Item 2. Management’s Discussion
and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of financial condition
and results of operations should be read in conjunction with the other sections of this Quarterly Report on Form 10-Q and with
our 2015 Form 10-K. In addition to historical consolidated financial information, the following discussion contains forward-looking
statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the
forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere
in this Quarterly Report on Form 10-Q, including under “Cautionary Statement Regarding Forward-Looking Statements,”
and in Part I, Item 1A. “Risk Factors” and Part II, Item 7A. “ Quantitative and Qualitative Disclosures about
Market Risk” of our 2015 Form 10-K.
We operate in the U.S. healthcare insurance benefit cost containment
marketplace. We provide coordination of benefits services to government and private healthcare payers and sponsors to ensure that
the responsible party pays healthcare claims. Our payment integrity services ensure that healthcare claims are billed accurately
and appropriately. Our care management technology helps risk-bearing organizations manage the care delivered to their members.
Together, these various services help customers recover improper payments, including those from liable third parties; prevent
future improper payments; reduce fraud, waste and abuse; ensure regulatory compliance; and improve outcomes.
Our customers are state and federal healthcare
agencies, including state Medicaid agencies, health plans, including Medicaid managed care, Medicare Advantage and group and individual
health lines of business; government and private employers; and other healthcare payers and sponsors. As of September 30, 2016,
we served 46 state Medicaid programs and the District of Columbia; federal government health agencies, including CMS and the Veterans
Health Administration; and approximately 250 health plans. We additionally served as a subcontractor to certain business outsourcing
and technology firms.
The Company has grown both organically
and through targeted asset and stock acquisitions. Initially, the Company provided coordination of benefits services to state Medicaid
agencies, then expanded its business by providing similar services to managed care organizations when Medicaid began delegating
members to those plans. After launching payment integrity services in 2007, HMS grew its product suite and expanded its reach in
the marketplace by acquiring IntegriGuard, LLC (2009), Verify Solutions, Inc. (2009), Chapman Kelly, Inc. (2010), HDI (2011), MedRecovery
Management, LLC (2012), and Essette, Inc. (2016).
Healthcare Environment
The Patient Protection and Affordable Care
Act (the “ACA”) was signed into law in 2010. This legislation touched almost every sector of the healthcare system,
and affords HMS a range of growth opportunities across a number of services. We are focused on three critical areas related to
this legislation:
|
·
|
Employer-Sponsored Health Coverage.
|
Medicaid Expansion:
States that
expand their Medicaid programs in accordance with the ACA receive federal funding for the total cost of the expansion for a period
of three years, and reduced funding thereafter. As of early 2016, approximately two-thirds of the states opted to expand their
Medicaid programs as provided under the ACA. According to the CMS National Health Expenditures (“NHE”) Projections,
the number of individuals enrolled in Medicaid and the Children’s Health Insurance Program (“CHIP”) is expected
to increase from 76.6 million in 2016 to 85.2 million in 2025, with expenditures over the same period expected to increase from
$593.3 billion to $999.5 billion. As a result, we currently anticipate continued demand for our cost containment services by states
and the managed care organizations with whom they contract with. We believe that our strong history of successful contracting
with Medicaid agencies and Medicaid managed care organizations will enable us to continue providing value-added services to help
control the escalating costs for this expanded population.
Payment Integrity:
The ACA contained
a number of provisions for combating fraud, waste and abuse throughout the healthcare system, including in Medicaid and Medicare.
These initiatives include: (i) requiring state Medicaid agencies to contract with state Medicaid RACs and deploy programs
modeled on the Medicare RAC Program administered by CMS, (ii) expanding the Medicare RAC Program to include Medicare Part C
and D, (iii) establishing a national healthcare fraud, waste and abuse data collection program and (iv) increasing scrutiny
of providers and suppliers who want to participate in Medicare, Medicaid and other federally-funded programs. The ACA further required
that each state establish a Medicaid RAC program by January 1, 2012. In addition, the ACA allowed for significant increases in
funding for these and other fraud, waste and abuse efforts. We continue to seek opportunities to expand our current partnerships
with CMS, states and health plans and to provide innovative ideas to support their payment integrity initiatives.
Employer-Sponsored Health Coverage:
The ACA largely preserves and builds upon the existing employer-sponsored health coverage model. Though not all employers will
be required to provide healthcare coverage, large employers (i.e. those with 50 or more full time equivalents) are penalized starting
in 2016 if (i) they do not offer coverage (or if they offer coverage that does not meet certain requirements) and (ii) one or more
of their full time employees receives a federal tax credit or cost sharing subsidy through a health insurance exchange. Employers
will also be prohibited from imposing waiting periods for enrollment of more than 90 days. We expect that we will be able
to offer a range of audit services to employers of all sizes, which will be valuable as these employers extend coverage to their
employees.
Customers
We provide products and services under
contracts (or sub-contracts) that contain various revenue structures, including contingent revenue and fixed fee arrangements.
Most of our state government contracts have terms of three to five years, including optional renewal terms. In many instances,
we provide our services pursuant to agreements that are subject to periodic reprocurements. Several of our contracts, including
those with some of our largest customers, may be terminated for convenience. Because we provide our services pursuant to agreements
that are open to competition from various businesses in the U.S. healthcare insurance benefit cost containment marketplace, we
cannot provide assurance that our contracts, including those with our largest customers, will not be terminated for convenience,
awarded to other parties, or renewed, and, if renewed, that the fee structures will be equal to those currently in effect.
For example, our third party liability (“TPL”)
services contract with the New Jersey Department of Human Services was originally awarded in January 2008. In July 2015, we received
notice from the State of New Jersey Division of Purchase and Property (the “Division”) of its intent to award the
new TPL contract to another bidder following a competitive reprocurement. In February 2016, we filed a protest challenging the
award. The bidder withdrew its bid in May 2016. On September 1, 2016, the Division awarded the new TPL contract to our wholly
owned subsidiary, Health Management Systems, Inc. The new contract has an initial term of four years through September 20, 2020,
with an option to extend the term for two additional one-year periods.
We are also involved in the procurement process for the
new Medicare RAC contract awards. In November 2015, CMS released a new RFP for recovery audit services that replaces the procurement
activities begun in February 2013. After a delay in the procurement of the new Medicare RAC contract awards, CMS resumed the procurement
in April 2016 and we submitted a proposal. On October 31, 2016, CMS announced the award of RAC Region 4 to our wholly owned subsidiary
HMS Federal Solutions. The timeline to finalize the new Medicare RAC contracts and their implementation remains uncertain. Our
current Medicare RAC contract requires we provide support services in connection with the appeal process through January 31, 2018.
In addition, in August 2014, CMS announced
it would settle with hospitals willing to withdraw inpatient status claims currently pending in the RAC appeals process by offering
to pay hospitals 68% for all eligible claims they had billed to Medicare. In June 2015, CMS notified HDI that based on the initial
lists of finalized settlements, HDI owed CMS approximately $28.6 million due to adjustments in contingency fees pursuant to HDI’s
Medicare RAC contract with CMS. HDI previously advised CMS that it disagrees with CMS’ interpretation of the contract and
that CMS does not have the contractual right, among other things, to require repayment of fees already paid. In response to the
inaccurate and incomplete data in certain backup documentation initially provided by CMS regarding settled claims, HDI provided
CMS with data which it believes more accurately reflects the number of claims which were apparently settled. The amount ultimately
payable to CMS by HDI remains uncertain as HDI continues to evaluate additional data provided by CMS in connection with its completion
of the settlement process. A portion of our reserve for estimated liability for appeals recorded as of September 30, 2016 may apply
to this population, and there could be a material negative impact on our future revenue in future periods to the extent that (i)
any final determination of amounts owed by HDI to CMS under the current Medicare RAC contract materially exceeds our accrued reserves
for such appeals, (ii) HDI is required to return certain fees which have been paid or (iii) HDI’s ability to collect fees
for audits already performed is affected.
Critical Accounting Policies
Since the date of our 2015 Form 10-K for
the year ended December 31, 2015, there have been no material changes to our critical accounting policies. Refer to the items disclosed
as our Critical Accounting Policies in Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition
and Results of Operations” of our 2015 Form 10-K.
SUMMARY OF OPERATING RESULTS
Selected Operating Performance and Other
Significant Items for the Three Months Ended September 30, 2016
|
·
|
Revenue increased $6.2 million, or 5.2%
from the same quarter in 2015.
|
|
·
|
Operating income decreased $0.4 million,
or 2.8% from the same quarter in 2015.
|
|
·
|
Net income increased $6.6 million, or
96.9% from the same quarter in 2015.
|
|
·
|
Diluted earnings per share increased $0.08
or 103.7% from the same quarter in 2015.
|
|
·
|
Shareholders’ equity increased $17.8
million since June 30, 2016.
|
|
·
|
Third quarter 2016 cash flow from operations
was $8.6 million.
|
Three Months Ended September 30, 2016 Compared to Three Months
Ended September 30, 2015
The following table sets forth, for the
periods indicated, certain items in our unaudited Consolidated Statements of Income expressed as a percentage of revenue:
|
|
Three Months Ended
September 30,
|
|
|
2016
|
|
2015
|
Revenue
|
|
|
100
|
%
|
|
|
100
|
%
|
Cost of services:
|
|
|
|
|
|
|
|
|
Compensation
|
|
|
38.8
|
|
|
|
36.8
|
|
Data processing
|
|
|
7.7
|
|
|
|
8.5
|
|
Occupancy
|
|
|
2.7
|
|
|
|
3.5
|
|
Direct project expenses
|
|
|
8.8
|
|
|
|
10.7
|
|
Other operating expenses
|
|
|
6.8
|
|
|
|
5.5
|
|
Amortization of acquisition related software and intangible assets
|
|
|
5.1
|
|
|
|
5.9
|
|
Total cost of services
|
|
|
69.9
|
|
|
|
70.9
|
|
Selling, general and administrative expenses
|
|
|
20.0
|
|
|
|
18.0
|
|
Total operating expenses
|
|
|
89.9
|
|
|
|
88.9
|
|
Operating income
|
|
|
10.1
|
|
|
|
11.1
|
|
Interest expense
|
|
|
(1.7
|
)
|
|
|
(1.6
|
)
|
Interest income
|
|
|
0.1
|
|
|
|
0.0
|
|
Income before income taxes
|
|
|
8.5
|
|
|
|
9.5
|
|
Income tax (benefit) expense
|
|
|
(2.3
|
)
|
|
|
3.6
|
|
Net income
|
|
|
10.8
|
%
|
|
|
5.9
|
%
|
Revenue
During the three months ended September 30, 2016, revenue was $124.6 million, an increase of $6.2 million, or
5.2% compared to $118.4 million for the three months ended September 30, 2015. This increase was primarily due to commercial health
plan growth of $7.2 million or 13.9% and higher Medicare RAC revenue of $1.3 million or 28.9% partially offset by a decrease in
state government revenue of $1.6 million or 2.9%.
Cost of Services
During the three months ended September 30, 2016, total cost of services as a percentage of revenue was
69.9% compared to 70.9% for the three months ended September 30, 2015. Total cost of services for the three months ended September
30, 2016 was $87.1 million, an increase of $2.9 million compared to $84.1 million for the three months ended September 30, 2015.
This change resulted primarily from increases in certain compensation expense which includes fringe benefits, salaries and temporary
work. These increases were partially offset by a decrease in direct project costs, which includes, subcontractor and chart fees,
as well as a decrease in stock compensation expense.
Selling, General and Administrative
Expense (“SG&A”)
During the three months ended September 30, 2016, SG&A expense as a percentage of revenue was 20.0% compared
to 18.0% for the three months ended September 30, 2015. SG&A expense for the three months ended September 30, 2016 was $24.9
million, an increase of $3.6 million, or 16.8% compared to $21.3 million for the three months ended September 30, 2015. This change
resulted from a $3.0 million increase in compensation related expenses. The increase was also attributable to a $0.4 million increase
in the provision for bad debt expense.
Operating Income
During the three months ended September
30, 2016 operating income was $12.7 million, a decrease of $0.4 million, or 2.8%, compared to operating income of $13.0 million
for the three months ended September 30, 2015.
Interest Expense
During the three months ended September
30, 2016, interest expense was $2.1 million, an increase of $0.2 million, compared to $1.9 million for the three months ended September
30, 2015. Interest expense represents borrowings under our revolving credit facility, interest on debt, commitment fees, letter
of credit fees and amortization of deferred financing costs.
Income Taxes
We recorded an income tax benefit of $2.9 million for
the three months ended September 30, 2016, compared to income tax expense of $4.2 million for the three months ended
September 30, 2015, a decrease of $7.1 million. Income before taxes decreased $0.4 million for the current quarter over
income before taxes in the same period in the prior year, which contributed to the decrease in our tax expense. The decrease
in tax expense is primarily due to our recognition during the third quarter of 2016 of a tax benefit for the Research and
Development tax credits (the “R&D Credits”) and the U.S. production activities deduction (the “Section
199 Deduction”) as discussed in Note 6 of the unaudited Consolidated Financial Statements. Additionally, our effective
tax rate decreased to 27% for the three months ended September 30, 2016 compared to 38.1% for the three months ended
September 30, 2015 primarily due to our recognition during the third quarter of 2016 of a tax benefit for the R&D Credits
and the Section 199 Deduction. The principal differences between the statutory rate and our effective rate include
the R&D Credits, the Section 199 Deduction, other permanent items, interest on unrecognized tax benefits, and changes in
state taxes.
Net Income
During the three months ended September
30, 2016, net income was $13.5 million which represents an increase of $6.6 million compared to net income for the three months
ended September 30, 2015 of $6.9 million.
SUMMARY OF OPERATING RESULTS
Selected Operating Performance and Other
Significant Items for the Nine Months Ended September 30, 2016
|
·
|
Revenue increased $22.2 million, or 6.4%
compared to the first nine months of 2015.
|
|
·
|
Operating income increased $6.2 million,
or 18.8% compared to the first nine months of 2015.
|
|
·
|
Net income increased $10.8 million, or
68.5% compared to the first nine months of 2015.
|
|
·
|
Diluted earnings per share increased $0.13
or 73.3% compared to the first nine months of 2015.
|
|
·
|
Shareholders’ equity increased $40.2
million since December 31, 2015.
|
|
·
|
Cash flow from operations was $54.4 million.
|
Nine Months Ended September 30, 2016 Compared to Nine Months
Ended September 30, 2015
The following table sets forth, for the
periods indicated, certain items in our unaudited Consolidated Statements of Income expressed as a percentage of revenue:
|
|
Nine Months Ended
September 30,
|
|
|
2016
|
|
2015
|
Revenue
|
|
|
100
|
%
|
|
|
100
|
%
|
Cost of services:
|
|
|
|
|
|
|
|
|
Compensation
|
|
|
38.6
|
|
|
|
38.1
|
|
Data processing
|
|
|
7.7
|
|
|
|
8.8
|
|
Occupancy
|
|
|
2.9
|
|
|
|
3.5
|
|
Direct project expenses
|
|
|
10.0
|
|
|
|
10.6
|
|
Other operating expenses
|
|
|
5.6
|
|
|
|
5.9
|
|
Amortization of acquisition related software and intangible assets
|
|
|
5.5
|
|
|
|
6.1
|
|
Total cost of services
|
|
|
70.3
|
|
|
|
73.0
|
|
Selling, general and administrative expenses
|
|
|
19.0
|
|
|
|
17.5
|
|
Total operating expenses
|
|
|
89.3
|
|
|
|
90.5
|
|
Operating income
|
|
|
10.7
|
|
|
|
9.5
|
|
Interest expense
|
|
|
(1.7
|
)
|
|
|
(1.7
|
)
|
Interest income
|
|
|
0.1
|
|
|
|
0.0
|
|
Income before income taxes
|
|
|
9.1
|
|
|
|
7.8
|
|
Income tax expense
|
|
|
1.7
|
|
|
|
3.2
|
|
Net income
|
|
|
7.4
|
%
|
|
|
4.6
|
%
|
Revenue
During the nine months ended September 30, 2016, revenue was $367.9 million, an increase of $22.2 million, or
6.4% compared to $345.7 million for the nine months ended September 30, 2015. This increase was primarily due to commercial health
plan growth of $25.8 million or 17.9% and higher Medicare RAC revenue of $7.5 million or 70.0%, partially offset by a decrease
in state government revenue of $10.3 million or 6.0%.
Cost of Services
During the nine months ended September 30, 2016, total cost of services as a percentage of revenue was
70.3% compared to 73.0% for the nine months ended September 30, 2015. Total cost of services for the nine months ended September
30, 2016 was $259.0 million, an increase of $6.6 million, or 2.6% compared to $252.4 million for the nine months ended September
30, 2015. This change resulted primarily from increases in certain compensation expense which includes fringe benefits, salaries
and temporary work. These increases were partially offset by a decrease in data processing costs and occupancy costs which includes
depreciation and rental expense as well as a decrease in stock based compensation.
Selling, General and Administrative
Expense (“SG&A”)
During the nine months ended September
30, 2016, SG&A expense as a percentage of revenue was 19.0% compared to 17.5% for the nine months ended September 30, 2015.
SG&A expense for the nine months ended September 30, 2016 was $70.0 million, an increase of $9.5 million, or 15.7% compared
to $60.5 million for the nine months ended September 30, 2015. This change resulted from a $2.0 million increase in compensation
related expenses. SG&A expense also increased $7.0 million due to an increase in the provision for bad debt expense.
Operating Income
During the nine months ended September
30, 2016, operating income was $38.9 million, an increase of $6.2 million, or 18.8%, compared to operating income of $32.7 million
for the nine months ended September 30, 2015.
Interest Expense
During the nine months ended September
30, 2016, interest expense was $6.3 million, a decrease of $0.5 million, compared to $5.8 million for the nine months ended September
30, 2015. Interest expense represents borrowings under our revolving credit facility, interest on debt, commitment fees, letter
of credit fees and amortization of deferred financing costs.
Income Taxes
We recorded income tax expense of $6.2
million for the nine months ended September 30, 2016, compared to income tax expense of $11.1 million for the nine months ended
September 30, 2015, a decrease of $4.9 million. Income before taxes increased $5.9 million for the nine months ended September
30, 2016 over income before taxes in the same period in the prior year, but tax expense decreased primarily due to our recognition
during the third quarter of 2016 of a tax benefit for the R&D Credits and the Section 199 Deduction as discussed in Note 6
of the unaudited Consolidated Financial Statements. Additionally, our effective tax rate decreased to 18.8% for the nine months
ended September 30, 2016 compared to 41.3% for the nine months ended September 30, 2015 primarily due to our recognition during
the third quarter of 2016 of a tax benefit for the R&D Credits and the Section 199 Deduction. The principal differences between
the statutory rate and our effective rate include R&D Credits, the Section 199 Deduction, other permanent items, interest on
unrecognized tax benefits, and changes in state taxes.
Net Income
During the nine months ended September
30, 2016, net income was $26.6 million which represents an increase of $10.8 million compared to net income for the nine months
ended September 30, 2015 of $15.8 million.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
Liquidity and Capital Resources
We believe our ability to generate cash
from operating activities is one of our fundamental financial strengths. The near-term outlook for our business remains strong,
and we currently expect to generate substantial cash flows from operations throughout the remainder of 2016. We believe that expected
cash flows from operations, available cash and cash equivalents and funds available under our revolving credit facility under the
Credit Agreement will be sufficient to meet our financial commitments for the next year, which include:
|
·
|
the working capital requirements of our
operations;
|
|
·
|
investments in our business;
|
|
·
|
repurchases of treasury stock; and
|
|
·
|
business development activities.
|
We may need to access debt and equity markets
in the future if unforeseen costs or opportunities arise, to fund acquisitions or to repay indebtedness under the Credit Agreement,
which matures in May 2018. If we need to obtain new debt or equity financing in the future, the terms and availability of such
financing may be impacted by economic and financial market conditions as well as our financial condition and results of operations
at the time we seek additional financing.
Our cash and cash equivalents, working
capital and available borrowings under our credit facility (based upon the borrowing base and financial covenants in our Credit
Agreement) were as follows:
(In thousands)
|
|
September 30,
2016
|
|
December 31,
2015
|
Cash and cash equivalents
|
|
$
|
171,519
|
|
|
$
|
145,610
|
|
Working capital
|
|
$
|
291,860
|
|
|
$
|
247,916
|
|
Available borrowings under credit facility
|
|
$
|
180,134
|
|
|
$
|
121,204
|
|
A summary of our cash flows is as follows:
|
|
Nine Months Ended
September 30,
|
(In thousands)
|
|
2016
|
|
2015
|
Net cash provided by operating activities
|
|
$
|
54,371
|
|
|
$
|
40,453
|
|
Net cash used in investing activities
|
|
|
(32,120
|
)
|
|
|
(7,888
|
)
|
Net cash provided by (used in) financing activities
|
|
|
3,658
|
|
|
|
(20,877
|
)
|
Net increase in cash and cash equivalents
|
|
$
|
25,909
|
|
|
$
|
11,688
|
|
Cash Flows from Operating Activities
Net cash provided by operating activities for the nine months ended September 30, 2016 was $54.4 million,
an increase of $13.9 million as compared to net cash provided by operating activities of $40.5 million for the nine months ended
September 30, 2015. The increase in operating cash flow is primarily attributable to collections of accounts receivable offset
primarily by the change in income tax receivable/payable. Additionally, the number of Days Sales Outstanding decreased from the
prior year period by 16 days from 132 days for the nine months ended September 30, 2015 to 117 days for the nine months ended September
30, 2016 as a result of stronger cash collections.
Cash Flows from Investing Activities
Net cash used in investing activities for the nine months
ended September 30, 2016 was $32.1 million, a $24.2 million increase compared to net cash used in investing activities of $7.9
million for the nine months ended September 30, 2015. The increase primarily related to a $20.9 million increase due to the Essette
acquisition and an increase in purchases of property and equipment and investment in capitalized software, partially offset by
receipt of proceeds from the sale of a cost basis investment of approximately $2.5 million.
Cash Flows from Financing Activities
Net cash provided by financing activities for the nine months ended September 30, 2016 was $3.7 million, a
$24.5 million increase compared to net cash used in financing activities of $20.9 million for the nine months ended September 30,
2015. This decrease was primarily attributable to the purchase of treasury stock for $25.0 million during same period in the prior
year.
Contractual Obligations
There have been no material changes in
our contractual obligations as presented in our 2015 Form 10-K.
Recently Issued Accounting Pronouncements
See “Recently Issued Accounting Pronouncements”
in Note 2 of the unaudited Consolidated Financial Statements.