HMS Holdings Corp
Q2 2015 Earnings Call Transcript

Published: 7 Aug 2015

[Operator:]

Good day, ladies and gentlemen and welcome to the HMS Second Quarter 2015 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 follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I will now like to turn the conference over to Dennis Oakes, Senior Vice President of Investor Relations. Please begin.

[Dennis Oakes:]

Thank you, Latoya. Good morning and thank you everyone for joining us for the HMS second quarter 2015 earnings conference call. With me today are Bill Lucia, our Chairman and Chief Executive Officer; and Jeff Sherman, our Chief Financial Officer. As you know, we distributed our earnings release through our Web site hms.com, under the Investor Relations tab. We also posted quarterly investor presentation containing supplemental information that we will not make specific reference to it in our prepared remarks. This call is being webcast and can be accessed by the Events & Presentations tab on our Investor Relations site and a replay of the call will be posted later this morning. Please remember that some of the information presented today regarding the company's future expectations, plans and prospects is considered forward-looking statements under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on the company's current expectations and actual events may differ materially from those expectations. We refer you to the company's filings with the Securities and Exchange Commission, including our annual report on Form 10-K and our quarterly reports on Form 10-Q which identify important risk factors that could cause actual results to differ materially from those contained in the company's projections or forward-looking statements. All information on this call is as of today, August 7, 2015, and the company disclaims any intent or obligation to update any forward-looking statements as a result of developments occurring after today's call. Additionally, we will be referring to certain non-GAAP measures during the call and our press release issued this morning includes a reconciliation of those measures to GAAP. Now we are ready to begin. Bill?

[Bill Lucia:]

Thank you, Dennis, and good morning everyone. Our second quarter financial performance reflected solid growth on several key measures. Combined with the first quarter, we are just about where we expected to be six months into 2015. Revenue this quarter excluding Medicare RAC was up over 7% compared to the second quarter of last year and was nearly 11% higher compared to the first half of last year. Commercial revenue at $49.3 million was the highest quarterly total in company history and 14% higher than the first quarter of this year. We expect ongoing sequential growth in our commercial business through the balance of 2015. The 9% jump in payment integrity revenue this quarter compared to the year ago quarter is also an encouraging sign. Payment integrity revenue can be uneven from quarter-over-quarter as we have significant findings and clients then fix the root cause. Second quarter PI increase, however, reflects an increasing percentage of new commercial sales of PI products to customers who previously bought our coordination of benefits products and acceleration of the sales implementation process. We made progress during the second quarter in the retention of several state third party liability contracts. We finalized the Florida agreement where we will return as the prime contractor for five years. The state also has the option to extend for up to five years subsequent to the initial term. We previously announced that Massachusetts has extended our current contracts until the end of 2016. During the quarter we also received one year extensions from Wisconsin and Washington State for TPL services pushing both existing contract terms to June 30, 2016 and postponing their respective competitive bids until next year. We won competitive re-procurements during the quarter in Oklahoma, New Mexico and Wisconsin. Oklahoma began July 1 and is a one-year contract with five one-year renewals. New Mexico was a four year TPL engagement and the Wisconsin renewal is a casualty contract for one-year with a one year renewal option which also started at the beginning of last month. We submitted our RFP response to New York in July. The state has indicated in the publicly available RFP, it's target date for announcing the contract award and that date is August 22, though such deadlines maybe modified in state procurements. And nevertheless, our current New York contract does not expire until next January. The only other significant state re-procurement we expect during the balance of 2015 is Tennessee, which is one of our top 10 state clients and that contract expires on January 31 of next year. As we mentioned on our first quarter earnings call, there will be a meaningfully lower level of state contract renewal activity next year. Even with the new extensions in Wisconsin and Washington, the state currently scheduled to seek bids for contracts expiring next year account for less than 12% of our projected 2015 state revenue based on our current forecast. That percentage assumes that states with whom we currently contract exercise available extension options as has been done historically. The only one of our top 10 states with a renewal option next year is North Carolina which is business we just re-won last November. Other than to say we disagree with the decision, we cannot say much about the proposed New Jersey TPL contract award to a competitor, since we are in the process of protesting it. Given that this is a legal process, it's just not prudent for us to address any aspect of the New Jersey RFP including questions about the basis for the state's decision, the content of our proposal, our protest or our expectations about the outcome. As we reported earlier this week, New Jersey has extended our contract for the existing scope of work on mutually agreeable terms for an additional 60 days which would take us to September 29. As most listeners know, New Jersey has communicated their intent to award the TPL re-procurement to Public Consulting Group home we are suing. Given the complexity and dynamic aspects of that litigation, our focus on trying the case in courts rather than via public avenues and our corporate policy not to provide commentary on such ongoing legal matters, we will not be discussing anything specific today regarding the law suits that are pending in Texas and New York. I can assure you, however, that we are vigorously pursuing these cases. Turning back now to the commercial business. I want to provide an update on sales of prepaid clinical product which we launched in alpha testing during the quarter and our ink to green initiative. Year-over-year commercial revenue increased by nearly $5 million or 11% in second quarter as a result of our targeted effort to sell our products to new commercial customers, increase product penetration with existing customers and progress on our initiative to speed up the implementation process which is a significant focus for us during 2015. We have spoken previously about our prepay complex clinical product offering. We are now in the production testing phase with a large client and a discreet subset of approximately 350,000 of their Medicare Advantage members. Early results are very encouraging in terms of our level of findings, relatively quick replies we are receiving from providers in response to medical record request, and our ability to collaboratively work with our customer to exchange data under very tight timelines. We do hope our alpha client will roll out the product to a broader population in the fall and we have begun to sell prepay clinical to other customers who have expressed interest. Our efforts to shorten the gap between contract signing and revenue production, what we have referred to as ink to green, are beginning to pay off. The increase we saw in PI revenue this quarter in part reflects that success. We now have dedicated implementation teams focused on increasing scalability throughout the organization creating more measurable standards for quality improvement which allow us to nail better track performance and to find additional opportunities for process improvements. We are also having discussions with customers regarding data needs much earlier in the sales process. We also now have separate teams dedicated to new implementations and re-implementations, which occur frequently as customers consolidate or switch data systems and platforms. We are soliciting revenue target dates from customers as we enter the final stages of contracting for new business and then incorporating that schedule into a scope of work document that becomes a roadmap for both HMS and our customers before a deal is finalized. While we have made progress, there is room for continued acceleration of implementation times as the year progresses. I think it's important to remember that new revenue captured in the second quarter of this year would largely be the result of product sales in the early to middle part of last year, which was prior to the expansion of our commercial sales team. The new team is putting up impressive sales numbers so far this year, which we anticipate will begin to be reflected in revenues towards the end of this year and into 2016. Before turning the call over to Jeff, I want to speak briefly about the Medicare RAC program and recent announcements by CMS regarding their intention to issue new requests for proposals and to re-formulate the so-called Two-Midnight rule after expiration of the audit moratorium on September 30. We know we have no visibility as yet on a schedule for the release of a new RFP for the Medicare RAC regions following the cancellation of the previous procurement several weeks ago. CMS did announce online in early July that new RFPs would be issued shortly and CMS has also indicated that the four current RAC contracts will be extended until July 31 of 2016. We actually did receive a lengthy communication from CMS on Wednesday which is the beginning of that extension process but we are still reviewing it to understand the details. Hopefully, the roughly 12-months before the extended contracts expire, will be sufficient time for a new RFP to be issued, proposals reviewed, any protests made and resolved, scope of work agreed upon, and contracts signed. Of course given the past history of this procurement, it's really not possible to predict the timeline with any certainty. In the interim, we are hopeful that CMS will expand the current scope of auditing. HMS has submitted a number of new audit scenarios and has others in development. We have the internal capacity to ramp up the Medicare RAC work and thereby increasing the level of revenue recovered for the Medicare trust fund. We did see modest growth in that regard during the second quarter as our Medicare RAC revenue grew from $2.3 million in the first quarter to $3.9 million last quarter. Though the increase is primarily attributable to our efforts to improve product yield rather than expansion of scope. Jeff is up next and he will provide us perspective on our second quarter financial results. Jeff?

[Jeff Sherman:]

Thank you, Bill and good morning. I want to focus on three aspects of our short-term strategic and operational plans, capital allocation, anticipated revenue growth during the balance of 2015 and our ongoing efforts to reduce operating cost and improve product yield. The $75 million repurchase program announced this morning reflects the view of executive management and our board of directors that our current share price does not properly value our company. The $150 million in cash on our balance sheet as of June 30 and operating cash flow in the range of $20 million to $25 million per quarter, we have the capacity to buy back shares in the short-term while still retaining sufficient dry powder to make acquisitions. Both are consistent with our capital allocation strategy between now and year-end. To be clear, we will continue to seek out and evaluate acquisitions that could expand our product portfolio or enhance the services we currently provide to our customers while simultaneously pursuing share repurchases. There is no other acquisition, however, we know better than our own company with no integration risk and a strong belief in our long-term growth prospects, we see buying our shares as an excellent opportunity to enhance shareholder value. We meaningfully ramped up our acquisition activities in the first half of this year. We looked at a number of potential deals and performed significant due diligence on three incurring costs of approximately $600,000 in the second quarter alone. Pipeline opportunities continue to be very active. We are adding resources to the company to increase our focus and future success rate. We will continue to be disciplined in our approach to find and make acquisitions at appropriate valuations that will drive shareholder value. Greater use of our very strong balance sheet is one of our top priorities and I believe it can also be one of the most important components of our overall short-term strategy. Bill touched on the record commercial revenue this quarter and the rebound in our payment integrity product revenue. Both are positive indications of progress we are making in commercial sales and the accelerated implementation of new sales. Product sales to new commercial customers and incremental sales to existing commercial customers were roughly a 50

[Bill Lucia:]

Thank you, Jeff. I'd like to close this morning with a summary of my views which are shared by the other members of our executive team and our board about where HMS is today and what we can achieve between now and the end of next year. Before doing so, I want to acknowledge the fact that the past 30 months have been extremely challenging in terms of total shareholder return. In particular, uncertainties relating to the Medicare RAC contract and more recently state renewals have pressured our share price. Looking forward however, I believe strongly that our business model, comprehensive suite of services and extensive client data are the best in the industry. They share repurchase program we announced this morning is a demonstration of the confidence we have in our ability to take advantage of available growth opportunities and the future financial performance of HMS. The challenges that may come from contracting with governments are evident. We began several years ago to diversify our business beyond the federal and state governments as our principal customers focusing with increasing intensity on commercial opportunities and following those Medicaid and Medicare lives as they migrated from fee-for-service to managed-care. With a strong revenue growth expected this year and anticipated for the foreseeable future, our short and intermediate term commercial opportunity is quite clear. We have significant relationships today among the largest payers. 17 of the top 25 our customers. But there is meaningful potential to add more of the top 25 to our customer base and to expand existing relationships. We are generally underpenetrated with the independent [Blues] [ph] plans and our commercial business has been focused primarily on the Medicaid managed care population. There are tremendous opportunities to expand sales for both the Medicare Advantage population such as the prepay clinical product, I discussed earlier, and the individual and group plan members for which our customers are at risk. We have a formal innovation team led by our CIO, which is charged with identifying and evaluating new product opportunities, whether they are customer or internally generated ideas. A number of initiatives are under development to add new products to expand the benefits of existing product offerings. We will have more to say about the specifics as new products are ready to launch and go to market. As you know, we put in place a significantly beefed-up salesforce in the latter part of last year in order to better take advantage of the commercial opportunities in front of us. Our sales activity through the first six months of the year is ahead of our internal plan and a clear indication that our capabilities are in demand among commercial payers. Our ink to green initiatives are gaining traction because accelerating revenue production is in the best interest of our customers as well as HMS. Our roots are in the state Medicaid COB business and we remain firmly committed to it. We believe we have the data, experience, proprietary algorithms that make our services superior to the competition. While the outcome in New Jersey is uncertain, we are hopeful the situation can be resolved in a fashion favorable to HMS. Whatever the ultimate resolution in New Jersey, we will continue to serve our state customers across the nation just as we have for the past 30 years with the goals of maximizing both our return on investment and customer satisfaction. With regard to Medicare RAC, which of course has been the greatest source of negative news over the past two years, I can only say that we strongly believe that a robust audit and recovery program is in the best interest of the Medicare trust fund, its beneficiaries and all American taxpayers. We know we can do the work and we remain hopeful that CMS will issue new and viable RFP soon and expand the scope of current auditing until the new program is implemented. More broadly, HMS's business of recovering erroneous payments on behalf of our government and private payer customers is essential to the long-term viability of the U.S. healthcare system. The demographics of our aging population alone suggests that the portion of our GDP spent on healthcare will continue to rise for many years to come. The billions of dollars we save for our customers is core to our value proposition. So the demand will likely grow along with healthcare expenditures. The introduction of ICD-10 and the move towards pay for performance reimbursement, are among just a number of changes on the horizon that will simply add complexity to the system and create additional opportunities for our data analytics and cost-containment expertise. On top of this strong foundation for growth, we are intently focused on leveraging our cost structure which Jeff spoke about earlier. Our solid base of state and commercial customers, a rapidly growing and sustainable commercial opportunity and the prospect of a new Medicare RAC program in place by the middle of next year are the source of our confidence that we can grow revenue, margins and our bottom line over the course of the next 18 months and beyond. The entire HMS team is committed to capitalizing on those opportunities. Operator, we are now ready for your first question.

[Operator:]

[Operator Instructions] The first question is from Ryan Daniels of William Blair. Your line is now open.

[Ryan Daniels:]

Yes. Thanks for the color and for taking the questions. Bill, maybe one for you. I know these calls are difficult as you are involved in both a lawsuit and a protest in the state that PCG won. But the real question here I think is, does the competitors suddenly have a novel technology that allows lower pricing and better recoveries. And I guess it's hard to discuss as they don’t really have any proof of what they can recover, so a bit like fighting a ghost. But maybe, I want you to take this opportunity to talk about in more depth why you have a competitive advantage and why you remain confident that HMS has the solutions of more value to state customers.

[Bill Lucia:]

Ryan, I appreciate the question. I think we have said for a while, we continue to see competition everyday and we take it very seriously. We track competition closely. That said, we particularly work on value and providing the best value to any of our clients, whether they are states or commercial health plans. We have the most effective solution in the industry in third party liability or COB. It's combined with an existing eligibility database that’s where the data comes from 1,100 plans across the nation that does not have to built, it's existing. We have the algorithms that have been built over the years. They are proprietary and they have, bar none, the best matching in the industry. And of course, we have the superior technology infrastructure where we make significant innovative investments year after year that can support this very massive data analysis. So we are not talking about 20,000 or 30,000 transactions that might happen in a week, we are talking about millions of transactions that are matched each week in the company. Demonstrated expertise. So we have reliable returns for our clients anywhere from 10 to 15 to 1 and greater. And then I would say, lastly, we have both the corporate but the individual expertise in our organization. And I think if we were to compare ourselves to any of the competitors in this space, we would be put ahead and most clearly to the newest entrant who has really an untested solution that has no demonstrated track record of recovering dollars for state Medicaid program. So rather than, I think , give a lot of color around our competitive positioning today.

[Ryan Daniels:]

I appreciate that. That’s very helpful color. Maybe just as a follow up. If we turn to the commercial market, are you seeing PCG emerge there? I think they promote actually working with CAQH, which is a registry with the national payers. Are you seeing the national payers move more towards them as well or are they not as emerging as much in that market?

[Bill Lucia:]

We probably won't comment a lot about PCG during the call, but we have not seen them as a competitor and we have not seen any erosion from that competitor in our commercial market whatsoever.

[Ryan Daniels:]

Okay. Thank you. And the last one and I will hop off, just any more color on the prepay pilot. It sounds like that’s going well. That’s a nice opportunity. And I might not have caught this, but do you have any initial ROI data? And then number two, is there an actual trigger for expanding that potential in the fall or is that just kind of a negotiation in place that looks favorable given the early outcomes. Thanks.

[Bill Lucia:]

So, unfortunately I don’t have the ROI data at my fingertips but I will tell you that -- I will tell you a couple of the major important points about that product. A, we are identifying the dollars well in advance, so before the payment is made for the provider. We the provider and the client do not have to go to what can be unpleasant post-payment recovery process either recouping dollars back or asking for checks back from providers. And because the provider wants to get the initial claim paid, their response rate in getting medical records and to us is very high. Our findings rate, that would be actual dollars per claim that we are finding, are actually higher than we and our client had initially thought would happen. So we think that’s very good. We also think the model systemically is a better model for us even from a cost perspective because we are not doing the post-payment recover. So we have had a great relationship collaborating with this first customer. We have a number of sales in the Q where the market has come to us and asked to start being, really lining up and getting a demo of the product and moving forward. So I think I would say that for a product that we just finished development of last year in an alpha production test, it's going very very well.

[Jeff Sherman:]

And this is Jeff. I would just add too, based upon the nature of the work and how we will be paid, there should be a much faster cash flow collection process because we are not waiting for dollars to be recouped. We are identifying the dollars up front before payment is made and then are paid based upon that.

[Operator:]

Thank you. The next question is from Dave Windley of Jefferies. Your line is open.

[Dave Windley:]

Bill, I wanted to make sure I understood something correctly. You were talking about sales activity and capture in revenue and referred to capture in revenue in the second half of this year. And I think you referenced sales in the early to mid part of 2014 or did I hear that incorrectly?

[Bill Lucia:]

No, you were correct that sales, depending on the complexity, the scope of work, it could have been a very difficult technology implementation on our clients side. May not have had access to their data or their clinical department for quite some time. So we could have had sales that closed in the first half and clearly in the second half of 2014, that are now coming on board and will be coming on board the balance of this year. Now as we have talked about, we are shortening that ink to green timeframe so sales that are closing this year are also going live. But that’s what we talked about with having what were longer ink to green times primarily from 2014 and shrinking those or collapsing those times now collaboratively with our customers.

[Dave Windley:]

Okay. And that gets to the spirit of my -- what I'm really trying to get at is, maybe understanding just how much your efforts have collapsed that implementation time because it would seem -- I'm thinking about the progression of commercial growth. With it being pretty substantially below your 20% for the year, you are pretty heavily back end loaded. If the implantation time for some of those 2014 sales is a better part of a year, it would seem like, I guess, it seems unlikely or kind of a stretch that sales that you've made in the first half of '15 are what's going to get you to that growth in the second half of '15, given what the historical implementation delay has been. So I guess I'm looking for more confidence around that, if you could elaborate.

[Bill Lucia:]

Well, it's actually a combination of sales that have happened through Q4 2014 as well as sales that have happened through the first half of 2015. I mean we are in implementation of deals that we have inked just in the last month. And we do expect, depending on the product line, that we will be able to have a flat enough or short enough and streamlined implementation process that even some deals that get inked in the third quarter of this year, maybe generating revenue by the end of the year. So we have seen that actual closing -- a sales closing funnel creep up at a higher rate than we had anticipated. We are putting the resources on the front-end to make sure that those implementations have been more timely and at a better process with our customers.

[Dave Windley:]

Okay.

[Jeff Sherman:]

And we have also -- this is Jeff -- we have also, we have learned along the way so we have separated new implementations from re-implementations which is maybe a change in a client system or something that needs to be reworked. And so that process has given us focus on the clients that will be generating incremental new revenue and prioritizing, from an implementation standpoint, the impact of those changes. So I think we have learned along with the way we had added resources to it. We have streamlined it and I think we expect we are going to continue to get better at that over the next several quarters. But I can tell you it has a significant amount of focus from an execution standpoint from the senior management team that we really have to continue to get better at that to the balance of this year and into next year as well.

[Dave Windley:]

Okay. Moving on then. On the contracts, the state contracts that you highlighted that had been finalized in the case of Florida and renewed I think in Oklahoma, New Mexico, Wisconsin. Can you talk about those in the context of your bid to win strategy and how the terms may or may not have changed from before to now or to the new?

[Bill Lucia:]

Well, so probably while we are in open procurements, we don’t want to talk too much about our bid to win strategy. But let me give you sort of the background about how we look at procurements. State procurements as you know, sometimes their scoring methodology is public and determining on their scoring methodology and how they -- if they have very clear definitions about references, requirements, past corporate experience, all of those things. As well as how much score plays a price or how much actual price plays in the calculation that helps us to find our bidding strategy. I can tell you that no matter what the market, we still, our message has always been to the marketplace that we are going to bid to make sure that our client receives the maximum value. And our story is not much different than it has been in the past. Surely, you can pay somebody a buck, we get $10 back, or you can pay somebody ten bucks to get $1000 back. And that’s really the magnitude of the difference, probably even greater than that in the markets that we serve against our competition. So some of the -- net, net for the procurements that we have re-won, our revenue I would say is just about even on those procurements. Either from price or scope expansion, they are just about even. So there hasn’t been what I would say a significant erosion at all.

[Dave Windley:]

Okay. And last question, probably for Jeff. How should we interpret, beyond the signaling of confidence in the business, how should we interpret your share repurchase renewal or refresh in terms of your intentions around pace of execution?

[Jeff Sherman:]

Yes. So it's not prudent for us to discuss a specific strategy with regard to buying back shares, including a target price or a specific quantity. We have the authority from the board to repurchase up to $75 million of our shares. Open market purchases are of course subject to applicable law and we can only make purchases when the company is not a blackout period or not in possession of material non-public information. Unless we have a 10b5-1 put in place, which we have the option to do that as well. In terms of looking at stock buybacks versus acquisitions, we think acquisitions can help expand our product portfolio where we have made it top priority as well. That has been a lot of activity in the marketplace and we have significantly increased our due diligence. As I said in my prepared remarks, so they are not mutually exclusive. We think we have the financial liquidity and capability to do both. And certainly as I said in my prepared remarks, the stock in the current price ranges we view as an attractive investment potential for the company to enhance shareholder value.

[Operator:]

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

[Charlie Strauzer:]

Just a couple of clarifications, if I could. On the Medicare RAC extension to next July, is it assumed that that's basically just going to basically extend the current revenue run rate as well?

[Bill Lucia:]

Charlie, this is Bill. What's happening now in the Medicare RAC is HDI, and of course I am sure the RACs, but clearly as we know for HDI. We are in dialog with Medicare to work through having new audit scenarios approved. I think they are working through that structure at the agency but we are hopeful that they will go through that process and we will be able to actually see the benefit of that. The new contract extension though that they are talking about, at this point is a draft, confidential document, that has been sent to us. So we are evaluating that to prepare comments back for the agency. So we really don’t know the impact of that until we have had further chance to communicate back to CMS.

[Charlie Strauzer:]

But there is a chance that you could see revenue growth in the next year from that extension though?

[Bill Lucia:]

I think we could providing the scope of audits that we perform today and the new request that we are requesting approval for. And I would mention that we are developing audit scenarios all the time. So we have a whole team that’s developing audit scenarios, not just for Medicare of course, but for our other customers.

[Charlie Strauzer:]

And the other clarification was, you had mentioned that you had won North Carolina this past year but you said it's also up for re-bid next year. Did I hear that correctly?

[Bill Lucia:]

No, North Carolina is -- we did win it in late 2014. It's a one year contract with one year renewals. I mean that’s how a number of states procure of the one year contract and then one year renewals, or a two year contract with one year renewals. And that’s how North Carolina has historically procured. So it's a renewal, not a re-procurement.

[Charlie Strauzer:]

Got it, understood. Thank you. And then lastly, can you remind us again of the approximate average annual contribution from the New York contract if you can?

[Jeff Sherman:]

Yes. So we don’t actually disclose margins on the individual client basis. But in our 10-K, New York, we disclosed that New York was approximately $23 million for 2014 revenue.

[Operator:]

Thank you. The next question is from Brooks O'Neil of Dougherty & Company. Your line is open.

[Brooks O'Neil:]

I have a couple of questions, and maybe just following on with Charlie's question there. Can you just help us to frame the size of the New Jersey business? Obviously I am not assuming it goes away, but I just think it would be helpful to have a sense for how you size it.

[Jeff Sherman:]

Yes. So we have spoken previously about the increase in the cost avoidance for states during 2014 as a result of the large influx of the newly eligible Medicaid enrollees from the ACA. New Jersey had a 30% in enrollment last year, which significantly raised our annual revenue. We have disclosed in our 10-K, New Jersey revenue was approximately $42 million in 2014, 90% of that was TPL. If you look back at the prior years, New Jersey was generating between $26 million to $30 million. So reasonable run rate for New Jersey. We believe going forward under the similar terms would be in that range of our historical rate of the $26 million to $30 million.

[Brooks O'Neil:]

Great, that's very helpful, Jeff. Thank you very much. Secondly, and I confess I got a little distracted a few minutes ago and if I ask a question you have already answered, let's just move on. But I'm curious, if you feel that the removal of the short-stay hospital reviews from the RAC program significantly lowers the attractiveness of that opportunity or do you see lots of ways you could make that a very viable business without the short-stay opportunity.

[Bill Lucia:]

That’s a good question and we didn’t get a chance to answer that earlier. But I think as everybody knows, the Two-Midnight rule was not really popular with any stakeholder. Clearly not the providers and the moratorium was not popular with the recovery audit contractors. Going forward the CMS has indicated that the QIOs, or quality improvement organizations, will perform the initial audits for what is now know as the Two-Midnight rule, which will become a new rule that they will memorialize over the summer. And that RACs will then audit hospitals with a consistently high denial rate. Of course, we don’t know where that line will be drawn yet and how CMS will calculate it. But even if we don’t get to touch another Two-Midnight or short-stay audit, there are significant errors that are processed everyday because of the complexity of the Medicare program. And we have seen through our internal analysis over the last six-months that we have a number of audit scenarios to perform regardless of short-stay that will allow us to have a meaningful -- under the right terms have a meaningful RAC contract and one that will have the margins that we would expect.

[Brooks O'Neil:]

That's very helpful. I do have one follow-up and I apologize, but I think historically some of us have speculated that it might be possible for you to win more than one region under a new RAC contract scenario. Do you have any comment on whether you think that's still possible?

[Bill Lucia:]

Well, I think it's possible. Depending on the request for proposal and the request for proposals that were cancelled, there were four hospital [a and b] [ph] regions and one national DME and home health region. That gave five regions for procurement and they said that a RAC could not be a RAC in more than two regions. So under scenario, if there were five bidders, potentially all five were qualified and scored well, they could each get one. If there were four bidders, somebody could get two. I mean it depends on who is eligible to bid the way that the federal government procures it. But I mean I think anything is possible if they leave that language in that you can win up to two regions.

[Operator:]

Thank you. The next question is from Mohan Naidu of Oppenheimer. Your line is open.

[Mohan Naidu:]

Maybe I want to go back to earlier questions around state renewals for a second. You have won almost all renewals so far, yet one competitor seems to be pushing the pricing pretty low which appears to be very disruptive. Can you help us understand how sustainable that strategy is? I know your basis is on providing a full net value, even though the price might be higher or at the end state you might end up making more. But help us understand how disruptive the new competition is going after our own pricing.

[Bill Lucia:]

Well, Mohan, that’s a good question. I mean I think I have to answer it by saying that a prudent buyer does not buy solely on price or what one might view as cost. That the buyer has to look at the returns, track record, the ability to actually have done this work and strong referencable accounts on work of this type. What we do in COB and particularly the largest areas, which is cost avoidance and the entire very full scope cost avoidance we provide, the recoveries in COB that come in various forms and through years of very delicate relationships with providers and carriers who these dollars come from. And then of course, in subrogation which is an area that you need to build up the appropriate legal expertise and have the systems that are going to allow you to do this well and manage the -- across the nation, millions of cases that we manage. You had to add to that, very very significant state Medicaid TPL experience. So when we add all that together, we still think that we can price accordingly to continue to win business and that will be the approach that we will take. But from a price erosion perspective, while it may look like there could be competitors that are just trying to buy into the market, the reality is that we have always sold on value returned and experienced doing a work.

[Jeff Sherman:]

And this is Jeff, I would just add, as we had said a few minutes ago, the deals that were closed -- the deals that have been closed in one this year have been in very similar pricing ranges as we have had in the past.

[Mohan Naidu:]

Okay, that was very, very helpful. Maybe one question on the commercial side. So you are ramping up the speeding of the implementation. Is there a requirement for you to actually get the members, the lives through the system before you actually be revenue generating in those commercial contracts? Is there a delay there that we should expect?

[Bill Lucia:]

You mean the existing members?

[Mohan Naidu:]

Yes.

[Bill Lucia:]

Yes. So on our commercial business, it's not dissimilar to other businesses but what we achieve in the -- or what we receive from a client and go through a very intensive data quality analysis internally and with them, is their eligibility file that is not usually the toughest thing for them to export but we go through it in a very detailed level to make sure we understand membership start and stop dates and benefit plans, types and dependence and all the other things we may need. And then we need their claims history we usually ask for at least three years, maybe five years of claims history. It's very detailed. Includes a lot of other files that come with that, reference files etcetera. And then we need all their provider file information. So we recreate something for them and if they have had three different systems storing that time or over the course of five years, we have all that for our client. So it does require a very heavy data lift. With that said, HMS is a little unique in the market in that we take all of that data which while it may come from nationally, 10 to 15 different claim platforms, each carrier has tweaked that if you are using a commercial one and many still have home grown systems. We normalize that into an HMS data format that allows us to effectively, really better than anyone, do the very sophisticated matching but in our other products, allows us to look at that against history and allows us to look at the -- from the know how we have captured from hundreds of customers. We then export in a customized format back to our client. So the efficiencies we gain internally is that all of our engines are looking at a single standardized HMS format and we think that’s different as you go from vendor to vendor.

[Operator:]

Thank you. The next question is from Matthew Gillmor of Robert Baird. Your line is open.

[Matthew Gillmor:]

Bill, I think you've probably just addressed some of this but I wanted to understand the interaction, to the extent there is any, between your commercial COB business and the state COB business. And I guess I wanted to confirm that if you did lose a state contract, there wouldn't be any major implications for your commercial contracts or capabilities.

[Bill Lucia:]

I mean, we don’t believe so. And what's happened, as you probably know, when a state delegates management, risk and management to a managed care plan, they often delegate program integrity, cost containment, third party liability. Every state is different. So some delegate all the third party liabilities, some delegate everything but casualty, subrogation. No states, of course delegate recoveries on states. So if I drew you a map, there would be many many colors on it about state rules. But suffice to say that when a state delegates the authority to a managed care plan to a third party liability, they delegate that to the them those managed care plans. Probably 80% to 90% of them buy from HMS and we perform those services. And we have the right to receive the files we receive, which are very prescriptive data use agreements with insurance carriers, on behalf of both Medicaid and for the most part Medicaid managed care plans. And that is governed by state law.

[Matthew Gillmor:]

Got it, that's really helpful. Thank you. And just one more. Jeff, I wanted to follow up on a comment you made about greater use of the balance sheet. I guess you are levered well under one times debt to EBITDA on a net basis, but can you maybe just remind us where you are comfortable in terms of leverage at this point?

[Jeff Sherman:]

So we do have a current credit agreement which allows us to go to 3.25 times. So you are correct, on a reported basis we are about two times levered debt to EBITDA and on a net basis, less than one. So we certainly have the capacity to go to 3.25 times today. Really, Matt, just depending on the opportunities that we see in front of us in terms of either acquisitions or other capital deployment needs. But we have a lot of find flexibility which is one thing that I think gives me a lot of confidence and comfort that we do have the capacity to make meaningful acquisitions as well buy back shares as authorized in our share repurchase agreement.

[Operator:]

Thank you. And the next question is from Frank Sparacino of First Analysis. Your line is open.

[Frank Sparacino:]

Bill, I wanted to go back to an earlier comment you made around the sales activity year-to-date for the commercial group. If I look at your normal disclosures in terms of products being sold to the existing commercial base, it seems like those numbers are down relative to previous figures going back a year ago. So just trying to reconcile that and where you stand heading into the second half of the year.

[Bill Lucia:]

Frank, are you referencing the lives that we issue per quarter?

[Frank Sparacino:]

That’s correct, yes. The additional products being sold to the base today.

[Bill Lucia:]

Yes. So we have sold now on average, and this is part of, I think we have talked about, our commitment to be able to get better data so that we are more transparent about the actual sales activity and the number of lives. But part of it is that we have actually sold more than, and we didn’t do a recent calculation, but more than two products, higher commercial account compared to what was in the average of five for state. But I think what blurs that is that our larger accounts, so as we mentioned we have 17 of the top 25, we are adding more product to and they are at a higher average rate. So that, initially when we entered the market we thought it was counter-intuitive but in reality these are very large organizations with an infrastructure and realize that as regulations change and other opportunities open the market, they want to use someone who is innovative. Who is large enough with the right capital structure and of course security systems to help them further contain cost, to kind of stay out on the edge and contain cost and recover dollars. So our growth aside from selling new plan, has been on doing more with the existing lives in the larger accounts and particularly the top ten that we serve. Does that help frame that? I mean, again, our commitment is to have more data and statistics so we can better breakdown the market. Show our presence in Medicare Advantage versus Medicaid managed care and better statistics around that. That’s something we are working on. The other thing that impacts it as we count lives, is the shift of people coming into Medicare Advantage from fee for service each year or new Medicare Advantage enrollees and then people coming on board the Medicaid program. So when we see a life, that doesn’t necessarily mean a, we are going to be actually have actionable work on that life, depending on the product site we have. So as we have been going down building these stats so we can share them, they are very -- they can be very confusing and we are trying to make that simple to explain it going forward.

[Frank Sparacino:]

That's fair enough. Thanks, Bill. And just one last question from me is, given the M&A that we have seen on the insurer side of things, I'm just curious looking at implementation schedules over the next two quarters, is there any risk in terms of that activity?

[Bill Lucia:]

We really don’t think so. Typically in the past when large M&As happened in the industry, we have ended up long-term being net neutral or a slight benefactor because more lives come on to our platform through -- if the parent is a customer, and in the cases that have been announced, if the parent is the customer and I think in all cases the target is a customer with the exception of one. So that could be a net positive for us. The systems integrations at health plan are not -- they don’t happen immediately. I mean it's a very -- converting your claims system and claims system history, putting all your benefit plans up is a very long process. I think what's positive for us is that, in any very large deal and as anyone would think these are very large deals, companies look for synergies. And we are one of the areas that we can bring significant cost savings. So we think, net-net, it's neutral or positive for us.

[Operator:]

Thank you. The next question is from Elizabeth Blake of Bank of America. Your line is open.

[Elizabeth Blake:]

Assuming that your protests in New Jersey are unsuccessful, I understand that you have a large presence in Trenton. So could you maybe talk about your expected cost cuts around the loss of that contract and maybe the timeline of when we would see some progress?

[Jeff Sherman:]

Yes. First I would say, we are certainly not ready to put New Jersey in the loss column. But it shouldn’t be a surprise that servicing any large customer such as New Jersey would include a combination of both fixed and variable cost. We have made significant investments in the large engine that supports TPL products which represent the largest component of fixed cost. We always look to manage expenses consistent with revenue expectations. And I think we have demonstrated our ability to do that with the Medicare RAC contract, as that revenue went down, we manage expenses accordingly. So you should expect that we will continue to do that, continue to look at our cost structure and manage our cost structure appropriately with regards to revenues.

[Elizabeth Blake:]

Okay. And then, Bill, you alluded to new audit scenarios for the Medicare RAC contract whenever that starts up in earnest again. Could you maybe talk about the approval process for those types of claims and how quickly could that happen after a contract start?

[Bill Lucia:]

Thank you, Elizabeth. CMS is working on -- as the contracts or the process went into a little bit of stalled activity, CMS has been working on making sure that they have the team ready to review approvals. And just to give you a little color on an approval. We identify through our data mining and algorithms where we think there is a problem. We test that, we write it up. It often includes our medical director, other clinicians. And then we present a package as well as a package with a sample claim so that CMS can understand that. We have to do provider impact analysis, there is a lot of things that go into that. And then we submit that and CMS goes through an approval process. Now their approval process also has to include talking to entities within CMS that are on the relationships with those provider communities. So if we found an error in the nursing home payment system, they may need to sit down with the people who deal with nursing home payment pricing. The same with home health or any other type of area. So it's a prudent process because they want to make sure that they can understand the impact on providers and potential appeals. So I can't give you a timeframe but I can tell you that we have significant audit scenarios ready for approval and a number of that are in CMS for their consideration now.

[Operator:]

Thank you. And our last question comes from Toby Wann of Obsidian Research Group. Your line is open.

[Toby Wann:]

Just maybe, could you walk us through the protest process or the due process on New Jersey and then also New York as well, in the event that that doesn't go your way?

[Bill Lucia:]

Okay. You know we haven't had many discussions on New Jersey in the call so I will tell you what I can say. We have not yet filed our protest. The deadline has been extended. Until we receive certain documents and information that we have requested from the state and as we said earlier, our current contract has been extended for 60 days until September 29. So while the protest is underway, we just don’t want to get into the mechanics of the protest process or any of those specifics. It's just really not prudent for us to talk about that at this point and we do have very capable legal counsel handling the matter. So we are very confident in our approach. As usual there is risk and uncertainties in any legal process including, say a procurement process. But we do believe that we have good grounds for protesting the award. The key thing I think I would like everybody to remember is, particularly about our business, is that we have built our success over years and acquiring and retaining state TPL business and it's a result of working for dozens of state Medicaid programs. Understanding they are very unique programs, having our extensive database, our unmatched results in the industry, our logic, the technology that we have innovated every year. So we really bring together that with the most highly qualified staff in the nation and we save our customers billion of dollars I would like to just reiterate that we are the best at what we do and we have shown that repeatedly over 30 years. You did ask about New York. The contract award is scheduled to be made through the state public RFP. They expect to make the award on August 22. We are not going to talk about the procurement while it's an active procurement because any discussion during an active procurement will jeopardize it. So suffice to say that we are looking forward to the award when New York announces.

[Operator:]

Thank you. There are no further questions in queue at this time. I will turn the call back over for closing remarks.

[Bill Lucia:]

Thank you, everybody. I want to thank our shareholders, our employees, our board of directors and our customers for their support of HMS and we look forward to talking to you on our next earnings call.

[Operator:]

Thank you. Ladies and gentlemen, this concludes today's program. You may now disconnect. Good day.