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HMSY > SEC Filings for HMSY > Form 10-Q on 9-Nov-2012All Recent SEC Filings

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Form 10-Q for HMS HOLDINGS CORP


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

We begin Management's Discussion and Analysis of Financial Condition and Results of Operations with a discussion of the critical accounting policies that we believe are important to understanding the assumptions and judgments incorporated in our reported financial results. We then present a business overview followed by a discussion of our results of operations. Lastly, we provide an analysis of our liquidity and capital resources, including discussions of our cash flows, sources of capital and financial commitments.

The following discussions and analysis of financial condition and results of operations should be read in conjunction with the other sections of our Annual Report on Form 10-K for the year ended December 31, 2011, including the Consolidated Financial Statements and Supplemental Data thereto appearing in Part II, Item 8 of the Annual Report, the Risk Factors appearing in Part I, Item 1A of the Annual Report and Part II of this 10-Q, and the disclaimer regarding forward-looking statements appearing at the beginning of Part I, Item 1 of the Annual Report. Historical results set forth in Part II, Item 6, Item 7 and Item 8 of the Annual Report should not be taken as necessarily indicative of our future operations.

Critical Accounting Policies

Since the date of our Annual Report on Form 10-K for the year ended December 31, 2011, there have been no material changes to our critical accounting policies.

General Overview

We provide cost containment services to government and private healthcare payers and sponsors. Our services ensure that healthcare claims are paid correctly, through our program integrity services, and by the responsible party, through our coordination of benefits services. Our services help clients recover amounts from liable third parties; prevent future inappropriate payments; reduce fraud, waste and abuse; and ensure regulatory compliance.

Our clients are state Medicaid agencies; the Centers for Medicare & Medicaid Services, or CMS; Medicaid and Medicare managed care plans; government and private employers; Pharmacy Benefit Managers, or PBMs; child support agencies; the Veterans Health Administration, or VHA; commercial health plans; and other healthcare payers.

Since our inception we have grown both organically and through targeted acquisitions. In 1985 we began providing coordination of benefits services to state Medicaid agencies. As Medicaid began to migrate members to managed care, we expanded into the Medicaid managed care market, providing the same coordination of benefits services. We launched our program integrity services in 2007 and have since acquired several businesses: Permedion, Inc., Prudent Rx, and Allied Management Group - Special Investigations Unit, Inc., or AMG-SIU, to build out our service offerings. In 2009, we entered the Medicare market with our acquisition of IntegriGuard, LLC, or IntegriGuard, which provides fraud, waste and abuse analytical services to the Medicare program. In 2009 and 2010, we entered the commercial market working with large self-funded employers through our acquisitions of Verify Solutions, Inc. and Chapman Kelly, Inc.

In December 2011, we acquired privately-held HDI Holdings, Inc. and its operating subsidiary, HealthDataInsights, Inc., or HDI. Based in Las Vegas, Nevada, HDI provides improper payment identification services for government and commercial health plans, and is the Medicare Recovery Audit Contractor (RAC) in CMS Region D, covering 17 states and three U.S. territories. HDI offers a comprehensive suite of claims integrity services, including complex medical reviews, automated reviews, hospital bill audits, and pharmacy audits. The acquisition of HDI extends our reach in the federal, state and commercial markets and provides us with an immediate platform to expand service offerings to our existing clients.

In connection with our acquisition of HDI, we entered into a five year, revolving and term secured credit agreement, which we refer to as the Credit Agreement, with certain financial institutions and Citibank, N.A. as Administrative Agent. The Credit Agreement is guaranteed by our material subsidiaries and is supported by a security interest in all or substantially all of our, and our subsidiaries', personal property assets. The Credit Agreement, which matures in December 2016, provides for a term loan of $350.0 million, or the Term Loan, which was used to finance our acquisition of HDI, and a revolving credit facility in an initial amount of $100.0 million. Under specified circumstances, the revolving credit facility can be increased by up to $50.0 million in additional term or revolving loan commitments.

At September 30, 2012, our cash and cash equivalents and net working capital were $128.0 million and $208.4 million, respectively. To date, we have grown our business through the internal development of new products and services, the extension of our products and services into new markets and through acquisitions of businesses whose core services strengthen our overall mission to help our clients control healthcare costs. In addition, we leverage our expertise to acquire new clients at the state, federal and employer levels and to expand our current contracts to provide new services to current clients. Our growth to date has also been driven by an overall increase in Medicaid expenditures and State governments' increased use of vendors for the coordination of


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benefits and other cost containment functions. We are continuously evaluating opportunities that will enable us to expand the breadth of the services we provide and will consider acquisition opportunities that enable us to continue to grow our business to address the increasing needs of the healthcare industry.

As of September 30, 2012, we served the District of Columbia and 44 state Medicaid programs, and 148 Medicaid health plans under an aggregate of 70 contracts. We also act as a subcontractor for certain business outsourcing and technology firms.

In September 2012, our wholly owned subsidiary, IntegriGuard, which is doing business as HMS Federal, entered into a contract with CMS to perform the Coordination of Benefits and Medicare Secondary Payer Business Program Operations. The contract has an initial term of one year and may be renewed by CMS for four additional one year periods. We have received a stop work order from CMS that will remain in effect until the Government Accountability Office (GAO) has made a determination with respect to bid protests filed with respect to this award. We now expect a GAO determination by the end of the first quarter of 2013.

In March 2010, the Patient Protection and Affordable Care Act, or the ACA, was signed into law. In early 2012, the US Supreme Court reviewed the constitutionality of the ACA and in its June 2012 decision, the Court addressed two overarching elements of the ACA, including the requirement that States add new categories of beneficiaries to their Medicaid programs or risk losing all their federal Medicaid funding (the Medicaid expansion). While upholding the constitutionality of the ACA, the Supreme Court ruled that the federal government could not condition continued receipt of a State's existing Medicaid funding on its agreement to implement the Medicaid expansion.

The ACA also includes a number of provisions for combating fraud, waste and abuse, and we believe that President Obama's re-election and the strong bipartisan support for containing healthcare costs through the measures identified in the ACA, provides us with platform for continued growth. We plan to develop and build on existing partnerships with states, the federal government, health plans, and partners to provide services that address these provisions and assist clients with their cost containment objectives.

In addition to the information provided below, you should 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 Annual Report.


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SUMMARY OF OPERATING RESULTS

Three Months Ended September 30, 2012 Compared to Three Months Ended September 30, 2011

The following table sets forth, for the periods indicated, certain items in our consolidated statements of comprehensive income expressed as a percentage of revenue:

                                                 Three months ended
                                                    September 30,
                                                  2012         2011
Revenue                                            100.0 %      100.0 %
Cost of service
Compensation                                        35.5 %       34.4 %
Data processing                                      7.0 %        6.5 %
Occupancy                                            3.9 %        4.1 %
Direct project costs                                12.8 %       10.7 %
Other operating costs                                2.8 %        5.0 %
Amortization of intangibles                          7.2 %        1.8 %
Total cost of services                              69.2 %       62.5 %
Selling, general, and administrative expenses       12.5 %       11.4 %
Total operating expenses                            81.7 %       73.9 %
Operating income                                    18.3 %       26.1 %
Interest expense                                    (3.6 )%       0.0 %
Other income, net                                      0 %        0.1 %
Interest income                                        0 %        0.0 %
Income before income taxes                          14.7 %       26.2 %
Income taxes                                        (5.4 )%     (10.6 )%
Net income                                           9.3 %       15.6 %

Revenue for the three months ended September 30, 2012 was $113.2 million, an increase of $20.8 million, or 22.6%, compared to revenue of $92.4 million in the same quarter for the prior year. Revenue generated by HDI, which we acquired in December 2011, provided $27.9 million of the increase in revenue. Revenue generated by new clients for whom there was no revenue in the prior year period provided $4.2 million of the increase. Fluctuations in existing client accounts, together with changes in the yield and scope of those projects, and differences in the timing of when client projects were completed in the current year compared to the prior year, provided a $9.4 million decrease in revenue. Contract expirations resulted in a revenue decrease of $1.9 million.

Compensation expense as a percentage of revenue was 35.5% for the three months ended September 30, 2012, compared to 34.4% for the three months ended September 30, 2011. Compensation expense for the current quarter was $40.2 million, an $8.4 million, or 26.5%, increase over compensation expense of $31.8 million for the same quarter in the prior year. During the quarter ended September 30, 2012, we averaged 2,274 employees, a 41.4% increase over our average of 1,608 employees during the quarter ended September 30, 2011. This increase reflects the addition of HDI staff in connection with our December 2011 acquisition, and the addition of staff in the areas of client support, technical support and operations.

Data processing expense as a percentage of revenue was 7.0% for the three months ended September 30, 2012, compared to 6.5% for the three months ended September 30, 2011. Data processing expense was $7.9 million for the current quarter, an increase of $1.9 million, or 31.8%, over data processing expense of $6.0 million for the same quarter in the prior year. This increase reflects $1.1 million in additional software related costs and $0.8 million in additional hardware and hosting costs due to the growth of our business, including increases in transaction volume and the number of employees.

Occupancy expense as a percentage of revenue was 3.9% for the three months ended September 30, 2012, compared to 4.1% for the three months ended September 30, 2011. Occupancy expense for the current quarter was $4.4 million, a $0.6 million, or 16.7%, increase compared to occupancy expense of $3.8 million for the same quarter in the prior year. This increase primarily reflects $0.4 million in additional rent and related expense resulting from our acquisition of HDI in December 2011.


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Direct project expense as a percentage of revenue was 12.8% for the three months ended September 30, 2012, compared to 10.7% for the three months ended September 30, 2011. Direct project expense for the current quarter was $14.5 million, a $4.6 million, or 46.9%, increase compared to direct project expense of $9.9 million for the same quarter in the prior year. This increase resulted from a $5.2 million increase primarily related to HDI subcontractor fees, partially offset by a $0.6 million decrease for subcontractor expenses and a $0.2 million decrease for temporary help.

Other operating costs as a percentage of revenue were 2.8% for the three months ended September 30, 2012 compared to 5.0% for the three months ended September 30, 2011. Other operating costs for the current quarter were $3.2 million, a decrease of $1.4 million, or 31.0%, compared to operating costs of $4.6 million for the same quarter in the prior year. This decrease primarily resulted from a $2.3 million decrease due to the reversal of contingent consideration due to the sellers of AMG, partially offset by a $0.6 million increase in professional fees, and a $0.3 million increase primarily related to professional fees incurred by HDI.

Amortization of acquisition-related software and intangibles as a percentage of revenue was 7.2% for the three months ended September 30, 2012, compared to 1.8% for the three months ended September 30, 2011. Amortization of acquisition-related software and intangibles for the current quarter was $8.1 million, compared to amortization expense of $1.7 million for the same quarter in the prior year. The increase in amortization expense of $6.5 million is primarily related to our acquisition of HDI.

Selling, general, and administrative expense as a percentage of revenue was 12.5% for the three months ended September 30, 2012 compared to 11.4% for the three months ended September 30, 2011. Selling, general, and administrative expense for the current quarter was $14.2 million, a $3.6 million, or 34.1%, increase compared to $10.6 million for the same quarter in the prior year. During the quarter ended September 30, 2012, we averaged 218 corporate employees, a 75.8% increase over our average of 124 corporate employees during the quarter ended September 30, 2011. Compensation expense increased by $2.5 million due to the increase in headcount and stock compensation expense. Data processing expense increased by $0.5 million due to higher software and equipment related expenses. Occupancy expenses increased by $0.2 million due to increases in telecommunications and equipment expense.

Operating income for the three months ended September 30, 2012 was $20.7 million, a decrease of $3.4 million, or 14.0%, compared to $24.1 million for the three months ended September 30, 2011.

Interest expense was $4.1 million for the three months ended September 30, 2012 and $19,000 for the three months ended September 30, 2011. Interest expense represents borrowings under our Term Loan, amortization of deferred financing costs, commitment fees for our Credit Agreement and issuance fees for our irrevocable standby letter of credit or Letter of Credit. The increase of $4.1 million compared to the prior year period primarily represents $3.0 million in interest expense on our Term Loan and $0.9 million in related amortization of deferred financing costs. Interest income was $13,000 for the three months ended September 30, 2012, compared to interest income of $14,000 for the three months ended September 30, 2011. Net other income decreased to $27,000 for the quarter ended September 30, 2012 from $165,000 in the prior year period, primarily as a result of a reduction in rental income as leases with tenants in the building we acquired in Irving, Texas expired and were not renewed.

We recorded income tax expense of $6.1 million for the quarter ended September 30, 2012, compared to income tax expense of $9.8 million for the three months ended September 30, 2011, a decrease of $3.7 million. Our effective tax rate decreased to 36.8% for the quarter ended September 30, 2012 from 40.5% for the quarter ended September 30, 2011, primarily due to a change in state apportionments and permanent differences. The principal difference between the statutory rate and our effective rate are state taxes and permanent differences.

Net income of $10.5 million in the current quarter represents a decrease of $3.9 million, or 27.1%, compared to net income of $14.4 million in the same quarter for the prior year.


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Nine Months Ended September 30, 2012 Compared to Nine Months Ended September 30, 2011

The following table sets forth, for the periods indicated, certain items in our consolidated statements of comprehensive income expressed as a percentage of revenue:

                                                  Nine months ended
                                                    September 30,
                                                  2012         2011
Revenue                                            100.0 %      100.0 %
Cost of service
Compensation                                        35.1 %       35.8 %
Data processing                                      6.7 %        6.3 %
Occupancy                                            3.7 %        4.3 %
Direct project costs                                11.9 %       11.5 %
Other operating costs                                4.2 %        5.1 %
Amortization of intangibles                          7.2 %        1.9 %
Total cost of services                              68.8 %       64.9 %
Selling, general, and administrative expenses       12.9 %       12.1 %
Total operating expenses                            81.7 %       77.0 %
Operating income                                    18.3 %       23.0 %
Interest expense                                    (3.6 )%       0.0 %
Other income, net                                    0.1 %        0.2 %
Interest income                                        0 %        0.0 %
Income before income taxes                          14.8 %       23.2 %
Income taxes                                        (5.8 )%      (9.3 )%
Net income                                           9.0 %       13.9 %

Revenue for the nine months ended September 30, 2012 was $340.6 million, an increase of $76.4 million, or 28.9%, compared to revenue of $264.2 million in the same period for the prior year. Revenue generated by HDI, which we acquired in December 2011, provided $75.1 million of the increase in revenue. Revenue generated by new clients for whom there was no revenue in the prior year period provided $8.7 million of the increase. Fluctuations in existing client accounts, together with changes in the yield and scope of those projects, and differences in the timing of when client projects were completed in the current year compared to the prior year, provided a $1.8 million decrease in revenue. Contract expirations resulted in a revenue decrease of $5.6 million.

Compensation expense as a percentage of revenue was 35.1% for the nine months ended September 30, 2012, compared to 35.8% for the nine months ended September 30, 2011. Compensation expense for the current quarter was $119.5 million, a $24.9 million, or 26.3%, increase over compensation expense of $94.6 million for the same quarter in the prior year. During the nine months ended September 30, 2012, we averaged 2,182 employees, a 35.2% increase over our average of 1,614 employees during the nine months ended September 30, 2011. This increase reflects the addition of HDI staff in connection with our December 2011 acquisition, and the addition of staff in the areas of client support, technical support and operations.

Data processing expense as a percentage of revenue was 6.7% for the nine months ended September 30, 2012, compared to 6.3% for the nine months ended September 30, 2011. Data processing expense was $22.8 million for the nine months ended September 30, 2012, an increase of $6.2 million, or 37.2%, over data processing expense of $16.6 million for the same period in the prior year. Revenue growth as well as acquisitions drove the need for increased capacity in our data processing environment. This increase reflects $3.3 million in additional software related costs, $2.1 million in additional hardware and hosting costs, and $0.8 million in additional data communications and data costs due to the growth of our business, including increases in transaction volume and the number of employees.

Occupancy expense as a percentage of revenue was 3.7% for the nine months ended September 30, 2012, compared to 4.3% for the nine months ended September 30, 2011. Occupancy expense for the current period was $12.7 million, a $1.4 million, or 12.5%, increase compared to occupancy expense of $11.3 million for the same period in the prior year. This increase reflects $1.0 million in additional rent and related expense resulting from our acquisition of HDI in December 2011, $0.3 million related to depreciation expense, and $0.1 million related to off-site storage.


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Direct project expense as a percentage of revenue was 11.9% for the nine months ended September 30, 2012, compared to 11.5% for the nine months ended September 30, 2011. Direct project expense for the current period was $40.6 million, a $10.0 million, or 32.8%, increase compared to direct project expense of $30.5 million for the same period in the prior year. This increase resulted from a $10.5 million increase primarily related to HDI subcontractor fees, partially offset by a $0.5 million reduction in software leases, local taxes and printing expenses.

Other operating costs as a percentage of revenue were 4.2% for the nine months ended September 30, 2012 compared to 5.1% for the nine months ended September 30, 2011. Other operating costs for the current period were $14.3 million, an increase of $0.9 million, or 6.4%, compared to operating costs of $13.4 million for the same period in the prior year. This increase primarily resulted from a $2.4 million increase in professional fees, a $1.0 million increase primarily related to professional fees incurred by HDI , a $0.1 million increase in travel expenses and a $0.1 million increase in postage expenses. These increases were partially offset by the reversal of the $2.3 million contingent consideration related to our AMG-SIU acquisition and a related $0.4 million decrease for previously accrued accretion for that contingent consideration.

Amortization of acquisition-related software and intangibles as a percentage of revenue was 7.2% for the nine months ended September 30, 2012, compared to 1.9% for the nine months ended September 30, 2011. Amortization of acquisition-related software and intangibles for the current period was $24.4 million, compared to amortization expense of $5.0 million for the same period in the prior year. The increase in amortization expense of $19.4 million is primarily related to our acquisition of HDI.

Selling, general, and administrative expense as a percentage of revenue was 12.9% for the nine months ended September 30, 2012 compared to 12.1% for the nine months ended September 30, 2011. Selling, general, and administrative expense for the current period was $43.9 million, a $12.0 million, or 37.5%, increase compared to $31.9 million for the same period in the prior year. During the period ended September 30, 2012, we averaged 207 corporate employees, a 72.5% increase over our average of 120 corporate employees during the period ended September 30, 2011. Compensation expense increased by $9.5 million due to the increase in headcount and stock compensation. Data processing expense increased by $1.3 million relating to software and equipment expense. Occupancy expenses increased by $0.5 million due to telecommunications expenses and additional space requirements. Other expenses increased by $0.7 million primarily due to an increase in professional fees.

Operating income for the nine months ended September 30, 2012 was $62.4 million, an increase of $1.8 million, or 2.8%, compared to $60.6 million for the nine months ended September 30, 2011.

Interest expense was $12.5 million for the nine months ended September 30, 2012 and $65,000 for the nine months ended September 30, 2011. Interest expense represents borrowings under our Term Loan, amortization of deferred financing costs, commitment fees for our Credit Agreement and issuance fees for our Letter of Credit. The increase of $12.4 million compared to the prior year period primarily represents $9.6 million in interest expense on our Term Loan and $2.8 million in related amortization of deferred financing costs. Interest income was $17,000 for the nine months ended September 30, 2012, compared to interest income of $50,000 for the nine months ended September 30, 2011. Net other income decreased to $346,000 for the nine months ended September 30, 2012 from $714,000 in the prior year period, primarily as a result of a reduction in rental income as leases with tenants in the building we acquired in Irving, Texas expired and were not renewed.

We recorded income tax expense of $19.7 million for the nine months ended September 30, 2012, compared to income tax expense of $24.7 million for the nine months ended September 30, 2011, a decrease of $5.0 million. Our effective tax rate decreased to 39.3% for the nine months ended September 30, 2012 from 40.3% for the nine months ended September 30, 2011, primarily due to a change in state apportionments and permanent differences. The principal difference between the statutory rate and our effective rate are state taxes and permanent differences.

Net income of $30.5 million in the current period represents a decrease of $6.2 million, or 16.7%, compared to net income of $36.7 million in the same period for the prior year.

Contractual Obligations

There have been no material changes in our contractual obligations as presented in our Annual report on Form 10-K for the year ended December 31, 2011.


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Off-Balance Sheet Arrangements

Other than our Letter of Credit, we do not have any off-balance sheet arrangements.

Liquidity and Capital Resources



This data should be read in conjunction with our Consolidated Statements of Cash
Flows.



(in thousands)               September 30, 2012     December 31, 2011

Cash and cash equivalents   $            127,952   $            97,003
Working capital             $            208,359   $           169,862

A summary of our cash flows is as follows:

                                                             Nine months ended
(in thousands)                                   September 30, 2012      September 30, 2011

Net cash provided by operating activities       $             54,920    $             49,090
Net cash used in investing activities           $            (21,702 )  $            (19,742 )
Net cash (used in)/provided by financing
. . .
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