Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following Management’s
Discussion and Analysis should be read in conjunction with the other sections of this Quarterly Report on Form 10-Q, including
the unaudited Consolidated Financial Statements, related Notes and other financial information appearing elsewhere in this Quarterly
Report, and with our 2016 Form 10-K.
Business Overview
HMS is a leading provider of cost containment
solutions in the U.S. healthcare marketplace. Using innovative technology as well as extensive data services and powerful analytics,
we deliver coordination of benefits, payment integrity, and health management and engagement solutions through our operating subsidiaries
to help healthcare payers improve performance and outcomes. We are managed and operate as one business segment with a single management
team that reports to the Chief Executive Officer. We serve state Medicaid programs, commercial health plans, federal government
health agencies, government and private employers, child support agencies, and other healthcare payers and sponsors. Together our
various services help our customers recover improper payments; prevent future improper payments; reduce fraud, waste and abuse;
better manage the care that members receive; and ensure regulatory compliance.
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We
serve 46 state Medicaid programs and the District of Columbia, CMS and the VHA;
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We
provide services to approximately 300 health plans in support of their multiple lines
of business, including Medicaid managed care, Medicare Advantage and group and individual
health; and
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We
also serve as a sub-contractor for certain business outsourcing and technology firms.
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Critical Accounting
Policies
Since the date of our 2016 Form 10-K, there
have been no material changes to our critical accounting policies. Refer to the items disclosed as our Critical Accounting Policies
in Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and
Note 1 – “Business and Summary of Significant Accounting Policies” in our Notes to the Consolidated Financial
Statements under Part II, Item 8 of our 2016 Form 10-K.
SUMMARY OF OPERATING
RESULTS
Selected Operating
Performance and Other Significant Items for the Three Months Ended March 31, 2017
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Revenue
decreased $6.0 million, or 5.0% from the same quarter in 2016
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Operating
income decreased $6.0 million, or 60.2% from the same quarter in 2016
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Net
income decreased $3.2 million, or 68.4% from the same quarter in 2016
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Diluted
earnings per share decreased $0.03 or 60% from the same quarter in 2016
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Shareholders’
equity increased $4.2 million since December 31, 2016
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First
quarter 2017 cash flow from operations was $3.4 million
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Comparison of Three Months Ended March
31, 2017 to March 31, 2016
The following table sets forth, for
the periods indicated, certain items in our unaudited Consolidated Statements of Income expressed as a percentage of revenue:
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Three Months Ended
March 31,
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2017
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2016
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Revenue
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100
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%
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100
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%
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Cost of services:
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Compensation
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43.0
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38.7
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Data processing
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8.6
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8.0
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Occupancy
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3.1
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3.0
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Direct project expenses
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9.2
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12.1
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Other operating expenses
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6.4
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4.8
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Amortization of acquisition related software and intangible assets
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5.5
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5.9
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Total cost of services
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75.8
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72.5
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Selling, general and administrative expenses
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20.7
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19.1
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Total operating expenses
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96.5
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91.6
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Operating income
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3.5
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8.3
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Interest expense
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(2.0
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(1.7
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Interest income
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0.1
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0.0
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Income before income taxes
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1.6
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6.6
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Income taxes
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0.3
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2.8
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Net income
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1.3
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%
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3.8
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%
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Revenue
Three Months Ended – 2017 vs. 2016
During the three months ended March
31, 2017 revenue was $113.7 million, a decrease of $6.0 million or 5.0% compared to prior year revenue of $119.8 million. The
decrease was primarily due to no new Medicare RAC claims being processed under the HDI Medicare RAC contract as a result of the
contract’s expiration in July 2016, however an administrative extension for certain appeal work was executed through January
2018. This decrease was partially offset by a slight increase in state government and commercial health plan revenue.
Total Cost of Services
Total cost of services consists of
compensation, data processing, occupancy, direct project expenses, other operating expenses, and amortization of acquisition related
software and intangible assets.
Three Months Ended – 2017 vs. 2016
During the three months ended March
31, 2017, total cost of services as a percentage of revenue was 75.8% compared to 72.5% for the three months ended March 31, 2016.
Total cost of services for the three months ended March 31, 2017 was $86.2 million, a decrease of $0.7 million compared to $86.9
million for the three months ended March 31, 2016. This change resulted primarily from increases in compensation costs, data processing
costs and other operating expenses. These increases were partially offset by decreases in occupancy costs, direct project expenses
and amortization of certain intangible assets.
Compensation
Compensation expense is primarily
composed of salaries and wages, which include overtime, health benefits, stock option expense, performance awards, commissions,
employers share of FICA and fringe benefits.
Three Months Ended – 2017 vs. 2016
During the three months ended March
31, 2017, compensation expense as a percentage of revenue was 43.0% compared to 38.7% for the three months ended March 31, 2016.
Compensation expense for the three months ended March 31, 2017 was $48.9 million, an increase of $2.5 million compared to $46.4
million for the three months ended March 31, 2016. This increase resulted from a $4.4 million total increase in salaries and stock-based
compensation expense. These increases were partially offset by decreases in fringe benefits and net variable compensation.
Data Processing
Three Months Ended – 2017 vs. 2016
During the three months ended March
31, 2017, data processing expense as a percentage of revenue was 8.6% compared to 8.0% for the three months ended March 31, 2016.
Data processing expense for the three months ended March 31, 2017 was $9.8 million, an increase of $0.2 million compared to $9.6
million for the three months ended March 31, 2016. This change resulted primarily from a $1.8 million increase in equipment maintenance
and software maintenance costs. This increase was partially offset by a $1.7 million total decrease in data costs, depreciation
expense and software expense.
Occupancy
Three Months Ended – 2017 vs. 2016
During the three months ended March
31, 2017, occupancy expenses as a percentage of revenue was 3.1% compared to 3.0% for the three months ended March 31, 2016. Occupancy
expense was $3.5 million, a decrease of $0.1 million compared to $3.6 million for the three months ended March 31, 2016. This
slight decrease was primarily a result of decreases in rental costs, utilities, and depreciation expenses.
Direct Project Expenses
Three Months Ended – 2017 vs. 2016
During the three months ended March
31, 2017, direct project expenses as a percentage of revenue was 9.2% compared to 12.1% for the three months ended March 31, 2016.
Direct project expenses were $10.4 million for the three months ended March 31, 2017, a decrease of $4.1 million, compared to
$14.5 million for the three months ended March 31, 2016. The decrease was primarily due to a $4.5 million decrease in sub-contractor
fees, chart fees and data costs.
Other Operating Expenses
Three Months Ended – 2017 vs. 2016
During the three months ended March 31,
2017, other operating expenses as a percentage of revenue was 6.4% compared to 4.8% for the three months ended March 31, 2016.
Other operating expenses for the three months ended March 31, 2017 were $7.2 million, an increase of $1.4 million compared to $5.8
million for the three months ended March 31, 2016. This increase primarily resulted from a $3.7 million total increase in sub-contractor
fees, travel and entertainment, and consulting project expenses. These increases were partially offset by a $2.2 million decrease
in temporary staffing. Additionally, during the quarter ended March 31, 2017, transaction costs related to a potential acquisition
were $1.3 million.
Amortization
of Acquisition Related Software and Intangible Assets
Three Months Ended – 2017 vs. 2016
During the three months ended March
31, 2017, amortization of acquisition related software and intangibles as a percentage of revenue was 5.5% compared to 5.9% for
the three months ended March 31, 2016. Amortization of acquisition related software and intangible assets for the three months
ended March 31, 2017 was $6.3 million, a decrease of $0.7 million compared to $7.0 million for the three months ended March 31,
2016. This decrease related to certain intangibles becoming fully amortized.
Selling, General and Administrative
expenses
Three Months Ended – 2017 vs. 2016
During the three months ended March
31, 2017, SG&A expense as a percentage of revenue was 20.7% compared to 19.1% for the three months ended March 31, 2016. SG&A
expense for the first quarter of 2017 was $23.6 million, an increase of $0.7 million compared to $22.9 million for the three months
ended March 31, 2016. Increases were comprised of compensation expense, professional fees and consulting fees. These increases
were partially offset by a reduction in legal fees.
Operating Income
Three Months Ended – 2017 vs. 2016
Operating income for the three months ended March 31,
2017 was $3.9 million, a decrease of $6.0 million, or 60.2% compared to operating income of $9.9 million for the three months
ended March 31, 2016.
Interest Expense
Interest expense represents interest
on borrowings under our revolving credit facility, amortization of deferred financing costs, commitment fees for our revolving
credit facility and issuance fees for our letter of credit.
Three Months Ended – 2017 vs. 2016
During the three months ended March
31, 2017 interest expense was $2.3 million, an increase of $0.2 million compared to $2.1 million for the same period in the prior
year. This increase resulted from an increase in the variable interest rate on our outstanding debt. Amortization of deferred
financing costs of $0.5 million in both periods is included within interest expense.
Income Taxes
Three Months Ended – 2017 vs. 2016
During the three months ended March
31, 2017 we recorded income tax expense of $0.4 million, a decrease of $2.9 million compared to $3.3 million for the same period
in 2016. Net income before taxes of $1.8 million decreased $6.1 million, compared to $7.9 million for the three months ended March
31, 2016. Additionally, our effective tax rate decreased to 20.4% for the three months ended March 31, 2017 compared to 42.0%
for the three months ended March 31, 2016. The decrease in the effective tax rate for the period ended March 31, 2017, compared
to March 31, 2016, is primarily due to a $0.4 million excess tax benefit related to stock option exercises recognized from the
adoption of ASU 2016-09 in December 2016, partially offset by a $0.1 million tax expense related to interest on unrecognized tax
benefits. The differences between the federal statutory rate and our effective tax rate are state taxes, unrecognized tax benefits
and permanent differences including the U.S. production activities deduction and research and development tax credits.
Net Income
Three Months Ended – 2017 vs. 2016
During the three months ended March
31, 2017, net income was $1.4 million which represents a $3.2 million decrease compared to net income of $4.6 million for the
same period in 2016.
Off-Balance Sheet
Arrangements
We do not have any off-balance sheet
arrangements.
Liquidity and
Capital Resources
The following tables should be read
in conjunction with the unaudited Consolidated Financial Statements and related Notes included in this Quarterly Report on Form
10-Q.
Our cash and cash equivalents, working
capital and available borrowings under our credit facility (based upon the borrowing base and financial covenants in our Credit
Agreement) were as follows:
(In
thousands)
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March
31,
2017
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December
31,
2016
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Cash and cash equivalents
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$
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168,289
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$
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175,999
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Working capital
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$
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285,788
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$
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277,478
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Available borrowings
under credit facility
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$
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157,809
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$
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183,913
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A summary of our cash flows was as follows:
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Three
Months Ended
March 31,
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(In
thousands)
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2017
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2016
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Net cash provided by operating activities
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$
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3,386
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$
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609
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Net cash used in investing activities
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(8,488
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(1,755
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Net cash used
in financing activities
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(2,608
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(1,013
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Net
decrease in cash and cash equivalents
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$
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(7,710
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$
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(2,159
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Our principal source of cash has
been our cash flow from operations and our $500 million five-year revolving credit facility. Other sources of cash include proceeds
from exercise of stock options and tax benefits associated with stock option exercises. The primary uses of cash are compensation
expenses, data processing, direct project costs and SG&A expenses and acquisitions. As previously disclosed, on April 17, 2017,
the Company completed the acquisition of Eliza Holding Corp. for a cash purchase price of approximately $172.0 million, after
adjustments for working capital, cash, transaction expenses and indebtedness. The acquisition was funded with available liquidity,
consisting of approximately 75% cash on hand and approximately 25% of borrowings under the Company’s revolving credit facility.
The purchase price is subject to certain post-closing purchase price adjustments.
We believe that expected cash flows
from operations, available cash and cash equivalents, and funds available under our revolving credit facility will be sufficient
to meet our liquidity requirements for the following year, which include:
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the
working capital requirements of our operations;
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§
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investments
in our business;
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§
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business
development activities;
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§
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repurchases
of common stock; and
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§
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repayment
of our revolving credit facility.
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Any projections of future earnings
and cash flows are subject to substantial uncertainty. We may need to access debt and equity markets in the future if unforeseen
costs or opportunities arise, to fund acquisitions or to repay indebtedness under the Credit Agreement, which matures in May 2018.
If we need to obtain new debt or equity financing in the future, the terms and availability of such financing may be impacted
by economic and financial market conditions as well as our financial condition and results of operations at the time we seek additional
financing.
Cash Flows
from Operating Activities
Net cash provided by operating
activities for the three months ended March 31, 2017 was $3.4 million, an increase of $2.8 million as compared to net cash
provided by operating activities of $0.6 million for the three months ended March 31, 2016. The increase in operating cash
flow is primarily attributable to accounts receivable and decreases in amortization of certain intangibles, partially offset
by a decrease in net income.
Cash Flows
from Investing Activities
Net cash used in investing activities
for the three months ended March 31, 2017 was $8.5 million, a $6.7 million increase compared to net cash used in investing activities
of $1.8 million for the three months ended March 31, 2016. The increase primarily related to an increase in purchases of property
and equipment and investment in capitalized software.
Cash Flows
from Financing Activities
Net cash used in financing activities
for the three months ended March 31, 2017 was $2.6 million, a $1.6 million increase compared to net cash used in financing activities
of $1.0 million for the three months ended March 31, 2016. This increase was primarily related to the payment of tax withholdings
on behalf of employees for net-share settlement for stock-based compensation.
Contractual Obligations
There have been no material changes in
our contractual obligations as presented in our 2016 Form 10-K except as disclosed in Note 11 – “Subsequent Events”
in our Notes to the unaudited Consolidated Financial Statements of the Quarterly Report on Form 10-Q.
Recently Issued
Accounting Pronouncements
See “Recently Issued Accounting
Pronouncements” in Note 1 of the unaudited Consolidated Financial Statements.