted stock units was approximately $1.9 million and $4.2 million for the three months ended
September 30, 2018 and 2017, respectively. Stock-based compensation expense related to restricted stock units was approximately
$10.0 million and $9.7 million for the nine months ended September 30, 2018 and 2017, respectively.
Presented below is a summary
of restricted stock units activity for the nine months ended September 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
|
|
|
763
|
|
|
|
16.76
|
|
Vesting of restricted
stock units, net of units withheld for taxes
|
|
|
(367
|
)
|
|
|
17.00
|
|
Units withheld for
taxes
|
|
|
(163
|
)
|
|
|
17.00
|
|
Forfeitures
|
|
|
(70
|
)
|
|
|
17.26
|
|
Outstanding
balance at September 30, 2018
|
|
|
1,509
|
|
|
$
|
19.98
|
|
For the
three months ended September 30, 2018 and 2017, HMS granted 1,794 and 59,784 restricted stock units, respectively, with an aggregate
fair market value of $58,861 and $1.0 million, respectively. For the nine months ended September 30, 2018 and 2017, HMS granted
762,877 and 599,441 restricted stock units, respectively, with an aggregate fair market value of $12.8 million and $11.3 million,
respectively.
As of
September 30, 2018, 1,281,206 restricted stock units remained unvested and there was approximately $11.3 million of unrecognized
compensation cost related to restricted stock units, which is expected to be recognized over a weighted average vesting period
of 1.13 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.
On September
11, 2018, a former employee filed an action in the New York County Supreme Court entitled
Christopher Frey v. Health Management
Systems, Inc.
alleging retaliation under New York law. The complaint seeks recovery of an unspecified amount of monetary damages,
including back pay and other compensatory and equitable relief. The Company believes this claim is without merit and intends to
vigorously defend this matter.
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 disclosures.