HMS Holdings Corp
Q1 2018 Earnings Call Transcript

Published: 4 May 2018

[Operator:]

Good day, ladies and gentlemen, and welcome to the HMS Holdings Corporation First Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this conference call is being recorded. I would now like to turn the conference over to our host for today, Dennis Oakes. You may begin.

[Dennis Oakes:]

Thank you, Sonia. Good morning, and welcome to the HMS earnings conference call for the first quarter of 2018. Joining me are Bill Lucia, our Chairman and Chief Executive Officer; and Jeff Sherman, our Chief Financial Officer. This call is being webcast and can be accessed by the Investor Relations section of our company website at hms.com. Today's earnings release as well as an investor slide presentation containing supplemental information are posted on our website as well. Bill and Jeff will provide their perspective this morning on our first quarter financial results and following their remarks, we will open the line for questions. We ask that you kindly limit inquiries to one question and one follow-up so we can get through the full list of callers in a timely fashion. Before we get started, I want to remind you that some of the statements we will make today are forward-looking based on our current expectations and the view of our business as we see it today. Such statements including those related to future performance and future business plans and objectives are subject to risks and uncertainties that may cause actual results to differ materially. As a result, they should be considered in conjunction with the cautionary statements in today's earnings release, and risk factors described in the company's most recent SEC filings including our Form 10-K. The financial results in today's earnings release reflect preliminary results which are not final until our first quarter 2018 Form 10-Q is filed. Finally, we may refer to certain non -GAAP measures this morning. And a reconciliation of those measures to GAAP is included in both our earnings release and the investor presentation. We're now ready to begin. Bill?

[William C. Lucia:]

Thank you, Dennis, and good morning, everyone. Following a record fourth quarter, we are encouraged by the strong start to 2018, reflected in the financial results we reported today. Total revenue, adjusted EBITDA and operating cash flow in the first quarter each exceeded our expectations, which we believe positions us nicely to achieve our full year objectives. The significant year-over-year growth in payment integrity revenue is an ongoing indication that the initiatives we implemented in 2017, to enhance the analytics and operations supporting PI, are continuing to boost savings for our customers and generate added revenue for HMS. Having recently passed the one year anniversary of our purchase of the Eliza consumer engagement platform, we are intently focused this year on cross-sales to our existing customers, particularly the middle-market Medicaid plans where a set analyzer have relatively lower penetration. We have spoken previously about our international target list of customers which we began to approach at the end of last year, and the positive reaction we have received about the capabilities of our new care management and consumer engagement solutions. We have inked several contracts and are in active dialogue with a number of our existing COB and PI customers about purchasing business solutions. More broadly, we continue to use technology to leverage our unparalleled database and analytics to innovate on behalf of our customers and their members. As we announced earlier this week, we hired a Chief Technology Officer to assist in that process. Jacob Sims has extensive experience leading large-scale healthcare it organizations and technology-based product development. So he is well equipped to ensure that we proactively maximize technology, stay at the forefront of changes impacting a rapidly-evolving healthcare IT world. A good example of our internal innovation activity is the new population risk intelligence product we have developed. This analytics software solution assists with early and accurate identification of health plan members who will most benefit from effective intervention and personalized engagement, designed to change behavior and improve clinical outcomes. We have spoken previously about this effort which began with an experiment in one state last year, including both the state fee-for-service population and the Medicaid managed care plans in that state. We will have more to say about this important new approach to total population management in the weeks ahead, as we formally launch the product. We worked hard during 2017 to overcome execution challenges, particularly with regard to payment integrity and related implementations of newly sold PI business. We have refined the entire implementation process for both PI and COP, to eliminate projects on hold due to HMS cause delays, improved throughput and reduced the total time required from contract signing to revenue generation. Going forward, we believe we now have the people, technology and processes in place to achieve the revenue growth we expect this year. There were three factors which contributed to the sequential and year-over-year growth in PI revenue we saw in the first quarter, including revenue from existing COB clients, who bought payment integrity products for the first time. Scope expansions with existing PI customers which produced incremental revenue was the second contributor. And the last is product yield improvements we put in place in recent months, which continued to expand our audit portfolio, increased audit volume, improved the savings rate per finding, and lowered the turnaround time for customers for whom we are already doing PI work. From a product perspective, data mining and complex clinical reviews, were the two areas of greatest PI outperformance in the first quarter compared to our expectations. More generally, we are seeing payment integrity growth that is broad based and spread across multiple hub plants and state Medicaid agencies. That should mitigate the risk that any individual customer actions related to provide our operation concerns or other network issues, will meaningfully impact PI revenue this year. Jeff will now provide added detail on the first quarter performance. Jeff?

[Jeffrey S. Sherman:]

Thank you, Bill, and good morning. I will begin this morning by reviewing first quarter revenue from both a customer and product perspective. Total revenue of $141.4 million, included $8.4 million in Medicare RAC revenue due to the reversal of a portion of the appeals reserve related to the original contract. Following expiration of our old Region B contract on January 31, the requirement to maintain a reserve for open or pending appeals ended and we reversed the associated reserve. Excluding the Reserve Release, normalized revenue for the quarter of $133 million was slightly above our projection. The RAC Reserve Release resulted in a net benefit in the quarter of $0.05 per diluted share, such that normalized adjusted EPS was $0.17. Eliza revenue was $9.7 million in the quarter. Excluding that from the year-over-year comparison, since we could not close on the acquisition until last April, first quarter commercial revenue was up double digits, state government revenue was up low-single digits as was coordination of benefits, and total revenue was up over 8% on an organic basis, excluding both the Eliza revenue and RAC reserve released in the quarter. As always, we expect to see a modest step-up in each of these revenue components in the second quarter followed by a more significant uptick in the second half. Coordination of benefits revenue was approximately 65% of total revenue in the first quarter compared to nearly 78% a year ago. That is a positive reflection of the diversification resulting from the addition of our new care management and consumer engagement vertical, as well as the relatively faster growth of payment integrity revenue in the quarter. Adjusted EBITDA of $35 million included a benefit of approximately $6 million from the Reserve Release, but it was still meaningfully higher than the 2017 first quarter total of $20 million. This strong performance reflects both the leverage we get on incremental revenue and ongoing efficiency and cost savings initiatives. Though the effective tax rate in the quarter was approximately 32%, we continue to expect it will be in a range of 28% to 30% on a full year basis. As we pointed out on our February call, that projection is based on the new lower federal rate, partially offset by the loss of deductions (00

[William C. Lucia:]

As Jeff just mentioned, the new year is off to a strong start for HMS. Looking ahead, we recognized the need for consistent and predictable performance throughout 2018, and we are committed to achieving it. Reaching our objectives is aided considerably by a favorable environment for sales of our services. Macro factors such as the growth of government programs and aging population with a high incidence of chronic disease, unsustainable cost pressures throughout healthcare services and an ever increasing focus on the consumer experience, provide a positive backdrop for our business. We also have the data, the analytics, the customer base, a committed and engaged workforce and a highly leverageable business model, which we believe will support and sustain profitable growth throughout this year and beyond. Before closing, I want to recognize the hard work of HMS employees around the country and in every department throughout HMS, who contribute each day to the company's growth and have success in service to our customers. In recognition of that contribution, we have recently announced internally that we will be sharing a portion of the federal tax-cut savings with employees by increasing the company match to our 401(k) plan. This is not a one-time bonus, but an indefinite change to our plan design which will provide an added incentive for employees to save for their future; a long-term reward for plan participants and an ongoing reminder of our appreciation. Operator, we are now ready for the first question.

[Operator:]

Thank you. Our first question comes from Sean Dodge of Jefferies. Your line is now open.

[Sean Dodge:]

Yeah. Good morning. Thanks for taking my questions. Maybe starting with a quick update on the commercial outlook, I know you've had some implementations that you've been working on; and Bill, you mentioned refining that process to speed those up. As we think about how commercial revenue progresses over the course of the year from here, should we expect to see a nice linear ramp, so sequential improvement or growth every quarter?

[William C. Lucia:]

So, we usually see a modest uptick in Q2 and then further ramp in the second half of the year. Typically, if you look at us historically, about 40% of our revenue's in the first half and 60% is in the second half. So you should expect that growth. I would also say that, getting through the backlog of implementations and more timely executing on those is lending our sales from that perspective.

[Sean Dodge:]

Okay. Very good. And then, on the care management or consumer engagement platform, Bill, you mentioned lots of client interest in those solutions. Can you put any numbers around conversations you're having or anticipated growth for that platform? And then, when we should begin to see all of that flow into revenue?

[William C. Lucia:]

Yes. So as we talked about in our call in February, we do expect the consumer engagement and care management vertical to grow double digits this year. So, that hasn't changed. I think with the level of interest we've seen and some of the sales that have already taken place both in the fourth quarter and the first quarter of 2018, we believe we'll be able to achieve that double-digit revenue growth in that product line.

[Sean Dodge:]

All right. Very good. Thank you.

[Operator:]

Thank you. Our next question comes from Mohan Naidu of Oppenheimer. Your line is now open.

[Mohan Naidu:]

Thanks for taking my questions. So, two questions. First one on the yield improvement. Bill or Jeff, you guys have been talking about using machine learning and AI quite a bit here. Can you discuss the impact these efforts are having? And specifically, I'm looking at any potential productivity improvements that can translate to margins? And how soon can we expect that to happen in the numbers? Thanks.

[William C. Lucia:]

Thank you, Mohan. It's a good question. So we have been using NLP and AI to assist us in reading medical records and to replicate what a medical record coder might do. For competitive reasons, I'm not going to go over – deep dive into how we do it. But what that is meant to do is, as we ramp new revenue in PI, we won't need to add as many resources and we're also making sure that we have more appropriate findings. So one of the things that's really important to us, our clients and of course the providers, is that we lower the number of false positives. We've always been very good about (00

[Jeffrey S. Sherman:]

Yeah. I think we've also talked about using robotic process automation to automate more manual tasks, I think which also then allows us to redeploy some of those staff and resources we have been working on at the hiring initiatives like driving incremental yield for our customers. So I think it's a win both from a cost perspective as well as a revenue lift perspective. And we started to see some of that in 2017, and expect to see more of that as we progress through 2018.

[Mohan Naidu:]

Thanks, guys. I guess, maybe a quick follow up on there. I mean, I guess, with the efforts that you are having here, are you – I guess, is this as effective or better than the human involvement. It looks like – in the beginning sort of machine learning, it looks like that's a big hurdle to get over, getting to an acceptable level of effectiveness compared to real human doing work. I guess, have you surpassed that threshold?

[William C. Lucia:]

So, we're implementing machine learning and AI in a couple of places in the company. PI is not the only part of the company that we're doing that, and we have two models. One is purely a machine learning tool that does this very specific task and can do that on a repetitive basis. The other model is a mentor-based machine learning, more of an artificial intelligence. So, it learns from how we do the work and then, of course, the better – the more efficient and effective our reviewers are, the more efficient and effective the tool is. And so, that's more a mentor-based model technology in AI and we've also deployed that. So there's really a couple different tools that we are both experimenting with or are in production in a number of areas of our business, not just payment integrity.

[Mohan Naidu:]

Got it. One quick one for Jeff. The $8 million-odd Reserve Release, was that anticipated in the guidance or should we think of that as an upside to your guidance?

[Jeffrey S. Sherman:]

Yeah. We didn't update guidance and don't plan on updating guidance each quarter. We did provide full year guidance in a range. So as we indicated in the call, with a strong start to this year positions us nicely to reach our full year objectives. But we were (00

[Mohan Naidu:]

Yeah. Got it. Thank you very much.

[Operator:]

Thank you. Our next comes from Ryan Daniels of William Blair. Your line is now open.

[Unknown Speaker:]

Hey, guys. This is Rob (00

[Jeffrey S. Sherman:]

Yeah. The delta is, as we have reported pluses and minuses over time in the RAC revenue related to reserves, it flows through to our bottom line and then our equity or our bonus calculation. So there is a variable bonus impact calculation from $8.4 million, so it was a little bit over $2 million. So the net benefit of the Reserve Release was just over $6.3 million. And then you have the tax-effected as well to get the EPS impact, and so that takes it down to about $4.3 million after tax-effecting it.

[Unknown Speaker:]

Okay. Thank you very much. That was really helpful. And then, I guess my second question. With Eliza, you got two top 10 plants that you're not working with yet. Has this led to any cross-sell opportunities for the core PI business?

[William C. Lucia:]

For those two plants, not yet. But we anticipate that, as we continue to build those relationships then the Eliza brand becomes more the HMS Eliza brand that we'll have opportunities with those accounts.

[Unknown Speaker:]

Okay. Thank you very much.

[Operator:]

Thank you. Our next question comes from Stephanie Demko of Citi. Your line is now open.

[Stephanie J. Demko:]

Hey, guys. Thank you for taking my questions and congrats on the quarter.

[William C. Lucia:]

Thank you.

[Stephanie J. Demko:]

So Bill, you touched on this in the prepared remarks, but you've made a few investments in PI since the back half of last year; (00

[Jeffrey S. Sherman:]

I'll start and – this is Jeff, and I'll let Bill jump in. So as you may recall, we did talk about actually exiting the third quarter that we started to see a significant uptick in the number of medical records we were requesting. Some of the technology investments we made and our improved screening helped drive that volume increase. And typically, we have a 90- to 120-day lag from when we request a record to actually having a finding in revenue generation. So I think, PI is playing out as we expected. We saw that trend of higher volume of requests continuing into Q4. And I think, right now we're just starting to capitalize and see the revenue recognition from that list (00

[Stephanie J. Demko:]

Thank you, Jeff. As a follow up to that on PI, could you, given recent market trends, give us an update on many build-outs or investments you've been (00

[William C. Lucia:]

So, we continue to invest in the prospective product to – as we said it in the past, our prospective product really was focused on complex clinical reviews, DRG, place to service, those types of things that we do in the complex world or the complex clinical side of coding. We are now in the process of moving the other data mining edits, virtually any edit that we run retrospectively and trying to or even attempting to refurbish them on the prospective side so they can move into that engine. It is a slow adoption rate, as we talked about before. It takes a little longer to implement these. They are more complex. But we have had increased adoption in the quarter in the marketplace. So, we still see that as a strong grower in the future for our business.

[Stephanie J. Demko:]

Given it's a machine learning kind of build-out, would then your PI product have a little more of a healthier margin than some of your peers?

[Jeffrey S. Sherman:]

I wouldn't compare it to peers. But I think as if we look at it, the more that we are able to leverage technology to both improve the screening and our success rates, we should see margin lift from that over time.

[Stephanie J. Demko:]

All right. Thank you, guys. I appreciate it.

[Operator:]

Thank you. Our next question comes from Charlie Strauzer of CJS Securities. Your line is open.

[Charles Strauzer:]

Hi, good morning. I know that some of the onboarding issues that were kind of prevalent last year, that seems to be kind of smoothing (00

[Jeffrey S. Sherman:]

So, we devoted a lot of time and resources in 2017 to improve implementations overall and in particular PI. As we mentioned on the call, we do think we have the people and processes in place to work through the inventory of sold business for both PI and COB, so that we are at a normalized level at the end of the year. We did budget much more discretely, at both our customer and product level, our implementations. And so, we have refined our tracking and analytics and implementations significantly in the back half of 2017. So we do have better visibility, which allows us to respond to changes because changes will happen, customers will make changes in their plans. And I think the other effort we've done that Bill noted in his prepared remarks is, we took a very hard look at projects that were on hold in our implementation queue based upon issues that HMS could control, and we have resolved all of those. And so, now our queue is very clean and I think we have a very focused team that is monitoring it every month. We certainly look at it and review it every month as an executive team, and we can respond accordingly to changes. So I think it's a combination of a lot of work that was done throughout 2017 that we're starting to see the benefits hitting in 2018.

[Charles Strauzer:]

Great. It sounds like you guys have your arms around that. Thank you very much.

[Operator:]

Thank you. Our next question comes from Richard Close of Canaccord Genuity. Your line is now open.

[Richard Collamer Close:]

Great. Thank you. Congratulations. Bill, maybe just talking about the PI revenue growth, you gave the three buckets there; existing COB that bought PI for the first time, the scope expansion with existing and then the yield improvement. Can you sort of break those three buckets down in terms of what was most important in terms of the growth and sort of rank them?

[Jeffrey S. Sherman:]

Hi, Richard. This is Jeff. I'm not going to give explosive details. But I would say, it's always a faster ramp to expand on existing customer base than ramping up a new customer base. So you should expect that, of the three, expanding sales with existing customers and yield improvement have a more immediate impact on revenue, or as new customers always take more time to ramp up. So I would just point you that more weighted towards existing customers in yield improvement, but with new customers over time ramping up.

[Richard Collamer Close:]

Okay. Bill, with the selling environment, it sounded like you made some positive comments there. Can you just talk about the overall selling environment and what people are maybe most interested in near-term versus long-term?

[William C. Lucia:]

Well, I think our product suite is attractive across the markets we serve, both government and the commercial or top line market. The payment integrity continues to be appealing, particularly across our customer base because remember, we're in state RACs – Medicaid State RACs, and then most of our commercial plans are government risk. So, they typically have (00

[Jeffrey S. Sherman:]

Yeah. And I would just add, we've mentioned this before, but care management and member engagement both lies in a set, principally focused on the commercial marketplace. The government marketplace is much more complex, much more detailed RFP processes. We have started and are having an active dialogue in the state market for both of those products as well, as well as the risk-intelligent product that Bill mentioned. And we do see that we're going to – we believe we're going to get traction there over time. We don't think there's going to be a big 2018 impact, but we are seeing more interest there and do think we have a good upside opportunity to sell those products into the state market as well.

[Richard Collamer Close:]

So, maybe a follow up on that last comment. One of the other companies we cover, Cerner, has talked about a recent win, and I think it was the State of Montana for some of their population health with regard to Medicaid. I'm just curious, on the Eliza set care management, member engagement offering, what's the competition like in that area? And are you running into people like Cerner at all, maybe in the state business there?

[William C. Lucia:]

Well, we haven't seen a lot of procurement. We just started marketing in the state market, but the states typically buy through procurement. So, RFP-driven. We haven't seen many RFPs for this. There have been a number of RFPs for care management systems that are wrapped into MMIS solutions, and so we're bearing with partners there. But we haven't seen a lot of population management RFPs out of the state market yet. What we're trying to do is, either sell the more holistic approach with the three tools linked together or just sell our new population risk intelligence product which helps them do everything from identifying members that they today don't know – they don't have the care management programs. And based on their analytics, are now (00

[Jeffrey S. Sherman:]

And we do think we are well positioned to be competitive, first and foremost, because of all the data that we currently already have, which we think positions us well to be very competitive using the data you already have; some physician claims, hospital claims and pharmacy claims. But we think that does give us an advantage as we look to how to utilize it and work with that data to provide actionable insights to states.

[Richard Collamer Close:]

My final question is along the lines of – I think you had a pilot that you talked about last year with the state Medicaid agency on this member health profile. Can you give us any update with respect to that pilot?

[William C. Lucia:]

Yes. So, that is the risk intelligence tool that we talked about.

[Richard Collamer Close:]

Okay.

[William C. Lucia:]

The state itself is – I think we're in final contract stages. They have the contract countersigned. It's also – there are subcontracts in front of the five health plans in that state. That's the product what I said we will do a formal market launch within the next month. And it'll not only be launched independently, but we'll talk about the integration of that with Eliza and Essette.

[Richard Collamer Close:]

Okay. Thank you.

[Operator:]

Thank you. Our next question comes from Jamie Stockton of Wells Fargo. Your line is now open.

[Jamie Stockton:]

Hey. Good morning. Thanks for taking my questions. Just a follow up on the population health products which – Bill, I kind of sense that you guys are trying to keep some of the details close to your vest at the moment. Should we think about this as the differentiation versus maybe the existing starts that a (00

[William C. Lucia:]

Yeah. So, you're right. We're not doing a lot of detail about the product as well as launch for competitive reasons. But I will tell you, the leg-up we have is the fact that the state authorizes the uses of data, right. So like in our pilot state, we took all of the claims and encounters of the state – encounters where they encountered (00

[Jeffrey S. Sherman:]

Yeah. So if they have the risk profile day one then as you know, Jamie, with the comprehensive platform of both care management and member engagement, we can also provide the best way to reach out to the patient to change their behavior as well as care management platform with a set to help manage the patient through the continuum of care. So, we do think we have a unique offering from that perspective and coming to the market with something differentiated.

[Jamie Stockton:]

Okay. That's great. And what's the – maybe just one other one, Jeff. The SG&A number did come down kind of the non-GAAP number from the Q4 level, where I think you had pretty heavy bonus accrual. But was there anything still in the SG&A number this quarter that was kind of unusual or should we view that as more of a clean number that's in the kind of a go-forward level?

[Jeffrey S. Sherman:]

Yeah. I mean, it's a clean number, but it does include a stepped-up level of stock comp expense, Jamie, that I noted. And so, stock comp expense, we do expect will trend down for the remaining quarters of the year.

[Jamie Stockton:]

Okay. That's great. Thank you.

[Operator:]

Thank you. And our last question comes from Frank Sparacino of First Analysis. Your line is now open.

[Frank Sparacino:]

Hi, guys. Given we're about a year past Eliza, just curious, have you seen any meaningful attrition in the client base? What's been the retention?

[Jeffrey S. Sherman:]

Retention has been very high. I think we talked about the Eliza revenue model. In 2017, about a quarter of it was on PMPM recurring revenue model. We did see some nice growth in that in Q1. So, we are seeing more technology-driven revenue generation at Eliza in Q1. We're always going to have puts and takes, but the transactional revenue with which we view as recurring because it occurs every year, that that can be a little more lumpier on a quarter-to-quarter basis, but we haven't seen any meaningful customer departures. And as Bill noted, we have seen several cross-sales and are still getting good receptivity in the marketplace on it. And it is – I think as a new sale on the care management or – excuse me, in the member engagement, we wouldn't necessarily expect a SaaS model on a new sale. We believe we're going to start transactional and evolve over time until there is a recurring revenue model, which we believe is a higher margin model and positions us to see margin expansion over time.

[Frank Sparacino:]

Great. And one last one for me just in terms of the PI business. Can you give us a sense in terms of visibility and, I guess, maybe kind of the current trend on the volume side or what type of backlog you have right now to work through as you look out to the remainder of 2018?

[Jeffrey S. Sherman:]

So, we saw the – as I mentioned, we saw the stepped-up volume of requests starting in September-October timeframe. That level has continued. I'd say, it's been stable, but it's stable at a much higher level than our average run rate for 2017. So I think we have good visibility on that. We're continuing to add some expansions, as Bill noted. And if we're expanding with an existing customer, that can be quicker to revenue generation and then we're still implementing throughout the year. So I think, overall we expect the see PI grow double digits in 2018. I think we're well positioned to do that based upon first quarter results.

[Frank Sparacino:]

Thank you, Jeff.

[Jeffrey S. Sherman:]

Yeah.

[Operator:]

Thank you. And ladies and gentlemen, this does conclude our question-and-answer session. I would now like to turn the call back over to Bill Lucia for any closing remarks.

[William C. Lucia:]

Well, I'd like to thank you all for attending our first quarter call and look forward to our second quarter call. Have a good day and a wonderful weekend. Thank you.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day.