It should be noted that the nature of our business sometimes leads to significant variations in revenue flow. For example, since we receive contingency fees for nearly all our services, we recognize revenue only after our clients have received payment from a third party. In addition, much of our work occurs on an annual or project-specific basis, and does not necessarily recur monthly or quarterly, as do our operating expenses.
The following table sets forth, for the periods indicated, certain items in our consolidated statements of operations expressed as a percentage of revenue:
Revenue for the three months ended March 31, 2008 was $38.9 million, an increase of $6.7 million or 20.8% compared to revenue of $32.2 million in the prior year quarter. The Revenue increase reflects the addition of new clients, changes in the 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.
Compensation expense as a percentage of revenue was 42.5% for the three months ended March 31, 2008 compared to 40.6% for the three months ended March 31, 2007 and for the current quarter was $16.6 million, a $3.5 million or 26.6% increase over the prior year quarter expense of $13.1 million. During the quarter ended March 31, 2008, we averaged 787 employees, a 29.4% increase over our average of 608 employees during the quarter ended March 31, 2007. Increases in compensation expense resulted from the acquisition of Permedion and added staff in the areas of customer support, operations, marketing, government relations and administration.
Data processing expense as a percentage of revenue was 7.6% for the three months ended March 31, 2008 compared to 6.7% for the three months ended March 31, 2007 and for the current quarter was $3.0 million, an increase of $0.8 million or 38.1% over the prior year quarter expense of $2.1 million. Expenses associated with mainframe and network upgrades increased by $0.4 million for software costs, $0.2 million for hardware costs, and $0.1 million for network communication expenses resulting from our increased number of field offices.
Occupancy expense as a percentage of revenue was 6.7% for the three months ended March 31, 2008 compared to 6.1% for the three months ended March 31, 2007 and for the current quarter was $2.6 million, a $0.6 million or 30.7% increase compared to the prior year quarter expense of $2.0 million. This increase reflected approximately $0.2 million for rent increases, $0.2 million for depreciation of leasehold improvements, furniture and fixtures and telephone systems, $0.1 million for equipment moving expenses, and $0.1 million for higher utility costs.
Direct project expense as a percentage of revenue was 14.1% for the three months ended March 31, 2008 compared to 16.0% for the three months ended March 31, 2007 and for the current quarter was $5.5 million, a $0.3 million or 6.5% increase compared to prior year quarter expense of $5.2 million. This increase resulted from higher transaction volumes during the current quarter.
Other operating costs as a percentage of revenue were 11.5% for the three months ended March 31, 2008 compared to 8.8% for the three months ended March 31, 2007 and for the current quarter were $4.5 million, an increase of $1.6 million or 57.8% compared to the prior year quarter expense of $2.8 million. This increase resulted primarily from $1.1 million in additional temporary help and consulting fees, a $0.2 million in travel and related expenses, $0.3 million for local taxes, recruiting fees and supplies expenses, and staff relocation expenses.
Amortization of acquisition-related software and intangibles as a percentage of revenue was 3.0% for the three months ended March 31, 2008 compared to 3.6% for the three months ended March 31, 2007 and for the current quarter was $1.2 million, equivalent to prior year quarter expense of $1.2 million.
Operating income for the three months ended March 31, 2008 was $5.7 million compared to $5.9 million for the three months ended March 31, 2007 primarily due to increased incremental operating cost incurred during the quarter ended March 31, 2008.
Interest expense was $0.4 million for the three months ended March 31, 2008 compared to $0.7 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 September 2006 acquisition of BSPA and amortization of deferred financing costs. Interest income was $0.2 million for the three months ended March 31, 2008 compared to interest income of $0.1 million for the three months ended March 31, 2007 principally due to higher cash balances.
Income tax expense of $2.3 million was recorded in the quarter ended March 31, 2008, equivalent to the $2.3 million in the quarter ended March 31, 2007. Our effective tax rate decreased to 42.0% in 2008 from 43.7% for the year ended December 31, 2007 primarily due to a change in state apportionments. The Company’s tax provision in 2008 is principally a deferred provision as federal income taxes payable have been offset by the benefit of disqualifying dispositions recognized in additional paid in capital. Additionally, the amortization of intangible assets has reduced current taxable income. The principal difference between the statutory rate and the Company’s effective rate is state taxes.
Net income of $3.2 million in the current quarter represents a $0.2 million increase compared to net income of $3.0 million in the prior year quarter.
Off-Balance Sheet Financing Arrangements
We do not have any off-balance sheet financing arrangements, other than operating leases discussed below.
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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. At March 31, 2008, our cash and cash equivalents and net working capital were $16.7 million and $25.2 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 Credit facility. In addition, at March 31, 2008, we had $22.1 million of debt outstanding from the $40.0 million Term Loan originally borrowed to fund the BSPA acquisition in September 2006. The Term Loan requires us to make quarterly payments of $1.575 million.
Operating cash flows could be adversely affected by a decrease in demand for our services. The majority of our client relationships have been in place for several years, and as a result, we do not expect any decrease in the demand for our services in the near term. We anticipate that our existing cash balances and funds generated by operations will be sufficient for all our 2008 cash needs.
For the three months ended March 31, 2008, cash used in operations was $2.6 million compared to cash provided by operations of $0.8 million in the prior year period. The current year period’s difference between net income of $3.2 million and cash used in operations of $2.6 million was principally due to a decrease in accounts payable, accrued expenses and other liabilities of $7.9 million and an increase in accounts receivable of $2.3 million. These were partially offset by non-cash charges, including depreciation and amortization expense of $2.9 million, share-based compensation expense of $0.8 million and a decrease in prepaid expenses of $0.7 million. During the current year period, cash used in investing activities was $2.2 million, reflecting investments in property, equipment and software development. Cash provided by financing activities of $0.2 million consisted $0.8 million received from stock option exercises and a $1.1 million tax benefit from disqualifying dispositions partially offset by $1.6 million of principal payments on the Term Loan.
The number of days sales outstanding (DSO) at March 31, 2008 increased to 97 days compared to 86 days at December 31, 2007. First quarter DSO has historically increased by several days over year-end. 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 timing of the monthly distribution of revenue during the quarter.
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At March 31, 2008, 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 | |
| |
|
|
Contractual obligations | | Total | | Less than 1
year | | 2-3 years | | 4-5 years | | More than
5 years | |
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|
|
|
|
|
|
|
|
|
|
|
Operating leases | | $ | 29,719 | | $ | 6,354 | | $ | 12,037 | | $ | 9,712 | | $ | 1,616 | |
| | | | | | | | | | | | | | | | |
Long-term debt | | | 22,050 | | | 6,300 | | | 12,600 | | | 3,150 | | | — | |
| | | | | | | | | | | | | | | | |
Interest expense(1) | | | 1,868 | | | 880 | | | 966 | | | 22 | | | — | |
| | | | | | | | | | | | | | | | |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total | | $ | 53,637 | | $ | 13,534 | | $ | 25,603 | | $ | 12,884 | | $ | 1,616 | |
| |
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(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):
| | | | | | | | | | | | | |
Total | | Less than
1 Year | | 2-3 Years | | 4-5 Years | | More than
5 years | |
| |
| |
| |
| |
| |
| | | | | | | | | |
$3,103 | | $586 | | $1,182 | | $1,138 | | $197 | |
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 three months ended March 31, 2008, 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 No. 157, Fair Value Measurements (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements, but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, with the exception of the application of the statement to the determination of fair value of nonfinancial assets and liabilities that are recognized or disclosed on a nonrecurring basis, which is effective for fiscal years beginning after November 15, 2008.
SFAS 157 establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows. Level 1 inputs
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are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument. Level 3 inputs are unobservable inputs based on our own assumptions used to measure assets and liabilities at fair value. A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.
At March 31, 2008, our interest rate derivative contract (see note 8) is being carried at fair value and measured on a recurring basis. Fair value is determined through the use of models that consider various assumptions, including time value, yield curves, as well as other relevant economic measures, which are inputs that are classified as Level 2 in the valuation hierarchy.
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,” (SFAS 159) which is effective for fiscal years beginning after November 15, 2007. This statement permits entities to choose to measure many financial instruments and certain other items at fair value. This statement also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. Unrealized gains and losses on items for which the fair value option is elected would be reported in earnings. We have adopted SFAS 159 and have elected not to measure any additional financial instruments and other items at fair value.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (SFAS 141(R)), which replaces SFAS No. 141, “Business Combinations.” SFAS 141(R) retains the underlying concepts of SFAS 141 in that all business combinations are still required to be accounted for at fair value under the acquisition method of accounting but SFAS 141(R) changed the method of applying the acquisition method in a number of significant aspects. Acquisition costs will generally be expensed as incurred; noncontrolling interests will be valued at fair value at the acquisition date; in-process research and development will be recorded at fair value as an indefinite-lived intangible asset at the acquisition date; restructuring costs associated with a business combination will generally be expensed subsequent to the acquisition date; and changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date generally will affect income tax expense. SFAS 141(R) is effective on a prospective basis for all business combinations for which the acquisition date is on or after the beginning of the first annual period subsequent to December 15, 2008, with the exception of the accounting for valuation allowances on deferred taxes and acquired tax contingencies. SFAS 141(R) amends SFAS 109 such that adjustments made to valuation allowances on deferred taxes and acquired tax contingencies associated with acquisitions that closed prior to the effective date of SFAS 141(R) would also apply the provisions of SFAS 141(R). Early adoption is not permitted. We are currently evaluating the effects, if any, that SFAS 141(R) may have on our financial statements
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133” (SFAS 161). This statement is intended to improve transparency in financial reporting by requiring enhanced disclosures of an entity’s derivative instruments and hedging activities and their effects on the entity’s financial position, financial performance, and cash flows. SFAS 161 applies to all derivative instruments within the scope of SFAS 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133) as well as related hedged items, bifurcated derivatives, and nonderivative instruments that are designated and qualify as hedging instruments. Entities with instruments subject to SFAS 161 must provide more robust qualitative disclosures and expanded quantitative disclosures. SFAS 161 is effective prospectively for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application permitted. We are currently evaluating the disclosure implications of this statement.
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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 March 31, 2008, we had total bank debt of $22.1 million. Our interest rate swaps effectively converted $12.0 million of this variable rate debt to fixed rate debt leaving approximately $10.1 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 $100,000 based on the balances outstanding at March 31, 2008.
Item 4. Controls and Procedures
As of March 31, 2008, 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 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 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.
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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, 2007, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K, 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: | May 15, 2008 | 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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