Item 2. Management’s Discussion
and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of financial
condition and results of operations should be read in conjunction with the other sections of this Quarterly Report on Form 10-Q
and with our 2015 Form 10-K. In addition to historical consolidated financial information, the following discussion contains forward-looking
statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the
forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere
in this Quarterly Report on Form 10-Q, including under “Cautionary Statement Regarding Forward-Looking Statements,”
and in Part I, Item 1A. “Risk Factors” of our 2015 Form 10-K.
We operate in the U.S. healthcare insurance benefit
cost containment marketplace. We provide coordination of benefits services to government and private healthcare payers and sponsors
to ensure that the responsible party pays healthcare claims. Our payment integrity services ensure that healthcare claims are billed
accurately and appropriately. Together, these various services help customers recover improper payments, including those from liable
third parties; prevent future improper payments; reduce fraud, waste and abuse; and ensure regulatory compliance.
Our customers are state and federal healthcare agencies,
including state Medicaid agencies, health plans, including Medicaid managed care, Medicare Advantage and group and individual health
lines of business; government and private employers; and other healthcare payers and sponsors. As of June 30, 2016, we served 46
state Medicaid programs and the District of Columbia; federal government health agencies, including CMS and the Veterans Health
Administration; and approximately 250 health plans. We additionally served as a subcontractor to certain business outsourcing and
technology firms.
The Company has grown both organically and through
targeted asset and stock acquisitions. Initially, the Company provided coordination of benefits services to state Medicaid agencies,
then expanded its business by providing similar services to managed care organizations when Medicaid began delegating members to
those plans. After launching payment integrity services in 2007, HMS grew its product suite and expanded its reach in the marketplace
by acquiring IntegriGuard, LLC (2009), Verify Solutions, Inc. (2009), Chapman Kelly, Inc. (2010), HDI (2011) and MedRecovery Management,
LLC (2012).
Healthcare Environment
The Patient Protection and Affordable Care Act (the
“ACA”) was signed into law in 2010. This legislation touched almost every sector of the healthcare system, and affords
HMS a range of growth opportunities across a number of services. We are focused on three critical areas related to this legislation:
|
·
|
Employer-Sponsored Health Coverage.
|
Medicaid Expansion:
States that expand
their Medicaid programs in accordance with the ACA receive federal funding for the total cost of the expansion for a period of
three years, and reduced funding thereafter. As of early 2016, approximately two-thirds of the states opted to expand their Medicaid
programs as provided under the ACA. According to the CMS National Health Expenditures (“NHE”) Projections, the number
of individuals enrolled in Medicaid and the Children’s Health Insurance Program (“CHIP”) is expected to increase
from 76.6 million in 2016 to 85.2 million in 2024, with expenditures over the same period expected to increase from $593.3 billion
to $999.5 billion. As a result, we currently anticipate continued demand for our cost containment services by states and the managed
care organizations with whom they contract with. We believe that our strong history of successful contracting with Medicaid agencies
and Medicaid managed care organizations will enable us to continue providing value-added services to help control the escalating
costs for this expanded population.
Payment Integrity:
The ACA contained a number
of provisions for combating fraud, waste and abuse throughout the healthcare system, including in Medicaid and Medicare. These
initiatives include: (i) requiring state Medicaid agencies to contract with state Medicaid RACs and deploy programs modeled on
the Medicare RAC Program administered by CMS, (ii) expanding the Medicare RAC Program to include Medicare Part C and D, (iii) establishing
a national healthcare fraud, waste and abuse data collection program and (iv) increasing scrutiny of providers and suppliers who
want to participate in Medicare, Medicaid and other federally-funded programs. The ACA further required that each state establish
a Medicaid RAC program by January 1, 2012. In addition, the ACA allowed for significant increases in funding for these and other
fraud, waste and abuse efforts. We continue to seek opportunities to expand our current partnerships with CMS, states and health
plans and to provide innovative ideas to support their payment integrity initiatives.
Employer-Sponsored Health Coverage:
The ACA
largely preserves and builds upon the existing employer-sponsored health coverage model. Though not all employers will be required
to provide healthcare coverage, large employers (i.e. those with 50 or more full time equivalents) are penalized starting in 2016
if (i) they do not offer coverage (or if they offer coverage that does not meet certain requirements) and (ii) one or more of their
full time employees receives a federal tax credit or cost sharing subsidy through a health insurance exchange. Employers will also
be prohibited from imposing waiting periods for enrollment of more than 90 days. We expect that we will be able to offer a range
of audit services to employers of all sizes, which will be valuable as these employers extend coverage to their employees.
Customers
We provide products and services under contracts
(or sub-contracts) that contain various revenue structures, including contingent revenue and fixed fee arrangements. Most of our
state government contracts have terms of three to five years, including optional renewal terms. In many instances, we provide our
services pursuant to agreements that are subject to periodic reprocurements. Several of our contracts, including those with some
of our largest customers, may be terminated for convenience. Because we provide our services pursuant to agreements that are open
to competition from various businesses in the U.S. healthcare insurance benefit cost containment marketplace, we cannot provide
assurance that our contracts, including those with our largest customers, will not be terminated for convenience, awarded to other
parties, or renewed, and, if renewed, that the fee structures will be equal to those currently in effect.
For example, our third party liability (“TPL”)
services contract with the New Jersey Department of Human Services was originally awarded in January 2008. In July 2015, we received
notice from the State of New Jersey Division of Purchase and Property (the “Division”) of its intent to award the new
TPL contract to another bidder following a competitive reprocurement. In February 2016, we filed a protest challenging the award.
The bidder withdrew its bid in May 2016. The most recent amendment to our current TPL contract with the New Jersey Department of
Human Services extends the term through August 31, 2016.
We are also actively involved in the procurement
process for the new Medicare RAC contract awards. In November 2015, CMS released a new RFP for recovery audit services that replaces
the procurement activities begun in February 2013. In response to the delays, CMS had extended the terms of its current contracts
with the Medicare RACs, including HDI, to July 31, 2016. After a delay in the procurement of the new Medicare RAC contract awards,
CMS resumed the procurement in April 2016 and we submitted a proposal on May 24, 2016. It remains uncertain as to when the new
Medicare RAC contracts will be awarded and the ultimate timing of implementation.
In addition, in August 2014, CMS announced
it would settle with hospitals willing to withdraw inpatient status claims currently pending in the RAC appeals process by offering
to pay hospitals 68% for all eligible claims they had billed to Medicare. In June 2015, CMS notified HDI that based on the initial
lists of finalized settlements, HDI owed CMS approximately $28.6 million due to adjustments in contingency fees pursuant to HDI’s
Medicare RAC contract with CMS. HDI previously advised CMS that it disagrees with CMS’ interpretation of the contract and
that CMS does not have the contractual right, among other things, to require repayment of fees already paid. In response to the
inaccurate and incomplete data in certain backup documentation initially provided by CMS regarding settled claims, HDI provided
CMS with data which it believes more accurately reflects the number of claims which were apparently settled. The amount ultimately
payable to CMS by HDI remains uncertain as HDI continues to evaluate additional data provided by CMS in connection with its completion
of the settlement process. A portion of our reserve for estimated liability for appeals recorded as of June 30, 2016 may
apply to this population, and there could be a material negative impact on our future revenue in future periods to the extent
that (i) any final determination of amounts owed by HDI to CMS under the current Medicare RAC contract materially exceeds our
accrued reserves for such appeals, (ii) HDI is required to return certain fees which have been paid or (iii) HDI’s
ability to collect fees for audits already performed is affected.
Critical Accounting
Policies
Since the date of our 2015 Form 10-K for the year
ended December 31, 2015, there have been no material changes to our critical accounting policies. Refer to the items disclosed
as our Critical Accounting Policies in Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition
and Results of Operations” of our 2015 Form 10-K.
SUMMARY OF OPERATING RESULTS
Selected Operating Performance and Other Significant
Items for the Three Months Ended June 30, 2016
|
·
|
Revenue increased $6.7 million, or 5.7% from the same quarter in 2015.
|
|
·
|
Operating income increased $4.6 million, or 39.0% from the same quarter in 2015.
|
|
·
|
Net income increased $3.2 million, or 59.3% from the same quarter in 2015.
|
|
·
|
Diluted earnings per share increased $0.04 or 66.7% from the same quarter in 2015.
|
|
·
|
Shareholders’ equity increased $15.2 million since March 31, 2016.
|
|
·
|
Second quarter 2016 cash flow from operations was $45.1 million.
|
Three Months Ended June 30, 2016 Compared to Three Months
Ended June 30, 2015
The following table sets forth, for the periods indicated, certain items in our
unaudited Consolidated Statements of Income expressed as a percentage of revenue:
|
|
Three Months Ended
June 30,
|
|
|
|
2016
|
|
|
2015
|
|
Revenue
|
|
|
100
|
%
|
|
|
100
|
%
|
Cost of services:
|
|
|
|
|
|
|
|
|
Compensation
|
|
|
38.3
|
|
|
|
37.5
|
|
Data processing
|
|
|
7.4
|
|
|
|
8.9
|
|
Occupancy
|
|
|
2.9
|
|
|
|
3.3
|
|
Direct project expenses
|
|
|
9.3
|
|
|
|
11.6
|
|
Other operating expenses
|
|
|
5.2
|
|
|
|
6.1
|
|
Amortization of acquisition related software and intangible assets
|
|
|
5.7
|
|
|
|
6.0
|
|
Total cost of services
|
|
|
68.8
|
|
|
|
73.4
|
|
Selling, general and administrative expenses
|
|
|
18.0
|
|
|
|
16.5
|
|
Total operating expenses
|
|
|
86.8
|
|
|
|
89.9
|
|
Operating income
|
|
|
13.2
|
|
|
|
10.1
|
|
Interest expense
|
|
|
(1.7
|
)
|
|
|
(1.7
|
)
|
Interest income
|
|
|
0.0
|
|
|
|
0.0
|
|
Income before income taxes
|
|
|
11.6
|
|
|
|
8.4
|
|
Income taxes
|
|
|
4.7
|
|
|
|
3.8
|
|
Net income
|
|
|
6.9
|
%
|
|
|
4.6
|
%
|
Revenue
During the three months ended June 30, 2016, revenue
was $123.6 million, an increase of $6.7 million, or 5.7% compared to $116.9 million for the three months ended June 30, 2015. This
increase was primarily due to commercial health plan growth, including expansion of services to existing health plan customers,
and an increase in the number of new customer contract implementations.
Cost of Services
During the three months ended June 30, 2016, total
cost of services as a percentage of revenue was 68.8% compared to 73.4% for the three months ended June 30, 2015. Total cost of
services for the three months ended June 30, 2016 was $85.0 million, a decrease of $0.9 million compared to $85.9 million for the
three months ended June 30, 2015. This change resulted primarily from decreases in direct project expenses, data processing expenses
and other operating costs. These decreases were partially offset by an increase in compensation. Compensation expense is composed
of salaries and wages, which include overtime, health benefits, stock option expense, performance awards, commissions, employer’s
share of FICA and fringe benefits.
Selling, General and Administrative
Expense (“SG&A”)
During the three months ended June 30, 2016,
SG&A expense as a percentage of revenue was 18.0% compared to 16.5% for the three months ended June 30, 2015. SG&A expense
for the three months ended June 30, 2016 was $22.2 million, an increase of $2.9 million, or 15.0% compared to $19.3 million for
the three months ended June 30, 2015. This change resulted from a $1.9 million increase in compensation and stock-based compensation
expense. SG&A expense also increased $3.2 million due to an increase in the provision for bad debt expense. These increases
were partially offset by a $2.7 million decrease in legal expense related to the settlement of litigation and certain disputes.
See Note 11, Commitments and Contingencies.
Operating Income
During the three months ended June 30, 2016 operating
income was $16.4 million, an increase of $4.6 million, or 39.0%, compared to operating income of $11.8 million for the three months
ended June 30, 2015.
Interest Expense
During the three months ended June 30, 2016, interest
expense was $2.1 million, an increase of $0.2 million, compared to $1.9 million for the three months ended June 30, 2015. Interest
expense represents borrowings under our revolving credit facility, interest on debt, commitment fees, letter of credit fees and
amortization of deferred financing costs.
Income Taxes
We recorded income tax expense of $5.7 million for
the three months ended June 30, 2016, compared to income tax expense of $4.4 million for the three months ended June 30, 2015,
an increase of $1.3 million. Income before taxes increased $4.5 million for the current quarter over income before taxes in the
same period in the prior year, which caused an increase in our tax expense. Additionally, our effective tax rate decreased to 40.1%
for the three months ended June 30, 2016 compared to 44.8% for the three months ended June 30, 2015 primarily due to state taxes
and permanent differences. The principal differences between our statutory rate and our effective rate are state taxes, interest
on unrecognized tax benefits, and permanent items.
Net Income
During the three months ended June 30, 2016, net
income was $8.6 million which represents an increase of $3.2 million compared to net income for the three months ended June 30,
2015 of $5.4 million.
SUMMARY OF OPERATING RESULTS
Selected Operating Performance and Other Significant
Items for the Six Months Ended June 30, 2016
|
·
|
Revenue increased $16.0 million, or 7.0% compared to the first half of 2015.
|
|
·
|
Operating income increased $6.6 million, or 33.5% compared to the first half of 2015.
|
|
·
|
Net income increased $4.2 million, or 47.2% compared to the first half of 2015.
|
|
·
|
Diluted earnings per share increased $0.05 or 50% compared to the first half of 2015.
|
|
·
|
Shareholders’ equity increased $22.4 million since December 31, 2015.
|
|
·
|
Cash flow from operations was $45.7 million.
|
Six Months Ended June 30, 2016 Compared to Six Months Ended
June 30, 2015
The following table sets forth, for the periods indicated, certain items in
our unaudited Consolidated Statements of Income expressed as a percentage of revenue:
|
|
Six Months Ended
June 30,
|
|
|
|
2016
|
|
|
2015
|
|
Revenue
|
|
|
100
|
%
|
|
|
100
|
%
|
Cost of services:
|
|
|
|
|
|
|
|
|
Compensation
|
|
|
38.5
|
|
|
|
38.7
|
|
Data processing
|
|
|
7.7
|
|
|
|
9.0
|
|
Occupancy
|
|
|
3.0
|
|
|
|
3.4
|
|
Direct project expenses
|
|
|
10.7
|
|
|
|
10.6
|
|
Other operating expenses
|
|
|
5.0
|
|
|
|
6.1
|
|
Amortization of acquisition related software and intangible assets
|
|
|
5.8
|
|
|
|
6.2
|
|
Total cost of services
|
|
|
70.6
|
|
|
|
74.0
|
|
Selling, general and administrative expenses
|
|
|
18.6
|
|
|
|
17.3
|
|
Total operating expenses
|
|
|
89.2
|
|
|
|
91.3
|
|
Operating income
|
|
|
10.8
|
|
|
|
8.7
|
|
Interest expense
|
|
|
(1.7
|
)
|
|
|
(1.7
|
)
|
Interest income
|
|
|
0.0
|
|
|
|
0.0
|
|
Income before income taxes
|
|
|
9.1
|
|
|
|
7.0
|
|
Income taxes
|
|
|
3.7
|
|
|
|
3.0
|
|
Net income
|
|
|
5.4
|
%
|
|
|
4.0
|
%
|
Revenue
During the six months ended June 30, 2016, revenue
was $243.3 million, an increase of $16.0 million, or 7.0% compared to $227.3 million for the six months ended June 30, 2015. This
increase was primarily due to commercial health plan growth, including expansion of services to existing health plan customers,
an increase in the number of new customer contract implementations and higher Medicare RAC revenue; partially offset by a decrease
in state government revenue in part due to the significant decrease in lives due to the ACA expansion and its resulting impact
on state revenue in 2015 and the first half of 2016.
Cost of Services
During the six months ended June 30, 2016,
total cost of services as a percentage of revenue was 70.6% compared to 74.0% for the six months ended June 30, 2015. Total cost
of services for the six months ended June 30, 2016 was $171.9 million, an increase of $3.6 million, or 2.1% compared to $168.3
million for the six months ended June 30, 2015. This change resulted primarily from increases in compensation and direct project
expenses. Compensation expense is composed of salaries and wages, which include overtime, health benefits, stock option expense,
performance awards, commissions, employer’s share of FICA and fringe benefits. Direct project expenses increased as a result
of increases in subcontractor fees, data costs and chart fees. Partially offsetting these increases were decreases in professional
fees and data processing expense.
Selling, General and Administrative Expense
(“SG&A”)
During the six months ended June 30, 2016, SG&A
expense as a percentage of revenue was 18.6% compared to 17.3% for the six months ended June 30, 2015. SG&A expense for the
six months ended June 30, 2016 was $45.2 million, an increase of $6.0 million, or 15.3% compared to $39.2 million for the six months
ended June 30, 2015. This change resulted from a $4.1 million increase in compensation and stock-based compensation expense. SG&A
expense also increased $6.6 million due to an increase in the provision for bad debt expense. The increase in SG&A expense
was offset by a $4.8 million decrease in legal expense related to the settlement of litigation and certain disputes. See Note
11, Commitments and Contingencies.
Operating Income
During the six months ended June 30, 2016, operating
income was $26.3 million, an increase of $6.6 million, or 33.5%, compared to operating income of $19.7 million for the six months
ended June 30, 2015.
Interest Expense
During the six months ended June 30, 2016, interest
expense was $4.2 million, an increase of $0.3 million, compared to $3.9 million for the six months ended June 30, 2015. Interest
expense represents borrowings under our revolving credit facility, interest on debt, commitment fees, letter of credit fees and
amortization of deferred financing costs.
Income Taxes
We recorded income tax expense of $9.1 million for the
six months ended June 30, 2016, compared to income tax expense of $6.9 million for the six months ended June 30, 2015, an increase
of $2.2 million. Income before taxes increased $6.3 million for the six months ended June 30, 2016 over income before taxes in
the same period in the prior year, which caused an increase in our tax expense. Additionally, our effective tax rate decreased
to 40.8% for the six months ended June 30, 2016 compared to 43.6% for the six months ended June 30, 2015 primarily due to a change
state taxes and permanent differences. The principal differences between our statutory rate and our effective rate are state taxes,
interest on unrecognized tax benefits, and permanent items.
Net Income
During the six months ended June 30, 2016, net income
was $13.1 million which represents an increase of $4.2 million compared to net income for the six months ended June 30, 2015 of
$8.9 million.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
Liquidity and Capital Resources
We believe our ability to generate cash from operating
activities is one of our fundamental financial strengths. The near-term outlook for our business remains strong, and we currently
expect to generate substantial cash flows from operations throughout the remainder of 2016. We believe that expected cash flows
from operations, available cash and cash equivalents and funds available under our revolving credit facility under the Credit Agreement
will be sufficient to meet our financial commitments for the next year, whichinclude:
|
·
|
the working capital requirements of our operations;
|
|
·
|
investments in our business;
|
|
·
|
repurchases of treasury stock; and
|
|
·
|
business development activities.
|
We may need to access debt and equity markets in the
future if unforeseen costs or opportunities arise, to fund acquisitions or to repay indebtedness under the Credit Agreement, which
matures in May 2018. If we need to obtain new debt or equity financing in the future, the terms and availability of such financing
may be impacted by economic and financial market conditions as well as our financial condition and results of operations at the
time we seek additional financing.
Our cash and cash equivalents, working capital and available
borrowings under our credit facility (based upon the borrowing base and financial covenants in our Credit Agreement) at June 30,
2016 and December 31, 2015 were as follows:
(In thousands)
|
|
June 30,
2016
|
|
|
December 31,
2015
|
|
Cash and cash equivalents
|
|
$
|
187,884
|
|
|
$
|
145,610
|
|
Working capital
|
|
$
|
285,560
|
|
|
$
|
247,916
|
|
Available borrowings under credit facility
|
|
$
|
188,460
|
|
|
$
|
121,204
|
|
A summary of our cash flows is as follows:
|
|
Six Months Ended
June 30,
|
|
(In thousands)
|
|
2016
|
|
|
2015
|
|
Net cash provided by operating activities
|
|
$
|
45,748
|
|
|
$
|
20,090
|
|
Net cash used in investing activities
|
|
|
(4,874
|
)
|
|
|
(6,362
|
)
|
Net cash provided by financing activities
|
|
|
1,400
|
|
|
|
3,585
|
|
Net increase in cash and cash equivalents
|
|
$
|
42,274
|
|
|
$
|
17,313
|
|
Cash Flows from Operating
Activities
Net cash provided by operating activities
for the six months ended June 30, 2016 was $45.7 million, an increase of $25.7 million as compared to net cash provided by operating
activities of $20.1 million for the six months ended June 30, 2015. The increase in operating cash flow is primarily attributable
to collections of accounts receivable. Additionally, the number of Days Sales Outstanding decreased from the prior year period
by 18 days from 129 days for the six months ended June 30, 2015 to 111 days for the six months ended June 30, 2016 as a result
of stronger cash collections.
Cash Flows from Investing
Activities
Net cash used in investing activities for the six months
ended June 30, 2016 was $4.9 million, a $1.5 million decrease compared to net cash used in investing activities of $6.4 million
for the six months ended June 30, 2015. The decrease primarily related to a $2.9 million reduction in purchases of property and
equipment, partially offset by a $1.4 million increase in investment in capitalized software.
Cash
Flows from Financing Activities
Net cash provided by financing activities for the six
months ended June 30, 2016 was $1.4 million, a $2.2 million decrease from net cash provided by financing activities of $3.6 million
for the six months ended June 30, 2015. This decrease was primarily attributable to a $2.2 million reduction in proceeds from exercise
of stock options.
Contractual Obligations
There have been no material changes in our contractual obligations
as presented in our 2015 Form 10-K.
Recently Issued Accounting Pronouncements
See “Recently Issued Accounting Pronouncements”
in Note 2 of the unaudited Consolidated Financial Statements.