Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following
Management’s Discussion and Analysis should be read in conjunction with the other sections of this Quarterly Report on Form
10-Q, including the unaudited consolidated financial statements, related notes and other financial information appearing elsewhere
in this Quarterly Report, and with our 2016 Form 10-K.
Business
Overview
HMS is
a leading provider of cost containment solutions in the U.S. healthcare marketplace. Using innovative technology as well as extensive
data services and powerful analytics, the Company delivers coordination of benefits, payment integrity, and health management
and member engagement solutions through its operating subsidiaries to help healthcare customers recover improper payments; prevent
future improper payments; reduce fraud, waste and abuse; better manage the care their members receive; and ensure regulatory compliance.
HMS is managed and operates as one business segment, with a single management team reporting to the Chief Executive Officer. The
Company serves commercial health plans, state government agencies, federal programs, at-risk providers, pharmacy benefit managers
and employers. As of June 30, 2017, the Company:
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§
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Serves
over 40 state Medicaid programs and the District of Columbia, CMS and the VHA;
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§
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Provides
services to over 300 health plans in support of their multiple lines of business, including
Medicaid managed care, Medicare Advantage and group and individual health and both at-risk
and ASO; and
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§
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Serves
as a sub-contractor for certain business outsourcing and technology firms.
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Critical
Accounting Policies
Since
the date of our 2016 Form 10-K, there have been no material changes to our critical accounting policies. Refer to the items disclosed
as our Critical Accounting Policies in Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition
and Results of Operations” and Note 1 – “Business and Summary of Significant Accounting Policies” in our
notes to the audited consolidated financial statements under Part II, Item 8 of our 2016 Form 10-K.
SUMMARY
OF OPERATING RESULTS
Selected
Operating Performance and Other Significant Items for the Three and Six Months Ended June 30, 2017
Three
Months Ended June 30, 2017
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§
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Revenue
increased $11.8 million, or 9.7% from the same quarter in 2016
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§
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Operating
income decreased $2.0 million, or 12.2% from the same quarter in 2016
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§
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Net
income decreased $3.4 million, or 34.0% from the same quarter in 2016
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§
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Diluted
earnings per share decreased $0.04 or 33.3% from the same quarter in 2016
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§
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Shareholders’
equity at June 30, 2017 increased $12.2 million from March 31, 2017
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§
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Second
quarter 2017 cash flow from operations was $17.4 million
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Six
Months Ended June 30, 2017
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§
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Revenue
increased $5.8 million, or 2.4% from the first six months of 2016
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§
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Operating
income decreased $8.0 million, or 30.3% from the first six months of 2016
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§
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Net
income decreased $6.5 million, or 44.9% from the first six months of 2016
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§
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Diluted
earnings per share decreased $0.08 or 47.1% from the first six months of 2016
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§
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Shareholders’
equity increased $16.5 million since December 31, 2016
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§
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Cash
flow from operations for the first six months of 2017 was $20.7 million
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Comparison
of Three and Six Months Ended June 30, 2017 to June 30, 2016
The following
table sets forth, for the periods indicated, certain items in our unaudited consolidated statements of income expressed as a percentage
of revenue:
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Three Months
Ended June 30,
|
|
Six Months Ended
June 30,
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Revenue
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
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%
|
Cost of services:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Compensation
|
|
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38.9
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|
|
|
39.0
|
|
|
|
40.8
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|
|
|
38.9
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|
Data processing
|
|
|
8.5
|
|
|
|
7.5
|
|
|
|
8.5
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|
|
|
7.7
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|
Occupancy
|
|
|
3.2
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|
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|
3.0
|
|
|
|
3.2
|
|
|
|
3.0
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|
Direct project expenses
|
|
|
7.6
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|
|
|
9.4
|
|
|
|
8.3
|
|
|
|
10.8
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|
Other operating expenses
|
|
|
4.9
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|
|
|
5.2
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|
|
|
5.6
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|
|
|
5.0
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|
Amortization of acquisition related software and intangible assets
|
|
|
5.5
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|
|
|
5.8
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|
|
|
5.5
|
|
|
|
5.8
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|
Total cost of services
|
|
|
68.6
|
|
|
|
69.9
|
|
|
|
71.9
|
|
|
|
71.2
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Selling, general and administrative expenses
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|
|
20.6
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|
|
|
16.6
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|
|
|
20.7
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|
|
|
17.9
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Total operating expenses
|
|
|
89.2
|
|
|
|
86.5
|
|
|
|
92.6
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|
|
|
89.1
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Operating income
|
|
|
10.8
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|
|
|
13.5
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|
|
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7.4
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|
|
|
10.9
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Interest expense
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|
|
(1.8
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)
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|
|
(1.7
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)
|
|
|
(1.8
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)
|
|
|
(1.7
|
)
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Interest income
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
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|
Income before income taxes
|
|
|
9.0
|
|
|
|
11.8
|
|
|
|
5.6
|
|
|
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9.2
|
|
Income taxes
|
|
|
4.1
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|
|
|
4.8
|
|
|
|
2.4
|
|
|
|
3.8
|
|
Net income
|
|
|
4.9
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%
|
|
|
7.0
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%
|
|
|
3.2
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%
|
|
|
5.4
|
%
|
Revenue
Three
Months Ended June 30, 2017 vs. 2016
During
the three months ended June 30, 2017 revenue was $133.3 million, an increase of $11.8 million or 9.7% compared to prior year revenue
of $121.5 million. The primary reason for the increase in total revenue was due to new commercial health plan revenue contributing
approximately $8.6 million in revenues, as well as an increase in the number of services provided to existing customers. Included
in revenue for commercial health plan revenue is approximately $7.6 million from Eliza. These increases were partially offset
by a decrease in CMS revenue.
Six
Months Ended June 30, 2017 vs. 2016
During
the six months ended June 30, 2017 revenue was $247.0 million, an increase of $5.8 million or 2.4% compared to prior year revenue
of $241.3 million. The primary reason for the increase in total revenue was due to state solutions and new commercial health plan
revenues contributing approximately $9.2 million to the first half of 2017 revenue, including an increase in the number of services
provided to existing customers. Included in revenue for commercial health plan revenue is approximately $7.6 million from Eliza.
These increases were partially offset by a decrease in CMS revenue.
Total
Cost of Services
Total
cost of services consists of compensation, data processing, occupancy, direct project expenses, other operating expenses, and
amortization of acquisition related software and intangible assets.
Three
Months Ended June 30, 2017 vs. 2016
During
the three months ended June 30, 2017, total cost of services as a percentage of revenue was 68.6% compared to 69.9% for the three
months ended June 30, 2016. Total cost of services for the three months ended June 30, 2017 was $91.4 million, an increase of
$6.4 million compared to $85.0 million for the three months ended June 30, 2016. This change resulted primarily from increases
in compensation costs, data processing costs, occupancy, other operating expenses, and amortization of intangible assets. These
increases were partially offset by decreases in direct project expenses.
Six
Months Ended June 30, 2017 vs. 2016
During
the six months ended June 30, 2017, total cost of services as a percentage of revenue was 71.9% compared to 71.2% for the six
months ended June 30, 2016. Total cost of services for the six months ended June 30, 2017 was $177.6 million, an increase of $5.7
million compared to $171.9 million for the six months ended June 30, 2016. This change resulted primarily from increases in compensation
costs, data processing costs, occupancy, other operating expenses. These increases were partially offset by decreases in direct
project expenses.
Compensation
Compensation
expense is primarily composed of salaries and wages, which include overtime, health benefits, stock option expense, performance
awards, commissions, employers’ share of FICA and fringe benefits.
Three
Months Ended June 30, 2017 vs. 2016
During
the three months ended June 30, 2017, compensation expense as a percentage of revenue was 38.9% compared to 39.0% for the three
months ended June 30, 2016. Compensation expense for the three months ended June 30, 2017 was $51.9 million, an increase of $4.6
million compared to $47.3 million for the three months ended June 30, 2016. This increase resulted primarily from an increase
in salaries due to compensation for additional personnel in connection with the Eliza acquisition, partially offset by a decrease
in fringe benefits.
Six Months Ended June 30,
2017 vs. 2016
During
the six months ended June 30, 2017, compensation expense as a percentage of revenue was 40.8% compared to 38.9% for the six months
ended June 30, 2016. Compensation expense for the six months ended June 30, 2017 was $100.8 million, an increase of $7.1 million
compared to $93.7 million for the six months ended June 30, 2016. This increase resulted primarily from increases in salaries
due to compensation for additional personnel in connection with the Eliza acquisition and stock compensation expense.
Data
Processing
Three
Months Ended June 30, 2017 vs. 2016
During
the three months ended June 30, 2017, data processing expense as a percentage of revenue was 8.5% compared to 7.5% for the three
months ended June 30, 2016. Data processing expense for the three months ended June 30, 2017 was $11.3 million, an increase of
$2.2 million compared to $9.1 million for the three months ended June 30, 2016. This change resulted primarily from a $2.0 million
increase in equipment expense and software costs.
Six Months Ended June 30,
2017 vs. 2016
During
the six months ended June 30, 2017, data processing expense as a percentage of revenue was 8.5% compared to 7.7% for the six months
ended June 30, 2016. Data processing expense for the six months ended June 30, 2017 was $21.1 million, an increase of $2.4 million
compared to $18.7 million for the six months ended June 30, 2016. This change resulted primarily from a $2.6 million increase
in equipment expense and software costs.
Occupancy
Three Months Ended June
30, 2017 vs. 2016
During
the three months ended June 30, 2017, occupancy expense as a percentage of revenue was 3.2% compared to 3.0% for the three months
ended June 30, 2016. Occupancy expense was $4.2 million, an increase of $0.6 million compared to $3.6 million for the three months
ended June 30, 2016. This increase was primarily a result of increases in utilities costs.
Six Months Ended June 30,
2017 vs. 2016
During
the six months ended June 30, 2017, occupancy expense as a percentage of revenue was 3.2% compared to 3.0% for the six months
ended June 30, 2016. Occupancy expense was $7.8 million, an increase of $0.5 million compared to $7.3 million for the six months
ended June 30, 2016. This increase was primarily a result of increases in utilities costs.
Direct
Project Expenses
Three
Months Ended June 30, 2017 vs. 2016
During
the three months ended June 30, 2017, direct project expense as a percentage of revenue was 7.6% compared to 9.4% for the three
months ended June 30, 2016. Direct project expenses were $10.1 million for the three months ended June 30, 2017, a decrease of
$1.4 million, compared to $11.5 million for the three months ended June 30, 2016. The decrease was primarily due to a $1.6 million
reduction in expenses related to the CMS contract.
Six
Months Ended June 30, 2017 vs. 2016
During
the six months ended June 30, 2017, direct project expense as a percentage of revenue was 8.3% compared to 10.8% for the six months
ended June 30, 2016. Direct project expenses were $20.5 million, a decrease of $5.5 million compared to $26.0 million for the
six months ended June 30, 2016. This decrease was primarily due to a $6.9 million reduction in expenses related to the CMS contract,
offset by increases in new project costs.
Other
Operating Expenses
Three
Months Ended June 30, 2017 vs. 2016
During
the three months ended June 30, 2017, other operating expenses as a percentage of revenue was 4.9% compared to 5.2% for the three
months ended June 30, 2016. Other operating expenses for the three months ended June 30, 2017 were $6.6 million, an increase of
$0.2 million compared to $6.4 million for the three months ended June 30, 2016. This increase primarily resulted from a $2.9 million
increase in sub-contractor fees, travel and entertainment, and consulting project expenses. These increases were offset by a $2.7
million decrease in temporary staffing and office related expenses.
Six
Months Ended June 30, 2017 vs. 2016
During
the six months ended June 30, 2017, other operating expenses as a percentage of revenue was 5.6% compared to 5.0% for the six
months ended June 30, 2016. Other operating expenses for the six months ended June 30, 2017 were $13.8 million, an increase of
$1.6 million compared to $12.2 million for the six months ended June 30, 2016. This increase primarily resulted from a $6.4 million
increase in sub-contractor fees, travel and entertainment, and consulting project expenses. These increases were offset by a $5.0
million decrease in temporary staffing and office related expenses.
Amortization
of Acquisition Related Software and Intangible Assets
Three
Months Ended June 30, 2017 vs. 2016
During
the three months ended June 30, 2017, amortization of acquisition related software and intangibles as a percentage of revenue
was 5.5% compared to 5.8% for the three months ended June 30, 2016. Amortization of acquisition related software and intangible
assets for the three months ended June 30, 2017 was $7.4 million, an increase of $0.4 million compared to $7.0 million for the
three months ended June 30, 2016. This increase related to the addition of certain intangibles as a result of the Eliza acquisition.
Six
Months Ended June 30, 2017 vs. 2016
During
the six months ended June 30, 2017, amortization of acquisition related software and intangibles as a percentage of revenue was
5.5% compared to 5.8% for the six months ended June 30, 2016. Amortization of acquisition related software and intangible assets
for the six months ended June 30, 2017 was $13.7 million, a decrease of $0.3 million compared to $14.0 million for the six months
ended June 30, 2016. This decrease related to certain intangibles becoming fully amortized slightly offset by the addition of
intangibles in connection with the Eliza acquisition.
Selling,
General and Administrative expenses
Three
Months Ended June 30, 2017 vs. 2016
During
the three months ended June 30, 2017, SG&A expenses as a percentage of revenue was 20.6% compared to 16.6% for the three months
ended June 30, 2016. SG&A expenses for the three months ended June 30, 2017 were $27.6 million, an increase of $7.4 million
compared to $20.2 million for the three months ended June 30, 2016. This increase was comprised primarily of increases in compensation
expense, professional fees and consulting fees, including $3.4 million of Eliza acquisition costs, partially offset by
a reduction in other operating expenses.
Six
Months Ended June 30, 2017 vs. 2016
During
the six months ended June 30, 2017, SG&A expenses as a percentage of revenue was 20.7% compared to 17.9% for the six months
ended June 30, 2016. SG&A expenses for the six months ended June 30, 2017 were $51.2 million, an increase of $8.1 million
compared to $43.1 million for the six months ended June 30, 2016. This increase was comprised primarily of increases in compensation
expense, professional fees and consulting fees, including $4.5 million of Eliza acquisition costs, partially offset by
a reduction in other operating expenses.
Operating
Income
Three
Months Ended June 30, 2017 vs. 2016
Operating
income for the three months ended June 30, 2017, was $14.4 million, a decrease of $2.0 million, or 12.2% compared to operating
income of $16.4 million for the three months ended June 30, 2016.
Six
Months Ended June 30, 2017 vs. 2016
Operating
income for the six months ended June 30, 2017, was $18.3 million, a decrease of $8.0 million, or 30.4% compared to operating income
of $26.3 million for the six months ended June 30, 2016.
Interest
Expense
Interest
expense represents interest on borrowings under our revolving credit facility, amortization of deferred financing costs, commitment
fees for our revolving credit facility and issuance fees for our letter of credit.
Three
Months Ended June 30, 2017 vs. 2016
During
the three months ended June 30, 2017, interest expense was $2.3 million, an increase of $0.2 million compared to $2.1 million
for the same period in the prior year. This increase resulted primarily from an increase in the principal amount on our outstanding
debt. Amortization of deferred financing costs of $0.5 million in both periods is included within interest expense.
Six
Months Ended June 30, 2017 vs. 2016
During
the six months ended June 30, 2017, interest expense was $4.6 million, an increase of $0.4 million compared to $4.2 million for
the same period in the prior year. This increase resulted primarily from an increase in the principal amount on our outstanding
debt. Amortization of deferred financing costs of $1.0 million in both periods is included within interest expense.
Income
Taxes
Three
Months Ended June 30, 2017 vs. 2016
During
the three months ended June 30, 2017, we recorded income tax expense of $5.5 million, an increase of $1.1 million compared to
income tax expense of $4.4 million for the three months ended June 30, 2016. Income before taxes decreased $2.2 million for the
three months ended June 30, 2017 compared to income before taxes in the same period in the prior year, which caused a decrease
in our tax expense. Our effective tax rate increased to 45.9% for the three months ended June 30, 2017 compared to 31.0% for the
three months ended June 30, 2016, primarily due to the prior year’s excess tax benefit. See “Recently Adopted Accounting
Pronouncements” in Note 1 of the unaudited consolidated financial statements. The change is also due to the non-tax deductible
Eliza acquisition transaction costs partially offset by U.S. production activities deduction and research and development tax
credits. The differences between the federal statutory rate and our effective tax rate are state taxes, acquisition related costs
and deferred adjustments, equity compensation impacts, unrecognized tax benefits and permanent differences including the U.S.
production activities deduction and research and development tax credits.
Six
Months Ended June 30, 2017 vs. 2016
During
the six months ended June 30, 2017, we recorded income tax expense of $5.9 million, a decrease of $1.8 million compared to income
tax expense of $7.7 million for the six months ended June 30, 2016. Income before taxes decreased $8.3 million for the six months
ended June 30, 2017 compared to income before taxes in the same period in the prior year, which caused a decrease in our tax expense.
Our effective tax rate increased to 42.6% for the six months ended June 30, 2017 compared to 34.9% for the six months ended June
30, 2016 primarily due to the prior year’s excess tax benefit. See “Recently Adopted Accounting Pronouncements”
in Note 1 of the unaudited consolidated financial statements. The change is also a result of the non-tax deductible Eliza acquisition
transaction costs, partially offset by U.S. production activities deduction and research and development tax credits. The differences
between the federal statutory rate and our effective tax rate are state taxes, acquisition related costs and deferred adjustments,
equity compensation impacts, unrecognized tax benefits and permanent differences including the U.S. production activities deduction
and research and development tax credits.
Net
Income
Three
Months Ended June 30, 2017 vs. 2016
During
the three months ended June 30, 2017, net income was $6.5 million which represents a $3.4 million decrease compared to net income
of $9.9 million for the same period in 2016.
Six
Months Ended June 30, 2017 vs. 2016
During
the six months ended June 30, 2017, net income was $8.0 million which represents a $6.5 million decrease compared to net income
of $14.4 million for the same period in 2016.
Off-Balance
Sheet Arrangements
We do
not have any off-balance sheet arrangements as of June 30, 2017.
Liquidity
and Capital Resources
The following
tables should be read in conjunction with the unaudited consolidated financial statements and related notes included in this Quarterly
Report on Form 10-Q.
Our cash
and cash equivalents, working capital and available borrowings under our credit facility (based upon the borrowing base and financial
covenants in our Credit Agreement) were as follows
(in thousands)
:
|
|
June 30,
2017
|
|
December 31,
2016
|
Cash and cash equivalents
|
|
$
|
51,369
|
|
|
$
|
175,999
|
|
Working capital
|
|
$
|
(55,553
|
)
|
|
$
|
277,478
|
|
Available borrowings under credit facility
|
|
$
|
112,498
|
|
|
$
|
183,913
|
|
Our cash
flows were as follows
(in thousands)
:
|
|
Six Months Ended
June 30,
|
|
|
2017
|
|
2016
|
Net cash provided by operating activities
|
|
$
|
20,740
|
|
|
$
|
47,061
|
|
Net cash used in investing activities
|
|
|
(186,681
|
)
|
|
|
(4,874
|
)
|
Net cash provided by financing activities
|
|
|
41,311
|
|
|
|
87
|
|
Net (decrease) / increase in cash and cash equivalents
|
|
$
|
(124,630
|
)
|
|
$
|
42,274
|
|
Our cash
and cash equivalents and available borrowings under credit facility were lower as of June 30, 2017 as compared to December 31,
2016 primarily as a result of our acquisition of Eliza on April 17, 2017. Our working capital was lower as of June 30, 2017 as
compared to December 31, 2016 primarily as a result of the Eliza acquisition as well as the classification of amounts outstanding
under our revolving credit facility as a current liability at June 30, 2017. We acquired Eliza for a cash purchase price of approximately
$171.6 million, after adjustments for working capital, cash, transaction expenses and indebtedness. The acquisition was funded
with available liquidity, consisting of approximately 75% cash on hand and approximately 25% of borrowings under the Company’s
revolving credit facility. The purchase price is subject to certain post-closing purchase price adjustments. Our revolving credit
facility matures in May 2018, and consequently amounts outstanding under the facility were classified as a current liability at
June 30, 2017.
Our principal
source of cash has been our cash flow from operations and our revolving credit facility. Other sources of cash include proceeds
from exercise of stock options and tax benefits associated with stock option exercises. The primary uses of cash are compensation
expenses, data processing, direct project costs, SG&A expenses and acquisitions. We believe that expected cash flows from
operations, available cash and cash equivalents, and funds available under our revolving credit facility will be sufficient to
meet our liquidity requirements until our revolving credit facility matures in May 2018. Our liquidity requirements include:
|
§
|
the
working capital requirements of our operations;
|
|
§
|
investments
in our business;
|
|
§
|
business
development activities;
|
|
§
|
repurchases
of common stock; and
|
|
§
|
repayment
of our revolving credit facility.
|
Any projections
of future earnings and cash flows are subject to substantial uncertainty. We have commenced discussions to extend or refinance
our revolving credit facility, and believe it is probable that we will be able to refinance or extend the facility prior to maturity.
In addition, we may need to access debt and equity markets in the future if unforeseen costs or opportunities arise. However,
the terms and availability of 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 financing.
Cash
Flows from Operating Activities
Net cash
provided by operating activities for the six months ended June 30, 2017 was $20.7 million, a decrease of $26.3 million as compared
to net cash provided by operating activities of $47.1 million for the six months ended June 30, 2016. This decrease was primarily
attributable to decreases in net income and collections of accounts receivable, partially offset by increases in
accounts payable and income taxes payable.
Cash
Flows from Investing Activities
Net cash
used in investing activities for the six months ended June 30, 2017 was $186.7 million, a $181.8 million increase compared to
net cash used in investing activities of $4.9 million for the six months ended June 30, 2016. The increase primarily related to
the acquisition of Eliza as well as an increase in purchases of property and equipment and investment in capitalized software.
Cash
Flows from Financing Activities
Net cash
provided by financing activities for the six months ended June 30, 2017 was $41.3 million, a $41.2 million increase compared to
net cash provided by financing activities of $0.01 million for the six months ended June 30, 2016. This increase was primarily
related to proceeds from our revolving credit facility partially offset by payment of tax withholdings on behalf of employees
for net-share settlement for stock-based compensation.
Contractual
Obligations
There
have been no material changes in our contractual obligations as presented in our 2016 Form 10-K.
Recently
Issued Accounting Pronouncements
See “Recently
Issued Accounting Pronouncements” in Note 1 of the unaudited consolidated financial statements.