HMS Holdings Corp.
HMS HOLDINGS CORP (Form: 10-Q, Received: 11/06/2009 15:00:35)
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2009
OR
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 000-50194
HMS HOLDINGS CORP.
(Exact name of registrant as specified in its charter)
     
New York   11-3656261
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer)
Identification No.)
     
401 Park Avenue South, New York, New York
(Address of principal executive offices)
  10016
(Zip Code)
(212) 725-7965
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  þ  No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for shorter period that the registrant was required to submit and post such files). Yes  o  No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer, accelerated filer, non-accelerated filer and smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o Accelerated filer þ
Non-accelerated filer o
(Do not check if a smaller reporting company)
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o  No  þ
The number of shares common stock, $.01 par value, outstanding as of November 2, 2009 was 26,332,231.
 
 

 

 


 

HMS HOLDINGS CORP. AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2009
TABLE OF CONTENTS
         
    Page  
PART I — FINANCIAL INFORMATION
       
Item 1. Consolidated Financial Statements
       
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    7  
    19  
    29  
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    30  
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    31  
    32  
  Exhibit 10.1
  Exhibit 10.2
  Exhibit 31.1
  Exhibit 31.2
  Exhibit 32.1
  Exhibit 32.2

 

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HMS HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
(unaudited)
                 
    September 30,     December 31,  
    2009     2008  
Assets
               
Current assets:
               
Cash and cash equivalents
  $ 69,532     $ 49,216  
Accounts receivable, net of allowance of $627 at September 30, 2009 and $664 at December 31, 2008
    57,794       45,155  
Prepaid expenses
    5,969       3,825  
Other current assets, including net deferred tax assets of $831 at September 30, 2009 and $1,697 at December 31, 2008
    1,415       1,716  
 
           
Total current assets
    134,710       99,912  
 
               
Property and equipment, net
    17,910       17,757  
Goodwill, net
    82,342       82,342  
Deferred income taxes, net
    1,256       2,040  
Intangible assets, net
    20,336       19,823  
Other assets
    983       639  
 
           
 
               
Total assets
  $ 257,537     $ 222,513  
 
           
Liabilities and Shareholders’ Equity
               
 
               
Current liabilities:
               
Accounts payable, accrued expenses and other liabilities
  $ 23,473     $ 22,859  
Current portion of long-term debt
    6,300       6,300  
 
           
Total current liabilities
    29,773       29,159  
 
           
 
               
Long-term liabilities:
               
Long-term debt
    6,300       11,025  
Accrued deferred rent
    3,476       3,257  
Other liabilities
    895       710  
 
           
Total long-term liabilities
    10,671       14,992  
 
           
 
               
Total liabilities
    40,444       44,151  
 
           
 
               
Commitments and contingencies
               
 
               
Shareholders’ equity:
               
Preferred stock — $.01 par value; 5,000,000 shares authorized; none issued
           
Common stock — $.01 par value; 45,000,000 shares authorized; 27,986,107 shares issued and 26,323,261 shares outstanding at September 30, 2009; 27,174,875 shares issued and 25,512,029 shares outstanding at December 31, 2008
    280       272  
Capital in excess of par value
    163,925       146,145  
Retained earnings
    62,285       41,562  
Treasury stock, at cost; 1,662,846 shares at September 30, 2009
and December 31, 2008
    (9,397 )     (9,397 )
Accumulated other comprehensive loss
          (220 )
 
           
 
Total shareholders’ equity
    217,093       178,362  
 
           
 
Total liabilities and shareholders’ equity
  $ 257,537     $ 222,513  
 
           
See accompanying notes to consolidated financial statements.

 

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HMS HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
For the Three and Nine Months Ended September 30, 2009 and 2008
(in thousands, except per share amounts)
(unaudited)
`
                                 
    Three months ended September 30,     Nine months ended September 30,  
    2009     2008     2009     2008  
Revenue
  $ 59,164     $ 48,965     $ 162,920     $ 132,091  
 
                       
 
                               
Cost of services:
                               
 
                               
Compensation
    19,191       15,862       54,537       43,960  
Data processing
    3,476       2,793       10,113       8,022  
Occupancy
    2,540       2,519       7,769       7,286  
Direct project costs
    7,446       7,310       21,170       19,749  
Other operating costs
    3,617       2,711       9,829       7,970  
Amortization of acquisition related software and intangibles
    1,211       1,205       3,643       3,530  
 
                       
 
                               
Total cost of services
    37,481       32,400       107,061       90,517  
 
                               
Selling, general & administrative expenses
    7,322       5,794       20,196       16,272  
 
                       
Total operating expenses
    44,803       38,194       127,257       106,789  
 
                       
Operating income
    14,361       10,771       35,663       25,302  
 
                               
Interest expense
    (254 )     (371 )     (820 )     (1,137 )
Interest income
    46       191       199       520  
 
                       
 
                               
Income before income taxes
    14,153       10,591       35,042       24,685  
Income taxes
    5,774       4,448       14,319       10,368  
 
                       
Net income
  $ 8,379     $ 6,143     $ 20,723     $ 14,317  
 
                       
 
                               
Basic income per share data:
                               
Net income per basic share
  $ 0.32     $ 0.24     $ 0.80     $ 0.57  
 
                       
 
                               
Weighted average common shares outstanding, basic
    26,228       25,083       25,953       24,965  
 
                       
 
                               
Diluted income per share data:
                               
Net income per diluted share
  $ 0.30     $ 0.23     $ 0.75     $ 0.53  
 
                       
 
                               
Weighted average common shares, diluted
    27,697       26,794       27,476       26,778  
 
                       
See accompanying notes to consolidated financial statements.

 

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HMS HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME
For the Nine Months Ended September 30, 2009
(in thousands, except share amounts)
(unaudited)
                                                                 
                                    Accumulated                        
    Common Stock     Capital In             Other                     Total  
    # of Shares     Par     Excess Of     Retained     Comprehensive     Treasury Stock     Shareholders’  
    Issued     Value     Par Value     Earnings     Income/(Loss)     # of Shares     Amount     Equity  
 
                                                               
Balance at December 31, 2008
    27,174,875     $ 272     $ 146,145     $ 41,562     $ (220 )     1,662,846     $ (9,397 )   $ 178,362  
 
                                               
 
                                                               
Comprehensive income:
                                                               
Net income
                      20,723                         20,723  
 
Current period net changes in hedging transactions, net of tax of $147
                            220                   220  
 
                                                             
Total comprehensive income
                                                            20,943  
 
                                                               
Share-based compensation cost
                4,482                               4,482  
Exercise of stock options
    811,232       8       5,725                               5,733  
Excess tax benefit from exercised stock options
                7,573                               7,573  
 
                                               
 
                                                               
Balance at September 30, 2009
    27,986,107     $ 280     $ 163,925     $ 62,285     $       1,662,846     $ (9,397 )   $ 217,093  
 
                                               
See accompanying notes to consolidated financial statements.

 

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HMS HOLDINGS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, 2009 and 2008
(in thousands)
(unaudited)
                 
    Nine months ended September 30,  
    2009     2008  
Operating activities:
               
Net income
  $ 20,723     $ 14,317  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Loss on disposal of fixed assets
    6       53  
Depreciation and amortization
    10,014       8,834  
Share-based compensation expense
    4,482       2,351  
Decrease/(increase) in deferred tax asset
    1,649       (640 )
Changes in assets and liabilities:
               
Increase in accounts receivable
    (10,195 )     (7,380 )
Increase in prepaid expenses and other current assets
    (2,653 )     (888 )
Increase in other assets
    (6 )     (18 )
Increase/(decrease) in accounts payable, accrued expenses and other liabilities
    669       (4,293 )
 
           
 
Net cash provided by operating activities
    24,689       12,336  
 
           
 
               
Investing activities:
               
Purchases of property and equipment
    (6,544 )     (4,908 )
Acquisition of IntegriGuard
    (5,217 )      
Acquisition of Prudent Rx
          (4,030 )
Investment in software
    (1,193 )     (735 )
 
           
 
               
Net cash used in investing activities
    (12,954 )     (9,673 )
 
           
 
               
Financing activities:
               
Proceeds from exercise of stock options
    5,733       1,647  
Repayment of long-term debt
    (4,725 )     (4,725 )
Excess tax benefit from exercised stock options
    7,573       10,738  
 
           
 
               
Net cash provided by financing activities
    8,581       7,660  
 
           
 
               
Net increase in cash and cash equivalents
    20,316       10,323  
 
               
Cash and cash equivalents at beginning of period
    49,216       21,275  
 
           
 
               
Cash and cash equivalents at end of period
  $ 69,532     $ 31,598  
 
           
 
               
Supplemental disclosure of cash flow information:
               
Cash paid for income taxes
  $ 7,165     $ 1,813  
 
           
Cash paid for interest
  $ 674     $ 979  
 
           
 
               
Supplemental disclosure of noncash investing activities:
               
Accrued purchase price relating to PrudentRx acquisition
  $     $ 466  
 
           
Accrued property and equipment purchases
  $ 774     $  
 
           
See accompanying notes to consolidated financial statements.

 

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HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
For the Nine Months Ended September 30, 2009 and 2008
1. Unaudited Interim Financial Information
The management of HMS Holdings Corp. (Holdings or the Company) is responsible for the accompanying unaudited interim consolidated financial statements and the related information included in the notes to the unaudited interim consolidated financial statements. In the opinion of management, the unaudited interim consolidated financial statements reflect all adjustments, including normal recurring adjustments necessary for the fair presentation of our financial position and results of operations and cash flows for the periods presented. Results of operations for interim periods are not necessarily indicative of the results to be expected for the entire year.
We are managed and operated as one business, with a single management team that reports to the chief executive officer. We do not operate separate lines of business with respect to any of our product lines. Accordingly, we do not prepare discrete financial information with respect to separate product lines or by location and do not have separately reportable segments.
These unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements as of and for the year ended December 31, 2008 included in our Annual Report on Form 10-K for such year, as filed with the Securities and Exchange Commission (SEC).
2. Basis of Presentation and Principles of Consolidation
(a) Organization and Business
We provide a variety of cost containment and payment accuracy services relating to government healthcare programs. These services are generally designed to help our clients recover amounts due from liable third parties, reduce their costs, and ensure regulatory compliance.
(b) Principles of Consolidation
The consolidated financial statements include our accounts and transactions and those of our wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
(c) Recent Accounting Pronouncement
In June 2009, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 168 (FAS 168), the Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles. FAS 168 names the FASB Accounting Standards Codification (ASC) as the sole source of authoritative accounting and reporting standards in the United States, in addition to guidance issued by the SEC. The ASC is a restructuring of accounting and reporting standards designed to simplify user access to all authoritative accounting principles generally accepted in the United States (U.S. GAAP) by providing the authoritative literature in a topically organized structure. The ASC reduces the U.S. GAAP hierarchy to two levels, one that is authoritative and one that is not. The ASC is not intended to change U.S. GAAP or any requirements of the SEC. The ASC became authoritative upon its release on July 1, 2009 and is effective for interim and annual periods ending after September 15, 2009. We adopted FASB ASC as of the required effective date of September 30, 2009 and applied its provisions prospectively by providing the new codification references disclosures in our consolidated financial statements.

 

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HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
For the Nine Months Ended September 30, 2009 and 2008
ASC Topic 820 “Fair Value Measurements and Disclosures”, defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. ASC 820 does not require any new fair value measurements, but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. ASC 820 is effective for fiscal years beginning after November 15, 2007, with the exception of the application of the Topic to the determination of fair value of nonfinancial assets and liabilities that are recognized or disclosed on a nonrecurring basis, which is effective as of January 1, 2009.
The Fair Value Measurements and Disclosures Accounting Standard 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 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’s or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.
Effective January 1, 2008, we partially adopted ASC Subtopic 820-10 Section 20 and have applied its provisions to financial assets and liabilities that are recognized or disclosed at fair value on a recurring basis (at least annually). Beginning January 1, 2009, we adopted ASC 820-10 as it related to non-financial assets and liabilities. Applying the provisions of ASC 820-10 to our non-financial assets does not presently have an impact on our financial position, operations or cash flows.
Prior to the expiration of our interest rate swap contract on September 30, 2009, our interest rate swap contract (see Note 8) was 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. During the period ending September 30, 2009, no such non-financial assets and liabilities requiring fair value determination under ASC Subtopic 820-20 Section 50 were recognized or disclosed on a non-recurring basis.
ASC Subtopic 825-10 Section 05 “Financial Instruments”, is effective for fiscal years beginning after November 15, 2007. ASC Subtopic 825-10 permits entities to choose to measure many financial instruments and certain other items at fair value. This Subtopic 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 ASC Subtopic 825-10 Section 05 during 2008 and have elected not to measure any additional financial instruments and other items at fair value.
ASC 805 “Business Combinations” is effective for all acquisitions finalized on or after January 1, 2009. The revised provisions changed a number of significant aspects. Acquisition costs generally are expensed as incurred; noncontrolling interests are valued at fair value at the acquisition date; in-process research and development is recorded at fair value as an indefinite-lived intangible asset at the acquisition date; restructuring costs associated with a business combination are generally expensed subsequent to the acquisition date; and changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date generally affect income tax expense. The revised provisions of the standard are 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. In connection with the acquisition of IntegriGuard during the period ended September 30, 2009, as discussed in Note 4, we have applied the provisions of this standard.

 

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HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
For the Nine Months Ended September 30, 2009 and 2008
ASC 815 “Derivatives and Hedging” requires enhanced disclosures about an entity’s derivative and hedging activities. Entities will be required to provide enhanced disclosures about how and why an entity uses derivative instruments, how these instruments are accounted for, and how they affect the entity’s financial position, financial performance and cash flows. We have applied the revised provisions of the standard as of the required effective date of January 1, 2009 and applied its provisions prospectively by providing the additional disclosures in our consolidated financial statements. We provided single period derivative disclosures for the period ended September 30, 2009, in Note 8, as allowed by ASC Subtopic 815-25. Periods in years after initial adoption will include comparative disclosures.
ASC 350 “Intangibles — Goodwill and Other” is intended to improve the consistency between the useful life of a recognized intangible asset and the period of expected cash flows used to measure the fair value. This pronouncement is effective for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years. The requirements for estimating useful lives must be applied prospectively to intangible assets acquired after the effective date. In connection with the acquisition of IntegriGuard during the period ended September 30, 2009, as discussed in Note 4, we have applied the provisions of this standard.
ASC Subtopic 825-10 “Financial Instruments” requires an entity to provide interim disclosures about the fair value of all financial instruments within the scope of ASC Subtopic 825-10 and to include disclosures related to the methods and significant assumptions used in estimating those instruments. The interim disclosure requirements in ASC 825 are effective for interim and annual periods ending after June 15, 2009. We have provided the required disclosures in Note 2(g) and Note 8.
ASC 855 “Subsequent Events” sets forth general standards of accounting for, and the disclosure of, events that occur after the balance sheet date but before financial statements are issued or are available to be issued.
In the second quarter of 2009, we adopted the provisions of ASC 855. We have evaluated subsequent events through November 6, 2009, which represents the date the financial statements are issued. We provided required disclosures in Note 9.
New FASB guidance (ASU 2009-05) amends ASC Topic 820, Fair Value Measurements (formerly FASB Statement No. 157 , Fair Value Measurements ) to allow companies to use the perspective of an investor that holds the related obligation as an asset when determining the fair value of a liability. The new guidance is effective for interim and annual periods beginning after August 27, 2009 , and applies to all fair-value measurements of liabilities required by GAAP. No new fair-value measurements are required by the standard.
ASC Subtopic 605-25, Revenue Recognition—Multiple-Element Arrangements (EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables”), sets forth requirements that must be met for an entity to recognize revenue from the sale of a delivered item that is part of a multiple-element arrangement when other items have not yet been delivered. One of those current requirements is that there be objective and reliable evidence of the standalone selling price of the undelivered items, which must be supported by either vendor-specific objective evidence (VSOE) or third-party evidence (TPE).

 

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HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
For the Nine Months Ended September 30, 2009 and 2008
ASU 2009-13 (EITF 08-1) amends ASC Subtopic 650-25 to eliminate the requirement that all undelivered elements have VSOE or TPE before an entity can recognize the portion of an overall arrangement fee that is attributable to items that already have been delivered. In the absence of VSOE or TPE of the standalone selling price for one or more delivered or undelivered elements in a multiple-element arrangement, entities will be required to estimate the selling prices of those elements. The overall arrangement fee will be allocated to each element (both delivered and undelivered items) based on their relative selling prices, regardless of whether those selling prices are evidenced by VSOE or TPE or are based on the entity’s estimated selling price. Application of the “residual method” of allocating an overall arrangement fee between delivered and undelivered elements will no longer be permitted upon adoption of ASU 2009-13 (EITF 08-1). Additionally, the new guidance will require entities to disclose more information about their multiple-element revenue arrangements.
The Consensus is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted. If a company elects early adoption and the period of adoption is not the beginning of its fiscal year, the requirements must be applied retrospectively to the beginning of the fiscal year. Retrospective application to prior years is an option, but is not required. In the initial year of application, companies are required to make qualitative and quantitative disclosures about the impact of the changes. We have determined that this ASU will not currently impact our existing accounting over our multiple element arrangement described below in Note 2(f) as the other separate unit of accounting criteria of the standard have not been met.
(d) Use of Estimates
The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reported period. The actual results could differ from those estimates.
(e) Reclassifications and Immaterial Adjustments
In 2008, we modified the presentation of operating expenses to separately present selling, general and administrative expenses for each of the periods presented to conform to SEC regulations. These immaterial modifications had no impact on total operating expenses, operating income, net income and cash flows for the period adjusted.

 

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HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
For the Nine Months Ended September 30, 2009 and 2008
The following table presents the previously reported and the revised balances:
                                 
    Three months ended     Nine months ended  
    September 30, 2008     September 30, 2008  
    Previously             Previously        
    Reported     Revised     Reported     Revised  
 
                               
Operating expenses:
                               
 
                               
Cost of services
                               
 
                               
Compensation
  $ 19,297     $ 15,862     $ 53,122     $ 43,960  
Data processing
    3,059       2,793       8,796       8,022  
Occupancy
    2,763       2,519       7,987       7,286  
Direct project costs
    7,310       7,310       19,749       19,749  
Other operating costs
    4,560       2,711       13,605       7,970  
Amortization of intangibles
    1,205       1,205       3,530       3,530  
 
                       
 
                               
Total cost of services
    38,194       32,400       106,789       90,517  
 
                               
Selling, general and administrative expenses
          5,794             16,272  
 
                       
 
                               
Total operating expenses
  $ 38,194     $ 38,194     $ 106,789     $ 106,789  
 
                       
The consolidated balance sheet as of September 30, 2008 and the statement of cash flows for the nine months ended September 30, 2008 reflect revisions as compared to the previously reported amounts. These revisions were to correct immaterial errors in the manner in which excess tax benefits from stock based compensation were recognized in our interim financial statements. The revisions reduced previously reported income tax payable and increased capital in excess of par value on the consolidated interim balance sheet at September 30, 2008, and increased net cash used in operating activities and net cash provided by financing activities during the period ending September 30, 2008 by $3.5 million. These amounts had no impact on previously reported income tax expense, net income and net changes in cash and cash equivalents.
(f) Revenue Recognition
We recognize revenue for our contingency fee based services when third party payors remit payments to our customers and consequently the contingency is deemed to have been satisfied. This revenue recognition policy is specifically addressed in the SEC’s “Frequently Asked Questions and Answers” bulletin pertaining to Staff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements. Transaction-related revenue is recognized based upon the completion of those transactions or services rendered during a given period.
ASC Subtopic 605-25 “Revenue Arrangements with Multiple Deliverables,” requires contracts with multiple deliverables to be divided into separate units of accounting if certain criteria are met. Arrangements including both implementation and transaction related revenue are accounted for as a single unit of accounting. Since implementation services do not carry a standalone value, the revenue relating to these services is recognized over the term of the customer contract to which it relates.

 

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HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
For the Nine Months Ended September 30, 2009 and 2008
(g) Fair Value of Financial Instruments
The carrying amounts for our cash equivalents, accounts receivable, accounts payable and accrued expense approximate fair value due to their short-term nature.
3. Stock-based Compensation
Presented below is a summary of our option activity for the nine months ended September 30, 2009:
                                 
                    Weighted        
                    average        
            Weighted     remaining     Aggregate  
            average     contractual     intrinsic  
    Shares     exercise     terms     value  
    (in thousands)     price     (in years)     (in thousands)  
Outstanding at January 1, 2009
    4,066     $ 12.26                  
Granted
    10     $ 34.51                  
Exercised
    (811 )   $ 7.07                  
Forfeitures
    (25 )   $ 20.56                  
Expired
    (1 )   $ 25.45                  
 
                           
Outstanding at September 30, 2009
    3,239     $ 13.56       4.75     $ 78,226  
 
                       
 
                               
Vested or expected to vest at September 30, 2009
    3,154     $ 13.31       4.51     $ 76,943  
 
                       
 
                               
Exercisable at September 30, 2009
    1,900     $ 7.78       4.27     $ 56,864  
 
                       
The fair value of each option grant was estimated using the Black-Scholes option pricing model and the related compensation expense is recognized ratably over the contractual service period, which is typically the vesting period. This model uses the expected term of the option, the expected volatility of the price of our common stock, risk free interest rates and expected dividend yield of our common stock. Expected volatilities are calculated based on the historical volatility of our stock. Management monitors share option exercise and employee termination patterns to estimate forfeiture rates within the valuation model. Separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. The expected holding period of options represents the period of time that options granted are expected to be outstanding. The risk-free interest rate for periods within the contractual life of the option is based on the interest rate of a 5-year U.S. Treasury note in effect on the date of the grant.
In February 2009, we granted 127,918 restricted stock awards. These restricted stock awards were assigned a price of $31.27 and will vest 25%, as of each applicable vesting date of February 19, 2011, February 19, 2012, February 19, 2013 and February 19, 2014, subject to the executives’ continued employment with us.

 

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HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
For the Nine Months Ended September 30, 2009 and 2008
As of September 30, 2009, there was approximately $12.0 million of total unrecognized compensation cost related to stock options and restricted stock outstanding. That cost is expected to be recognized over a weighted-average period of 2.3 years. No compensation cost related to stock options or restricted stock was capitalized for the three months ended September 30, 2009.
The following table summarizes the weighted average assumptions utilized in developing the Black-Scholes pricing model:
                 
    Nine months ended  
    September 30,  
    2009     2008  
 
               
Expected dividend yield
    0 %     0 %
Risk-free interest rate
    2.34 %     2.6 %
Expected volatility
    44.9 %     39.7 %
Expected life
  4.0 years   5.0 years
No stock options were granted during the three-month period ended September 30, 2009.
The total intrinsic value of options exercised during the three months ended September 30, 2009 and 2008 was $4.5 million and $2.7 million, respectively. During the nine months ended September 30, 2009 and 2008, total intrinsic value of options exercised was $21.2 million and $9.1 million, respectively.
Total compensation cost for share-based payments arrangements charged against income for the three months ended September 30, 2009 and 2008 was $1.6 million and $0.8 million, respectively. The total income tax benefit recognized in the income statement for share-based arrangements for the three months ended September 30, 2009 and 2008 was $0.6 million and $0.4 million, respectively.
Total compensation cost for share-based payments arrangements charged against income for the nine months ended September 30, 2009 and 2008 was $4.5 million and $2.4 million, respectively. The total income tax benefit recognized in the income statement for share-based arrangements for the nine months ended September 30, 2009 and 2008 was $1.8 million and $1.0 million, respectively. See Note 9, for stock-based compensation awards approved and granted on October 1, 2009.
4. Acquisitions
On September 29, 2009, we acquired all the issued and outstanding membership interests of IntegriGuard LLC (IntegriGuard), an ISO-certified and Utilization Review Accreditation Commission (URAC) accredited organization providing services to the prevention and detection of fraud, waste, and abuse in the healthcare system. The company is based in Omaha, Nebraska and operates as a wholly owned subsidiary. With this acquisition, we further expanded our portfolio of program integrity service offerings for government healthcare programs, particularly in the Medicare and Medicaid programs. IntegriGuard’s services include audit, compliance and education, data and analysis, eligibility verification, medical review, and investigation services. In addition to being designated by the Centers for Medicare and Medicaid Services (CMS) as one of 12 Program Safeguard Contractors, IntegriGuard is also one of eight Qualified Independent Contractors for CMS.

 

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HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
For the Nine Months Ended September 30, 2009 and 2008
The purchase price for IntegriGuard was $5.3 million in cash, subject to certain subsequent adjustments based on working capital balances and was accounted for under the purchase method of accounting.
The acquisition of IntegriGuard did not have a material effect on our revenues, earnings, earnings per share or liquidity for the three and nine-month periods ended September 30, 2009.
The allocation of the purchase price was based upon preliminary fair value estimates of the assets and liabilities acquired in accordance with ASC 805 “Business Combinations.” The acquisition of IntegriGuard was based on management’s consideration of past and expected future performance as well as the potential strategic fit with our long-term goals. The expected long-term growth, market position and expected synergies to be generated by IntegriGuard were the primary factors which gave rise to an acquisition price which resulted in the recognition of unidentified intangible assets.
As a result of the acquisition occurring late in the current quarter, we have not had adequate time to complete the valuation of assets acquired, accordingly we have not completed the purchase price allocation, therefore, the aggregate purchase price allocation of this acquisition presented below is subject to adjustments:
         
Unidentified goodwill and intangible assets
  $ 3,694  
Identified intangible assets
    5  
Net assets acquired
    1,628  
 
     
 
       
Total purchase price
  $ 5,327  
 
     
As part of the acquisition, the Company and Lumetra (seller) entered into a twelve months Intercompany Services Agreement (the ISA) to allow each party to perform contractual transition services. Services performed under the ISA are billed at pre-determined rates as specified in the ISA.
On September 16, 2008, we purchased the net assets of Prudent Rx, Inc. (Prudent Rx), an independent pharmacy audit and cost containment company based in Culver City, California. With this acquisition, we further expanded our portfolio of program integrity service offerings for government healthcare programs and managed care organizations, particularly in the pharmacy arena. Prudent Rx’s key products and services include audit programs, program design and benefit management, as well as general and pharmacy systems consulting.
The purchase price of Prudent Rx’s net assets, inclusive of the acquisition cost, was approximately $4.5 million and was accounted for under the asset purchase accounting model. Additional future payments of $2.3 million ($1.15 million for each of the years ending December 31, 2009 and 2010) will be made contingent upon Prudent Rx meeting certain financial performance milestones and will be recorded as additional goodwill upon meeting the milestones.
The acquisition of Prudent Rx did not have a material effect on our revenues, earnings, earnings per share or liquidity for the three and nine-month periods ended September 2009.
The allocation of the purchase price was based upon fair value estimates of the assets and liabilities. The acquisition of Prudent Rx was based on management’s consideration of past and expected future performance as well as the potential strategic fit with our long-term goals. The expected long-term growth, market position and expected synergies to be generated by Prudent Rx were the primary factors which gave rise to an acquisition price which resulted in the recognition of goodwill.

 

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HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
For the Nine Months Ended September 30, 2009 and 2008
The allocation of the aggregate purchase price of this acquisition is as follows:
         
Goodwill
  $ 2,100  
Identifiable intangible assets
    1,432  
Net assets acquired
    964  
 
     
 
       
Total Purchase Price
  $ 4,496  
 
     
Identifiable intangible assets principally include customer relationships and Prudent Rx’s trade name.
5. Income Taxes
We file income tax returns with the U.S. federal government and various state jurisdictions. We are no longer subject to U.S. federal income tax examinations for years before 2006. We operate in a number of state and local jurisdictions, substantially all of which have never audited our records. Accordingly, we are subject to state and local income tax examinations based upon the various statutes of limitations in each jurisdiction.
At September 30, 2009, we had net operating loss carry-forwards (NOLs) of $0.3 million which are subject to limitation set forth in the Internal Revenue Code of 1986, as amended (Code) and are available to offset future federal and state and local taxable income.
During the nine-month period ended September 30, 2009 and 2008, we recorded a tax benefit of $7.6 million and $10.7 million, respectively, related to the utilization of the income tax benefit from stock transactions by reducing income tax payable and crediting capital. For the nine-month period ended September 30, 2009, we utilized excess tax deductions of $19.1 million of excess tax benefit generated from 2009 stock option transactions to recognize this tax benefit. For the nine-month period ended September 30, 2008, we utilized $26.8 million from stock options transactions and related NOL carry-forwards to recognize this tax benefit.
There was no change in the valuation allowance from December 31, 2008. At September 30, 2009, the valuation allowance was $2.7 million. The sale of our subsidiary, Accordis Inc. (Accordis) in 2005 resulted in a capital loss of $6.0 million, which can be carried forward for five years and produced a deferred tax asset of $2.5 million. We believe the available objective evidence, principally the capital loss carryforward being utilizable to offset only future capital gains, creates sufficient uncertainty regarding the realizability of our capital loss carryforward that it is more likely than not, that substantially all of the capital loss carryforward is not realizable.
The remaining valuation allowance of $0.2 million relates to certain state NOLs where we do not currently operate and there is sufficient doubt about our ability to utilize these NOLs that it is more likely than not that this portion of the state NOLs are not realizable.
At September 30, 2009, we had approximately $0.2 million of tax positions for which there is uncertainty about the allocation and apportionment of state tax deductions. If recognized, all of this balance would impact the effective tax rate; however we do not expect any significant change in unrecognized tax benefits during the next twelve months. We recognize interest accrued related to unrecognized tax benefits in interest expense and penalties in operating expense. The accrued liabilities related to uncertain tax positions of approximately $92,000 have not changed since December 31, 2008.

 

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HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
For the Nine Months Ended September 30, 2009 and 2008
6. Earnings Per Share
Basic income per share is calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted income per share is calculated by dividing net income by the weighted average number of common shares and dilutive common share equivalents outstanding during the period. Our common share equivalents consist of stock options and restricted stock awards.
The following reconciles the basic to diluted weighted average shares outstanding:
                                 
    Three months ending     Nine months ending  
    September 30,     September 30,  
    2009     2008     2009     2008  
Weighted average shares outstanding — basic
    26,228       25,083       25,953       24,965  
Potential shares exercisable under stock option plans
    1,454       1,711       1,516       1,813  
Potential issuable restricted stock awards
    15             7        
 
                       
Weighted average shares outstanding — diluted
    27,697       26,794       27,476       26,778  
 
                       
For the three months ended September 30, 2009, 10,000 stock options were not included in the diluted earnings per share calculation because the effect would have been antidilutive. For the three months ended September 30, 2008, 639,000 stock options were not included in the diluted earnings per share calculation because the effect would have been antidilutive.
For the nine months ended September 30, 2009, 4,579 stock options were not included in the diluted earnings per share calculation because the effect would have been antidilutive. For the nine months ended September 30, 2008, 599,000 stock options were not included in the diluted earnings per share calculation because the effect would have been antidilutive.
7. Debt
We have a credit agreement (the Credit Agreement) among the Company, several banks and other financial institutions or entities from time to time parties thereto, and JPMorgan Chase Bank, N.A. (JPMCB), as administrative agent, which was utilized to fund a portion of the purchase price for our 2006 acquisition of the Benefits Solutions Practice Area (BSPA) assets from Public Consulting Group, Inc. The Credit Agreement provides for a term loan of $40 million (the “Term Loan”) and revolving credit loans of up to $25 million (the Revolving Loan). Borrowings under the Credit Agreement mature on September 13, 2011. The loans are secured by a security interest in favor of the lenders covering our assets and subsidiaries. Interest on borrowings under the Credit Agreement is calculated, at our option, at either (i) LIBOR, including statutory reserves, plus a variable margin based on our leverage ratio, or (ii) the higher of (a) the prime lending rate of JPMCB, and (b) the Federal Funds Effective Rate plus 0.50%, in each case plus a variable margin based on our leverage ratio. In connection with the Revolving Loan, we agreed to pay a commitment fee, payable quarterly in arrears, at a variable rate based on our leverage ratio, on the unused portion of the Revolving Loan.

 

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HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
For the Nine Months Ended September 30, 2009 and 2008
Commitments under the Credit Agreement will be reduced and borrowings are required to be repaid with the net proceeds of, among other things, sales or issuances of equity (excluding equity issued under employee benefit plans and equity issued to sellers as consideration in acquisitions), sales of assets and any incurrence of indebtedness by us, subject, in each case, to limited exceptions. Our obligations under the Credit Agreement may be accelerated upon the occurrence of an event of default under the Credit Agreement, which encompasses customary events of default including, without limitation, payment defaults, defaults in the performance of affirmative and negative covenants, the inaccuracy of representations or warranties, bankruptcy and insolvency related defaults, defaults relating to such matters as ERISA, uninsured judgments and the failure to pay certain indebtedness, and a change of control default.
In addition, the Credit Agreement contains affirmative, negative and financial covenants customary for financings of this type. The negative covenants include restrictions on indebtedness, liens, fundamental changes, dispositions of property, investments, dividends and other restricted payments. The financial covenants include a consolidated fixed charge coverage ratio, as defined, of not less than 1.75 to 1.0 and a consolidated leverage ratio as defined not to exceed 3.0 to 1.0, through September 30, 2009. We are in full compliance with these covenants.
The Term Loan requires quarterly repayments of approximately $1.6 million. There have been no borrowings under the Revolving Loan, however, we had outstanding a $4.6 million irrevocable standby letter of credit which relates to contingent, default payment obligations required by a contractual arrangement with a client. As a result of the letter of credit issued, the amount available under the Revolving Loan was reduced by $4.6 million at September 30, 2009. Fees and expenses incurred in 2006 related to the Credit Agreement of $0.9 million have been recorded as Deferred Financing Costs (included in other assets, non-current) and are amortized to interest expense over the five-year life of the credit facilities using the effective interest method.
Long-term debt consists of the following at September 30, 2009 and December 31, 2008:
                 
    September 30,     December 31,  
    2009     2008  
    (in thousands)  
Borrowings under the Credit Agreement:
               
$40 million Term Loan, interest at 1.25%
  $ 12,600     $ 17,325  
$25 million Revolving Loan
           
 
           
Total long-term debt
    12,600       17,325  
Less current portion of long-term debt
    6,300       6,300  
 
           
Long-term debt, net of current portion
  $ 6,300     $ 11,025  
 
           
See Note 9 for disclosure on term-loan payments made on October 28, 2009.

 

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HMS HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
For the Nine Months Ended September 30, 2009 and 2008
8. Derivative Contract
We had an interest rate swap agreement to hedge the fluctuations in variable interest rates which matured on September 30, 2009. We do not use derivative instruments for speculative purposes.
In December 2006, we entered into a three-year interest rate swap agreement, which matured on September 30, 2009, and was accounted for as a cash flow hedge. The agreement effectively converted $12.0 million of our variable rate debt to fixed-rate debt, reducing our exposure to changes in interest rates. Under the swap agreement, we received an average variable LIBOR rate of 1.11% and paid a LIBOR fixed rate of 5.295% for the period from December 31, 2008 to September 30, 2009. The LIBOR interest rates exclude the applicable interest rate spread under our Credit Agreement. We have recognized, net of tax, a reduction to accumulated comprehensive loss of $220,000 for the nine-month period ended September 30, 2009. As the contract has expired as of September 30, 2009, there is no fair value or cumulative unrealized gains and losses at September 30, 2009. The reduction in accumulated loss for the period relates to the change in the derivative’s fair value and reclassification of such derivative gain and losses to interest expense as a yield adjustment of the hedged interest payouts in the same period in which the related interest affect earnings.
The fair value of this swap, a liability of $367,000 at December 31, 2008, was recorded in the consolidated balance sheet as other current liability, with changes in its fair value included in other comprehensive income.
9. Subsequent Events
On October 1, 2009, the Compensation Committee of the Board of Directors approved 339,000 stock option awards and 25,272 restricted stock units to officers, executives, management and board members and employees at the price of $37.82 per share, the closing stock price for the Company’s common stock on the date of the grant. A portion of this stock option grant will be vest over a three-year period, while the balance will vest upon the Company’s achievement of certain predefined performance-based criteria.
On October 28, 2009, the Company paid the remainder of its $12.6 million Term Loan referred to in Note 7.

 

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Special Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains “forward-looking” statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. For this purpose any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believes,” “anticipates,” “plans,” “expects” and similar expressions are intended to identify forward-looking statements. These statements involve unknown risks, uncertainties and other factors, which may cause our actual results to differ materially from those implied by the forward looking statements. Among the important factors that could cause actual results to differ materially from those indicated by such forward-looking statements include those risks identified in “Item 1A-Risk Factors” and other risks identified in our Form 10-K for the year ended December 31, 2008 and presented elsewhere by management from time to time. There have been no material changes from the risk factors previously disclosed in our Form 10-K for the year ended December 31, 2008. Such forward-looking statements represent management’s current expectations and are inherently uncertain. Readers are cautioned that actual results may differ from management’s expectations.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, or U.S. GAAP.
In addition to the information provided below, you should refer to the items disclosed as our critical accounting policies in Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2008.
Revenue Recognition. We principally recognize revenue for our service offerings when third party payors remit payment to our customers and consequently the contingency is deemed to have been satisfied. Arrangements including both implementation and transaction related revenue are accounted for as a single unit of accounting. Since implementation services do not carry a standalone value, the revenue relating to these services is recognized over the term of the customer contract to which it relates. Due to this revenue recognition policy, our operating results may vary significantly from quarter to quarter because of the timing of such collections by our customers and the fact that a significant portion of our operating expenses are fixed.
Expense Classifications: Cost of services in the statement of income is presented in the seven categories noted below. Each category of cost excludes costs relating to selling, general and administrative functions which are presented separately as a component of total operating expenses. All revenue and cost are reported under one operating segment. A description of the primary costs included in each category is provided below:
   
Compensation : Salary, fringe benefit, bonus and stock based compensation costs.
 
   
Data processing : Hardware, software and data communication cost.
 
   
Occupancy : Rent, utilities, depreciation, office equipment, repair and maintenance costs.

 

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Direct project costs : Variable costs incurred from third party providers that are directly associated with specific revenue generating projects.
 
   
Other operating costs : Professional fees, temporary staffing, travel and entertainment, insurance and local and property tax costs.
 
   
Amortization of intangibles : Amortization cost of acquisition-related software and intangible assets.
 
   
Selling, general and administrative : Consists of costs related to general management, marketing and administration activities.
Current Overview
We provide a variety of cost management services for government-sponsored health and human services programs. These services help customers recover amounts due from third parties, avoid and reduce costs, and ensure regulatory compliance.
Our customers are State Medicaid agencies, government-sponsored managed care plans, child support agencies, the Veterans Health Administration, the Centers for Medicare and Medicaid Services and other public programs. We help these programs contain healthcare costs by identifying third party insurance coverage and recovering expenditures that were the responsibility of the third party, or that were paid in error. The identification of other insurance coverage also helps these programs avoid future expenditures.
Our revenue, most of which is derived from contingent fees, grew at an average compounded rate of approximately 33.9% per year for the last five fiscal years. Our growth has been attributable to acquisitions as well as the growth in Medicaid costs, which has historically averaged approximately 8% annually. State governments also have increased their use of vendors for coordination of benefits and other cost containment functions, and we have been able to increase our revenue through these initiatives. Leveraging our work on behalf of state Medicaid fee for service programs, we have penetrated the Medicaid managed care market, into which more Medicaid lives are being shifted. As of September 30, 2009, we served 39 state Medicaid agencies and 109 Medicaid health plans including several of the largest Medicaid health plans in the nation as our clients.
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.

 

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Three Months Ended September 30, 2009 Compared to Three Months Ended September 30, 2008
The following table sets forth, for the periods indicated, certain items in our consolidated statements of income expressed as a percentage of revenue:
                 
    Three months ended September 30,  
    2009     2008  
Revenue
    100.0 %     100.0 %
Cost of services:
               
Compensation
    32.4 %     32.4 %
Data processing
    5.9 %     5.7 %
Occupancy
    4.3 %     5.1 %
Direct project costs
    12.6 %     14.9 %
Other operating costs
    6.1 %     5.6 %
Amortization of acquisition related intangibles
    2.0 %     2.5 %
 
           
Total cost of services
    63.3 %     66.2 %
Selling, general and administrative
    12.4 %     11.8 %
 
           
Total operating expenses
    75.7 %     78.0 %
Operating income
    24.3 %     22.0 %
Interest expense
    -0.4 %     -0.8 %
Interest income
    0.1 %     0.4 %
 
           
Income before income taxes
    24.0 %     21.6 %
Income taxes
    9.8 %     9.1 %
 
           
Net income
    14.2 %     12.5 %
 
           
Revenue for the three months ended September 30, 2009 was $59.2 million, an increase of $10.2 million or 20.8% compared to revenue of $49.0 million in the same quarter for the prior year. The revenue increase reflects the organic growth in existing client accounts, the addition of new clients, including those gained through the acquisition of other companies, 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 comparable quarter in the prior year.
Compensation expense as a percentage of revenue was 32.4% for the three months ended September 30, 2009 compared to 32.4% for the three months ended September 30, 2008 and for the current quarter was $19.2 million, a $3.3 million or 21.0% increase over the same quarter for the prior year expense of $15.9 million. During the quarter ended September 30, 2009, we averaged 966 employees, a 21.1% increase over our average of 798 employees during the quarter ended September 30, 2008. The increase in compensation resulted from a $3.0 million increase due to headcount additions and annual salary increases, a $0.2 million increase for fringe benefits and a $0.1 million increase for variable compensation.
Data processing expense as a percentage of revenue was 5.9% for the three months ended September 30, 2009 compared to 5.7% for the three months ended September 30, 2008 and for the current quarter was $3.5 million, an increase of $0.7 million or 24.5% over the same quarter for the prior year expense of $2.8 million. The increase resulted from a $0.6 million increase in software expense associated with mainframe and network upgrades, and a $0.1 million increase in hardware costs.

 

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Occupancy expense as a percentage of revenue was 4.3% for the three months ended September 30, 2009 compared to 5.1% for the three months ended September 30, 2008 and for the current quarter was $2.5 million, equivalent to the expense in the same quarter for the prior year. Occupancy expense as a percentage of revenue was lower than that in the comparable 2008 period due to savings associated with subleasing one of the floors in our New York City location, together with migrating operational support to our Irving, Texas location.
Direct project expense as a percentage of revenue was 12.6% for the three months ended September 30, 2009 compared to 14.9% for the three months ended September 30, 2008 and for the current quarter was $7.4 million, a $0.1 million or 1.9% increase compared to same quarter for the prior year expense of $7.3 million. This increase resulted from $0.1 million in additional subcontractor expense for the quarter. Direct project expenses increased at a rate lower than revenue growth due to our efforts to reduce subcontractor utilization by bringing the work in-house, savings related to efficiencies and economies of scale, and the content of revenue earned during the quarter.
Other operating costs as a percentage of revenue were 6.1% for the three months ended September 30, 2009 compared to 5.6% for the three months ended September 30, 2008 and for the current quarter were $3.6 million, an increase of $0.9 million or 33.4% compared to the same quarter for the prior year expense of $2.7 million. This increase resulted primarily from increases of $0.4 million for travel, $0.3 million for employee relocation, and $0.2 million in the aggregate for supplies, postage and delivery expenses, all consistent with business expansion.
Amortization of acquisition-related software and intangibles as a percentage of revenue was 2.0% for the three months ended September 30, 2009 compared to 2.5% for the three months ended September 30, 2008 and for the current quarter was $1.2 million, equivalent to the expense in the same quarter for the prior year.
Selling, general, and administrative expense as a percentage of revenue was 12.4% for the three months ended September 30, 2009 compared to 11.8% for the three months ended September 30, 2008 and for the current quarter was $7.3 million, a $1.5 million or 26.4% increase compared to the same quarter for the prior year expense of $5.8 million. During the quarter ended September 30, 2009, we averaged 79 employees, a 19.7% increase over our average of 66 employees during the quarter ended September 30, 2008. Compensation increased by $1.0 million due to a $0.7 million increase in stock compensation expense, a $0.2 million increase due to headcount additions and annual salary increases, and a $0.1 million increase for fringe expenses. Other Costs increased by $0.5 million, primarily due to $0.3 million in transaction costs relating to the IntegriGuard acquisition, and $0.2 million in consulting expenses related to software implementation support.
Operating income for the three months ended September 30, 2009 was $14.4 million, an increase of $3.6 million or 33.3%, compared to $10.8 million for the three months ended September 30, 2008 primarily due to increased revenue partially offset by incremental operating cost incurred during the quarter ended September 30, 2009.
Interest expense was $0.3 million for the three months ended September 30, 2009 compared to $0.4 million for the same quarter for the prior year. In both periods, interest expense was attributable to borrowings under the Term Loan and amortization of deferred financing costs. The decrease in interest expense is due to both lower variable interest rates and a reduction in the principal balance in the current period compared to the prior period. Interest income was $46,000 for the three months ended September 30, 2009 compared to interest income of $191,000 for the three months ended September 30, 2008, principally due to lower interest rates partially offset by higher cash balances.

 

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Income tax expense of $5.8 million was recorded in the quarter ended September 30, 2009 compared to $4.4 million for the three months ended September 30, 2008, an increase of $1.3 million. Our effective tax rate decreased to 40.8% for the quarter ended September 30, 2009 from 42.0% for the quarter ended September 30, 2008 primarily due to a change in state apportionments. The principal difference between the statutory rate and our effective rate is state taxes.
Net income of $8.3 million in the current quarter represents an increase of $2.2 million, or 36.1%, compared to net income of $6.1 million in the same quarter for the prior year.
Nine Months Ended September 30, 2009 Compared to Nine Months Ended September 30, 2008
The following table sets forth, for the periods indicated, certain items in our consolidated statements of operations expressed as a percentage of revenue:
                 
    Nine months ended September 30,  
    2009     2008  
 
               
Revenue
    100.0 %     100.0 %
Cost of services:
               
Compensation
    33.5 %     33.3 %
Data processing
    6.2 %     6.1 %
Occupancy
    4.8 %     5.5 %
Direct project costs
    13.0 %     14.9 %
Other operating costs
    6.0 %     6.0 %
Amortization of acquisition related intangibles
    2.2 %     2.7 %
 
           
Total cost of services
    65.7 %     68.5 %
Selling, general and administrative
    12.4 %     12.3 %
 
           
Total operating expenses
    78.1 %     80.8 %
Operating income
    21.9 %     19.2 %
Interest expense
    -0.5 %     -0.9 %
Interest income
    0.1 %     0.4 %
 
           
Income before income taxes
    21.5 %     18.7 %
Income taxes
    8.8 %     7.9 %
 
           
Net income
    12.7 %     10.8 %
 
           
Revenue for the nine months ended September 30, 2009 was $162.9 million, an increase of $30.8 million or 23.3% compared to revenue of $132.1 million in the prior year period. The revenue increase reflects organic growth in existing client accounts, 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.

 

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Compensation expense as a percentage of revenue was 33.5% for the nine months ended September 30, 2009 compared to 33.3% for the nine months ended September 30, 2008 and for the current period was $54.5 million, a $10.6 million or 24.1% increase over the prior year period expense of $44.0 million. During the nine-month period ended September 30, 2009, we averaged 916 employees, a 19.9% increase over our average of 764 employees during the period ended September 30, 2008. The increase in compensation resulted from a $7.6 million increase due to headcount additions and annual salary increases, a $1.5 million increase for variable compensation, and a $1.5 million increase for fringe benefits.
Data processing expense as a percentage of revenue was 6.2% for the nine months ended September 30, 2009 compared to 6.1% for the nine-months ended September 30, 2008 and for the current period was $10.1 million, an increase of $2.1 million or 26.1% over the prior year period expense of $8.0 million. Expenses associated with mainframe and network upgrades increased by $1.5 million for software costs, $0.5 million for hardware costs, and $0.1 million for communications costs.
Occupancy expense as a percentage of revenue was 4.8% for the nine months ended September 30, 2009 compared to 5.5% for the nine months ended September 30, 2008 and for the current period was $7.8 million, a $0.5 million or 6.6% increase compared to the prior year period expense of $7.3 million. This increase reflected $0.3 million of million of additional equipment expense, rental and maintenance, $0.1 million of additional depreciation of leasehold improvements, furniture and fixtures and telephone systems, and $0.1 million of additional rent expense. Occupancy expense as a percentage of revenue for the nine months ended September 30, 2009, was lower than that in the comparable 2008 period due to savings associated with subleasing one of the floors in our New York City location, together with migrating operational support to our Irving, Texas location.
Direct project expense as a percentage of revenue was 13.0% for the nine months ended September 30, 2009 compared to 14.9% for the nine months ended September 30, 2008 and for the current period was $21.2 million, a $1.4 million or 7.2% increase compared to prior year period expense of $19.7 million. This increase resulted from $1.2 million in additional subcontractor expense for the quarter related to revenue composition and a $0.4 million increase in professional fees, partially offset by $0.2 million decrease in reimbursable and miscellaneous expenses. Direct project expense increased at a rate lower than revenue growth due to our efforts to reduce subcontractor utilization by bringing the work in-house, savings related to efficiencies and economies of scale, and the content of revenue earned during the quarter.
Other operating costs as a percentage of revenue were 6.0% for the nine months ended September 30, 2009 compared to 6.0% for the nine months ended September 30, 2008 and for the current period were $9.8 million, an increase of $1.9 million or 23.3% compared to the prior year period expense of $8.0 million. This resulted from increases of $0.9 million in travel expenses, $0.7 million in consulting, marketing and temporary help expenses, and $0.3 million in the aggregate for supplies, postage and delivery consistent with business expansion.
Amortization of acquisition-related software and intangibles as a percentage of revenue was 2.2% for the nine months ended September 30, 2009 compared to 2.7% for the nine months ended September 30, 2008 and for the current period was $3.6 million, an increase of $0.1 million or 3.2% compared to prior year period expense of $3.5 million. The increase resulted from the Prudent Rx acquisition in the fourth quarter of 2008.

 

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Selling, general, and administrative expense as a percentage of revenue was 12.4% for the nine months ended September 30, 2009 compared to 12.3% for the nine months ended September 30, 2008 and for the current period was $20.2 million, a $3.9 million or 24.1% increase compared to the prior year period expense of $16.3 million. During the nine months ended September 30, 2009, we averaged 74 employees, a 23.3% increase over our average of 60 employees during the nine months ended September 30, 2008. Compensation increased by $3.2 million due to a $2.1 million increase in stock compensation expense, a $0.5 million increase due to headcount additions and annual salary increases, a $0.5 million increase for variable compensation, and a $0.1 million increase for fringe benefits. Occupancy expense increased by $0.5 million related to square footage utilization of the sales, general and administrative group. Other expenses increased by $0.3 million, primarily resulting transaction costs related to the IntegriGuard acquisition. Data processing expenses decreased by $0.1 million related to software leases.
Operating income for the nine months ended September 30, 2009 was $35.7 million, an increase of $10.4 million or 40.9%, compared to $25.3 million for the nine months ended September 30, 2008 primarily due to increased revenue partially offset by incremental operating cost incurred during the quarter ended September 30, 2009.
Interest expense was $0.8 million for the nine months ended September 30, 2009 compared to $1.1 million for the prior year period. In both periods, interest expense was attributable to borrowings under the Term Loan and amortization of deferred financing costs. The decrease in interest expense is due to both lower variable interest rates and a reduction in the principal balance in the current period compared to the prior period. Interest income was $199,000 for the nine months ended September 30, 2009 compared to interest income of $520,000 for the nine months ended September 30, 2008, principally due to lower interest rates partially offset by higher cash balances.
Income tax expense of $14.3 million was recorded in the period ended September 30, 2009 compared to $10.4 million for the period ended September 30, 2008, an increase of $3.9 million. Our effective tax rate decreased to 40.9% in 2009 from 42.0% for the year ended December 31, 2008 primarily due to a change in state apportionments. The principal difference between the statutory rate and our effective rate is state taxes.
Net income of $20.7 million in the current period represents an increase of $6.4 million, or 44.7%, compared to net income of $14.3 million in the prior year period.
Off-Balance Sheet Financing Arrangements
We do not have any off-balance sheet financing arrangements, other than our irrevocable standby letter of credit previously discussed, and the operating leases discussed below.
Liquidity and Capital Resources
Historically, our principal source of funds has been operations and we have sufficient cash and cash equivalents to support our operating needs. At September 30, 2009, our cash and cash equivalents and net working capital were $69.5 million and $104.9 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 $25.0 million Revolving Credit facility available for future cash flow needs. There have been no borrowings under the Revolving Loan, however, we have outstanding a $4.6 million irrevocable standby letter of credit which relates to contingent, default payment obligations required by a contractual arrangement with a client. In addition, at September 30, 2009, we had $12.6 million of debt outstanding from the $40.0 million Term Loan originally borrowed to fund the acquisition of BSPA in September 2006. The Term Loan requires us to make quarterly repayments of approximately $1.6 million.

 

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On October 28, 2009, the Company paid the remainder of its $12.6 million Term Loan.
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.
The number of days sales outstanding (DSO) at September 30, 2009 decreased to 84 days compared to 88 days at September 30, 2008.
At September 30, 2009, our primary contractual obligations, which consist of principal maturities of long-term debt and amounts due under future lease payments, principally of facility lease obligations, 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  
 
                                       
Operating leases
  $ 38,781     $ 9,507     $ 15,350     $ 6,486     $ 7,438  
 
                                       
Long-term debt
    12,600       6,300       6,300              
 
                                       
Interest expense (1)
    180       130       50              
 
                             
 
                                       
Total
  $ 51,561     $ 15,937     $ 21,700     $ 6,486     $ 7,438  
 
                             
     
(1)  
Future interest payments are amounts due on debt at current interest rates and based on the full repayment of the debt on October 28, 2009.
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   1 Year     2-3 Years     4-5 Years     5 years  
 
                               
$5,044
  $ 1,380     $ 2,761     $ 903     $  
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 September 30, 2009, no purchases were made. Since the inception of the repurchase program, we have repurchased 1,662,846 shares having an aggregate purchase price of $9.4 million.

 

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Recent Accounting Pronouncements
In June 2009, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 168 (FAS 168), the Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles. FAS 168 names the FASB Accounting Standards Codification (ASC) as the sole source of authoritative accounting and reporting standards in the United States, in addition to guidance issued by the SEC. The ASC is a restructuring of accounting and reporting standards designed to simplify user access to all authoritative accounting principles generally accepted in the United States (U.S. GAAP) by providing the authoritative literature in a topically organized structure. The ASC reduces the U.S. GAAP hierarchy to two levels, one that is authoritative and one that is not. The ASC is not intended to change U.S. GAAP or any requirements of the SEC. The ASC became authoritative upon its release on July 1, 2009 and is effective for interim and annual periods ending after September 15, 2009. We adopted FASB ASC as of the required effective date of September 30, 2009 and applied its provisions prospectively by providing the new codification references disclosures in our consolidated financial statements.
ASC Topic 820 “Fair Value Measurements and Disclosures”, defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. ASC 820 does not require any new fair value measurements, but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. ASC 820 is effective for fiscal years beginning after November 15, 2007, with the exception of the application of the Topic to the determination of fair value of nonfinancial assets and liabilities that are recognized or disclosed on a nonrecurring basis, which is effective as of January 1, 2009.
The Fair Value Measurements and Disclosures Accounting Standard 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 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’s or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.
Effective January 1, 2008, we partially adopted ASC Subtopic 820-10 Section 20 and have applied its provisions to financial assets and liabilities that are recognized or disclosed at fair value on a recurring basis (at least annually). Beginning January 1, 2009, we adopted ASC 820-10 as it related to non-financial assets and liabilities. Applying the provisions of ASC 820-10 to our non-financial assets does not presently have an impact on our financial position, operations or cash flows.
Prior to the expiration of our interest rate swap contract on September 30, 2009, our interest rate swap contract (see Note 8) was 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. During the period ending September 30, 2009, no such non-financial assets and liabilities requiring fair value determination under ASC Subtopic 820-20 Section 50 were recognized or disclosed on a non-recurring basis.

 

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ASC Subtopic 825-10 Section 05 “Financial Instruments”, is effective for fiscal years beginning after November 15, 2007. ASC Subtopic 825-10 permits entities to choose to measure many financial instruments and certain other items at fair value. This Subtopic 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 ASC Subtopic 825-10 Section 05 during 2008 and have elected not to measure any additional financial instruments and other items at fair value.
ASC 805 “Business Combinations” is effective for all acquisitions finalized on or after January 1, 2009. The revised provisions changed a number of significant aspects. Acquisition costs generally are expensed as incurred; noncontrolling interests are valued at fair value at the acquisition date; in-process research and development is recorded at fair value as an indefinite-lived intangible asset at the acquisition date; restructuring costs associated with a business combination are generally expensed subsequent to the acquisition date; and changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date generally affect income tax expense. The revised provisions of the standard are 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. In connection with the acquisition of IntegriGuard during the period ended September 30, 2009, as discussed in Note 4, we have applied the provisions of this standard.
ASC 815 “Derivatives and Hedging” requires enhanced disclosures about an entity’s derivative and hedging activities. Entities will be required to provide enhanced disclosures about how and why an entity uses derivative instruments, how these instruments are accounted for, and how they affect the entity’s financial position, financial performance and cash flows. We have applied the revised provisions of the standard as of the required effective date of January 1, 2009 and applied its provisions prospectively by providing the additional disclosures in our consolidated financial statements. We provided single period derivative disclosures for the period ended September 30, 2009, in Note 8, as allowed by ASC Subtopic 815-25. Periods in years after initial adoption will include comparative disclosures.
ASC 350 “Intangibles — Goodwill and Other” is intended to improve the consistency between the useful life of a recognized intangible asset and the period of expected cash flows used to measure the fair value. This pronouncement is effective for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years. The requirements for estimating useful lives must be applied prospectively to intangible assets acquired after the effective date. In connection with the acquisition of IntegriGuard during the period ended September 30, 2009, as discussed in Note 4, we have applied the provisions of this standard.
ASC Subtopic 825-10 “Financial Instruments” requires an entity to provide interim disclosures about the fair value of all financial instruments within the scope of ASC Subtopic 825-10 and to include disclosures related to the methods and significant assumptions used in estimating those instruments. The interim disclosure requirements in ASC 825 are effective for interim and annual periods ending after June 15, 2009. We have provided the required disclosures in Note 2(g) and Note 8.
ASC 855 “Subsequent Events” sets forth general standards of accounting for, and the disclosure of, events that occur after the balance sheet date but before financial statements are issued or are available to be issued.

 

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In the second quarter of 2009, we adopted the provisions of ASC 855. We have evaluated subsequent events through November 6, 2009, which represents the date the financial statements are issued. We provided required disclosures in Note 9.
New FASB guidance (ASU 2009-05) amends ASC Topic 820, Fair Value Measurements (formerly FASB Statement No. 157 , Fair Value Measurements ) to allow companies to use the perspective of an investor that holds the related obligation as an asset when determining the fair value of a liability. The new guidance is effective for interim and annual periods beginning after August 27, 2009 , and applies to all fair-value measurements of liabilities required by GAAP. No new fair-value measurements are required by the standard.
ASC Subtopic 605-25, Revenue Recognition—Multiple-Element Arrangements (EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables”), sets forth requirements that must be met for an entity to recognize revenue from the sale of a delivered item that is part of a multiple-element arrangement when other items have not yet been delivered. One of those current requirements is that there be objective and reliable evidence of the standalone selling price of the undelivered items, which must be supported by either vendor-specific objective evidence (VSOE) or third-party evidence (TPE).
ASU 2009-13 (EITF 08-1) amends ASC Subtopic 650-25 to eliminate the requirement that all undelivered elements have VSOE or TPE before an entity can recognize the portion of an overall arrangement fee that is attributable to items that already have been delivered. In the absence of VSOE or TPE of the standalone selling price for one or more delivered or undelivered elements in a multiple-element arrangement, entities will be required to estimate the selling prices of those elements. The overall arrangement fee will be allocated to each element (both delivered and undelivered items) based on their relative selling prices, regardless of whether those selling prices are evidenced by VSOE or TPE or are based on the entity’s estimated selling price. Application of the “residual method” of allocating an overall arrangement fee between delivered and undelivered elements will no longer be permitted upon adoption of ASU 2009-13 (EITF 08-1). Additionally, the new guidance will require entities to disclose more information about their multiple-element revenue arrangements.
The Consensus is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted. If a company elects early adoption and the period of adoption is not the beginning of its fiscal year, the requirements must be applied retrospectively to the beginning of the fiscal year. Retrospective application to prior years is an option, but is not required. In the initial year of application, companies are required to make qualitative and quantitative disclosures about the impact of the changes. We have determined that this ASU will not currently impact our existing accounting over our multiple element arrangement described below in Note 2(f) as the other separate unit of accounting criteria of the standard have not been met.
Item 3. Quantitative and Qualitative Disclosures About Market Risks
None.

 

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Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act) that are designed to ensure that information required to be disclosed by us in reports that we file under the Exchange Act is recorded, processed, summarized and reported as specified in the SEC’s rules and forms and that such information required to be disclosed by us in reports that we file under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer, or CEO, and our Chief Financial Officer, or CFO, to allow timely decisions regarding required disclosure. Management, with the participation of our CEO and CFO, performed an evaluation of the effectiveness of our disclosure controls and procedures as of September 30, 2009. Based on that evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of September 30, 2009.
There have been no changes in our internal control over financial reporting identified in connection with the evaluation of our controls performed during the quarter ended September 30, 2009 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
There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2008. 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, 2008, 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
The Exhibits filed as part of this Quarterly Report on Form 10-Q are listed on the Exhibit Index immediately following the Signatures.

 

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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 6, 2009  
HMS HOLDINGS CORP.
(Registrant)
 
 
  By:    /s/ William C. Lucia    
    William C. Lucia   
    Chief 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 No.   Description
 
   
10.1
  Form Non-Qualified Stock Option Agreement Under the Third Amendment and Restated 2006 Stock Plan
 
   
10.2
  Form Restricted Stock Unit Agreement Under the Third Amendment and Restated 2006 Stock Plan
 
   
31.1
  Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
   
31.2
  Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
   
32.1
  Section 906 Principal Executive Officer Certification.
 
   
32.2
  Section 906 Principal Executive Officer Certification.

 

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Exhibit 10.1

Option No. XXXXX
HMS HOLDINGS CORP.
Non-Qualified Stock Option Agreement
THIS AGREEMENT, made as of the October 1, 2009 between HMS HOLDINGS CORP., a New York corporation (the “Corporation”), and First Name Last Name (the “Optionee”), is pursuant to the 2006 Stock Plan of the Corporation (the “Plan”). The Plan, as adopted by the Board of Directors (the “Board”), was approved by the shareholders (the “Shareholders”) of the Corporation on June 12, 2009. Said Plan, as it may hereafter be amended and continued by the Board and the Shareholders, is incorporated herein by reference and made a part of this Agreement.
The Plan is administered by the Compensation Committee (the “Committee”) of the Board, as defined in the Plan. The Board has determined that it would be to the advantage and interest of the Corporation and its shareholders to grant the option provided for herein to the Optionee as an inducement to remain in the service of the Corporation, or a Parent or a Subsidiary thereof, and as incentive for increased efforts during such service.
NOW, THEREFORE, pursuant to the Plan, the Corporation, with the approval of the Committee, hereby grants to the Optionee as of the date hereof an option (the “Option”) to purchase all or any part of an aggregate of XXX shares of the Corporation’s common shares, $.01 par value per share (the “Common Stock”), at $37.82 per share upon the following terms and conditions:
1. The Option and all rights of the Optionee to purchase shares of Common Stock hereunder shall terminate on October 1, 2016 (hereinafter referred to as the “Expiration Date”).

 

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2. The Optionee’s right and option to purchase one-half of the shares of Common Stock pursuant to the Option shall vest as follows:
         
December 31, 2010
      XXX shares
December 31, 2011
  an additional   XXX shares
December 31, 2012
  an additional   XXX shares
The Optionee’s right and option to purchase the other one-half of the shares of Common Stock pursuant to the Option shall vest in accordance with the requirements set forth on Exhibit A.
3. Once the Option has vested in accordance with the preceding Section 2, it shall continue to be exercisable until the earlier of the termination of the Optionee’s rights hereunder pursuant to Section 5, or the Expiration Date. A partial exercise of the Option shall not affect the Optionee’s right to exercise the Option with respect to the remaining shares subject thereto, subject to the conditions of the Plan and this Agreement. Full payment for shares acquired shall be made in cash at or prior to the time that an Option, or any part thereof, is exercised.
4. (a) Except as provided in Section 5, the Option may not be exercised unless the Optionee is, at the time of exercise, an employee, as defined in the Plan, of the Corporation or of a Parent or Subsidiary, as defined in the Plan, thereof (collectively hereinafter referred to as the “Corporation”). The Option shall not be affected by any change of duties or position so long as the Optionee continues to be an employee of the Corporation. A leave of absence or an interruption in service (including an interruption during military service) authorized or approved by the Corporation shall not be deemed an interruption of employment for the purposes of Section 5.
(b) No partial exercise of the Option may be for less than 100 full shares (or less than all the shares as to which the Option is exercisable, if less than 100 shares), and in no event shall the Corporation be required to issue any fractional shares.

 

Page 2


 

5. (a) In the event the Optionee shall cease to be employed by the Corporation by reason of the Optionee’s death, disability (as defined below) or involuntarily by the Company other than for cause (as defined in paragraph (b) below) within 24 months following a Change in Control (as defined in the Plan), all Options held by the Optionee shall become fully vested and exercisable. In the event the Optionee shall cease to be employed by the Corporation for any other reason, all unexercised Options held by the Optionee which are not then exercisable by the Optionee shall lapse effective the date of termination of employment. For purposes of this Agreement “disability” shall mean permanent and total disability as defined by Section 22(e)(3) of the Internal Revenue Code of 1986, as amended (the “Code”) as it now exists or may hereafter be amended.
(b) To the extent not theretofore exercised, any Options held by the Optionee which are then exercisable shall terminate as follows: If the employment is terminated for any reason other than for cause (as defined below), disability, death or involuntarily by the Corporation other than for cause within 24 months following a Change in Control, any then exercisable Options shall terminate upon the expiration of three months after the termination of employment. If the employment terminates because of disability (as defined in paragraph (a) above) or because of death, any then exercisable Options shall terminate upon the expiration of one year after the termination of employment. If the termination is “for cause” as determined by the Board, which shall be deemed to mean the deliberate gross misconduct of the Optionee or the violation by the Optionee, after any such termination, of the terms of a Restrictive covenant and Confidentiality/Non-Disclosure Agreement with the Corporation, any then exercisable Options shall terminate upon the termination of employment. If the employment is terminated by the Corporation other than for cause (as defined above) within 24 months following a Change in Control, any then exercisable Options shall terminate upon the expiration of one year after the termination of employment.
6. Nothing in this Agreement shall confer upon the Optionee any right to continue in the employ or service of the Corporation or affect the right of the Corporation to terminate the Optionee’s employment or service at any time.
7. (a) The Optionee may exercise the Option with respect to all or any part of the shares then exercisable by giving the Corporation written notice at 401 Park Avenue South, New York, New York 10016. Such notice shall specify the number of shares as to which the Option is being exercised and shall be preceded or accompanied by payment in full in accordance with Section 3 hereof.
(b) Prior to or concurrently with delivery by the Corporation to the Optionee of a certificate(s) representing such shares, the Optionee shall:

 

Page 3


 

(i) upon notification of the amount due, pay promptly any amount necessary to satisfy applicable federal, state or local tax requirements; and
(ii) if such shares are not currently or effectively registered under the Securities Act of 1933, as amended (the “Act”) and applicable state securities laws, give satisfactory assurance in writing signed by the Optionee or his legal representative, as the case may be, that such shares are being purchased for investment and not with a view to the distribution thereof.
(c) As soon as practicable after receipt of the notice and payment referred to in subparagraph (a) of this Section 7, the Corporation shall cause to be delivered to the Optionee at the office of the Corporation at 401 Park Avenue South, New York, New York 10016 or such other place as may be mutually acceptable to the Corporation and the Optionee, a certificate or certificates for such shares; provided however, that the time of such delivery may be postponed by the Corporation for such period of time as may be required for the Corporation, with reasonable diligence, to comply with applicable registration requirements under the Act, the Securities Exchange Act of 1934, as amended, and any requirements under any other law or regulation applicable to the issuance or transfer of shares. If the Optionee fails for any reason to accept delivery of all or any part of the number of shares specified in such notice upon tender of delivery thereof, his right to purchase such undelivered shares may be terminated.
8. In the event of any merger, reorganization, consolidation, recapitalization, stock dividend, stock split, reverse stock split, spin-off, extraordinary cash dividend or similar transaction or other change on corporate structure affecting the Common Stock, the Committee shall make such adjustments and substitutions to the number, class and kind of shares (to the nearest possible full share) and to the price per share subject to the unexercised portion of this Option as the Committee determines to be appropriate in its sole discretion.
9. This Option shall not be transferable other than by will or by the laws of descent and distribution, or pursuant to a qualified domestic relations order as defined by the Code or Title I of the Employee Retirement Income Security Act, or the rules thereunder. During the lifetime of the Optionee, this Option shall be exercisable only by the Optionee. In the event of any attempt by the Optionee to transfer, assign, pledge, hypothecate or otherwise dispose of the Option or of any right hereunder, except as provided for herein or in the 2006 Stock Plan, or in the event of the levy of any attachment, execution or similar process upon the rights or interest hereby conferred, the Corporation may terminate this Option by notice to the Optionee and it shall thereupon become null and void.

 

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IN WITNESS WHEREOF, the Corporation has caused this Agreement to be signed by a duly authorized officer, and the Optionee has affixed his signature hereto.
         
     
  By:   HMS HOLDINGS CORP.    
 
         
     
  Signature:   -S- WILLIAM C. LUCIA    
    William C. Lucia   
    Chief Executive Officer    
 
  Date:   October 1, 2009  
 
  Optionee:      
    First Name Last Name   
 
  Date:    
 

 

Page 5

Exhibit 10.2

RSU Grant No. XXX
HMS HOLDINGS CORP.
Restricted Stock Unit Agreement
THIS AGREEMENT, made as of October 1, 2009 between HMS HOLDINGS CORP., a New York corporation (the “Corporation”), and First Name Last Name (the “Participant”), is pursuant to the 2006 Stock Plan of the Corporation (the “Plan”). The Plan, as amended by the Board of Directors (the “Board”), was last approved by the shareholders (the “Shareholders”) of the Corporation on June 12, 2009. Said Plan, as it may hereafter be amended and continued by the Board and the Shareholders, is incorporated herein by reference and made a part of this Agreement.
The Plan is administered by the Compensation Committee (the “Committee”) of the Board, as defined in the Plan. The Board has determined that it would be to the advantage and interest of the Corporation and its shareholders to grant the restricted stock units provided for herein to the Participant as an inducement to remain in the service of the Corporation, or a Parent or a Subsidiary thereof, and as incentive for increased efforts during such service.
NOW, THEREFORE, pursuant to the Plan, the Corporation, with the approval of the Committee, hereby grants to the Participant as of the date hereof, XXX restricted stock units (the “Units”), upon the following terms and conditions:
1. The Units shall be credited to a bookkeeping account (the “Account”) maintained by the Company for the Participant’s benefit. Each Unit shall be deemed to be the equivalent of one share of the Corporation’s common shares, $.01 par value per share (the “Common Stock”).
2. The Participant’s right to one-half of the Units shall vest as follows:
         
December 31, 2010
      XXX Units
December 31, 2011
  an additional   XXX Units
December 31, 2012
  an additional   XXX Units
The Participant’s right to the other one-half of the Units shall vest in accordance with the requirements set forth on Exhibit A.

 

 


 

3. (a) In the event the Participant shall cease to be employed by the Corporation by reason of the Participant’s death, disability (as defined below) or involuntarily by the Corporation other than for cause (as defined in paragraph (b) below) within 24 months following a Change in Control (as defined in the Plan), all of the Units shall become fully vested. In the event the Participant shall cease to be employed by the Corporation by reason of the Participant’s retirement (as defined below), the Units shall continue to vest under Section 2 and Exhibit A as if the Participant had continued to be employed by the Corporation until the expiration of two years after the Participant’s retirement. In the event the Participant shall cease to be employed by the Corporation for any other reason, the Units which are not then vested shall be forfeited effective as of the date of termination of employment. For purposes of this Agreement (i) “disability” shall mean permanent and total disability as defined by Section 22(e)(3) of the Internal Revenue Code of 1986, as amended as it now exists or may hereafter be amended and (ii) “retirement” shall mean termination of employment on or after attaining age 60 and completing 5 years of service with the Corporation. The vesting of the Units shall not be affected by any change of duties or position so long as the Participant continues to be an employee of the Corporation. A leave of absence or an interruption in service (including an interruption during military service) authorized or approved by the Corporation shall not be deemed an interruption of employment for purposes of this Section.
(b) For purposes of this Section a termination “for cause” as determined by the Board, shall be deemed to mean the deliberate gross misconduct of the Participant or the violation by the Participant, after any such termination, of the terms of a Restrictive Covenant and Confidentiality/Non-Disclosure Agreement with the Corporation.
4. Nothing in this Agreement shall confer upon the Participant any right to continue in the employ or service of the Corporation or affect the right of the Corporation to terminate the Participant’s employment or service at any time.
5. In the event of any merger, reorganization, consolidation, recapitalization, stock dividend, stock split, reverse stock split, spin-off, extraordinary cash dividend or similar transaction or other change on corporate structure affecting the Common Stock, the Committee shall make such adjustments and substitutions to the number of Units credited to the Account and the class and kind of shares (to the nearest possible full share) deemed to be the equivalent of one Unit as the Committee determines to be appropriate in its sole discretion.

 

 


 

6. During the period that Units remain unvested, the Participant shall have none of the rights of a stockholder of the Corporation with respect to the Common Stock subject to the Units. On each date that cash dividends are paid on the Common Stock, the Corporation will credit the Account with a number of additional Units equal to the result of dividing (i) the product of the total number of Units credited to the Account on the record date for such dividend and the per share amount of such dividend by (ii) the Fair Market Value of one share of Common Stock on the date such dividend is paid by the Corporation to shareholders. The additional Units shall be or become vested to the same extent as the Units that resulted in the crediting of such additional Units.
7. The Corporation shall make payments to the Participant of the vested Units credited to the Account upon the dates the Units vest. Payment shall be made in shares of Common Stock equal to the number of vested Stock Units credited to the Account on each such date. Payment shall be made as soon as practicable after the applicable vesting date, but in no event later than 30 days after the applicable vesting date, by delivering the shares to the Participant at the office of the Corporation at 401 Park Avenue South, New York, New York 10016 or such other place as may be mutually acceptable to the Corporation and the Participant. Notwithstanding the foregoing, delivery may be postponed by the Corporation for such period of time as may be required for the Corporation, with reasonable diligence, to comply with applicable registration requirements under the Act, the Securities Exchange Act of 1934, as amended, and any requirements under any other law or regulation applicable to the issuance or transfer of shares.
8. Prior to or concurrently with delivery by the Corporation to the Participant of a certificate(s) representing the shares of Common Stock in payment of Units, the Participant upon notification of the amount due, shall pay promptly to the Corporation any amount necessary to satisfy applicable federal, state or local tax requirements.
9. In the event of the Participant’s death prior to payment of the Units credited to the Account, payment shall be made to the last beneficiary designated in writing that is received by the Company prior to the Participant’s death or, if no designated beneficiary survives the Participant, such payment shall be made to the Participant’s estate. In the event of any attempt by the Participant to transfer, assign, pledge, hypothecate or otherwise dispose of the Units or of any right hereunder, except as provided for herein or in the 2006 Stock Plan, or in the event of the levy of any attachment, execution or similar process upon the rights or interest hereby conferred, the Units to the extent unvested may be forfeited by the Corporation by notice to the Participant.

 

 


 

10. The Units shall not be transferable other than by will or by the laws of descent and distribution, or pursuant to a qualified domestic relations order as defined by the Code or Title I of the Employee Retirement Income Security Act, or the rules thereunder. In the event of any attempt by the Participant to transfer, assign, pledge, hypothecate or otherwise dispose of the Units or of any right hereunder, except as provided for herein or in the 2006 Stock Plan, or in the event of the levy of any attachment, execution or similar process upon the rights or interest hereby conferred, the Corporation may terminate this Units by notice to the Participant and they shall thereupon become null and void.
11. The Participant’s right to receive payment under this Agreement shall be an unfunded entitlement and shall be an unsecured claim against the general assets of the Corporation. The Participant has only the status of a general unsecured creditor hereunder, and this Agreement constitutes only a promise by the Corporation to pay the value of the Account on the payment date.
12. This Agreement shall inure to the benefit of and be binding upon the heirs, legatees, distributees, executors and administrators of the Participant and the successors and assigns of the Corporation.
13. This Agreement shall be governed by, and interpreted in accordance with, the laws of the State of New York, other than its conflict of laws principles.
14. This Agreement (and the grant of Units) is not an employment or service contract, and nothing in this Agreement shall be deemed to create in any way whatsoever any obligation on the Participant to continue as an employee, or on the Corporation to continue the Participant’s service as an employee.
15. This Agreement contains the entire agreement between the parties with respect to the subject matter hereof, and may not be modified except as provided in the Plan or in a written document executed by both parties.
16. If any provision of this Agreement shall be held unlawful or otherwise invalid or unenforceable in whole or in part by a court of competent jurisdiction, such provision shall (i) be deemed limited to the extent that such court of competent jurisdiction deems it lawful, valid and/or enforceable and as so limited shall remain in full force and effect, and (ii) not affect any other provision of this Agreement or part thereof.

 

 


 

IN WITNESS WHEREOF, the Corporation has caused this Agreement to be signed by a duly authorized officer, and the Participant has affixed his signature hereto.
         
     
  By:   HMS HOLDINGS CORP.    
 
         
     
  Signature:   -S- WILLIAM C. LUCIA    
    William C. Lucia   
    Chief Executive Officer    
 
  Date:   October 1, 2009  
 
 
  Participant      
    First Name Last Name   
 
  Date:      
 

 

 

Exhibit 31.1
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, William C. Lucia, certify that:
1. I have reviewed this quarterly report on Form 10-Q of HMS Holdings Corp.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
  a)  
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
  b)  
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
  c)  
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
  d)  
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s Board of Directors (or other persons performing the equivalent functions):
  a)  
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
  b)  
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
         
     
Date: November 6, 2009  /s/ William C. Lucia    
  William C. Lucia   
  Chief Executive Officer   

 

 

         
Exhibit 31.2
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Walter D. Hosp, certify that:
1. I have reviewed this quarterly report on Form 10-Q of HMS Holdings Corp.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
  a)  
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
  b)  
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
  c)  
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
  d)  
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s Board of Directors (or other persons performing the equivalent functions):
  a)  
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
  b)  
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
         
     
Date: November 6, 2009  /s/ Walter D. Hosp    
  Walter D. Hosp   
  Chief Financial Officer   

 

 

         
EXHIBIT 32.1
Certification Pursuant To
18 U.S.C. Section 1350
As Adopted Pursuant To
Section 906 of the Sarbanes-Oxley Act of 2002
In connection with the Quarterly Report of HMS Holdings Corp. (the “Company”) on Form 10-Q for the quarter ended September 30, 2009 as filed with the Securities and Exchange Commission (the “Report”), I, William C. Lucia, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that:
  (1)  
The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
 
  (2)  
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
         
     
  /s/ William C. Lucia    
  William C. Lucia   
  Chief Executive Officer

November 6, 2009 
 
 
A signed original of this written statement required by Section 906 has been provided to HMS Holdings Corp. and will be retained by HMS Holdings Corp. and furnished to the Securities and Exchange Commission or its staff upon request.

 

 

EXHIBIT 32.2
Certification Pursuant To
18 U.S.C. Section 1350
As Adopted Pursuant To
Section 906 of the Sarbanes-Oxley Act of 2002
In connection with the Quarterly Report of HMS Holdings Corp. (the “Company”) on Form 10-Q for the quarter ended September 30, 2009 as filed with the Securities and Exchange Commission (the “Report”), I, Walter D. Hosp, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that:
  (1)  
The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
 
  (2)  
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
         
     
  /s/ Walter D. Hosp    
  Walter D. Hosp   
  Chief Financial Officer

November 6, 2009 
 
 
A signed original of this written statement required by Section 906 has been provided to HMS Holdings Corp. and will be retained by HMS Holdings Corp. and furnished to the Securities and Exchange Commission or its staff upon request.