Business and Summary of Significant Accounting Policies

(a) Business

HMS is an industry-leading provider of cost containment solutions in the healthcare marketplace. We use healthcare technology, analytics and engagement solutions, to deliver coordination of benefits, payment integrity, population risk analytics, and care management and consumer engagement solutions to help payers reduce costs, improve healthcare outcomes and enhance member experiences. We provide coordination of benefits services to government and commercial healthcare payers to ensure that the correct party pays the claim. Our payment integrity services promote accuracy by fighting fraud, waste and abuse, and our total population management solutions provide risk-bearing organizations with reliable intelligence across their member populations to identify risks and improve patient engagement and outcomes. Together these various services help move the healthcare system forward for our customers. We currently operate as

one

business segment with a single management team that reports to the Chief Executive Officer.

(b) Summary of Significant Accounting Policies

For certain accounting topics, the description of the accounting policy

may

be found in the related Note.

(i)

Principles of Consolidation

The consolidated financial statements include the Company’s accounts and transactions and those of the Company’s wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

(ii)

Use of Estimates

The preparation of the consolidated financial statements in conformity with U.S. 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 financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

(iii)

Cash and Cash Equivalents

The Company considers all highly liquid investments with an original maturity of

three

months or less to be cash equivalents. Cash equivalents consist of deposits that are readily convertible into cash.

(iv)

Concentration of Credit Risk

The Company’s policy is to limit credit exposure by placing cash in accounts which are exposed to minimal interest rate and credit risk. HMS maintains cash and cash equivalents in cash depository accounts with large financial institutions with a minimum credit rating of

A1/P1

or better, as defined by Standard and Poor’s. The balance at these institutions generally exceeds the maximum balance insured by the Federal Deposit Insurance Corporation of up to

$250,000

per entity. HMS has

not

experienced any losses in cash and cash equivalents and believes these cash and cash equivalents do

not

expose the Company to any significant credit risk.

The Company is subject to potential credit risk related to changes in economic conditions within the healthcare market. However, HMS believes that the billing and collection policies are adequate to minimize the potential credit risk. The Company performs ongoing credit evaluations of customers and generally does

not

require collateral.

(v)

Property and Equipment

Property and equipment are stated at cost less accumulated depreciation. Depreciation is provided over the estimated useful lives of the assets utilizing the straight-line method. HMS amortizes leasehold improvements on a straight-line basis over the shorter of (i) the term of the lease or (ii) the estimated useful life of the improvement. Equipment leased under capital leases is depreciated over the shorter of (i) the term of the lease or (ii) the estimated useful life of the equipment. Capitalized software costs relate to software that is acquired or developed for internal use while in the application development stage. All other costs to develop software for internal use, either in the preliminary project stage or post-implementation stage, are expensed as incurred. Amortization of capitalized software is calculated on a straight-line basis over the expected economic life. Land is

not

depreciated.

Estimated useful lives are as follows:

Property and Equipment

Useful Life
(in years)

Equipment

Leasehold improvements

Furniture and fixtures

Capitalized software

Building and building improvements

up to 39

Property and equipment is reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset

may

not

be recoverable. When indicators exist, recoverability of assets is measured by a comparison of the carrying value of the asset group to the estimated undiscounted future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized and charged to earnings is measured by the amount by which the carrying value of the asset group exceeds the fair value of the assets. The Company did

not

recognize any impairment charges related to property and equipment during the years ended

December 31, 2018,

2017

2016.

(vi)

Intangible assets

The Company records assets acquired and liabilities assumed in a business combination based upon their acquisition date fair values. In most instances there is

not

a readily defined or listed market price for individual assets and liabilities acquired in connection with a business, including intangible assets. The Company determines fair value through various valuation techniques including discounted cash flow models, quoted market values and

third

party independent appraisals, as considered necessary. Significant assumptions used in those techniques include, but are

not

limited to, growth rates, discount rates, customer attrition rates, expected levels of revenues, earnings, cash flows and tax rates. The use of different valuation techniques and assumptions are highly subjective and inherently uncertain and, as a result, actual results

may

differ materially from estimates.

All of the Company’s intangible assets are subject to amortization and are amortized using the straight-line method over their estimated period of benefit. Estimated useful lives are as follows:

Intangible Assets	Useful Life (in years)
Customer relationships		7	to	15
Restrictive covenants		1	to	3
Trade names		1.5	to	7
Intellectual property		4	to	6

Intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset

may

not

recognize any impairment charges related to intangible assets during the years ended

December 31, 2018,

2017

2016.

(vii)

Goodwill

Goodwill is the excess of acquisition costs over the fair values of assets and liabilities of acquired businesses. During the measurement period, which is up to

one

year from the acquisition date, the Company

may

record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings.

Goodwill is subject to a periodic assessment for impairment. The Company assesses goodwill for impairment on an annual basis as of

June

30th

of each year or more frequently if an event occurs or changes in circumstances would more likely than

not

reduce the fair value of a reporting unit below its carrying amount. Assessment of goodwill impairment is at the HMS Holdings Corp. entity level as the Company operates as a single reporting unit. We have the option to perform a qualitative or quantitative assessment to determine if impairment is more likely than

not

to have occurred. The Company completed the annual impairment test as of

June 30, 2018

electing to perform the quantitative assessment of which the

first

step is to compare the fair value of the reporting unit with its carrying value, including goodwill. In calculating the fair value of the reporting unit, the Company utilized a weighting across

three

commonly accepted valuation approaches: an income approach, a guideline public company approach, and a merger and acquisition approach. The income approach to determining fair value computes projections of the cash flows that the reporting unit is expected to generate converted into a present value equivalent through discounting. Significant assumptions in the income approach include income projections, a discount rate and a terminal growth value which are all level

inputs. The income projections include assumptions for revenue and expense growth which are based on internally developed business plans and largely reflect recent historical revenue and expense trends. The discount rate was based on a risk free rate plus a beta adjusted equity risk premium and specific company risk premium. The terminal growth value is Company specific and was determined analyzing inputs such as historical inflation and the GDP growth rate. The guideline public company approach and merger and acquisition approach are based on pricing multiples observed for similar publicly traded companies or similar market companies that were sold. The results of the annual impairment assessment provide that the fair value of the reporting unit was significantly in excess of the Company’s carrying value, including goodwill; therefore,

impairment was indicated. There were

impairment charges related to goodwill during the years ended

December 31, 2018,

2017

2016.

There were

changes in the carrying amount of goodwill for the year ended

December 31, 2018.

(viii)

Income Taxes

Income taxes are accounted for under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. This method also requires the recognition of future tax benefits for net operating loss carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date. A valuation allowance is provided against deferred tax assets to the extent their realization is

not

more likely than

not.

Uncertain income tax positions are accounted for by prescribing a minimum recognition threshold that a tax position is required to meet before being recognized in the financial statements. Although the Company believes that it has adequately reserved for uncertain tax positions (including interest and penalties), it can provide

assurance that the final tax outcome of these matters will

not

be materially different. The Company makes adjustments to these reserves in accordance with the income tax accounting guidance when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made, and could have a material impact on our financial condition and operating results.

(ix)

Expense Classifications

HMS cost of services is presented in the categories set forth below. Each category within cost of services excludes expenses relating to SG&A functions, which are presented separately as a component of total operating costs. A description of the primary expenses included in each category is as follows:

Cost of Services:

Compensation:

Salary, fringe benefits, bonus and stock-based compensation.

Information technology:

Hardware, software and data communication costs.

Occupancy:

Rent, utilities, depreciation, office equipment and repair and maintenance costs.

Direct project expense:

Variable costs incurred from

third

party providers that are directly associated with specific revenue generating projects and employee travel expenses.

Other operating expenses:

Professional fees, temporary staffing, travel and entertainment, insurance and local and property tax costs.

Amortization of acquisition related software and intangible assets:

Amortization of the cost of acquisition related software and intangible assets.

SG&A:

Expenses related to general management, marketing and administrative activities.

(

)

Estimating Valuation Allowances and Accrued Liabilities

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenue and expenses during the reported period. In particular, management must make estimates of the probability of collecting accounts receivable. When evaluating the adequacy of the accounts receivable allowance, management reviews the accounts receivable based on an analysis of historical revenue adjustments, bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in customer payment terms. As of

December 31, 2018

and

2017,

the accounts receivable balance was

$206.8

million and

$189.5

million, net of allowance of

$13.7

million and

$14.8

million, respectively.

(xi)

Stock-Based Compensation

Long-Term Incentive Award Plans

The Company grants stock options and restricted stock units (“equity awards”) to HMS employees and non-employee directors under the

2016

Omnibus Plan, as approved by the Company’s shareholders on

June 23, 2016.

The

2016

Omnibus Plan replaced and superseded the Company’s

2006

Stock Plan and

2011

HDI Plan. As of

December 31, 2018,

the number of securities remaining available for future issuance under equity compensation plans, excluding securities to be issued upon exercise of outstanding options and vesting of restricted stock units, is

4,758,398

shares. All of the Company’s employees as well as HMS non-employee directors are eligible to participate in the

2016

Omnibus Plan. Awards granted under the

2016

Omnibus Plan generally vest over

one

four

years. The exercise price of stock options granted under the

2016

Omnibus Plan

may

not

be less than the fair market value of a share of stock on the grant date, as measured by the closing price of the Company’s common stock on the Nasdaq Global Select Market and the term of a stock option

may

not

exceed

ten

years. Prior to

2018,

the Company granted

two

types of equity awards:

) equity awards with service conditions and

) equity awards with market and service conditions. The market condition is based on the Company’s common stock price during the applicable measurement period. In

2018,

the Company only issued equity awards with service conditions.

Stock-Based Compensation Expense

The Company recognizes stock-based compensation expense equal to the grant date fair value of the award on a straight-line basis over the requisite service period.

The fair value of each option grant with only service-based conditions is estimated using the Black-Scholes pricing model. The fair value of each option grant with market and service-based conditions is estimated using a Monte Carlo simulation model. The fair value of each restricted stock unit is calculated based on the closing sale price of the Company’s common stock on the grant date.

The determination of the fair value of the options on the grant date using the Black-Scholes pricing model and/or the Monte Carlo simulation model is affected by the Company’s stock price, as well as assumptions regarding a number of complex and subjective variables. Certain key variables include: the Company’s expected stock price volatility over the expected term of the awards; a risk-free interest rate; and any expected dividends. The Company estimates stock price volatility based on the historical volatility of the Company’s common stock and estimates the expected term of the awards based on the Company’s historical option exercises for similar types of stock option awards. The assumed risk-free interest rate is based on the yield on the measurement date of a

zero

-coupon U.S. Treasury bond with a maturity period equal to the option’s expected term. The Company does

not

anticipate paying any cash dividends in the foreseeable future and therefore, uses an expected dividend yield of

zero

in the option valuation models. The fair value of all awards also includes an estimate of expected forfeitures. Forfeitures are estimated based on historical experience. If actual forfeitures vary from estimates, a difference in compensation expense will be recognized in the period the actual forfeitures occur. Upon the exercise of stock options or the vesting of restricted stock units, the resulting excess tax benefits or deficiencies, if any, are recognized as income tax expense or benefit.

(xii)

Fair Value of Financial Instruments

Financial instruments are categorized into a

three

-level fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into

three

broad levels. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level

) and the lowest priority to unobservable inputs (Level

). If the inputs used to measure fair value fall within different levels of the hierarchy, the category level is based on the lowest priority level input that is significant to the fair value measurement of the instrument. In the event the fair value is

not

readily available or determinable, the financial instrument is carried at cost and referred to as a cost method investment. The fair value hierarchy is as follows:

Level

Observable inputs such as quoted prices in active markets;

Level

: Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and

Level

Unobservable inputs in which there is little or

market data, which require the reporting entity to develop its own assumptions.

(xiii)

Leases

HMS accounts for lease agreements as either operating or capital leases, depending on certain defined criteria. Lease costs are amortized on a straight-line basis without regard to deferred payment terms, such as rent holidays, that defer the commencement date of required payments. Additionally, incentives such as tenant improvement allowances, are capitalized and are treated as a reduction of rental expense over the term of the lease agreement.

(xiv)

Recent Accounting Guidance

Recently Adopted Accounting Guidance

May 2014,

the FASB issued ASU

2014

09,

Revenue from Contracts with Customers

(Topic

606

) (“ASU

2014

09”

), which is the new comprehensive revenue recognition standard that supersedes all existing revenue recognition guidance under U.S. GAAP. The Company adopted ASU

2014

January 1, 2018

using the modified retrospective method and the Company recognized the cumulative effect of initially applying the new revenue standard as an adjustment to the opening balance of retained earnings. The financial information for comparative prior periods has

not

been restated and continues to be reported under the accounting standards in effect for those periods. The effect of adopting ASU

2014

in the current annual reporting period as compared with the guidance that was in effect before the change is immaterial. The Company’s internal control framework did

not

materially change, but existing internal controls were modified due to certain changes to business processes and systems to support the new revenue recognition standard as necessary. The Company continues to expect the impact of the adoption of the new standard to be immaterial to its net income and its internal control framework on an ongoing basis.

March 2016,

the FASB issued ASU

No.

2016

09,

Compensation – Stock Compensation

(Topic

718

Improvements to Employee Share-Based Payment Accounting

, (“ASU

2016

09”

) that changes the accounting for certain aspects of share-based payments to employees. The new guidance requires excess tax benefits and tax deficiencies to be recorded in the income statement when stock awards vest or are settled. In addition, cash flows related to excess tax benefits will

longer be separately classified as a financing activity apart from other income tax cash flows. The standard also allows companies to repurchase more of an employee’s vesting shares for tax withholding purposes without triggering liability accounting, clarifies that all cash payments made to tax authorities on an employee’s behalf for withheld shares should be presented as a financing activity on the cash flows statement and provides an accounting policy election to account for forfeitures as they occur. ASU

2016

is effective for annual reporting periods beginning after

December 15, 2016,

including interim periods within such annual reporting periods with early adoption permitted. The Company elected to early adopt the new guidance in the

fourth

quarter of fiscal year

2016

which requires us to reflect any adjustments as of

January 1, 2016,

the beginning of the annual period that includes the interim period of adoption. The primary impact of adoption was the recognition of excess tax benefits in the provision for income taxes rather than paid-in capital for all periods in fiscal year

2016.

Additional amendments to the accounting for income taxes and minimum statutory withholding tax requirements had

impact to retained earnings as of

January 1, 2016,

where the cumulative effect of these changes are required to be recorded. The Company elected to continue to estimate forfeitures expected to occur to determine the amount of compensation cost to be recognized in each period. Adoption of the new standard resulted in the recognition of net excess tax benefits in the provision for income taxes rather than paid-in capital of

$1.9

million for the year ended

December 31, 2016.

The presentation requirements for cash flows related to employee taxes paid for withheld shares had

impact to any of the

2016

periods presented on the consolidated statements of cash flow since such cash flows have historically been presented as a financing activity.

August 2016,

the FASB issued ASU

No.

2016

15,

Statements of Cash Flows

(Topic

230

Classification of Certain Cash Receipts and Cash Payments

(“ASU

2016

15”

). ASU

2016

clarifies where certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments are effective for annual reporting periods beginning after

December 15, 2017,

and for interim reporting periods within such annual periods. The Company adopted this guidance on

January 1, 2018.

The adoption of this guidance did

not

have a material effect on the Company’s consolidated financial statements.

January 2017,

the FASB issued ASU

No.

2017

01,

Business Combinations

(Topic

805

) –

Clarifying the Definition of a Business

(“ASU

2017

01”

). ASU

2017

finalizes previous proposals regarding shareholder concerns that the definition of a business is applied too broadly. The guidance assists entities with evaluating whether transactions should be accounted for as acquisitions of assets or of businesses. The amendments are effective for annual periods beginning after

December 15, 2017,

including interim periods within those periods. The Company adopted this guidance on

January 1, 2018.

The adoption of this guidance did

not

have a material effect on the Company’s consolidated financial statements.

May 2017,

the FASB issued ASU

No.

2017

09,

Compensation – Stock Compensation

(Topic

718

Scope of Modification Accounting

, (“ASU

2017

09”

). ASU

2017

requires entities to apply modification accounting to changes made to a share-based payment award. The new guidance specifies that entities will apply modification accounting to changes to a share-based payment award only if any of the following are

not

the same immediately before and after the change:

) The award’s fair value (or calculated value or intrinsic value, if those measurement methods are used),

) the award’s vesting conditions, and

) the award’s classification as an equity or liability instrument. ASU

2017

is effective for annual reporting periods beginning after

December 15, 2017,

including interim periods within such annual periods, with early adoption permitted. The Company adopted this guidance on

January 1, 2018.

The adoption of this guidance did

not

have a material effect on the Company’s consolidated financial statements.

January 2017,

the FASB issued ASU

No.

2017

04,

Goodwill and Other

(Topic

350

Simplifying the Test for Goodwill Impairment

(“ASU

2017

04”

). This amendment simplifies the manner in which an entity is required to test for goodwill impairment by eliminating Step

from the goodwill impairment test. Step

measures goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. The amendment simplifies this approach by having the entity (

) perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, and (

) recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, with the understanding that the loss recognized should

not

exceed the total amount of goodwill allocated to that reporting unit. The Company elected to early adopt the new guidance in the

fourth

quarter of fiscal year

2018.

The adoption of this guidance did

not

have a material effect on the Company’s consolidated financial statements.

August 17, 2018

the SEC issued SEC Final Rule Release

No.

10532,

Disclosure Update and Simplification

(“Final Rule”). The Final Rule amends certain disclosure requirements to facilitate the disclosure of information to investors and simplify compliance without significantly altering the total mix of information provided to investors. The Final Rule was effective for public entities that are SEC filers on

November 5, 2018.

The adoption of this guidance did

not

have a material effect on the Company’s consolidated financial statements.

Recent Accounting Guidance

Not

Yet Adopted

February 2016,

the FASB issued ASU

No.

2016

02,

Leases (Topic

842

) (“ASU

2016

02”

). ASU

2016

will require most lessees to recognize a majority of the company’s leases on the balance sheet, which will increase reported assets and liabilities. ASU

2016

was subsequently amended by ASU

No.

2018

01,

Land Easement Practical Expedient for Transition to Topic

842;

ASU

No.

2018

10,

Codification Improvements to Topic

842,

Leases; and ASU

No.

2018

11,

Targeted Improvements. The new standard establishes a right-of-use model (ROU) that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer than

months. Leases will be classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the income statement. ASU

2016

is effective for annual reporting periods beginning after

December 15, 2018

including interim periods within such annual reporting periods with early adoption permitted. The Company has

not

early adopted this guidance, and therefore is adopting this guidance on

January 1, 2019

and will use the effective date as our date of initial application. Consequently, financial information will

not

be updated and the disclosures required under the new standard will

not

be provided for dates and periods prior to the date of adoption. The Company developed a preliminary implementation plan and reviewed historical lease agreements in order to quantify the impact of adoption. Based upon the preliminary implementation plan, the Company expects the adoption of ASU

2016

will have a material impact on the consolidated balance sheet due to the recognition of the ROU assets and lease liabilities. The adoption of ASU

2016

not

expected to have a material impact on the consolidated statement of income or consolidated statement of cash flow. However, the Company continues to perform the necessary reviews and other implementation considerations, including an evaluation of the incremental borrowing rate, in order to appropriately quantify the changes. While we continue to assess all of the effects of adoption, we currently believe the most significant effects relate to (

) the recognition of new ROU assets and lease liabilities on our balance sheet for our real estate operating leases and (

) financial statement disclosures. We do

not

expect a significant change in our leasing activities between now and adoption. A range of undiscounted ROU assets and lease liabilities at

January 1, 2019

$28

million to

$31

million. We expect to recognize operating lease ROU assets and lease liabilities that reflect the present value of these future payments. The Company plans adopt this guidance using the optional transition method. The new standard also provides practical expedients for an entity’s existing and ongoing accounting and we expect to adopt the package of practical expedients as well as the practical expedient to

not

separate lease and non-lease components of our leases and the short-term lease practical expedient.

June 2016,

the FASB issued ASU

No.

2016

13,

Financial Instruments – Credit Losses

(“ASU

2016

13”

). ASU

2016

introduces the current expected credit losses methodology (“CECL”) for estimating allowances for credit losses. ASU

2016

applies to all financial instruments carried at amortized cost and off-balance-sheet credit exposures

not

accounted for as insurance, including loan commitments, standby letters of credit, and financial guarantees. The new accounting standard does

not

apply to trading assets, loans held for sale, financial assets for which the fair value option has been elected, or loans and receivables between entities under common control. ASU

2016

is effective for public entities for fiscal year beginning after

December 15, 2019,

including interim periods within that fiscal year. Early adoption is permitted. The Company is currently evaluating the impact on the Company’s financial statements of adopting this guidance but this guidance is

not

expected to have a material impact on the Company’s financial position, results of operations or internal control framework.

June 2018,

the FASB issued ASU

No.

2018

07,

Compensation – Stock Compensation

(Topic

718

) –

Improvements to Nonemployee Share Based Payment Accounting

, (“ASU

2018

07”

). ASU

2018

requires entities to apply similar accounting for share-based payment transactions with non-employees as with share-based payment transactions with employees. ASU

2018

is effective for public entities for fiscal year beginning after

December 15, 2018,

not

expected to have a material impact on the Company’s financial position, results of operations or internal control framework.