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Item 2.
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Management’s Discussion and Analysis of Financial Condition and Results of Operations
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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 at-risk healthcare organizations 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 September 30, 2017, the Company:
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Serves over 40 state Medicaid programs and the District of Columbia, CMS and the VHA;
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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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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 Nine Months Ended September 30, 2017
Three Months Ended September 30, 2017
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Revenue increased $2.8 million, or 2.3% from the same quarter in 2016
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Operating income increased $0.2 million, or 1.6% from the same quarter in 2016
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Net income decreased $7.6 million, or 54.3% from the same quarter in 2016
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Diluted earnings per share decreased $0.10 or 58.8% from the same quarter in 2016
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Shareholders’ equity at September 30, 2017 increased $14.3 million from June 30, 2017
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Third quarter 2017 cash flow from operations was $34.4 million
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Nine Months Ended September 30, 2017
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Revenue increased $8.6 million, or 2.4% from the first nine months of 2016
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Operating income decreased $7.8 million, or 20.1% from the first nine months of 2016
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Net income decreased $14.2 million, or 49.8% from the first nine months of 2016
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Diluted earnings per share decreased $0.16 or 48.5% from the first nine months of 2016
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Shareholders’ equity increased $30.8 million since December 31, 2016
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Cash flow from operations for the first nine months of 2017 was $55.1 million
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Comparison of Three and Nine Months Ended September 30, 2017 to September 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
September 30,
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Nine Months Ended
September 30,
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2017
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2016
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2017
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2016
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Revenue
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100
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%
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100
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%
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100
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%
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100
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%
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Cost of services:
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Compensation
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39.0
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39.3
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40.2
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39.0
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Data processing
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9.6
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7.7
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8.9
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7.8
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Occupancy
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3.4
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2.8
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3.2
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2.9
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Direct project expenses
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7.6
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9.0
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8.1
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10.1
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Other operating expenses
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5.9
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6.9
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5.7
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5.7
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Amortization of acquisition related software and intangible assets
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6.5
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5.2
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5.8
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5.6
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Total cost of services
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72.0
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70.9
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71.9
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71.1
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Selling, general and administrative expenses
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17.7
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18.8
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19.7
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18.2
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Total operating expenses
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89.7
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89.7
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91.6
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89.3
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Operating income
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10.3
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10.3
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8.4
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10.7
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Interest expense
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(2.5
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)
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(1.7
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)
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(2.1
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)
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(1.7
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)
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Interest income
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—
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—
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—
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—
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Income before income taxes
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7.8
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8.6
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6.3
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9.0
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Income taxes
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2.7
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(2.8
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)
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2.5
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1.2
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Net income
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5.1
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%
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11.4
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%
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3.8
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%
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7.8
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%
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Revenue
Three Months Ended September 30, 2017 vs. 2016
During the three months ended September 30, 2017 revenue was $125.7 million, an increase of $2.8 million, or 2.3% compared to prior year revenue of $122.9 million. The primary reason for the increase in total revenue was due to growth in commercial health plan revenue of $19.7 million as compared to prior year same quarter. This increase was largely driven by Eliza which generated $9.9 million of revenue in the third quarter of 2017. These increases were offset by decreases in Federal, Medicare RAC and other revenue.
Nine Months Ended September 30, 2017 vs. 2016
During the nine months ended September 30, 2017 revenue was $372.7 million, an increase of $8.6 million or 2.4% compared to prior year revenue of $364.1 million. The primary reason for the increase in total revenue was due to growth in commercial health plan revenue of $24.7 million as compared to prior year same period. This increase was largely driven by Eliza which generated $17.5 million of revenue since acquisition. These increases were partially offset by decreases in Federal, Medicare RAC and other 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 September 30, 2017 vs. 2016
During the three months ended September 30, 2017, total cost of services as a percentage of revenue was 72.0% compared to 70.9% for the three months ended September 30, 2016. Total cost of services for the three months ended September 30, 2017 was $90.6 million, an increase of $3.5 million, compared to $87.1 million for the three months ended September 30, 2016. This change resulted primarily from increases in compensation costs, data processing costs, occupancy and amortization of intangible assets. These increases were partially offset by decreases in direct project expenses and other operating expenses.
Nine Months Ended September 30, 2017 vs. 2016
During the nine months ended September 30, 2017, total cost of services as a percentage of revenue was 71.9% compared to 71.1% for the nine months ended September 30, 2016. Total cost of services for the nine months ended September 30, 2017 was $268.2 million, an increase of $9.2 million, compared to $259.0 million for the nine months ended September 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.
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 September 30, 2017 vs. 2016
During the three months ended September 30, 2017, compensation expense as a percentage of revenue was 39.0% compared to 39.3% for the three months ended September 30, 2016. Compensation expense for the three months ended September 30, 2017 was $49.0 million, an increase of $0.7 million, compared to $48.3 million for the three months ended September 30, 2016. This increase resulted primarily from an increase in salaries due to compensation for additional personnel in connection with the Eliza acquisition and increases in stock compensation expense, partially offset by a decrease in fringe benefits and variable compensation.
Nine Months Ended September 30, 2017 vs. 2016
During the nine months ended September 30, 2017, compensation expense as a percentage of revenue was 40.2% compared to 39.0% for the nine months ended September 30, 2016. Compensation expense for the nine months ended September 30, 2017 was $149.8 million, an increase of $7.8 million, compared to $142.0 million for the nine months ended September 30, 2016. This increase resulted primarily from an increase in salaries due to compensation for additional personnel in connection with the Eliza acquisition and increases in stock compensation expense, partially offset by a decrease in fringe benefits and variable compensation.
Data Processing
Three Months Ended September 30, 2017 vs. 2016
During the three months ended September 30, 2017, data processing expense as a percentage of revenue was 9.6% compared to 7.7% for the three months ended September 30, 2016. Data processing expense for the three months ended September 30, 2017 was $12.1 million, an increase of $2.6 million, compared to $9.5 million for the three months ended September 30, 2016. This change resulted primarily from a $2.1 million increase in equipment expense and software costs.
Nine Months Ended September 30, 2017 vs. 2016
During the nine months ended September 30, 2017, data processing expense as a percentage of revenue was 8.9% compared to 7.8% for the nine months ended September 30, 2016. Data processing expense for the nine months ended September 30, 2017 was $33.1 million, an increase of $4.8 million, compared to $28.3 million for the nine months ended September 30, 2016. This change resulted primarily from a $4.7 million increase in equipment expense and software costs.
Occupancy
Three Months Ended September 30, 2017 vs. 2016
During the three months ended September 30, 2017, occupancy expense as a percentage of revenue was 3.4% compared to 2.8% for the three months ended September 30, 2016. Occupancy expense was $4.3 million, an increase of $0.9 million, compared to $3.4 million for the three months ended September 30, 2016. This increase was primarily a result of the acquisition of Eliza.
Nine Months Ended September 30, 2017 vs. 2016
During the nine months ended September 30, 2017, occupancy expense as a percentage of revenue was 3.2% compared to 2.9% for the nine months ended September 30, 2016. Occupancy expense was $12.1 million, an increase of $1.5 million, compared to $10.6 million for the nine months ended September 30, 2016. This increase was primarily a result of the acquisition of Eliza.
Direct Project Expenses
Three Months Ended September 30, 2017 vs. 2016
During the three months ended September 30, 2017, direct project expense as a percentage of revenue was
7.6% compared to 9.0% for the three months ended September 30, 2016. Direct project expenses were $9.5 million for the three months
ended September 30, 2017, a decrease of $1.5 million, compared to $11.0 million for the three months ended September 30, 2016.
The decrease was primarily due to a $1.3 million reduction in expenses related to our contracts with CMS.
Nine Months Ended September 30, 2017 vs. 2016
During the nine months ended September 30, 2017, direct project expense as a percentage of revenue was
8.1% compared to 10.1% for the nine months ended September 30, 2016. Direct project expenses were $30.1 million, a decrease of
$6.9 million compared to $37.0 million for the nine months ended September 30, 2016. This decrease was primarily due to an $8.5
million reduction in expenses related to our contracts with CMS, partially offset by increases related to new initiatives.
Other Operating Expenses
Three Months Ended September 30, 2017 vs. 2016
During the three months ended September 30, 2017, other operating expenses as a percentage of revenue was 5.9% compared to 6.9% for the three months ended September 30, 2016. Other operating expenses for the three months ended September 30, 2017 were $7.4 million, a decrease of $1.1 million, compared to $8.5 million for the three months ended September 30, 2016. This decrease primarily resulted from a $2.6 million decrease in temporary staffing expenses offset by a $1.5 million increase in sub-contractor fees.
Nine Months Ended September 30, 2017 vs. 2016
During the nine months ended September 30, 2017, other operating expenses as a percentage of revenue was 5.7% compared to 5.7% for the nine months ended September 30, 2016. Other operating expenses for the nine months ended September 30, 2017 were $21.2 million, an increase of $0.6 million, compared to $20.6 million for the nine months ended September 30, 2016. This increase primarily resulted from a $7.5 million increase in sub-contractor fees, consulting fees and travel and entertainment expenses. These increases were offset by a $8.2 million decrease in temporary staffing and office related expenses.
Amortization of Acquisition Related Software and Intangible Assets
Three Months Ended September 30, 2017 vs. 2016
During the three months ended September 30, 2017, amortization of acquisition related software and intangibles as a percentage of revenue was 6.5% compared to 5.2% for the three months ended September 30, 2016. Amortization of acquisition related software and intangible assets for the three months ended September 30, 2017 was $8.2 million, an increase of $1.8 million, compared to $6.4 million for the three months ended September 30, 2016. This increase related to the addition of certain intangibles as a result of the Eliza acquisition.
Nine Months Ended September 30, 2017 vs. 2016
During the nine months ended September 30, 2017, amortization of acquisition related software and intangibles as a percentage of revenue was 5.8% compared to 5.6% for the nine months ended September 30, 2016. Amortization of acquisition related software and intangible assets for the nine months ended September 30, 2017 was $21.8 million, an increase of $1.4 million, compared to $20.4 million for the nine months ended September 30, 2016. This increase related to the addition of intangibles in connection with the Eliza acquisition.
Selling, General and Administrative expenses
Three Months Ended September 30, 2017 vs. 2016
During the three months ended September 30, 2017, SG&A expenses as a percentage of revenue was 17.7% compared to 18.8% for the three months ended September 30, 2016. SG&A expenses for the three months ended September 30, 2017 were $22.2 million, a decrease of $0.9 million, compared to $23.1 million for the three months ended September 30, 2016. This decrease was comprised primarily of decreases in legal and other operating expenses partially offset by increases in compensation for the additional personnel in connection with the Eliza acquisition.
Nine Months Ended September 30, 2017 vs. 2016
During the nine months ended September 30, 2017, SG&A expenses as a percentage of revenue was 19.7% compared to 18.2% for the nine months ended September 30, 2016. SG&A expenses for the nine months ended September 30, 2017 were $73.4 million, an increase of $7.2 million, compared to $66.2 million for the nine months ended September 30, 2016. This increase was comprised primarily of increases in compensation for the additional personnel in connection with the Eliza acquisition and consulting fees, partially offset by a reduction in other operating expenses.
Operating Income
Three Months Ended September 30, 2017 vs. 2016
Operating income for the three months ended September 30, 2017, was $12.9 million, an increase of $0.2 million, or 1.6% compared to operating income of $12.7 million for the three months ended September 30, 2016.
Nine Months Ended September 30, 2017 vs. 2016
Operating income for the nine months ended September 30, 2017, was $31.2 million, a decrease of $7.7 million, or 19.8% compared to operating income of $38.9 million for the nine months ended September 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 September 30, 2017 vs. 2016
During the three months ended September 30, 2017, interest expense was $3.1 million, an increase of $1.0 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.
Nine Months Ended September 30, 2017 vs. 2016
During the nine months ended September 30, 2017, interest expense was $7.7 million, an increase of $1.4 million, compared to $6.3 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 $1.6 million in both periods is included within interest expense.
Income Taxes
Three Months Ended September 30, 2017 vs. 2016
During the three months ended September 30, 2017, we recorded income tax expense of $3.4 million, an increase of $6.8 million, compared to income tax benefit of ($3.4) million for the three months ended September 30, 2016. Our effective tax rate increased to 34.8% for the three months ended September 30, 2017 compared to (32.1%) for the three months ended September 30, 2016, primarily due to the Company’s recognition of tax benefits in the third quarter of 2016 for the research and development tax credits and the U.S. production activities deduction for all open tax years at that time. 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.
Nine Months Ended September 30, 2017 vs. 2016
During the nine months ended September 30, 2017, we recorded income tax expense of $9.3 million, an increase of $5.0 million, compared to income tax expense of $4.3 million for the nine months ended September 30, 2016. Our effective tax rate increased to 39.4% for the nine months ended September 30, 2017 compared to 13.2% for the nine months ended September 30, 2016 primarily due to the Company’s recognition of tax benefits in the third quarter of 2016 for the Research and Development tax credits and the U.S. production activities deduction for all open tax years at that time. 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 September 30, 2017 vs. 2016
During the three months ended September 30, 2017, net income was $6.4 million which represents a $7.6 million decrease compared to net income of $14.0 million for the same period in 2016.
Nine Months Ended September 30, 2017 vs. 2016
During the nine months ended September 30, 2017, net income was $14.3 million which represents a $14.2 million decrease compared to net income of $28.5 million for the same period in 2016.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements as of September 30, 2017.
Liquidity and Capital Resources
The following tables should be read in conjunction with the unaudited consolidated financial statements and related notes included in this Quarterly Report on Form 10-Q.
Our cash and cash equivalents, working capital and available borrowings under our credit facility (based upon the borrowing base and financial covenants in our Credit Agreement) were as follows
(in thousands)
:
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September 30,
2017
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December 31,
2016
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Cash and cash equivalents
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$
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79,484
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$
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175,999
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Working capital
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$
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(38,084
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)
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$
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277,478
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Available borrowings under credit facility
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$
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139,356
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$
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183,913
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Our cash flows were as follows
(in thousands)
:
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Nine Months Ended
September 30,
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2017
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2016
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Net cash provided by operating activities
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$
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55,098
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$
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56,222
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Net cash used in investing activities
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(193,494
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)
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(32,120
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)
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Net cash provided by financing activities
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41,881
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|
1,807
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Net (decrease) / increase in cash and cash equivalents
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$
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(96,515
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)
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$
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25,909
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Our cash and cash equivalents and available borrowings under our revolving credit facility were lower as of September 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 September 30, 2017 as compared to December 31, 2016, primarily due to the Eliza acquisition, as well as the classification of amounts outstanding under our revolving credit facility as a current liability at September 30, 2017. Our revolving credit facility matures in May 2018, and consequently, amounts outstanding under the facility are classified as a current liability at September 30, 2017 because such amounts are due within one year.
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 capital investments, 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:
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the working capital requirements of our operations;
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§
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investments in our business;
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§
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business development activities;
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§
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repurchases of common stock; and
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§
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repayment of our revolving credit facility.
|
Any projections of future earnings and cash flows are subject to substantial uncertainty. In addition, we may need to access debt and equity markets in the future if unforeseen costs or opportunities arise. During the second quarter of 2017, we commenced plans to extend or refinance our revolving credit facility, and we are currently engaged in ongoing discussions with potential and existing lenders regarding these plans. We believe it is probable that we will be able to extend or refinance the facility prior to maturity; however, the terms and availability of such financing or any other proposed 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 to obtain such financing.
Cash Flows from Operating Activities
Net cash provided by operating activities for the nine months ended September 30, 2017 was $55.1 million, a decrease of $1.1 million as compared to net cash provided by operating activities of $56.2 million for the nine months ended September 30, 2016. This decrease was primarily attributable to decreases in net income and a decrease in 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 nine months ended September 30, 2017 was $193.5 million, a $161.4 million increase compared to net cash used in investing activities of $32.1 million for the nine months ended September 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 nine months ended September 30, 2017 was $41.9 million, a $40.1 million increase compared to net cash provided by financing activities of $1.8 million for the nine months ended September 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 outside the ordinary course of business 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.