NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2019 and 2018
(unaudited)
1. Business and Summary of Significant Accounting Policies
(a) Business
The terms “HMS,” “Company,” “we,” “us,” and “our” refer to HMS Holdings Corp. and its consolidated subsidiaries unless the context clearly indicates otherwise. HMS is an industry-leading provider of cost containment solutions in the healthcare marketplace. We use healthcare data technology, analytics and engagement solutions, to deliver coordination of benefits, payment integrity and population health management solutions to help payers reduce costs, improve healthcare outcomes and enhance member experiences. We provide coordination of benefits services to government and commercial healthcare payers to ensure that the correct party pays the claim, and our payment integrity services promote accuracy by fighting fraud, waste and abuse. Our population health management solutions consist of population risk analytics and care management and consumer engagement services that provide risk-bearing organizations with reliable intelligence across their member populations to identify risks and improve patient engagement and outcomes. Together these various services help move the healthcare system forward for our customers. We currently operate as one business segment with a single management team that reports to the Chief Executive Officer.
The Consolidated Financial Statements and accompanying Notes in this Form 10-Q are unaudited. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles (“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 and notes thereto as of and for the year ended December 31, 2018, which were filed with the SEC as part of the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 (“2018 Form 10-K”). The consolidated balance sheet as of December 31, 2018 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 2018 Form 10-K other than as described below with respect to leases.
Recently Adopted Accounting Pronouncements
In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 requires most lessees to recognize a majority of the company’s leases on the balance sheet, which increases reported assets and liabilities. ASU 2016-02 was subsequently amended by ASU No. 2018-01, Land Easement Practical Expedient for Transition to Topic 842; ASU No. 2018-10, Codification Improvements to Topic 842, Leases; and ASU No. 2018-11, Targeted Improvements. The new standard establishes a right-of-use (“ROU”) model that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer than 12 months. Leases are classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the income statement. 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 adopted this guidance on January 1, 2019, utilizing the optional transition method approach with an effective date of January 1, 2019. Consequently, financial information prior to the effective date was not updated and the disclosures required under the new standard are not provided for dates and periods prior to the effective date. There were no cumulative effect adjustments to retained earnings as part of adoption. The Company elected the available practical expedients, including the practical expedient to not separate lease and non-lease components of its leases and the short-term lease practical expedient. 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 leasing standard as necessary. As the Company previously disclosed, the standard had a material impact on its consolidated balance sheets, the most significant impact being the recognition of approximately $21.3 million of ROU assets and $26.3 million of lease liabilities on the effective date, but there was no impact on its consolidated income statements. The Company continues to expect that any impact from its adoption of the new standard will be immaterial to its net income and its internal control framework for future periods.
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 years beginning after December 15, 2018, including interim periods within those fiscal years. The Company adopted this guidance on January 1, 2019. The adoption of this guidance did not have a material effect on the Company’s consolidated financial statements.
Recently Issued Accounting Pronouncements Not Yet Adopted
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (“ASU 2016-13”). ASU 2016-13 introduces the current expected credit losses methodology for estimating allowances for credit losses. ASU 2016-13 applies to all financial instruments carried at amortized cost and off-balance-sheet credit exposures not accounted for as insurance,
including loan commitments, standby letters of credit, and financial guarantees. The new accounting standard does not apply to trading assets, loans held for sale, financial assets for which the fair value option has been elected, or loans and receivables between entities under common control. ASU 2016-13 is effective for public entities for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted. The Company continues to evaluate whether the adoption of this guidance will have any impact on the Company’s financial statements but does not expect that this guidance will have a material impact on the Company’s financial position, results of operations or internal control framework.
In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract ("ASU 2018-15"). The standard aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal use software. ASU 2018-15 is effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted, including adoption in any interim period for which financial statements have not been issued. Entities can choose to adopt the new guidance prospectively to eligible costs incurred on or after the date this guidance is first applied or retrospectively. This guidance is not expected to have a material impact on the Company’s financial position, results of operations or internal control framework.
2. Revenue Recognition
The Company’s revenue disaggregated by solution for the three and nine months ended September 30, 2019 and 2018 was as follows (in thousands):
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|
|
|
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|
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|
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Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2019
|
|
2018
|
2019
|
|
2018
|
Coordination of Benefits
|
$
|
94,619
|
|
|
$
|
105,694
|
|
$
|
305,564
|
|
|
$
|
298,201
|
|
Payment Integrity
|
37,016
|
|
|
33,289
|
|
113,863
|
|
|
103,122
|
|
Population Health Management
|
15,180
|
|
|
15,263
|
|
43,523
|
|
|
41,139
|
|
Total
|
$
|
146,815
|
|
|
$
|
154,246
|
|
$
|
462,950
|
|
|
$
|
442,462
|
|
Coordination of benefits revenue is derived from contracts with state governments and Medicaid managed care plans that can span 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 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 include 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 primarily recognized at a point in time when our customers realize economic benefits from our services when our services are completed. However, we have a limited number of fixed fee arrangements where revenue is recognized over time as performance obligations are satisfied within one to three years. 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 revenue consists of revenue for our payment integrity services and population health management solutions.
Payment integrity services revenue is derived from contracts with federal and state governments, commercial health plans and other at-risk entities that can span 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 amount of recovery findings the Company identifies, 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 include 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 primarily recognized at a point in time when our customers realize economic benefits from our services when our services are completed. However, we have a limited number of fixed fee arrangements where revenue is recognized over time as performance obligations are satisfied within one to three years. Generally, payment integrity contract payment terms are not standardized within the respective contract; however, invoice payment is typically due on demand and there is a clear and distinct history of customers making consistent payments.
Population health management revenue is derived from contracts with health plans and other risk-bearing entities that can span 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 when the amount we have the right to invoice the customer corresponds directly with the value to the
customer. Additionally, certain population health management 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. Lastly, we have a limited number of fixed fee arrangements where revenue is recognized over time as performance obligations are satisfied within one to three years. 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 $1.1 million, net of tax, as of January 1, 2018 for the cumulative adoption of ASC 606. Generally, population health management 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. A portion of the payment received may relate to future performance obligations and will result in an increase to deferred revenue until the obligation has been met.
In connection with coordination of benefits and certain payment integrity services, lockboxes and their associated bank accounts are set up to support recoveries and remittances. Generally, these bank accounts are for the benefit of the Company’s customers. Customer cash held in Company bank accounts for the benefit of the customer was approximately $4.0 million as of September 30, 2019. This amount is included in cash and cash equivalents and other current liabilities on the accompanying consolidated balance sheet.
The Company’s revenue disaggregated by market for the three and nine months ended September 30, 2019 and 2018 was as follows (in thousands):
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Three Months Ended
September 30,
|
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|
Nine Months Ended
September 30,
|
|
|
|
2019
|
|
2018
|
2019
|
|
2018
|
Commercial
|
$
|
69,711
|
|
|
$
|
86,609
|
|
$
|
225,014
|
|
|
$
|
238,987
|
|
State
|
62,830
|
|
|
59,374
|
|
189,752
|
|
|
172,709
|
|
Federal
|
14,274
|
|
|
8,263
|
|
48,184
|
|
|
30,766
|
|
Total
|
$
|
146,815
|
|
|
$
|
154,246
|
|
$
|
462,950
|
|
|
$
|
442,462
|
|
A portion of the Company’s services are deferred and revenue is recognized at a later time. Deferred revenue was approximately $4.6 million and $5.6 million as of September 30, 2019 and December 31, 2018, respectively, and is included in Accounts payable, accrued expenses and other liabilities in the Consolidated Balance Sheets. Approximately $4.2 million of the December 31, 2018 balance was recognized in revenue during the year ended September 30, 2019.
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. The Company has elected to use the practical expedient to expense the incremental costs of obtaining a contract if the amortization period of the asset that the Company would have otherwise recognized is one year or less.
3. Accounts Receivable and Accounts Receivable Allowance
The Company’s accounts receivable, net, consisted of the following (in thousands):
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|
|
September 30,
2019
|
|
December 31,
2018
|
Accounts receivable
|
$
|
213,771
|
|
|
$
|
220,455
|
|
Allowance
|
(16,316)
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|
|
(13,683)
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|
Accounts receivable, net
|
$
|
197,455
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|
|
$
|
206,772
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|
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. The following is a summary of the activity in the accounts receivable allowance (in thousands)
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|
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|
|
|
September 30,
2019
|
|
December 31,
2018
|
Balance--beginning of period
|
$
|
13,683
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|
|
$
|
14,799
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|
Provision
|
15,908
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|
|
20,453
|
|
Charge-offs
|
(13,275)
|
|
|
(21,569)
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|
Balance--end of period
|
$
|
16,316
|
|
|
$
|
13,683
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|
4. Intangible Assets, Goodwill and Other Assets
(a) Intangible Assets
Intangible assets consisted of the following (in thousands, except for weighted average amortization period):
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Gross Carrying Amount
|
|
Accumulated
Amortization
|
|
Net Carrying Amount
|
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Weighted Average Amortization Period in Years
|
September 30, 2019
|
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|
|
|
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|
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Customer relationships
|
$
|
68,290
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|
|
$
|
(20,284)
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|
|
$
|
48,006
|
|
|
12.3
|
Intellectual property
|
27,700
|
|
|
(9,575)
|
|
|
18,125
|
|
|
3.9
|
Trade names
|
136
|
|
|
(136)
|
|
|
—
|
|
|
0.0
|
Restrictive covenants
|
133
|
|
|
(133)
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|
|
—
|
|
|
0.0
|
Total
|
$
|
96,259
|
|
|
$
|
(30,128)
|
|
|
$
|
66,131
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Carrying Amount
|
|
Accumulated
Amortization
|
|
Net Carrying Amount
|
|
Weighted Average Amortization Period in Years
|
December 31, 2018
|
|
|
|
|
|
|
|
Customer relationships
|
$
|
156,790
|
|
|
$
|
(104,740)
|
|
|
$
|
52,050
|
|
|
12.8
|
Intellectual property
|
21,700
|
|
|
(6,670)
|
|
|
15,030
|
|
|
4.1
|
Trade names
|
16,246
|
|
|
(16,215)
|
|
|
31
|
|
|
0.7
|
Restrictive covenants
|
263
|
|
|
(234)
|
|
|
29
|
|
|
0.7
|
Total
|
$
|
194,999
|
|
|
$
|
(127,859)
|
|
|
$
|
67,140
|
|
|
|
Amortization expense of intangible assets is expected to approximate the following (in thousands):
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|
|
|
|
|
Year ending December 31,
|
Amortization
|
2019 (excluding the nine months ended September 30, 2019)
|
$
|
2,487
|
|
2020
|
8,866
|
|
2021
|
8,399
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|
2022
|
8,399
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|
2023
|
6,024
|
|
Thereafter
|
31,956
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|
Total
|
$
|
66,131
|
|
For the three months ended September 30, 2019 and 2018, amortization expense related to intangible assets was $2.3 million and $6.1 million, respectively. For the nine months ended September 30, 2019 and 2018, amortization expense related to intangible assets was $7.0 million and $18.9 million, respectively.
(b) Goodwill
On September 16, 2019, HMS acquired VitreosHealth, Inc. ("VitreosHealth"), a company that offers predictive and prescriptive health insights utilized by population risk models, for aggregate consideration of $36.6 million, which was funded with cash on hand. The purchase price is subject to certain post-closing adjustments based upon the final amounts of the adjusted working capital of VitreosHealth and other final amounts at closing.
The Company's preliminary allocation of consideration exchanged to the net tangible and intangible assets acquired and liabilities assumed in the acquisition is based on estimated fair values as of September 16, 2019. The Company allocated the purchase price, net of cash acquired, to the following significant assets: intellectual property subject to amortization of $6.0 million, and goodwill of $29.8 million which represents the excess purchase price over the net identifiable tangible and intangible assets. There were no additional material allocations to assets and liabilities. The intangible assets are valued using various methods which requires several judgments, including growth rates, discount rates, expected levels of revenues, earnings, cash flows and tax rates. The intangible assets are amortized over their estimated useful lives on a straight-line basis and are not expected to be deductible for tax purposes. The goodwill recognized from the acquisition was a result of expected synergies to be realized from
future revenue growth, is not expected to be deductible for tax purposes, has an indefinite useful life and will be included in the Company’s annual impairment testing. The amounts shown above are subject to change in the near term as management continues to assess the fair value of the acquired assets and liabilities.
Pro forma historical results of operations related to this business acquisition for the year ended December 31, 2018, or interim periods thereafter, have not been presented and are not considered material. The results of VitreosHealth's operations since September 16, 2019 have been included in the Company's consolidated financial statements.
(c) Other Assets
During the three months ended September 30, 2019, a third party acquired one hundred percent of the outstanding stock of InstaMed Holdings, Inc. ("InstaMed") including the Company's cost based investment in Instamed of $2.1 million. As a result, the Company received proceeds of $9.8 million from the sale of the investment and recognized a $7.7 million gain in other income for the three and nine months ended September 30, 2019.
5. Accounts Payable, Accrued Expenses and Other Liabilities
Accounts payable, accrued expenses and other liabilities consisted of the following (in thousands):
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|
|
|
|
|
|
|
|
|
|
|
|
September 30,
2019
|
|
December 31,
2018
|
Accounts payable, trade
|
$
|
15,225
|
|
|
$
|
12,394
|
|
Accrued compensation and other
|
27,188
|
|
|
42,833
|
|
Accrued operating expenses
|
24,142
|
|
|
19,675
|
|
Current portion of lease liabilities
|
6,879
|
|
|
—
|
|
Total accounts payable, accrued expenses and other liabilities
|
$
|
73,434
|
|
|
$
|
74,902
|
|
6. Income Taxes
The Company’s effective tax rate decreased to 12.6% for the nine months ended September 30, 2019 from 21.3% for the nine months ended September 30, 2018. The effective tax rate for the nine months ended September 30, 2019 includes discrete tax benefits primarily related to net equity compensation deductions and releases of uncertain tax benefits. For the nine months ended September 30, 2019, the differences between the federal statutory rate and our effective tax rate are tax expense items related to state taxes, equity compensation impacts, unrecognized tax benefits, including interest, officer compensation deduction limits, research and development tax credits, and other permanent differences.
Included in Other liabilities on the Consolidated Balance Sheets, are the total amount of unrecognized tax benefits (net of the federal benefit for state issues) of approximately $3.9 million and $4.8 million, as of September 30, 2019 and December 31, 2018, respectively, that, if recognized, would favorably affect the Company’s future effective tax rate. Also included in Other
liabilities on the Consolidated Balance Sheets, are accrued liabilities for interest expense and penalties related to unrecognized tax benefits of $0.7 million and $0.7 million as of September 30, 2019 and December 31, 2018, 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, 2019 and 2018 was $0.03 million and $0.4 million, respectively. The Company believes it is reasonably possible that the amount of unrecognized tax benefits may decrease by $0.1 million over the next twelve months, due to the expiration of the statute of limitations in federal and various state jurisdictions.
HMS files income tax returns with the U.S. Federal government and various state and local jurisdictions and will file income tax returns in certain foreign jurisdictions in future periods as a result of its acquisition of VitreosHealth. HMS is generally no longer subject to U.S. Federal income tax examinations for years before 2016. HMS operates in a number of state, local and foreign jurisdictions. Accordingly, HMS is subject to state, local and foreign income tax examinations based on the various statutes of limitations in each jurisdiction.
7. Liability For Appeals
Under the Company’s contracts with certain commercial health plan customers and its Medicare Recovery Audit Contractor (“RAC”) contract with the Centers for Medicare & Medicaid Services (“CMS”) (included within the Company’s payment integrity services 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 Company’s original Medicare RAC contract with CMS expired on January 31, 2018. As a result of the original contract expiration, which historically had net settlement terms, the Company’s contractual obligation with respect to any appeals resolved in favor of providers subsequent to the expiration date ceased, and the Company released its estimated liability and increased revenue by $8.4 million during the first quarter of 2018. The Company's liability for appeals related to CMS and commercial contracts was approximately $21.7 million as of December 31, 2018, and $2.6 million as of September 30, 2019. The Company determined, based on communications, that there was no further contractual obligation to CMS with respect to the original Medicare RAC contract as of June 30, 2019. Accordingly, the Company released its remaining estimated liability of $19.4 million and net receivables during the second quarter of 2019. As a result of the release, there was a $10.5 million increase to the Company's revenue for the three months ended June 30, 2019. For the nine months ended September 30, 2019, the net change in the liability resulted in a $10.5 million increase to the Company's revenue.
8. Credit Agreement
In December 2017, the Company entered into an amendment to its Amended and Restated Credit Agreement, as amended (the “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 therefore and meeting certain other conditions.
As of September 30, 2019 and December 31, 2018, the outstanding principal balance due on the Amended Revolving Facility was $240 million. No principal payments were made against the Amended Revolving Facility during the nine months ended September 30, 2019.
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 London Interbank Offered Rate (or any successor rate determined in accordance with the Credit Agreement) (“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. As part of a contractual agreement with a customer, the Company has an outstanding irrevocable letter of credit for $6.5 million, which is issued against the Amended Revolving Facility and expires June 30, 2020.
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, 2019, 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 Amended Revolving Facility were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2019
|
|
2018
|
2019
|
|
2018
|
Interest expense
|
$
|
2,342
|
|
|
$
|
2,527
|
|
$
|
7,392
|
|
|
$
|
7,224
|
|
Commitment fees
|
157
|
|
|
211
|
|
473
|
|
|
688
|
|
As of September 30, 2019 and December 31, 2018, the unamortized balance of deferred origination fees and debt issuance costs was $1.8 million and $2.2 million, respectively. For the nine month periods ended September 30, 2019 and 2018, HMS amortized $0.4 million and $0.4 million, respectively, of interest expense related to the Company’s deferred origination fees and debt issue costs.
9. Earnings Per Share
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,
|
|
|
|
2019
|
|
2018
|
2019
|
|
2018
|
Net income
|
$
|
21,136
|
|
|
$
|
18,574
|
|
$
|
69,878
|
|
|
$
|
21,598
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding-basic
|
86,324
|
|
|
83,509
|
|
88,190
|
|
|
83,373
|
|
Plus: net effect of dilutive stock options and restricted stock units
|
2,000
|
|
|
1,635
|
|
2,251
|
|
|
1,868
|
|
Weighted average common shares outstanding-diluted
|
88,324
|
|
|
85,144
|
|
90,441
|
|
|
85,241
|
|
Net income per common share -- basic
|
$
|
0.24
|
|
|
$
|
0.22
|
|
$
|
0.79
|
|
|
$
|
0.26
|
|
Net income per common share -- diluted
|
$
|
0.24
|
|
|
$
|
0.22
|
|
$
|
0.77
|
|
|
$
|
0.25
|
|
For the three months ended September 30, 2019 and 2018, (i) 625,573 and 21,105 stock options, respectively, and (ii) restricted stock units representing 1,693 and 202 shares of the Company's 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, 2019 and 2018, (i) 472,627 and 531,378 stock options, respectively, and (ii) restricted stock units representing 2,791 and 595 shares of common stock, respectively, were not included in the diluted earnings per share calculation because the effect would have been anti-dilutive.
10. Stock-Based Compensation
(a) Long-Term Incentive Award Plans
The Company grants stock options and restricted stock units to HMS employees and non-employee directors of the Company under the HMS Holdings Corp. 2019 Omnibus Incentive Plan (the “2019 Omnibus Plan”), as approved by the Company’s shareholders on May 22, 2019. The 2019 Omnibus Plan replaces and supersedes the HMS Holdings Corp. 2016 Omnibus Incentive Plan.
(b) 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,
|
|
|
|
2019
|
|
2018
|
2019
|
|
2018
|
Cost of services-compensation
|
$
|
982
|
|
|
$
|
1,537
|
|
$
|
7,825
|
|
|
$
|
5,802
|
|
Selling, general and administrative
|
1,952
|
|
|
1,900
|
|
10,890
|
|
|
11,843
|
|
Total
|
$
|
2,934
|
|
|
$
|
3,437
|
|
$
|
18,715
|
|
|
$
|
17,645
|
|
(c) Stock Options
For the three months ended September 30, 2019 and 2018, stock-based compensation expense related to stock options was approximately $0.9 million and $1.6 million, respectively. For the nine months ended September 30, 2019 and 2018, stock-based compensation expense related to stock options was approximately $7.8 million and $7.6 million, respectively.
Presented below is a summary of stock option activity for the nine months ended September 30, 2019 (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, 2018
|
4,402
|
|
|
$
|
17.07
|
|
|
|
|
|
Granted
|
634
|
|
|
38.71
|
|
|
|
|
|
Exercised
|
(2,427)
|
|
|
16.18
|
|
|
|
|
|
Forfeitures
|
(146)
|
|
|
19.68
|
|
|
|
|
|
Expired
|
(2)
|
|
|
15.78
|
|
|
|
|
|
Outstanding balance at September 30, 2019
|
2,461
|
|
|
|
|
|
|
|
|
|
Expected to vest at September 30, 2019
|
1,051
|
|
|
$
|
28.22
|
|
|
8.75
|
|
$
|
8,746
|
|
Exercisable at September 30, 2019
|
979
|
|
|
$
|
17.18
|
|
|
5.78
|
|
$
|
16,918
|
|
During the three months ended September 30, 2019 and 2018, the Company received proceeds of $12.2 million and $11.2 million, respectively, for the issuance of 740,748 and 535,077 shares of common stock upon the exercise of outstanding stock options, respectively. The total intrinsic value of stock options exercised during the three months ended September 30, 2019 and 2018 was $16.0 million and $4.0 million, respectively. During the nine months ended September 30, 2019 and 2018, the Company received proceeds of $39.2 million and $13.6 million, respectively, for the issuance of 2,427,156 and 686,111 shares of common stock upon the exercise of outstanding stock options, respectively. The total intrinsic value of stock options exercised during the nine months ended September 30, 2019 and 2018 was $45.5 million and $4.7 million, respectively.
As of September 30, 2019, there was approximately $5.6 million of total unrecognized compensation cost related to stock options outstanding, which is expected to be recognized over a weighted average period of 1.1 years.
The weighted-average grant date fair value per share of the stock options granted during the nine months ended September 30, 2019 and 2018 was $13.87 and $7.52, 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,
|
|
|
|
2019
|
|
2018
|
Expected dividend yield
|
0
|
%
|
|
0
|
%
|
Risk-free interest rate
|
2.5
|
%
|
|
2.7
|
%
|
Expected volatility
|
40.9
|
%
|
|
42.4
|
%
|
Expected life (years)
|
6.35
|
|
6.00
|
The total tax benefits recognized on stock-based compensation related to stock options for the nine months ended September 30, 2019 and 2018 was $16.1 million and $1.0 million, respectively.
(d) Restricted Stock Units
For the three months ended September 30, 2019 and 2018, stock-based compensation expense related to restricted stock units was approximately $1.9 million and $1.9 million, respectively. For the nine months ended September 30, 2019 and 2018, stock-based compensation expense related to restricted stock units was approximately $10.9 million and $10.0 million, respectively.
Presented below is a summary of restricted stock units activity for the nine months ended September 30, 2019 (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, 2018
|
1,488
|
|
|
$
|
17.60
|
|
Granted
|
473
|
|
|
34.19
|
|
Vesting of restricted stock units, net of units withheld for taxes
|
(405)
|
|
|
16.60
|
|
Units withheld for taxes
|
(200)
|
|
|
16.60
|
|
Forfeitures
|
(99)
|
|
|
19.97
|
|
Outstanding balance at September 30, 2019
|
1,257
|
|
|
$
|
25.82
|
|
For the three months ended September 30, 2019 and 2018, HMS granted 12,687 and 1,794 restricted stock units, respectively, with an aggregate fair market value of $0.5 million and $0.1 million, respectively. For the nine months ended September 30, 2019 and 2018, HMS granted 474,520 and 762,877 restricted stock units, respectively, with an aggregate fair market value of $16.2 million and $12.8 million, respectively.
As of September 30, 2019, 995,860 restricted stock units remained unvested and there was approximately $12.4 million of unrecognized compensation cost related to restricted stock units, which is expected to be recognized over a weighted average vesting period of 1.1 years.
11. Leases
The Company determines if an arrangement is a lease at inception. Operating leases are reported on the Company’s consolidated balance sheet within Operating lease right-of-use assets, Operating lease liabilities and Accounts payable, accrued expenses and other liabilities. Finance leases are reported on the Company’s consolidated balance sheets within Other assets, Other liabilities and Accounts payable, accrued expenses and other liabilities.
Operating lease ROU assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. As most of the Company’s leases do not provide an implicit rate, we use the Company’s incremental borrowing rate based on the information available at the lease’s commencement date in determining the present value of future payments. The operating lease ROU asset also includes any lease payments made and excludes lease incentives and initial direct costs incurred. The lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term. For certain real estate and equipment leases, the Company has lease agreements with lease and non-lease components, which are generally accounted for as a single component.
The Company primarily leases real estate, information technology equipment and data centers on terms that expire on various dates through 2026, some of which include options to extend the lease for up to 10 years. We evaluate whether to include the option period in the calculation of the ROU asset and lease liability on a lease-by-lease basis.
As of September 30, 2019, all operating and finance leases that create significant rights and obligations for the Company have commenced.
The components of lease expense for the three and nine months ended September 30, 2019 were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30, 2019
|
|
Nine Months Ended
September 30, 2019
|
|
|
|
|
Operating lease cost
|
$
|
1,653
|
|
|
$
|
4,967
|
|
|
|
|
|
Finance lease cost:
|
|
|
|
Amortization of right-of-use assets
|
$
|
59
|
|
|
$
|
97
|
|
Interest on lease liabilities
|
$
|
8
|
|
|
$
|
13
|
|
Total finance lease cost
|
$
|
67
|
|
|
$
|
110
|
|
Supplemental cash flow and other information related to leases for the nine months ended September 30, 2019 were as follows (in thousands):
|
|
|
|
|
|
|
Nine Months Ended
September 30, 2019
|
|
|
Cash paid for amounts included in measurement of lease liabilities:
|
|
Operating cash flows from operating leases
|
$
|
5,559
|
|
Operating cash flows from finance leases
|
$
|
11
|
|
Financing cash flows from finance leases
|
$
|
93
|
|
Right-of-use assets obtained in exchange for new lease liabilities:
|
|
Operating leases
|
$
|
1,253
|
|
Finance leases
|
$
|
1,160
|
|
Supplemental balance sheet information related to leases as of September 30, 2019 consisted of the following (in thousands):
|
|
|
|
|
|
|
Nine Months Ended
September 30, 2019
|
Operating Leases
|
|
Operating lease right-of-use assets
|
$
|
18,351
|
|
|
|
Other current liabilities
|
$
|
6,475
|
|
Operating lease liabilities
|
$
|
16,269
|
|
Total operating lease liabilities
|
$
|
22,744
|
|
|
|
Finance Leases
|
|
Other Assets
|
$
|
1,167
|
|
|
|
Other current liabilities
|
$
|
404
|
|
Other long-term liabilities
|
$
|
769
|
|
Total finance leases liabilities
|
$
|
1,173
|
|
As of September 30, 2019, the weighted-average remaining lease term for operating and finance leases was 4.2 years and 2.8 years, respectively. As of September 30, 2019, the weighted-average discount rates were 5.7% and 4.6% for operating and finance leases, respectively.
Sublease income for the nine months ended September 30, 2019 and 2018 was $1.6 million and $1.3 million, respectively.
Maturities of lease liabilities were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31,
|
Operating Leases
|
|
Finance Leases
|
2019 (excluding the nine months ended September 30, 2019)
|
$
|
1,874
|
|
|
$
|
112
|
|
2020
|
7,468
|
|
|
447
|
|
2021
|
5,768
|
|
|
447
|
|
2022
|
3,487
|
|
|
240
|
|
2023
|
3,259
|
|
|
—
|
|
Thereafter
|
3,741
|
|
|
—
|
|
Total lease payments
|
25,597
|
|
|
1,246
|
|
Less: Imputed interest
|
2,853
|
|
|
73
|
|
Total lease obligation
|
$
|
22,744
|
|
|
$
|
1,173
|
|
12. 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, Inc. (“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. In March 2018, the Company provided certain documents and information in response to the CID. HMS has not received any further requests for information in connection with this CID.
In September 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 moved to dismiss the complaint and the Court heard oral arguments on May 2, 2019. A decision on the motion has not yet been issued by the Court. The Company continues to believe that 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.
13. Subsequent Events
Investment in MedAdvisor
On October 6, 2019, the Company announced its planned investment of $7.5 million in ordinary shares of MedAdvisor Limited ("MedAdvisor")(ASX: MDR), a leading digital medication management company based in Australia. On October 11, 2019, the Company completed the investment with cash on hand for a 12.8% ownership stake in MedAdvisor and the Company's Chief Financial Officer was appointed to MedAdvisor's board of directors in connection with the transaction.
Share Repurchase
On November 1, 2019, the Board of Directors of the Company approved a share repurchase program authorizing the Company to repurchase up to $50.0 million in shares of its common stock from time to time on the open market or in privately negotiated or other transactions. The repurchase program is authorized for a period of up to two years, and may be suspended or discontinued at any time. Repurchased shares will be available for use in connection with reissuance under the Company’s stock plans and for other corporate purposes. The timing and amount of any shares repurchased under the program will be determined by the Company’s management based on its evaluation of market conditions, share price and other factors. In order to facilitate repurchases, the Company may enter into a Rule 10b5-1 plan from time to time, which would permit shares to be repurchased when the Company might otherwise be precluded from doing so under insider trading laws or because of a self-imposed trading blackout period.