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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2013

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)

(Registrant’s Telephone Number, Including Area Code)

(212) 453-3000

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 x  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).  x Yes  o No

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” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

As of August 2, 2013, there were approximately 87,807,066 shares of the registrant’s common stock (par value $0.01 per share) outstanding.

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HMS HOLDINGS CORP. AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2013

INDEX

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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 the U.S. Private Securities Litigation Reform Act of 1995.  From time to time, we also provide forward-looking statements in other materials we release to the public, as well as oral forward-looking statements.  Such statements give our expectations or forecasts of future events; they do not relate strictly to historical or current facts.

We have tried, wherever possible, to identify such statements by using words such as “anticipate,” “estimate,” “expect,” “project,” “intend,” “plan,” “believe,” “will,” “target,” “seek,” “forecast” and similar expressions.  In particular, these include statements relating to future actions, business plans, objects and prospects, future operating or financial performance or results of current and anticipated services, acquisitions and the performance of companies we have acquired, sales efforts, expenses, interest rates, and the outcome of contingencies, such as financial results.

We cannot guarantee that any forward-looking statement will be realized.  Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy and other future conditions.  Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could differ materially from past results and those anticipated, estimated or projected.  We caution you, therefore, against relying on any of these forward-looking statements.  They are neither statements of historical fact nor guarantees or assurances of future performance. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in our Annual Report on Form 10-K, and in particular, the risks discussed under the heading “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K, Part II of this 10-Q and those discussed in other documents we file with the Securities and Exchange Commission.

Any forward-looking statements made by us in this Report on Form 10-Q speak only as of the date on which they are made.  Factors or events that could cause actual results to differ may emerge from time to time and it is not possible for us to predict all of them.  We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required by law.  You are advised, however, to consult any further disclosures we make on related subjects in our filings with the Securities and Exchange Commission, including but not limited to our Current Reports on Form 8-K.

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HMS HOLDINGS CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)

See accompanying notes to unaudited consolidated financial statements.

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HMS HOLDINGS CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands, except per share amounts)

(unaudited)

See accompanying notes to unaudited consolidated financial statements.

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HMS HOLDINGS CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

For the Six Months Ended June 30, 2013

(in thousands, except share amounts)

(unaudited)

See accompanying notes to unaudited consolidated financial statements.

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HMS HOLDINGS CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS

(in thousands)

(unaudited)

See accompanying notes to unaudited consolidated financial statements.

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HMS HOLDINGS CORP. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

For the Three and Six Months Ended June 30, 2013 and 2012

(unaudited)

1.              Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles, or U.S. GAAP, for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by U.S. GAAP for complete financial statements. In the opinion of management, the unaudited interim financial statements furnished herein include all adjustments necessary (consisting only of normal recurring adjustments) for a fair presentation of our and our subsidiaries’ financial position at June 30, 2013, the results of our operations for the three and six months ended June 30, 2013 and 2012 and cash flows for the six months ended June 30, 2013 and 2012. Interim financial statements are prepared on a basis consistent with our annual financial statements. The financial statements included herein should be read in conjunction with the financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2012, which we refer to as our Annual Report.

We provide cost containment services to government and private healthcare payers and sponsors. Our program integrity services ensure that healthcare claims are paid correctly, and our coordination of benefits services ensure that they are paid by the responsible party. Together, these services help clients recover amounts from liable third parties; prevent future improper payments; reduce fraud, waste and abuse; and ensure regulatory compliance.

Since our inception, we have grown both organically and through targeted acquisitions. In 1985 we began providing coordination of benefits services to state Medicaid agencies. We expanded into the Medicaid managed care market, providing similar coordination of benefits services when Medicaid began to migrate members to managed care. We launched our program integrity services in 2007 and have since acquired several businesses to expand our service offerings. In 2009, we entered the Medicare market with our acquisition of IntegriGuard, LLC, or IntegriGuard, now doing business as HMS Federal, which provides fraud, waste and abuse analytical services to the Medicare program. In 2009 and 2010, we entered the employer market, working with large self-funded employers through our acquisitions of Verify Solutions, Inc. and Chapman Kelly, Inc. In 2011, we extended our reach in the federal, state and commercial markets with our acquisition of HealthDataInsights, Inc., or HDI. HDI provides improper payment identification services for government and commercial health plans, and is the Medicare Recovery Audit Contractor (RAC) in CMS Region D, covering 17 states and three U.S. territories. In December 2012, we acquired the assets and liabilities of MedRecovery Management, LLC, or MRM, a provider of Workers’ Compensation recovery services for commercial health plans.

These unaudited 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.

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.

We provide products and services under contracts that contain various fee structures, including contingency fee and fixed fee arrangements. We recognize revenue when a contract exists, products or services have been provided to the client, the fee is fixed and determinable, and collectability is reasonably assured. In addition, we have contracts with the federal government which are generally cost-plus or time and material based. Revenue on cost-plus contracts is recognized based on costs incurred plus an estimate of the negotiated fee earned. Revenue on time and materials contracts is recognized based on hours worked and expenses incurred.

Under our Medicare RAC contract with CMS, we recognize revenue when claims are sent to CMS for offset against future Medicare claims payments. Providers have the right to appeal a claim and may pursue additional appeals if the initial appeal is found in favor of CMS.  We accrue an estimated liability for appeals based on the amount of fees that are subject to appeal and which we estimate are probable of being returned to providers following a successful appeal. This estimated liability for appeals is an offset to revenue in our unaudited Consolidated Statements of Comprehensive Income.  Our estimates are based on our historical experience with appeals activity under our Medicare RAC contract. The estimated liability of appeals of $25.3 million at June 30, 2013, and $21.8 million as of December 31, 2012, represents our estimate of the potential amount of repayments related to appeals of claims for which fees were previously collected and recognized as revenue. This is reflected as a separate line item in the current liabilities section of our balance sheet titled “Estimated liability for appeals” to reflect our estimate of this liability. To the extent the amount to be returned to providers following a successful appeal exceeds the amount accrued, revenue in the applicable period would be reduced by the amount of the excess.

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As of June 30, 2013, we have accrued an estimated liability for appeals and estimated allowance for appeals based on our historical experience with appeals activity under our Medicare RAC contract. At this time, we do not believe that we face a risk of significant loss in excess of the amounts accrued.  Accordingly, we believe that an estimate of any reasonably possible loss in excess of the amounts accrued is immaterial.  Any future changes to the Medicare RAC contract, including further modifications to the transition plan for incumbent Medicare recovery audit contractors, may require us to apply different assumptions that could affect our estimated liability for appeals in future periods. We similarly accrue an allowance against accounts receivable related to fees yet to be collected, based on the same estimates used to establish the estimated liability for appeals of fees received. Our inability to correctly estimate the estimated liabilities and allowance against accounts receivable could adversely affect our revenue in future periods.

Allowance for doubtful accounts and estimated allowance and liability for appeals as of June 30, 2013 are as follows:

Allowance for doubtful accounts (in thousands):

Estimated allowance for appeals and estimated liability for appeals (in thousands):

*Includes $10,949 and $6,985 related to estimated allowance for appeals that apply to uncollected accounts receivable as of June 30, 2013 and December 31, 2012, respectively.

Where contracts have multiple deliverables, we evaluate these deliverables at the inception of each contract and as each item is delivered. As part of this evaluation, we (i) consider whether a delivered item has value to a client on a standalone basis; (ii) use the vendor specific objective evidence (VSOE) of selling price or third party estimate (TPE) of selling price, and if neither VSOE nor TPE of selling price exist for a deliverable, use best estimated selling price for that deliverable; and (iii) allocate revenue to each non-contingent element based upon the relative selling price of each element. Revenue allocated to each element is then recognized when the above four basic revenue recognition criteria are met for each element. Arrangements, including 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 client contract to which it relates.

In addition, some of our contracts may include client acceptance provisions. Formal client sign-off is not always necessary to recognize revenue, provided we objectively demonstrate that the criteria specified in the acceptance provision are satisfied. Due to the range of products and services that we provide and the differing fee structures associated with each type of contract, we may recognize revenue in irregular increments.

The preparation of the unaudited consolidated financial statements in conformity with U.S. GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, primarily accounts receivable, intangible assets, accrued expenses, estimated allowance for appeals and estimated liability for appeals and disclosure of contingent assets and liabilities at the date of the unaudited consolidated financial statements and the reported amounts of revenue and expenses during the reporting periods. Our actual results could differ from those estimates.

Cash equivalents consist of deposits that are readily convertible into cash. We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents.

Our 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

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active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). 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/determinable, the financial instrument is carried at cost and referred to as a cost method investment.  The evaluation of whether an investment’s fair value is less than cost is determined by using a disclosed fair value estimate, if one is available, otherwise, it is determined by evaluating whether an event or change in circumstances has occurred that may have a significant adverse effect on the fair value of the investment (an impairment indicator). We are not aware of any identified events or change in circumstances that would have a significant adverse effect on the carrying value of our cost method investments. Financial instruments recorded at fair value on our unaudited consolidated balance sheets are categorized as follows:

·           Level 1: Observable inputs such as quoted prices in active markets;

·           Level 2: Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and

·           Level 3: Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

Our policy is to limit our credit exposure by placing our investments with financial institutions evaluated as being creditworthy, or in short-term money market funds that are exposed to minimal interest rate and credit risk. We maintain our cash in cash depository accounts and certificate of deposits with large financial institutions. The balance in certain of these accounts exceeds the maximum balance insured by the Federal Deposit Insurance Corporation of up to $250,000 per bank account. We have not experienced any losses on our bank deposits and we believe these deposits do not expose us to any significant credit risk.

We are subject to potential credit risk related to changes in economic conditions within the healthcare market. However, we believe that our billing and collection policies are adequate to minimize the potential credit risk.

We evaluate the recoverability of goodwill either annually or whenever events or changes in circumstances indicate that an asset’s carrying amount may not be recoverable. Such circumstances could include, but are not limited to (i) a significant decrease in the market value of an asset, (ii) a significant adverse change in the extent or manner in which an asset is used, or (iii) an accumulation of costs significantly in excess of the amount originally expected for the acquisition of an asset.

For long-lived assets and intangible assets, we measure the carrying amount of the asset against the estimated undiscounted future cash flows associated with it. If the sum of the expected future undiscounted net cash flows is less than the carrying value of the asset being evaluated, we would recognize an impairment charge. The impairment charge would be calculated as the amount by which the carrying value of the asset exceeds its fair value. The determination of fair value is based on quoted market prices, if available. If quoted market prices are not available, the estimate of fair value is based on various valuation techniques, including the discounted value of estimated future cash flows. We did not recognize any impairment charges related to our long-lived assets, property and equipment, goodwill or intangible assets, during the six months ended June 30, 2013 and 2012, as management believes that carrying amounts were not impaired. Depreciation expense related to property and equipment was $7.8 million and $6.6 million for the three months ended June 30, 2013 and 2012, respectively, and $15.2 and $12.9 million for the six months ended June 30, 2013 and 2012, respectively.

The carrying amounts for our cash equivalents, accounts receivable, accounts payable and accrued expenses approximate fair value due to their short-term nature.

On October 29, 2012, our Board of Directors authorized management to repurchase up to $50.0 million of our common stock from time to time on the open market or in privately negotiated transactions, for a period of up to two years.  Repurchased shares will be available for future use in connection with our stock plans and for other corporate purposes.

Certain reclassifications were made to prior year amounts to conform to the current period presentation.

Recently Issued Accounting Pronouncements

In December 2011, the Financial Accounting Standards Board, or FASB issued Accounting Standards Update (ASU) 2011-11, Balance Sheet (Topic 210), Disclosures about Offsetting Assets and Liabilities, updated by ASU 2013-01, Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities, which requires companies to disclose information about financial instruments that have been offset and related arrangements to enable users of the company’s financial statements to understand the effect of those arrangements on the company’s  financial position. Companies will be required to provide both net (offset amounts) and gross information in the notes to the financial statements for relevant assets and liabilities that are offset. ASU 2011-11, as amended by ASU 2013-01, is effective for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. The adoption of this guidance did not have a material effect on our unaudited consolidated financial statements.

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In July 2012, FASB issued ASU No. 2012-02, Intangibles — Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. This newly issued accounting standard allows an entity the option to first assess qualitative factors to determine whether it is necessary to perform a quantitative impairment test for indefinite-lived intangibles other than goodwill. Under that option, an entity would no longer be required to calculate the fair value of an indefinite-lived intangible asset unless the entity determines, based on that qualitative assessment, that it is more likely than not that the fair value of the indefinite-lived intangible asset is less than its carrying amount. This ASU is effective for annual and interim indefinite-lived intangible asset impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. The adoption of this guidance did not have a material effect on our unaudited consolidated financial statements.

In March 2013, FASB issued ASU No. 2013-04, Obligations Resulting from Joint and Several Liability Arrangements for which the Total Amount of the Obligation is Fixed at the Reporting Date, which addresses the recognition, measurement, and disclosure of certain joint and several obligations including debt arrangements, other contractual obligations, and settled litigation and judicial rulings. The ASU is effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2013.  The adoption of this guidance will not have a material effect on our unaudited consolidated financial statements.

2.              Acquisitions

The results of operations for our acquisitions have been included in our unaudited consolidated financial statements from the respective dates of acquisition.

MedRecovery Management, LLC. ( MRM)

In December 2012, we acquired the assets and liabilities of MRM, for an aggregate purchase price of $11.7 million, consisting of a $10.8 million initial cash payment and $0.9 million in future contingent payments that are based on the achievement of certain performance milestones. We recognized $1.9 million of goodwill in connection with our acquisition of MRM.

During the three months ended June 30, 2013, we finalized the valuation of intangibles and future contingent consideration related to this acquisition. Based on our valuation of the MRM acquisition, the intangible assets and future contingent consideration on the acquisition date were $9.2 million and $0.9 million, respectively. The consolidated balance sheet for the year ended December 31, 2012, was  retrospectively adjusted to increase the carrying amount of intangible assets by $9.2 million, decrease the carrying value of future contingent consideration by $0.1 million and decrease the carrying value of goodwill by $9.3 million. Of the total intangible assets acquired, $8.9 million was related to client relationships and has an amortization period of seven years and $0.3 million was related to restrictive covenants and has an amortization period of two years.

3.                                      Intangible Assets

Intangible assets consisted of the following at June 30, 2013 and December 31, 2012 (in thousands):

Estimated amortization expense for intangible assets is expected to approximate the following (in thousands):

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For the three and six months ended June 30, 2013, amortization expense related to intangible assets was $6.8 million and $12.7 million, respectively.  For the three and six months ended June 30, 2012, amortization expense related to intangible assets was $6.1 million and $12.2 million, respectively.

4.              Income Taxes

Our effective tax rate decreased to 39.3% for the six months ended June 30, 2013 from 40.4% for the six months ended June 30, 2012, primarily due to changes in state apportionments and permanent differences. The principal differences between the statutory rate and our effective rate are state taxes and permanent differences.

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 2009. We operate in a number of state and local jurisdictions, most 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. We are currently being examined by the Internal Revenue Service and the States of New York and Idaho.

During the six months ended June 30, 2013 and 2012, we recorded a tax benefit of $4.2 million and $6.8 million, respectively, related to the utilization of the income tax benefit from stock transactions by reducing income tax payable and increasing capital.

At June 30, 2013 and 2012, we had approximately $2.3 million and $1.5 million, respectively, of net unrecognized tax benefits for which there is uncertainty about the allocation and apportionment impacting state taxable income. We do not expect any significant change in unrecognized tax benefits during the next twelve months. We have recognized interest accrued related to unrecognized tax benefits in interest expense and penalties in tax expense. The accrued liabilities related to uncertain tax positions were $0.9 million and $0.6 million for the six month periods ending June 30, 2013 and 2012, respectively.  We believe that it is reasonably possible that decreases in unrecognized tax benefits of up to $0.1 million may be recorded within the next year.

5.              Credit Agreement

In connection with our acquisition of HDI, we entered into a five year, revolving and term secured credit agreement, which we refer to as the 2011 Credit Agreement, with certain financial institutions and Citibank, N.A. as Administrative Agent. In May 2013, we amended and restated the 2011 Credit Agreement and entered into a $500 million five-year, amended and restated revolving credit agreement, which we refer to as the 2013 Credit Agreement.

The 2013 Credit Agreement provides for an initial $500 million revolving credit facility, and, under specified circumstances, the revolving credit facility can be increased or one or more incremental term loan facilities can be added, provided that the incremental credit facilities do not exceed in the aggregate the sum of (a) $75 million plus (b) an additional amount not less than $25 million, so long as our total secured leverage ratio, calculated giving pro forma effect to the requested incremental borrowing and other customary and appropriate pro forma adjustment events, including any permitted acquisitions, is no greater than 2.5:1.0.

The 2013 Credit Agreement contains certain customary representations and warranties, affirmative and negative covenants, and events of default.  The 2013 Credit Agreement requires us to comply, on a quarterly basis, with certain principal financial covenants, including  a maximum consolidated leverage ratio reducing from 3.50:1.00 to 3.25:1.00 over the next five years and a minimum interest coverage ratio of 3.00:1.00.

The interest rates applicable to the revolving credit facility are, at our option, either (a) the LIBOR  multiplied by the statutory reserve rate plus an interest margin ranging from 1.50% to 2.25% based on our  consolidated leverage ratio, or (b) a base rate (which is equal to the greatest of (a) Citibank’s prime rate, (b) the federal funds effective rate plus 0.50% and (c) the one-month LIBOR  plus 1.00% plus an interest margin ranging from 0.50% to 1.25% based on our  consolidated leverage ratio).  We will pay an unused commitment fee on the revolving credit facility during the term of the 2013 Credit Agreement ranging from 0.375% to 0.50% per annum based on our consolidated leverage ratio.

Our obligations under the 2013 Credit Agreement may be accelerated upon the occurrence of an event of default, which includes customary events of default including, without limitation, payment defaults, failures to perform affirmative covenants, failure to refrain from actions or omissions prohibited by negative covenants, the inaccuracy of representations or warranties, cross-defaults, bankruptcy and insolvency related defaults, defaults relating to judgments, defaults due to certain ERISA related events and a change of control default.  As of June 30, 2013, we were in compliance with all the terms of the 2013 Credit Agreement.

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Borrowings under the 2013 Credit Agreement were used to refinance  the outstanding principal and unpaid interest of $323.8 million and $1.1 million, respectively, under the term loan facility of the 2011 Credit Agreement. We paid lender fees of $2.9 million in connection with amending and restating the Credit Agreement.

For the three months ended June 30, 2013 and 2012, we incurred $2.3 million and $3.1 million, respectively, of interest expense.  For the six months ended June 30, 2013 and 2012, we incurred $5.0 million and $6.1 million, respectively, of interest expense. For the three months ended June 30, 2013 and 2012, we incurred $0.2 million of commitment fees on the unused revolving credit facility. For the six months ended June 30, 2013 and 2012, we incurred $0.3 million of commitment fees.

At June 30, 2013 and December 31, 2012, the unamortized balance of deferred origination fees and debt issue costs were $9.8 million and $9.2 million, respectively.  For the three months ended June 30, 2013 and 2012, we amortized $1.5 million and $0.9 million, respectively, of interest expense related to our deferred origination fees and debt issue costs.  For the six months ended June 30, 2013 and 2012, we amortized $2.3 million and $1.9 million, respectively, of interest expense related to our deferred origination fees and debt issue costs.

As part of our contractual agreement with a client, we have an outstanding irrevocable letter of credit or Letter of Credit for $4.6 million, which we established against our existing revolving credit facility.

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 and units.

The following table reconciles the basic to diluted weighted average shares outstanding using the treasury stock method (shares in thousands):

For the three months ended June 30, 2013 and 2012, 1,413,369 and 897,368 stock options, respectively, were not included in the diluted earnings per share calculation because the effect would have been anti-dilutive.  For the three months ended June 30, 2013 and 2012, restricted stock units representing 189,278 and 50,721 shares of common stock, respectively, were not included in the diluted earnings per share calculation because the effect would have been anti-dilutive.

For the six months ended June 30, 2013 and 2012, 1,375,346 and 485,837 stock options, respectively, were not included in the diluted earnings per share calculation because the effect would have been anti-dilutive. For the six months ended June 30, 2013 and 2012, restricted stock units representing 102,847 and 50,818 shares of common stock, respectively, were not included in the diluted earnings per share calculation because the effect would have been anti-dilutive.

7.              Stock-Based Compensation

Total stock-based compensation expense charged as a selling, general and administrative expense in our unaudited consolidated statements of comprehensive income related to our stock compensation plans was $3.1 million and $3.4 million for the three months ended June 30, 2013 and June 30, 2012, respectively, and $6.1 million and $7.1 million for the six months ended June 30, 2013 and June 30, 2012, respectively.

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The total income tax benefit related to stock-based compensation expense recognized in our unaudited consolidated statements of comprehensive income was $1.2 million and $1.3 million, for the three months ended June 30, 2013 and 2012, respectively, and $4.2 million and $6.8 million, for the six months ended June 30, 2013 and 2012, respectively.

Presented below is a summary of our stock option activity for the six months ended June 30, 2013 (shares in thousands):

The fair value of each option grant was estimated using the Black-Scholes option pricing model. Expected volatilities are calculated based on the historical volatility of our common stock. Management monitors stock option exercises 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 expected terms of options granted are based on our historical experience for similar types of stock option awards. The risk-free interest rate is based on U.S. Treasury Notes.

We estimated the fair value of each stock option grant on the date of grant using a Black-Scholes option-pricing model and the weighted-average assumptions set forth in the following table:

During the three months ended June 30, 2013 and 2012, we issued 0.2 million shares and 0.2 million shares, respectively, of our common stock upon the exercise of outstanding stock options and received proceeds of $0.9 million and $1.8 million, respectively.  For the three months ended June 30, 2013 and 2012, we realized a tax benefit of $1.2 million and $1.3 million, respectively from the exercise of stock options.

For the six months ended June 30, 2013 and 2012, we issued 0.7 million shares, and 0.9 million shares, respectively, of our common stock upon the exercise of outstanding stock options and received proceeds of $6.3 million, and $7.5 million, respectively. For the six months ended June 30, 2013 and 2012, we realized $4.2 million and $6.8 million, respectively in tax benefits from the exercise of stock options.

For the three months ended June 30, 2013, and 2012, approximately $1.8 million, and $2.4 million, respectively, of stock-based compensation cost relating to stock options has been charged against income.  For the six months ended June 30, 2013, and 2012, approximately $3.7 million, and $5.2 million, respectively, of stock-based compensation cost relating to stock options has been charged against income.  As of June 30, 2013, there was approximately $12.3 million of total unrecognized compensation cost, adjusted for estimated forfeitures, related to stock options outstanding, which is expected to be recognized over a weighted-average period of 1.4 years.

The aggregate intrinsic value in the previous table reflects the total pretax intrinsic value (the difference between our closing stock price on the last trading day of the period and the exercise price of the options, multiplied by the number of in-the-money stock options) that would have been received by the option holders had all option holders exercised their options on June 30, 2013. The intrinsic value of our stock options changes based on the closing price of our common stock. The total intrinsic value of options exercised (the difference in the market price of our common stock on the exercise date and the price paid by the optionee to exercise the option) for the three months ended June 30, 2013 and 2012 was approximately $4.0 million and $5.0 million, respectively.  The

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total intrinsic value of options exercised during the six month periods ended June 30, 2013 and 2012 was $13.9 million and $20.9 million, respectively.

Restricted Stock Units

Our non-employee members of the Board and certain employees have received restricted stock units under our 2006 Stock Plan, as amended. The fair value of restricted stock units is estimated based on the closing sale price of our common stock on the NASDAQ Global Select Market on the date of issuance. The total number of restricted stock units expected to vest is adjusted by estimated forfeiture rates. Shares withheld to pay taxes upon the vesting of the restricted stock units are retired.

For the three months ended June 30, 2013, we granted 21,861 restricted stock units with an aggregate fair market value of $0.6 million.  For the six months ended June 30, 2013, we granted 218,698 restricted stock units, with an aggregate fair market value of $6.2 million. At June 30, 2013, 569,540 restricted stock units remained unvested and there was $11.2 million of unamortized compensation cost related to restricted stock units, which is expected to be recognized over the remaining weighted-average vesting period of 1.9 years.  Stock-based compensation expense related to restricted stock units was $1.2 million and $0.8 million for the three months ended June 30, 2013 and 2012, respectively and $2.1 million and $1.5 million for the six months ended June 30, 2013 and 2012, respectively.

A summary of the status of our restricted stock units and of changes in restricted stock units outstanding under the 2006 Stock Plan, as amended, for the six months ended June 30, 2013 is as follows (in thousands, except for weighted average grant date fair value per unit):

Restricted Stock Awards

Our executive officers have received grants of restricted stock awards under the 2006 Stock Plan.  The vesting of restricted stock awards is subject to the executive officers’ continued employment with us. Recipients of restricted stock awards are not required to provide us with any consideration other than rendering service.  Holders of restricted stock are permitted to vote and to receive dividends.

The stock-based compensation expense for restricted stock awards is determined based on the closing market price of our common stock on the grant date of the awards applied to the total number of awards that are anticipated to fully vest. Shares withheld to pay taxes are retired upon the vesting of the restricted stock awards. We did not issue restricted stock awards during the six months ended June 30, 2013. At June 30, 2013 approximately 81,549 shares underlying restricted stock awards remained unvested and there was approximately $0.4 million of unrecognized compensation cost related to restricted stock awards, which is expected to be recognized over the weighted-average period of 0.6 years. Stock-based compensation expense related to restricted stock awards was $0.2 million and $0.2 million for the three months ended June 30, 2013 and 2012, respectively, and $0.3 and $0.4 million for the six months ended June 30, 2013 and 2012, respectively.

A summary of the status of our restricted stock awards at June 30, 2013 and of changes in restricted stock awards outstanding under the 2006 Stock Plan for the six months ended June 30, 2013 is as follows (in thousands, except for weighted average grant date fair value):

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The total fair value of restricted stock awards vested during the six months ended June 30, 2013 was $1.0 million.

8.              Commitment and Contingencies

From time to time, we may be subject to investigations, legal proceedings and other disputes arising in the ordinary course of our business, including but not limited to regulatory audits, billing and contractual disputes and employment-related matters. We record accruals for outstanding legal matters when we believe it is probable that a loss will be incurred and the amount can be reasonably estimated.  We evaluate, on a quarterly basis, developments in legal matters that could affect the amount of any accrual and developments that would make a loss contingency both probable and reasonably estimable. If a loss contingency is not both probable and estimable, we do not establish an accrued liability. None of our accruals for outstanding legal matters are material individually or in the aggregate to our financial position.

Our contractual relationships, including those with federal and State government entities, subject our operations, billing, and business practices to scrutiny and audit, including by multiple agencies and levels of government, as well as to frequent transitions and changes in the personnel responsible for oversight of our contractual performance. From time to time, we may have contractual disputes with our clients arising from differing interpretations of contractual provisions that define our rights, obligations, scope of work, or terms of payment, and with associated claims of liability for inaccurate or improper billing for reimbursement of contract fees, or for sanctions or damages for alleged performance deficiencies.  Resolution of such disputes may involve litigation or may require that we accept some amount of loss or liability in order to avoid client abrasion, negative marketplace perceptions and other disadvantageous results that could impact our business, results of operations and financial condition.

We believe that there are no disputes, litigation or other legal proceedings asserted or pending against us that could have, individually or in the aggregate, a material adverse effect on its financial position, results of operations or cash flows, and believe that adequate provision for any probable and estimable losses has been made in our consolidated financial statements. However, the ultimate result of any current or future litigation or other legal proceedings, audits or disputes is inherently unpredictable and could result in liabilities that are higher than currently predicted.

9.              Subsequent Events

In connection with the preparation of these unaudited Consolidated Financial Statements, an evaluation of subsequent events was performed through the date these unaudited Consolidated Financial Statements were issued and there are no other events that have occurred that would require adjustments or disclosure to our unaudited Consolidated Financial Statements.

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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

We begin Management’s Discussion and Analysis of Financial Condition and Results of Operations with a discussion of the critical accounting policies that we believe are important to understanding the assumptions and judgments incorporated in our reported financial results. We then present a business overview followed by a discussion of our results of operations. Lastly, we provide an analysis of our liquidity and capital resources, including discussions of our cash flows, sources of capital and financial commitments.

You should read the following discussion of our financial condition and results of operations in conjunction with the unaudited  consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2012, as filed with the Securities and Exchange Commission. In addition to historical condensed consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below, in Part I, Item 1A “Risk Factors” of the Annual Report and elsewhere in this Quarterly Report on Form 10-Q, particularly in Part II, Item 1A. “Risk Factors.”

Critical Accounting Policies

Since the date of our Annual Report on Form 10-K for the year ended December 31, 2012, there have been no material changes to our critical accounting policies.

General Overview

We provide cost containment services to government and private healthcare payers and sponsors. Our program integrity services ensure that healthcare claims are paid correctly, and our coordination of benefits services ensure that they are paid by the responsible party. Together, these services help clients recover amounts from liable third parties; prevent future improper payments; reduce fraud, waste and abuse; and ensure regulatory compliance.

Our clients are the Centers for Medicare & Medicaid Services (CMS); state Medicaid agencies; commercial health plans, including Medicaid managed care, Medicare Advantage, and group health lines of business; government and private employers; Pharmacy Benefit Managers (PBMs); child support agencies; the Veterans Health Administration (VHA); and other healthcare payers and sponsors.

Since our inception, we have grown both organically and through targeted acquisitions. In 1985, we began providing coordination of benefits services to state Medicaid agencies. We expanded into the Medicaid managed care market, providing similar coordination of benefits services when Medicaid began to migrate members to managed care. We launched our program integrity services in 2007 and have since acquired several businesses to expand our service offerings. In 2009, we entered the Medicare market with our acquisition of IntegriGuard, LLC, or IntegriGuard, now doing business as HMS Federal, which provides fraud, waste and abuse analytical services to the Medicare program. In 2009 and 2010, we entered the employer market, working with large self-funded employers through our acquisitions of Verify Solutions, Inc. and Chapman Kelly, Inc. In 2011, we extended our reach in the federal, state and commercial markets with our acquisition of HealthDataInsights, Inc., or HDI. HDI provides improper payment identification services for government and commercial health plans, and is the Medicare Recovery Audit Contractor (RAC) in CMS Region D, covering 17 states and three U.S. territories. In December 2012, we expanded our Workers’ Compensation recovery services to include commercial health plans through our acquisition of MedRecovery Management, LLC, or MRM. MRM provides Workers’ Compensation recovery services for commercial health plans.

In connection with our acquisition of HDI, we entered into a five-year, revolving and term secured credit agreement, which we refer to as the 2011 Credit Agreement, with certain financial institutions and Citibank, N.A. as Administrative Agent.  In May 2013, we amended and restated the 2011 Credit Agreement and entered into a $500 million five-year, amended and restated revolving credit agreement, which we refer to as the 2013 Credit Agreement.

At June 30, 2013, our cash and cash equivalents and net working capital were $131.5 million and $252.1 million, respectively. To date, we have grown our business through the internal development of new products and services, the extension of our products and services into new markets and through acquisitions of businesses whose core services strengthen our overall mission to help our clients control healthcare costs.  In addition, we leverage our expertise to acquire new clients at the state, federal and employer levels and to expand our current contracts to provide new services to current clients.  Our growth to date has also been driven by growth in government programs as well as increased use of vendors by government agencies for  coordination of benefits and other cost containment functions. We are continuously evaluating opportunities that will enable us to expand the breadth of the services we provide and will consider acquisition opportunities that enable us to continue to grow our business to address the increasing needs of the healthcare industry.

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As of June 30, 2013, we served CMS, the VHA, 46 state Medicaid agencies and the District of Columbia. We also provided services to approximately 150 commercial clients and supported their multiple lines of  business, including Medicaid managed care, Medicare Advantage, and group health plans. We also act as a subcontractor for certain business outsourcing and technology firms.

In September 2012, our wholly owned subsidiary, IntegriGuard, LLC, which is doing business as HMS Federal, was awarded the Coordination of Benefits and Medicare Secondary Payer Business Program Operations contract by CMS.  The incumbent vendor filed a bid protest with the GAO in October 2012 with respect to the contract award and HMS Federal received a stop work order from CMS, pending resolution of the protest. CMS then undertook a procurement corrective action with respect to the contract award, and in June 2013, HMS Federal received notification from CMS that CMS had determined not to affirm HMS Federal’s contract award and instead was issuing the contract award to the incumbent vendor.  HMS Federal subsequently filed a bid protest with Government Accountability Office (GAO), and the GAO now has through early October to issue its decision on the protest.

In February 2013, CMS issued a Request For Quote (RFQ) for the new Medicare recovery audit contract.  Our current Medicare RAC contract, pursuant to which HDI serves as the Medicare RAC for Region D, expires in February 2014 and is one of our largest contracts.  In April 2013, HDI submitted its response to the RFQ and also filed a bid protest with the GAO, which was subsequently dismissed based on CMS’s decision to take voluntary corrective action to resolve the issues raised in the protest in an amendment to the RFQ.  The amended RFQ and any award made thereunder may be protested, which could extend the time frame for implementing the new Medicare RAC contracts.

On August 2, 2013, HDI entered into a modification of its Medicare Recovery Audit Contract with CMS which amends the previously disclosed transition plan for the incumbent Medicare RACs.  Under the amended transition plan, the Medicare RACs are now permitted to continue requesting certain medical records through November 15, 2013 and sending improper payments for processing until January 30, 2014.  In addition, under the amended transition plan, each Medicare RAC will remain responsible for assisting CMS with the  appeals process, and returning fees previously paid on successful appeals, for their current region through December 31, 2015. We expect that the amended transition plan will enable us to achieve our originally anticipated financial performance under the Medicare Recovery Audit Contract through the remainder of its term.  Also on August 2, 2013, CMS released the final rules regarding the Fiscal Year 2014 Inpatient Prospective Payment System which relates to Part A/B rebillings. We are evaluating the financial impact of this final ruling.

Revenues under HDI’s Medicare RAC contract for Region D generated approximately 20.9% and 16.9% of our consolidated total revenues for the six months ended June 30, 2013 and 2012, respectively and 21.7% and 15.7% of our consolidated total revenues for the three months ended June 30, 2013 and 2012, respectively.

Healthcare Environment

In March 2010, the Patient Protection and Affordable Care Act, as amended, or the ACA, was signed into law and in June 2012, the U.S. Supreme Court upheld the constitutionality of the ACA, ruling that the federal government could not condition continued receipt of a State’s existing Medicaid funding on its agreement to implement the Medicaid expansion.  As a result, states choosing not to expand their Medicaid programs will forgo only the federal matching funds associated with such expanded coverage. As a result of the ACA, states face increasing pressure to cover more individuals even as many of them are projecting significant budget deficits.

It is expected that enrollment in government healthcare programs will continue to grow, particularly under the ACA.  However, healthcare spending on Medicare and Medicaid has been reported to be growing more slowly than predicted, with the most recent report from the Congressional Budget Office, or the CBO, showing federal spending for the two programs was 5% lower than it estimated in March 2010.  As a result, the CBO has lowered its seven-year spending projections for these programs by approximately 15% for each program and made changes to Medicaid spending outlays for the next 10 years, citing lower expected costs per person through Medicaid expansion.  The CBO also expects Medicaid enrollment by 2014 will not be as high as previously thought because it is expected that more people will gain health coverage through other sources.

The ACA also includes a number of provisions for combating fraud, waste and abuse, and we believe that the strong bipartisan support for containing healthcare costs through the measures identified in the ACA, provides us with platform for continued growth across products and markets.  We plan to develop and build on existing partnerships with our state, federal and commercial clients and our other partners to provide services that address these provisions and assist these clients with their cost containment objectives.

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.

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SUMMARY OF OPERATING RESULTS

Three Months Ended June 30, 2013 Compared to Three Months Ended June 30, 2012

The following table sets forth, for the periods indicated, certain items in our unaudited consolidated statements of comprehensive income expressed as a percentage of revenue:

Revenue for the three months ended June 30, 2013 was $125.8 million, an increase of $5.7 million, or 4.8%, compared to revenue of $120.1 million in the same quarter for the prior year.  Fluctuations in existing client accounts, together with changes in the yield and scope of those projects, and differences in the timing of when client projects were completed in the current year compared to the prior year, provided a $1.7 million increase in revenue.  Revenue generated by new clients for whom there was no revenue in the prior year period provided $5.7 million of the increase.  Revenue generated by our 2012 acquisition, MRM, was $1.0 million. These increases were offset by contract expirations in the amount of $2.7 million.

Compensation expense as a percentage of revenue was 36.6% for the three months ended June 30, 2013, compared to 33.3% for the three months ended June 30, 2012. Compensation expense for the current quarter was $46.0 million, a $6.0 million, or 15.0%, increase over compensation expense of $40.0 million for the same quarter in the prior year.  During the quarter ended June 30, 2013, we averaged 2,388 employees, a 10.0% increase over our average of 2,171 employees during the quarter ended June 30, 2012.  This increase reflects the addition of staff in the areas of client support, technical support and operations.

Data processing expense as a percentage of revenue was 7.3% for the three months ended June 30, 2013, compared to 6.7% for the three months ended June 30, 2012. Data processing expense was $9.2 million for the current quarter, an increase of $1.2 million, or 14.5%, over data processing expense of $8.0 million for the same quarter in the prior year. This increase reflects $1.2 million in additional hardware and hosting costs.

Occupancy expense as a percentage of revenue was 3.8% for the three months ended June 30, 2013, compared to 3.5% for the three months ended June 30, 2012. Occupancy expense for the current quarter was $4.8 million, a $0.6 million, or 14.0%, increase compared to occupancy expense of $4.2 million for the same quarter in the prior year. This increase reflects $0.4 million in additional equipment and maintenance expense and $0.2 million in additional utilities and maintenance expenses.

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Direct project expense as a percentage of revenue was 9.8% for the three months ended June 30, 2013, compared to 11.0% for the three months ended June 30, 2012.  Direct project expense for the current quarter was $12.3 million, a $0.9 million, or 7.1%, decrease compared to direct project expense of $13.2 million for the same quarter in the prior year. This resulted from a $1.6 million decrease in temporary headcount expenses, partially offset by a $0.6 million increase in data conversion expenses.

Other operating costs as a percentage of revenue were 6.1% for the three months ended June 30, 2013 compared to 5.0% for the three months ended June 30, 2012. Other operating costs for the current quarter were $7.7 million, an increase of $1.7 million, or 27.8%, compared to other operating costs of $6.0 million for the same quarter in the prior year.  This increase primarily resulted from a $1.4 million increase in professional fees, a $0.2 million increase in office -related expenses, including postage, delivery and supplies and a $0.1 million increase in travel expenses.

Amortization of acquisition-related software and intangibles as a percentage of revenue was 6.9% for the three months ended June 30, 2013, compared to 6.8% for the three months ended June 30, 2012. Amortization of acquisition-related software and intangibles for the current quarter was $8.8 million, compared to amortization expense of $8.1 million for the same quarter in the prior year.  This increase was related to our acquisition of MRM in December 2012.

Selling, general, and administrative expense as a percentage of revenue was 13.3% for the three months ended June 30, 2013 compared to 12.4% for the three months ended June 30, 2012.  Selling, general, and administrative expense for the current quarter was $16.8 million, a $1.9 million, or 12.7%, increase compared to $14.9 million for the same quarter in the prior year.  During the quarter ended June 30, 2013, we averaged 239 corporate employees, a 14.4% increase over our average of 209 corporate employees during the quarter ended June 30, 2012.  Compensation expense increased by $0.4 million due to the increase in headcount.  Data processing expenses increased by $0.3 million due to additional software expenses.  Occupancy costs increased by $0.1 million due to moving expenses.  Other costs increased by $1.0 million primarily due to a $1.1 million increase in legal fees, partially offset by a reduction of $0.1 million in training and employee relocation costs.

Operating income for the three months ended June 30, 2013 was $20.4 million, a decrease of $5.2 million, or 20.4%, compared to $25.6 million for the three months ended June 30, 2012.

Interest expense was $4.0 million for the three months ended June 30, 2013 and $4.2 million for the three months ended June 30, 2012. The decrease of $0.1 million compared to the prior year period represents a reduction of $0.6 million in interest expense on our debt, partially offset by an increase in amortization of deferred financing costs of $0.5 million.  Interest income was $17,000 for the three months ended June 30, 2013, compared to interest income of $2,000 for the three months ended June 30, 2012.  Net other income increased to $776,000 for the quarter ended June 30, 2013 from $209,000 in the prior year period.   Other income in the second quarter represents a release to us of a portion of the funds held in escrow related to our HDI acquisition that occurred after the measurement period.  This increase was partially offset by a $0.2 million reduction related to tenant leases associated with our Irving, Texas building that expired and were not renewed.

We recorded income tax expense of $6.7 million for the quarter ended June 30, 2013, compared to income tax expense of $8.7 million for the three months ended June 30, 2012, a decrease of $2.0 million.  Our effective tax rate decreased to 39.1% for the quarter ended June 30, 2013 from 40.0% for the quarter ended June 30, 2012, primarily due to a change in state apportionments and permanent differences. The principal differences between the statutory rate and our effective rate are state taxes and permanent differences.

We reported net income and comprehensive income of $10.4 million for the three months ended June 30, 2013 versus $13.0 million for the three months ended June 30, 2012.

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Six Months Ended June 30, 2013 Compared to Six Months Ended June 30, 2012

The following table sets forth, for the periods indicated, certain items in our unaudited consolidated statements of comprehensive income expressed as a percentage of revenue:

Revenue for the six months ended June 30, 2013 was $242.4 million, an increase of $15.0 million, or 6.6%, compared to revenue of $227.4 million in the same period for the prior year.  Fluctuations in existing client accounts, together with changes in the yield and scope of those projects, and differences in the timing of when client projects were completed in the current year compared to the prior year, provided a $8.6 million increase in revenue.  Revenue generated by new clients for whom there was no revenue in the prior year period provided $10.3 million of the increase. Revenue generated by our 2012 acquisition, MRM, was $1.8 million. These increases were offset by contract expirations in the amount of $5.7 million.

Compensation expense as a percentage of revenue was 37.1% for the six months ended June 30, 2013, compared to 34.9% for the six months ended June 30, 2012. Compensation expense for the current period was $90.0 million, a $10.7 million, or 13.5%, increase over compensation expense of $79.3 million for the same period in the prior year.  During the six months ended June 30, 2013, we averaged 2,397 employees, a 12.2% increase over our average of 2,136 employees during the six months ended June 30, 2012.  This increase reflects the addition of staff in the areas of client support, technical support and operations.

Data processing expense as a percentage of revenue was 7.5% for the six months ended June 30, 2013, compared to 6.6% for the six months ended June 30, 2012. Data processing expense was $18.3 million for the six months ended June 30, 2013, an increase of $3.4 million, or 22.6%, over data processing expense of $14.9 million for the six months ended June 30, 2012. This increase reflects $2.3 million in additional hardware and hosting costs, $1.2 million in additional software related costs, partially offset by a reduction of $0.1 million related to data and data communications costs.

Occupancy expense as a percentage of revenue was 3.9% for the six months ended June 30, 2013, compared to 3.7% for the six months ended June 30, 2012. Occupancy expense for the current period was $9.4 million, a $1.1 million, or 13.1%, increase compared to occupancy expense of $8.3 million for the same period in the prior year. This increase reflects $0.6 million in additional utilities and maintenance costs and $0.5 million in additional equipment and maintenance expense.

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Direct project expense as a percentage of revenue was 10.6% for the six months ended June 30, 2013, compared to 11.4% for the six months ended June 30, 2012.  Direct project expense for the current period was $25.5 million, a $0.5 million, or 1.9%, decrease compared to direct project expense of $26.0 million for the same period in the prior year. This resulted from a $1.1 million decrease in subcontractor and professional fees.

Other operating costs as a percentage of revenue were 5.9% for the six months ended June 30, 2013 compared to 4.9% for the six months ended June 30, 2012. Other operating costs for the current period were $14.3 million, an increase of $3.2 million, or 28.6%, compared to other operating costs of $11.1 million for the same period in the prior year.  This increase primarily resulted from a $2.0 million increase in professional fees, a $0.6 million increase in office-related expenses, including postage, delivery and supplies, a $0.4 million increase in travel expenses and a $0.2 million increase in recruiting and training costs.

Amortization of acquisition-related software and intangibles as a percentage of revenue was 6.9% for the six months ended June 30, 2013, compared to 7.2% for the six months ended June 30, 2012. Amortization of acquisition-related software and intangibles for the current period was $16.7 million, compared to amortization expense of $16.3 million for the same period in the prior year.   This increase was related to our acquisition of MRM in December 2012, partially offset by other intangibles having become fully amortized.

Selling, general, and administrative expense as a percentage of revenue was 13.4% for the six months ended June 30, 2013 compared to 13.0% for the six months ended June 30, 2012.  Selling, general, and administrative expense for the current period was $32.6 million, a $2.8 million, or 9.5%, increase compared to $29.7 million for the same period in the prior year.  During the period ended June 30, 2013, we averaged 244 corporate employees, a 21.4% increase over our average of 201 corporate employees during the period ended June 30, 2012.  Compensation expense increased by $0.7 million due to the increase in headcount, partially offset by decreases in stock compensation expense.  Data processing expense increased by $0.3 million primarily due to software costs. Occupancy costs increased by $0.3 million. Other costs increased by $1.5 million primarily due to a $1.7 million increase in legal fees, partially offset by a reduction of $0.2 million in training and employee relocation costs.

Operating income for the six months ended June 30, 2013 was $35.6 million, a decrease of $6.0 million, or 14.4%, compared to $41.6 million for the six months ended June 30, 2012.

Interest expense was $7.8 million for the six months ended June 30, 2013 and $8.4 million for the six months ended June 30, 2012. The decrease of $0.6 million compared to the prior year period represents a reduction of $1.0 million in interest expense on our debt, partially offset by an increase in amortization of deferred financing costs of $0.4 million.  Interest income was $18,000 for the six months ended June 30, 2013, compared to interest income of $4,000 for the six months ended June 30, 2012.  Net other income increased to $799,000 for the six months ended June 30, 2013 from $209,000 for the six months ended June 30, 2012.   Other income in the current period represents a release to us of a portion of the funds held in escrow related to our HDI acquisition that occurred after the measurement period.  This increase was partially offset by a $0.2 million reduction related to tenant leases associated with our Irving, Texas building that expired and were not renewed.

We recorded income tax expense of $11.3 million for the six months ended June 30, 2013, compared to income tax expense of $13.6 million for the six months ended June 30, 2012, a decrease of $2.3 million.  Our effective tax rate decreased to 39.3% for the period ended June 30, 2013 from 40.4% for the period ended June 30, 2012, primarily due to a change in state apportionments and permanent differences. The principal differences between the statutory rate and our effective rate are state taxes and permanent differences.

We reported net income and comprehensive income of $17.4 million for the six months ended June 30, 2013 versus $20.0 million for the six months ended June 30, 2012.

Contractual Obligations

As of June 30, 2013, we are contractually obligated to pay $302.7 million of the outstanding revolving debt related to the 2013 Credit Agreement by April 2018. We estimate that interest expense related to this debt over its term to be $41.4 million.

With the exception above, there have been no material changes in our contractual obligations as presented in our Annual report on Form 10-K for the year ended December 31, 2012.

Off-Balance Sheet Arrangements

Other than our Letter of Credit, we do not have any off-balance sheet arrangements.

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Liquidity and Capital Resources

This data should be read in conjunction with our unaudited Consolidated Statements of Cash Flows.

A summary of our cash flows is as follows: