the amortization of intangible assets has reduced current taxable income. Taxes currently payable principally arise from federal alternative minimum tax requirements and state tax liabilities. The principal difference between the statutory rate and the Company’s effective rate is state taxes.
Income from continuing operations was $4.1 million in the current year quarter compared to income from continuing operations of $0.4 million in the prior year quarter. Income from discontinued operations in the prior year was $0.2 million resulting from the resolution of a contingent liability issue. Net income of $4.1 million in the current year represents a $3.5 million increase compared to net income of $0.6 million in the prior year quarter.
The following table sets forth, for the periods indicated, certain items in our consolidated statements of income expressed as a percentage of revenue:
Revenue for the nine months ended September 30, 2007 was $105.0 million, an increase of $50.7 million or 93.3% compared to revenue of $54.3 million in the prior year period. Revenue from contracts obtained with the BSPA acquisition was approximately $48.0 million in the period ended September 30, 2007, an increase of $44.1 million compared to $3.9 million in the prior year period which represented revenue for only the month of September 2006. Exclusive of BSPA, revenue increased by $6.6 million, which represents additional clients, changes in volumes, yields and scope of client projects, and differences in the timing of when client projects were completed in the current year compared to the prior year. Immediately following the BSPA acquisition, we began to convert its projects to our legacy-processing platform as well as integrating BSPA and HMS management teams. As a result, while a particular contract may have been acquired with BSPA, the results achieved reflect combined management and processing technology.
Compensation expense as a percentage of revenue was 38.9% for the nine months ended September 30, 2007 compared to 45.9% for the nine months ended September 30, 2006 and for the
current period was $40.9 million, a $15.9 million or 63.9% increase over the prior year period expense of $24.9 million. During the nine-month period ended September 30, 2007, we averaged 637 employees, a 64.6% increase over our average of 387 employees during the period ended September 30, 2006. Increases aggregating approximately $3.3 million resulted from variable compensation, share-based compensation, and severance expense. Excluding these items from both periods, base compensation, consisting primarily of salaries and employee benefits, increased approximately 56.1%, significantly below our headcount increase due to the large number of service center employees added as a result of the BSPA acquisition.
Data processing expense as a percentage of revenue was 6.9% for the nine months ended September 30, 2007 compared to 8.8% for the nine months ended September 30, 2006 and for the current period was $7.1 million, an increase of $2.3 million or 48.7% over the prior year period expense of $4.8 million. Expenses increased as a result of mainframe and network upgrades by $1.3 million for software costs, $0.8 million for hardware costs, and $0.2 million for network communication expenses resulting from our increased number of field offices.
Occupancy expense as a percentage of revenue was 6.1% for the nine months ended September 30, 2007 compared to 7.7% for the nine months ended September 30, 2006 and for the current period was $6.4 million, a $2.3 million or 54.7% increase compared to the prior year period expense of $4.2 million. This increase principally reflected additional rent and associated expenses resulting from our BSPA acquisition, together with incremental rent expense of $0.2 million, telephone and utilities expense of $0.1 million, and equipment rental and maintenance expense consistent with existing office expansions and upgrades.
Direct project expense as a percentage of revenue was 15.1% for the nine months ended September 30, 2007 compared to 15.1% for the nine months ended September 30, 2006 and for the current period was $15.8 million, a $7.6 million or 92.6% increase compared to prior year period expense of $8.2 million. This increase resulted from increased revenue for the quarter, and is within our usual 15%-17% direct costs expense rate as a percentage of revenue.
Other operating costs as a percentage of revenue were 10.0% for the nine months ended September 30, 2007 compared to 10.0% for the nine months ended September 30, 2006 and for the current period were $10.5 million, an increase of $5.1 million or 93.3% compared to the prior year period expense of $5.4 million. This increase resulted from a $3.5 million increase in temporary help, consulting and professional fees, a $0.5 million increase in travel, marketing and related expenses, a $0.6 million increase in supplies, recruiting expenses and local taxes, and a $0.5 million increase in insurance costs and other costs.
Amortization of acquisition-related software and intangibles as a percentage of revenue was 3.3% for the nine months ended September 30, 2007 compared to 5.2% for the nine months ended September 30, 2006 and for the current period were $3.5 million, an increase of $0.7 million or 23.1% compared to the prior year period expense of $2.8 million. Amortization of software and intangibles expense of $3.5 million in the current period primarily consists of amortization of software resulting from the purchase of BSPA. Amortization of software and intangibles expense of $2.8 million in the prior year period included both amortization of work-in-progress and software.
Operating income for the nine months ended September 30, 2007 was $20.7 million compared to $4.0 million for the nine months ended September 30, 2006 and was primarily the result of incremental margin associated with the increased revenue.
Interest expense was $1.7 million for the nine months ended September 30, 2007 compared to $0.4 million for the prior year quarter. In both periods, interest expense was attributable to borrowings under the Term Loan used to finance a portion of the BSPA acquisition and amortization of deferred financing costs. Interest income was $0.4 million for the nine months ended September 30, 2007 compared to interest income of $1.6 million for the nine months ended September 30, 2006 principally due to lower cash balances following the BSPA acquisition effective September 1, 2006.
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Income tax expense of $8.4 million was recorded in the period ended September 30, 2007, an increase of $6.3 million from the $2.1 million in the period ended September 30, 2006. Our effective tax rate increased to 43.6% in 2007 from the 42.2% for the year ended December 31, 2006 primarily due to state allocations and an increase in the statutory rate. The Company’s tax provision in 2007 is principally a deferred provision as federal income taxes payable have been offset by the utilization of net operating loss (NOL) carryforwards recorded as deferred tax assets in prior years as well as from the tax benefit of disqualifying dispositions recognized in additional paid in capital during the current year. Additionally, the amortization of intangible assets has reduced current taxable income. Taxes currently payable principally arise from federal alternative minimum tax requirements and state tax liabilities. The principal difference between the statutory rate and the Company’s effective rate is state taxes.
Income from continuing operations was $10.9 million in the current year period compared to income from continuing operations of $3.0 million in the prior year period. Income from discontinued operations in the prior year was $0.4 million resulting from the resolution of a contingent liability issue. Net income of $10.9 million in the current year represents a $7.4 million increase over net income in the prior year period of $3.5 million.
Off-Balance Sheet Financing Arrangements
We do not have any off-balance sheet financing arrangements, other than operating leases discussed below.
Liquidity and Capital Resources
Historically, our principal source of funds has been operations and we had cash, cash equivalents and short-term investments significantly in excess of our operating needs. Prior to September 2006, these excess funds were generally invested in short-term, interest yielding investments. To fund the BSPA acquisition in September 2006, we utilized $41.2 million of our existing cash and borrowed an additional $40 million on the Term Loan. At September 30, 2007, our cash and cash equivalents and net working capital were $6.7 million and $27.9 million, respectively. Although we expect that operating cash flows will continue to be a primary source of liquidity for our operating needs, we also have a $25 million Revolving Credit facility available for future cash flow needs. To date, there have been no borrowings made on the Revolving Loan.
We have several significant cash requirements in 2007. The terms of the BSPA acquisition provided for a cash payment of $15.0 million made on September 28, 2007 as the specified BSPA revenue target for the twelve months ending June 30, 2007 was met. In addition, we estimate that we will purchase approximately $8.0 million of property and equipment during 2007 and that scheduled repayments in 2007 on the Term Loan will approximate $7.9 million. On October 5, 2007, HMS Holdings Acquisition Corp purchased the business of Peer Review Systems, Inc. doing business as Permedion, an independent health care quality review and improvement organization based in Westerville, Ohio. The purchase price was paid in cash and will be accounted for under asset purchase accounting. It is anticipated that the acquisition of Permedionwill not have a material effect on the Company’s liquidity. We anticipate that existing cash balances and funds generated by operations will be sufficient for all our 2007 cash needs. The Company may, however, from time to time, need to borrow on a short-term basis on its available Revolving Credit facility for potential timing differences between cash receipts and payments.
Operating cash flows could be adversely affected by a decrease in demand for our services. Our typical client relationship, however, usually sustains over several years, and as a result we do not expect any decrease in demand in the near term.
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For the nine months ended September 30, 2007, cash provided by operations was $13.8 million compared to $7.8 million in the prior year period. The current year period’s difference between net income of $10.9 million and cash provided by operations of $13.8 million was principally due to non-cash charges, including depreciation and amortization expense of $7.7 million, and the change in deferred taxes of $2.9 million and share-based compensation expense of $1.4 million. These amounts were partially offset by an increase in accounts receivable of $8.6 million and a reduction in accounts payable and accrued expenses of $0.3 million. During the current year period, cash used in investing activities was $22.2 million, reflecting the payment of $15.0 million to PCG of additional consideration for the BSPA acquisition, $7.2 million of investments in property, equipment and software development. Cash provided by financing activities of $2.6 million consisted $3.8 million received from stock option exercises and a $5.1 million tax benefit from disqualifying dispositions partially offset by $6.3 million of principal payments on the Term Loan.
At September 30, 2007, we had $25.2 million of debt outstanding of the $40.0 million Term Loan originally borrowed to fund the BSPA acquisition. The Term Loan requires us to make quarterly payments of $1.575 million.
The number of days sales outstanding (DSO) at September 30, 2007 increased to 94 days compared to 83 days at June 30, 2007. Third quarter DSO has historically increased by several days over the second quarter. A substantial portion of the increase in the current quarter’s DSO levels resulted from state government administrative delays in payment processing, together with the variability of revenue recognition during the quarter.
At September 30, 2007, our primary contractual obligations, which consist principally of amounts due under future lease payments and payments of principal and interest on long-term debt, are as follows (in thousands):
| | | | Primary Contractual Payments due by period | | | |
| | | | | | | Less than 1 | | | | | | | | | More than |
| Contractual obligations | | | Total | | | year | | | 2-3 years | | | 4-5 years | | | 5 years |
| | | | | | | | | | | | | | | | |
| Operating leases | | $ | 33,316 | | $ | 6,300 | | $ | 12,673 | | $ | 10,903 | | $ | 3,440 |
| | | | | | | | | | | | | | | | |
| Long-term debt | | | 25,200 | | | 6,300 | | | 12,600 | | | 6,300 | | | - |
| | | | | | | | | | | | | | | | |
| Interest expense(1) | | | 3,359 | | | 1,433 | | | 1,680 | | | 246 | | | - |
| | | | | | | | | | | | | | | | |
| Total | | $ | 61,875 | | $ | 14,033 | | $ | 26,953 | | $ | 17,449 | | $ | 3,440 |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| |
| (1)Future interest payments are estimates of amounts due on long-term debt and credit facility at current interest rates and based on scheduled repayments of principal. |
We have entered into sublease arrangements for some of our facility obligations and expect to receive the following rental receipts (in thousands):
| | | | Less than | | | | | | More than |
| | Total | | 1Year | | 2-3 Years | | 4-5 Years | | 5 years |
| |
| | $3,475 | | $669 | | $1,171 | | $1,218 | | $417 |
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As a result of BSPA exceeding target revenue for the twelve months ended June 30, 2007, we paid $15.0 million of additional cash consideration paid to PCG on September 28, 2007. We paid this amount was paid from existing cash balances. Our FIN No. 48 liabilities, as disclosed in Note 5 to the consolidated financial statements, are not material.
On May 28, 1997, the Board of Directors authorized us to repurchase such number of shares of our common stock that have an aggregate purchase price not in excess of $10 million. On February 24, 2006, the Board of Directors increased the authorized aggregate purchase price by $10 million to an amount not to exceed $20 million. During the nine months ended September 30, 2007, no purchases were made. Cumulatively since the inception of the repurchase program, we have repurchased 1,662,846 shares having an aggregate purchase price of $9.4 million.
Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS 157 “Fair Value Measurements”, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The provisions of SFAS 157 are effective as of the beginning of our 2008 fiscal year. We are currently evaluating the impact of adopting SFAS 157 on our financial statements.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities, Including an amendment of FASB Statement No. 115," which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value. SFAS No. 159 is effective as of the beginning of an entity's first fiscal year that begins after November 15, 2007. The adoption of SFAS No. 159 is not expected to have a material impact on our results of operations or our financial position.
Item 3. Quantitative and Qualitative Disclosures About Market Risks
We are exposed to changes in interest rates, primarily from our Term Loan, and use an interest rate swap agreement to fix the interest rate on variable debt and reduce certain exposures to interest rate fluctuations. There is a risk that market rates will decline and the required payments will exceed those based on current market rates on the long-term debt. Our risk management objective in entering into such contracts and agreements is only to reduce our exposure to the effects of interest rate fluctuations and not for speculative investment. At September 30, 2007, we had total bank debt of $25.2 million. Our interest rate swaps effectively converted $12.0 million of this variable rate debt to fixed rate debt leaving approximately $13.2 million of the total long-term debt exposed to interest rate risk. If the effective interest rate for all of our variable rate debt were to increase by 100 basis points (1%), our annual interest expense would increase by a maximum of $132,000 based on the balances outstanding at September 30, 2007.
Item 4. Controls and Procedures
As of September 30, 2007, we carried out an evaluation, under the supervision and with the participation of our management, including our Chairman and Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934. Based upon our evaluation, our Chairman and Chief Executive Officer and Chief Financial Officer
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concluded that our disclosure controls and procedures were effective in enabling us to record, process, summarize and report information required to be included in our periodic SEC filings within the required time period.
There have been no changes in our internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II – OTHER INFORMATION
Item 1A. Risk Factors
In addition to the other information set forth in this report, you should carefully consider the risk factors discussed in Part I,“Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2006, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K, as updated by our quarterly reports on Form 10-Q, are not the only risks facing our Company. Additional risks and uncertainties not currently known to us, or that we currently deem to be immaterial, may also materially adversely affect our business, financial condition and/or operating results.
Item 6. Exhibits
| 31.1 | Certification pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, executed by Robert M. Holster, Chief Executive Officer of HMS Holdings Corp. |
| |
| 31.2 | Certification pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, executed by Walter D. Hosp, Chief Financial Officer of HMS Holdings Corp. |
| |
| 32.1 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, executed by Robert M. Holster, Chief Executive Officer of HMS Holdings Corp. |
| |
| 32.2 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, executed by Walter D. Hosp, Chief Financial Officer of HMS Holdings Corp. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| Date: | November 7, 2007 | | | HMS HOLDINGS CORP. |
| | | | | | | (Registrant) |
| |
| |
| |
| | | | By: | | /s/ Robert M. Holster |
| | | | | | Robert M. Holster |
| | | | | | Chief Executive Officer |
| | | | | | (Principal Executive Officer) |
| |
| |
| |
| |
| | | | By: | | /s/ Walter D. Hosp |
| | | | | | Walter D. Hosp |
| | | | | | Chief Financial Officer (Principal |
| | | | | | Financial Officer and Accounting Officer) |
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Exhibit Index
| Exhibit | | |
| Number | | Description |
| |
| |
| |
| 31.1 | | Certification pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, executed by Robert M. Holster, Chief Executive Officer of HMS Holdings Corp. |
| |
| 31.2 | | Certification pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, executed by Walter D. Hosp, Chief Financial Officer of HMS Holdings Corp. |
| |
| 32.1 | | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, executed by Robert M. Holster, Chief Executive Officer of HMS Holdings Corp. |
| |
| 32.2 | | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, executed by Walter D. Hosp, Chief Financial Officer of HMS Holdings Corp. |
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