HMS Holdings Corp
Q3 2015 Earnings Call Transcript

Published: 6 Nov 2015

[Operator:]

Good day, ladies and gentlemen and welcome to the HMS' third quarter 2015 earnings call. [Operator Instructions] I would now like to turn the call over to Mr. Dennis Oakes. You may begin.

[Dennis Oakes:]

Thank you, Michelle. Good morning, and thank you for joining us for the HMS third quarter 2015 earnings conference call. With me today are Bill Lucia, our Chairman, President and Chief Executive Officer; and our Chief Financial Officer, Jeff Sherman. As you know, we distributed our earnings release through our website, hms.com, under the Investor Relations tab. We also posted quarterly investor presentation containing supplemental information that we will not be making specific reference to it today in our prepared remarks. This call is being webcast and can be accessed via 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. Those filings 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, November 6, 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. Finally, we will be referring to certain non-GAAP measures during the call. Our earnings press release includes a reconciliation of those measures to GAAP. Now, we're ready to begin. Bill?

[William Lucia:]

Thank you, Dennis, and good morning everyone. With three quarters of the year behind us, I am pleased to say that we are essentially where we expected to be in terms of our overall financial performance. Commercial sales are very encouraging and our full year revenue expectation, which includes 20% year-over-year commercial growth, remains achievable. We have successfully renewed or extended the vast majority of our state contracts that were scheduled for rebid this year. All that remains is to file our protest in New Jersey and submit our response for the Tennessee TPL procurement. A low level of auditing in the Medicare RAC program has persisted throughout the year, though revenue is a bit higher than we expected. Continued innovation will be an important component of our future growth. Consistent with that view, we believe our pre-pay clinical product presents one of the most significant opportunities for us in the near-term. We'll continue working with our alpha client through the balance of this year to further refine the product for their Medicare population. With approximately four months of data now available, we've seen higher finding rates than post-pay recoveries, accelerating cash flows and less burdensome administrative processes for both our customer and their providers. We also closed an additional sale during the third quarter to an existing Medicare Advantage customer. Our new prepaid product largely eliminates the administrative waste and expense associated with the more traditional pay-and-chase approach. And doing this audit before claims are paid is beneficial to all parties involved. But we anticipate little incremental revenue impact in the fourth quarter from the two pre-pay customers. We expect this new and innovative product will be a key component of our 2016 growth. Third quarter commercial revenue of $52 million topped the record set last quarter by 5.5%. It was also 17% ahead of the last year's third quarter and 20% higher than the first quarter of this year. This commercial revenue growth is reflective of our targeted effort to sell our full suite of products to new commercial customers, increased product penetration among our existing customer base, and improved product yield, as well as the added resources we have devoted to product implementations. Since the beginning of the year, we have hired a number of individuals to join our dedicated implementation teams. Both added resources together with the integration of a variety of process improvements has allowed us to reduce the number of pending implementations and also reduced the expected implementation time to produce sales. We have developed various metrics and benchmarks to measure our progress, as we continue to reduce the timeline between contract signing and going live with our customers. We've also adopted new project management tools and established quality assurance teams that help ensure a very high quality customer experience. Incremental third quarter commercial revenue largely reflects sales closed toward the end of 2014 and the early part of this year. Over the first three quarters our ink-to-green initiative, which is focused on shortening the time from contract signing to revenue generation has nearly doubled our quarterly implementation capacity. Accelerated product implementations and generating the resulting savings is what our customers want and we are clear beneficiaries as well. We have a plan in place designed to further compress implementation timelines and to increase the number of quarterly installations over the next few quarters. The additions to our commercial sales team in the latter half of last year, together with the rigor and discipline, which Doug Williams has instilled in the entire marketing and sales organization, are clearly paying dividends. The commercial sales opportunity in front of us remains very significant. Our Medicaid coordination of benefits business built over the last 30 years provides a solid foundation, which we are leveraging to sell products to customers for their Medicare Advantage populations and to sell a relatively greater percentage of payment integrity products, such as pr-pay clinicals. We ultimately expect to work with our commercial customers to expand the sale of existing or jointly developed new products to their at-risk commercial members. These factors combined give us confidence in the sustainability of commercial revenue growth at levels similar to what we expect this year. Another indication of encouraging progress we saw this quarter was the 15% year-over-year growth in payment integrity revenue with virtually all new commercial sales recorded in the third quarter touching about 3.3 million existing customer lives, resulting from the sale of PI products, such as clinical reviews, prior authorization and utilization management. Though not a major revenue opportunity, we were very pleased to be on the team awarded the trusted third-party contract in late September by CMS. HMS is a subcontractor to Computer Sciences Corporation and we were selected because of our expertise and deep experience in Medicaid and fraud identification. The award was issued by the Healthcare Fraud Prevention Partnership, which is a voluntary public/private effort among federal and state government officials, law enforcement, private health insurance plans and healthcare anti-fraud associations. The focus of the group is to detect and prevent healthcare fraud for data and information sharing and analytics. With the database exceeding $10 billion Medicaid claims and vast Medicaid program integrity experience, we're excited about participating in this important effort. Additionally, we see developing new products or acquiring businesses focused on combating fraud as a significant growth opportunity over time. In fact, we recently introduced HMS Link, our fraud analytics link analysis software, which is offered on a SaaS basis. This cloud-based software includes predefined and common fraud scenarios and it displays actionable results in a visual fashion for ease of use by our client's fraud examiners. This fraud tool and all of our new cloud-based software is being developed with advanced technology and in a natural environment designed to get new products to market quickly. Turning now to the state government business, let me briefly recap the status of the 12 procurements, which we expected when the year began. The most recent award came in August. We re-won the New York Third Party Liability contract for a base period of five years with two one-year renewal options. We expect the new contract will be finalized between now and yearend including resolution of a protect filed by another bidder. Earlier in the year, three TPL contracts expected to be rebid where instead extended into 2016. Those include Massachusetts, which now expires December 31 of next year; and Wisconsin and Washington, which were both extended until June 30 of 2016. We were awarded the five-year Florida TPL contract in May, which went live in the third quarter and the state remains an option to extend for up to five additional years. We also renewed contracts for causality business in Wisconsin and TPL work in Oklahoma and New Mexico. The award for the Kansas TPL contract were rebid as a subcontractor to the state's MMIS vendor has not yet been announced, but that contract does not expire until 2017. We have filed a protest in Illinois in connection with the award of their limited scope TPL work to a competitor and we will be filing a timely protect in New Jersey as early as this month, assuming we get all the needed information from the state. We feel there are solid grounds for protesting both awards, but there is no way to predict the timeframe for the resolution of either. The one remaining proposal to be submitted this year is Tennessee. RFP responses are due November 16 and the RFP indicates the state will announce this award on November 25. Our current contract with Tennessee runs until the end of January. As we mentioned on our second quarter call, 2016 will include a meaningfully lower level of state contract renewal activity. There really is not much to report regarding the Medicare RAC program. We continue to be hopeful that CMS will issue the RFP shortly, evaluate them promptly and make awards early enough in 2016. So the new contracts can be in place and fully operational by the expected start of the program next August. As a bridge to the new program, we're in the process of finalizing an agreement to extend our current contract through July 31 of next year. Jeff will now provide his perspective on the quarter. Jeff?

[Jeffrey Sherman:]

Thank you, Bill, and good morning. I want to focus my comments on the continued strength of our balance sheet and the flexibility, which that provides us, as we pursue our capital allocation strategy. I'll elaborate a bit on our full year revenue expectations, provide some commentary on our expense management initiatives and touch on two small items that warrant explanation in an otherwise fairly straightforward and clean quarter. Operating cash flow of approximately $20.4 million in the third quarter allowed us to maintain a healthy cash balance at September 30 of $145 million, despite repurchasing $25 million of our shares during the quarter. We are pleased we were able to buyback about 2.7 million shares at an average price of $9.40. We did so pursuant to a 10b5-1 program and we still have $50 million under the buyback program adopted by our Board in late July. We expect cash flow from operations in the coming quarter will remain in the $20 million to $25 million range. Our balance sheet cash, together with our existing borrowing capacity of approximately $124 million puts our available liquidity at approximately $269 million. As a result, we're very comfortable pursuing a robust pipeline of acquisition opportunities simultaneous with the potential completion of our share repurchase program. We continue to look for businesses or platforms to buy that would complement our core strengths and/or expand our data analytics capabilities. Fraud, waste and abuse solutions are another specific focus and we plan to be more proactive in our approach now that we have hired an experienced individual who has devoted full time to identifying acquisition opportunities. In many cases, we now expect to initiate conversations with possible targets rather than waiting for opportunities to find us after an auction process has begun. The bid-ask divide remains a challenge, but we believe HMS offers an expansive distribution platform, which could make potential combinations more attractive to both parties, particularly for smaller companies who like the breadth of customer relationships we have. As we began the year, we anticipated revenue growth excluding Medicare RAC of 7% and 9% on our 2014 base of approximately $421 million. Through the first nine months, we have recorded $335 million in non-RAC revenue, which is up approximately 7.5% compared to the same period of last year. Looking ahead to the fourth quarter, we are expecting commercial revenue to increase by approximately $8.5 million. Our forecast shows incremental revenue coming from five sources

[William Lucia:]

Thank you, Jeff. I'd like to close this morning with a reminder of where we are headed as a company and the strategies we are perusing to get there. We have a customer base that is constantly seeking to improve their financial performance by adopting cost containment solutions. The HMS products suite addresses the growing costs and risks our customers faced, as they navigate the frequent changes and the overall complexity of our nation's healthcare system, which have only intensified in recent years with adoption of the Affordable Care Act. We are focused on continuing to leverage our experience, expertise and extensive data on their behalf. At a high level, our strategy is straightforward. We will fight hard to preserve our state Medicaid heritage, while continuing to significantly grow in the commercial arena. Three out of every four Medicaid lives are now managed by health plans. More and more of new Medicaid enrollees are gravitating there as well. Commercial plans that serve those two government programs, as well as serving employer groups and individuals continue to be our principle target for growth. Reflecting that focus, 2016 commercial revenue should for the first time exceed what we generate from our state government business. Our products provide attractive returns with typical ROIs for customers of between 10 to 1 and 15 to 1. As a result, we have compiled a backlog of new commercial sales and are working hard to shrink the time from contract signing to revenue generation. We have made substantial strides in doing so this year and expect meaningful progress to continue throughout 2016. Though HMS has the broadest and deepest portfolio of cost containment solutions available to the market today, we are intensely focused on innovation. In order to sustain growth in a competitive healthcare information technology environment, we must innovate continually in both our coordination of benefits products and across the entire spectrum of payment integrity from clinical audits to fraud analytics. We have an internal process in place, led by our CIO, Cynthia Nustad, which is designed to incubate new solutions and streamline product development. We are devoting the resources necessary to ensure we stay one step ahead of our customers needs. Finally, we have a strong balance sheet that we are prepared to use strategically, but will continue to allocate wisely, including share repurchases when appropriate. Acquisitions that move us forward in our chosen markets and help the company bring new solutions to our large base of customers are also our focus, as a supplement to our organic growth. Additionally, we'll continue to utilize available capital to invest in new product development and partnership with our customers in order to provide actionable analytics, which address the evolving needs of all risk variances in our healthcare system. We look forward to a strong close to 2015 and the opportunity to share our views on 2016 performance on our fourth quarter call in February. I'd like to thank our customers for their support and partnership, the 2,000 HMS associates who work so hard everyday to address the errors in our nation's healthcare system and our investors who understand where this company is headed and who share our vision of the enormous opportunities in our future. Operator, we're now ready to take questions.

[Operator:]

[Operator Instructions] Our first question comes from Ryan Daniels of William Blair.

[Ryan Daniels:]

Bill, one for you on the prepaid clinical audit. You mentioned stronger yield or finding rates, and I'm curious if you can provide a bit more color on how that's changing the ROI for clients, maybe how large the delta is between the traditional pay and chase versus that solution?

[William Lucia:]

So four months into it, with the data we have. We're seeing an uptick of, I think, about 10% on the yield per finding. And I think that's because we're getting the claim well before it's been reviewed by potentially other vendors. As you may know in the commercial arena, clients -- health plan stack vendors, sometimes you get claims after their age, 30 days, sometimes after six months. So we're seeing that higher yield, because this is going through our client systems and all of their claim editing processes, and we're getting that first bite at the apple. I think it's also because the other factor that's important to us and I think to our customers and their providers is, we're doing this in a very short timeframe, it's before that dollars have actually left the client, providers heavily incented on getting the medical referred in and working with us. So there is a really rapid turnaround time and of course to fit within prompt pay statues. So all of that is leading to a higher finding rate, and ultimately less administrative cost for us and our client.

[Ryan Daniels:]

And then, I guess another question on that to follow-up. Is there anything unique about Medicare Advantage? It looks like that's your first client that you're deploying. You signed another MA plan. Do you see this more broadly working into your Medicaid RACs or other commercial markets on the broader population?

[William Lucia:]

I think this is applicable really to particularly really any claim, but particularly institutional claims in any payer markets, whether it's Medicaid, Medicare or true commercial. We started in Medicare, primarily because a lot of our clinical auditing today has been across a Medicare Advantage population. And of course, we grew from the roots of Medicare RAC and having a deep understanding of Medicare payment policy and build our analytics from that. But I think what it will help us do for really all of our clients is deal with some of the things that we've been withheld from doing at the federal level, like short stay orders. Doing those now, at the time of payment or report a claim that's actually been paid to the provider, gives us much more insight and the provider a lot of willingness. They are able to review the record. If not a record that a physician signed off on nine months ago, with something that was just signed off on within the last couple of weeks. So it's a much different type of audit. And I think we'll be able to do more audits in that approach than what we do in post-pay.

[Jeffrey Sherman:]

Ryan, I would just add, we do believe from a cash flow perspective. This will lead the cash flow acceleration for us, because it will not be a lag in terms of the work done and having to actually recoup the dollars back. It should also lead to less administrative cost and trying to track and actually collect the dollars on the backend. So I think both from a efficiency standpoint and a cash flow timing and yield perspective, it's a beneficial product for us.

[Ryan Daniels:]

And then last one, and I'll hop up. Bill, I guess a big picture question for you. A lot of your commentary I think today was around kind of the macro trends we're seeing in the market with lives moving from fee-for-service to MA and Managed Medicaid and exchanges. Can you talk a little bit about the work you've done over the last few years, repositioning the company to have success in what are now the faster growing commercial markets? I think we did hung up on the nuances of individual contracts and maybe missed some of the big picture changes you've made to your sales force and product portfolio. So just kind of your update on where you stand in regards to what will now be the higher growth markets over the next decade?

[William Lucia:]

So as you know, years ago we entered the commercial market through Medicaid Managed Care plans, primarily in the beginning doing Medicaid coordination of benefits, and that was the strategy to follow the lives. But over the last two years, we've invested in the sales infrastructure, broadened an entire new sales leadership team and of course utilized some of the sales people that had existed in our team and doing a great job, but expanded the sales team. And then we focused the market, that team into specific areas within the market. So we have a group that focuses solely on independent Blues plans, which we're now in our sales queue getting significant traction from. We have a focused group on the large nationals. We think we're trying to focus our subgroups in sales and account management on the types of companies that behave similarly. And then we have a group that really focuses on the regional players within the market, starting to look at other risk-bearing entities outside of traditional, what you would consider the traditional health plans. So we've really structured the company to align more closely with the type of commercial customer. We've been heavily focused on expanding into the Medicare Advantage space and into the true commercial space, which we do have some revenue from today. So the last market that we also focus on is the large self-insured employer. So we've really branched that we've kind of stuck at sales team and account management team into separate branches within commercial, and now they're heading the market on their much structured approach. They are of course supported by product SMEs that come out of by their COB payment integrity, fraud analytics or some of the new products that we're launching into the market.

[Jeffrey Sherman:]

And as we've build the sales queue, we then had to deal with operational issues inherent in that. So as we've talked about in our prepared remarks, we have added new implementation resources. And then as those implementations come online, we're starting to ramp up operational resources to service that business. So there was infrastructure changes that we've been making over the last couple of quarters, once we had the sales pipeline built to actually service that pipeline faster and more efficiently.

[William Lucia:]

Now, the good news is, with well over 200 health plans under contract, we've seen just about every commercial claims adjudication engine, a lot of the data warehouse systems and other tools that we have to integrate with. And once we're done implementation, we are very tightly integrated with our clients, both on the front end and the backend of our processes.

[Operator:]

Our next question comes from Brooks O'Neil of Dougherty & Company.

[Brooks ONeil:]

Was there any litigation expenses this quarter? And if so, can you give us a rough feel for how much?

[Jeffrey Sherman:]

In specific related to PCG cost in the quarter, we had $900,000 this quarter, and on a year-to-date basis that number is $4 million that compares to about $1.5 million through the third quarter of last year, with really all the expense in 2014 occurring in the third quarter.

[Brooks ONeil:]

And then, secondly, would it be possible for you guys to provide any kind of a feel for the timeline on the New Jersey protest and any other steps you might take to put yourself into better position there?

[William Lucia:]

So Brooks, we're waiting to file the protest, until the state gives us all of the information that we've requested. Hopefully, that will come shortly. Once that happens, we have I think maybe a week to respond to the state, see if there is additional information we need. And then, once that's final, I think I forget the procurement rules, but probably 10 days to file the protest. So it's hard to say with any certainty how long the state will take to review the protest. And then of course after their decision, if it's favorable to HMS, and we believe we have very strong ground to protest. If it's favorable to HMS, then we don't know what the process necessarily will be after that. I mean, there is a number of outcomes that could happen. And if it's an unfavorable decision, we have a next path to pursue through the legal process in New Jersey. So this could be a couple of weeks, it could be a couple of months. We really can't be very precise about the timeframe.

[Brooks ONeil:]

And you might have said this and I might have missed it. But in the meantime, you are continuing to service the state of New Jersey?

[William Lucia:]

Yes, we are. The current contract has been extended again through November 29. We would anticipate that if the protest period goes beyond that that the state would continue to extend the contract. That's just our expectation.

[Brooks ONeil:]

That makes total sense. And then, again, I apologize, I might have missed it. But did you provide any update on the RAC re-procurement or what might be going on with that whole situation?

[William Lucia:]

Well, CMS has said that they except to have re-procurement out shortly, so we're expecting to see it some time in November or December. We don't know how long it will take for them to actually go through the bid and award process. And then, of course, there is always the potential for protest through that process too. In the meantime, we are working hard to have -- we have a number of new audit scenarios in front of CMS to approve, so that we can expand the auditing we're doing under the existing contract and negotiating the extension of our existing contracts through July 31 of next year.

[Brooks ONeil:]

And then just following-on with Ryan's last question. I have a sense that obviously you had a lot of success with the commercial Medicaid players. It sounds like you're having increasing success with the commercial Medicare players. I mean, could you just elaborate a little bit more on success that you might be having or targeting to have in the future with what I might call the pure commercial insurance companies that are there?

[William Lucia:]

So we have a very small percentage of our revenue today comes out of what I would consider pure commercial, and that's revenue generated from both employers and revenue generated from the pure commercial carriers. It's about 5% of total, little over 5% of total company revenue. But it is an area of growth. And particularly because many of the plans we serve are on the exchange, the reports you may have read is that risks from their perspective has not necessarily been profitable. So we're seeking to pursue all of the carriers that are offering individual policies on the exchange as well as those that have a significant block of ensured or at-risk commercial lives. To us, it's really sort of the third leg on the stool, as we're dealing with a large national plan. Margins in their Medicaid business are probably the tightest and we've often started there, moved to Medicare; and then of course, the last avenue is the true commercial. So we have our sales team focused on all, what I would consider, lines of business for the big nationals and the Blues plan.

[Operator:]

Our next question comes from Charlie Strauzer of CJS Securities.

[Charlie Strauzer:]

Just picking up on Ryan's initial questions on pre-pay and the overall kind of longer-term view of that, Bill. When you look at -- if successful products rollout, do you see this as more like a complementary service to COB or is it something that you think overtime could replace that as states look to kind of create more of an upfront safety net?

[William Lucia:]

Well, the pre-pay today is really regarded to -- is really clinical or other payment errors versus COB. Our prepaid solution on the COB side is what we call cost avoidance, and that's delivered depending on the client daily, weekly or monthly, and allowing them to avoid making payments and redirecting the claims to another payer. But in this space, we think it's going to continue to grow. And the reasons why are, it's much easier to get provider cooperation and much less burdensome on the provider to do this right after they've submitted the claim. So they've submitted the claim. It's gone through the normal adjudication process at our clients. Many of our clients have bolt-on backend claim editing engines, and when they are ready, they hit the check right. So before they hit check right, they send us that transaction overnight. In that same evening, we send them back transactions, let's say, we have no findings, go ahead and pay or we have findings, and these are the medical records that we request or that we're asking you to request, depending on the client implementation. That provider has just has that medical record still in their billing department, it's not or coding, it's not sent off to archives or it's right there, and we can very quickly retrieve that record and make a determination. So it's much less burdensome for the providers. They don't have to use a record retrieval company or go back six months and dig up a record. And we believe we're going to continue to have higher findings only because the claim will not have been adjusted, gone through further changes, that could happen over six, nine or 12 month period.

[Jeffrey Sherman:]

It also provides more financial statement and cash flow certainty for providers upfront, so you don't have take-backs or adjustments from previously recorded revenue in future periods.

[Charlie Strauzer:]

And then shifting to the increased focus, I should say, from you on M&A. Can you maybe expand a little bit more as to potential size of acquisitions you're going to be targeting? Are you looking at more transformative acquisitions or are these more bolt-ons to kind of enhance what you're already doing?

[William Lucia:]

We're looking at both. We're looking for acquisitions that can further expand our product portfolio that we can bring into our large and growing business, and so there is a lot of activity in the marketplace. We haven't put a limit or a capacity in terms of small, medium or large opportunities. I think the significant change for us is, we've hired a dedicated individual, [ph] Abram Smith is leading our acquisition efforts. And we are being more proactive, so we're going out and building our own pipeline now of potential deals that fit within our strategic plan, and so both from where we see growth opportunities, as well as our existing product portfolio or existing marketplace, we're looking at acquisitions in both of those. And as I said in my prepared remarks, we have a very active pipeline, but we're going to maintain a disciplined approach as to what we're going to pay and how quickly we think it could be accretive to the company's financial performance.

[Operator:]

Our next question comes from Jamie Stockton of Wells Fargo.

[Jamie Stockton:]

Maybe just one real quick one on the pre-payment. Are the contingency fees that you get paid there similar to what you would do if you were doing post-payment work?

[Jeffrey Sherman:]

Yes, they're in the same range. Our alpha client that we brought up and running on the account -- let me take a step back and give you a little view of sort of go-to-market on some of our new products. So we are going to market with looking for, what we call, a lighthouse account in any of the new products we roll out, and for that purpose we're not necessarily charging a premium, because they're working through a process with us. They're adding their ideas. We're making sure that we're fine tuning the products through that process, so we'll see that with all of our products, early adopters of HMS Link and any of the new tools that we'll be launching over the next year. But ultimately prepaid clinical should have the same or higher, depending on the fact that we are blocking the claims from being paid, we're providing much less provider abrasion for our plans, it could have higher pricing, it could also have other pricing models depending on the client, implementation fees, or maybe a [ph] PM-TM model in the future. So we're still open to different pricing models on that product, but the easiest go-to-market strategy for us was utilizing the contingency fee structure, so that we could amend existing contracts with our clients.

[Jamie Stockton:]

And then maybe just one more. You're looking for a big step up in commercial revenue sequentially in the December quarter. I mean, I know that there is some seasonality in that business, but if I just annualize that number, then it seems like it provides a lot of visibility into kind of 20% growth in '16 for the commercial business. Is there any reason that we shouldn't think about the level of business in the fourth quarter as being generally sustainable or something that you can grow off of?

[Jeffrey Sherman:]

Yes, so without talking about 2016 yet, we did see sequential revenue growth in each month in the third quarter, Jamie, and do expect that we'll see the increase we talked about in the forth quarter. We do have some seasonality that we talked about in the past, as we go in to the first quarter of next year. But as Bill said in his prepared remarks, we do see the ability and have a roadmap to continue to see commercial growth in what we expected in 2015.

[Operator:]

Our next question comes from Dave Windley of Jefferies.

[Dave Windley:]

I am probably going to try to split the hair a little more here. Following up on Jamie's last questions on the commercial revenue step up, Jeff, you named off several drivers to get there. Which one of those drivers is the most significant contributor to that sequential growth in the fourth quarter?

[Jeffrey Sherman:]

We didn't call out any specific. We said kind of evenly spread across those categories. So I think fourth quarter historically, we have seen big yearend revenue in the fourth quarter as companies are looking to -- customers are looking to finish their year strong. I think new product implementations that we've talked about will be a big component as well, both once in the third quarter and in the fourth quarter.

[Dave Windley:]

So I suppose I was trying to get a little bit better sense of certainty or confidence. I know there is probably an inclination you said a 20% growth flag in the ground and then an inclination to want to keep that. This fourth quarter growth rate is going to be 30%-plus year-over-year on what is your toughest comp from last year. I guess, can you help us a little bit more into your visibility or the confidence that you have that you're going to be able to stretch and reach this 20% goal for the year?

[Jeffrey Sherman:]

We have detailed plans by category of revenue improvement and by customers. So we go through a robust forecast in process each quarter by customer and product line. And so as we look at implementations that have been sold, that are beginning to implement and ramping up, as well as new ones coming online, its a really a bottom-up process by customer. And also as I noted on the payment integrity side, we're continuing to ramp up our resources there. So as we came into this with new product implementations ramping up throughout the year, we have to try and time the resources to service that business as well. And so we've been going through that process. We have training requirements as we bring on new coders, et cetera. So it's a really a combination of all those individual items across the company on a detailed level, as we forecast our revenue that gives us confidence we can reach to the 20% growth. I think it is important to note, as we looked at where we started the year, we were expecting, as Bill noted earlier, we were expecting to see more short stay audits on the commercial site this year. And so through the first nine months of this year, we're about half of where we expected to be, because of delays and our customers allowing us to do that, that in and of itself was about a $7 million or $8 million shortfall through the first nine months of the year. We expect we're going to be able to climb over that with the initiatives we have in place going through the fourth quarter, so there was an expectation that from the onset, it was a little bit higher in the short stay. We are seeing some moment on that from some of our customers that will help as well in the fourth quarter.

[Dave Windley:]

So on the M&A front, just quick question there in terms of appetite, you've described your interests. What are your financial requirements, I guess, short version would be, does it have to be accretive before you will close on something or would you do a dilutive deal?

[Jeffrey Sherman:]

Yes, on balance, we're looking for an acquisition to be accretive in a fairly short period of time. I would say, within a one year period. I think for us, the question is with an acquisition if we can put it into our existing customer sales channel, how quickly can we accelerate growth with an acquisition? So we have a return on investment thresholds that I won't necessarily discuss, but certainly significant enough that we're going to get a good return on our capital. And we do expect acquisitions, once in, will be continue to be part of organic growth going forward. And we see us developing a cadence of doing acquisitions on a more consistent basis overtime to actually drive long-term revenue growth.

[Dave Windley:]

Then my last question, in this pre-pay product, I guess I am interested in how we should think about. One, you mentioned efficiency as it relates to the claims not having gone into archive and things like that. Are the cost resources that HMS have to apply either on a per claim basis, per client basis, however we can think about that, are those also more efficient? Can you potentially get a higher contingency fee or higher payment on this because of the lower provider friction, and also deploy less cost on your side?

[William Lucia:]

Well, if we're having a higher average finding rate, meaning the dollar amount and the number of findings, then that's going to lift revenue, anyway even if we charge the same contingency fee. But the other thing is the cost what happens in this case is, we ultimately send in a transaction into the client system that says, no, this claims needs to be denied or adjusted, so it wasn't coded correctly. So we send in an adjustment and we get paid the savings. At that point, there is no collection effort on our side. And depending on our client contracts, we may have a long tail on both our client collecting the dollars or us actually doing the collections process from providers on the typical pay-and-chase or retrospective. So we shortened that immediately as soon as that transaction is sent into our client that month is when we're able to book revenue. And then, of course, the dollars are taken back from the provider through the claim adjustment process. It's the first time they actually get paid on that claim, and then we're paid very quickly after that due to the payment terms in our contracts. So it's very different. The appeal rate has been much lower. So I think that's other factor. Now, it's our job to model this all out and make sure that as we see clients two and three come onboard that we have the appropriate metrics and can show what impact that's having on both, our cost structure, our clients' efficiencies and the recoveries or the savings we're providing to them. But there are backend processes on our side that we don't have to expend.

[Dave Windley:]

Bill, I'm going to ask one more on this. So I'm assuming during an alpha period that this client's post-pay recovery activities would remain. Would they remain ad infinitum? Would you still have the net on the backside to chase after claims or would this totally replace the backside?

[William Lucia:]

Well, it's a good question. The client, that's our alpha client, we were not doing post-pay clinical audits for their Medicare population. So to us it's a very important customer to get up live and running. Our second client, we are doing some post-pay clinical reviews after payment. But we still expect that there are reasons why claims will be looked at on a post-payment basis, long-term that won't be caught in the prepayment plans. And that's really just the more we learn about that specific provider in that specific plan and their billing and coding activities, the better our system gets. Remember, it's learning every night, based on the claims that are coming in. So as a provider may change their billing habits, we may see it in pre-pay, but we may catch it in post-pay later. So there are a lot of reasons why there still will be a post-pay opportunity. The nice thing is our first client we were not even doing post-pay, so we're able to show significant savings to them upfront.

[Operator:]

Our next question comes from Mohan Naidu of Oppenheimer.

[Mohan Naidu:]

Bill, thanks for all the details on these pre-pay clinical trial act. Just maybe one more question around that. So the new client that you talked about in Medicare Advantage, do they do post-pay with you guys at this point?

[William Lucia:]

They do.

[Mohan Naidu:]

And you're going to continue to do that even though they're going to do preclinical?

[William Lucia:]

Yes. That has not been turned off. Actually, I think they may even use two other vendors on post-pay.

[Mohan Naidu:]

When is the product going to be generally available for customer?

[William Lucia:]

Well, it's actually generally available now. We've both launched to the marketing of it, there is a very large conference coming up, The National Healthcare Anti-Fraud Association, we'll be previewing it their along with our new HMS Link product for fraud. So it's generally available. It's taking up significant space in our sales queue right now. So there has been a lot of interest across the market. And we're targeting really -- we started with the commercial segment, meaning Medicaid Managed Care, Medicare Advantage and true commercial. But we really, ultimately we believe it's applicable to really any payer of claims. So the state Medicaid agencies could buy it, we could potentially sell it under an MMIS procurement. There is a lot of other avenues that we're now just starting to position the product for.

[Mohan Naidu:]

Maybe a couple of questions on the commercial side. Bill, you talked a lot about the actual rate of implementation work that you guys are trying to do. What's the end goal there? Can we realistically think about a turnaround from contract revenue within one to two quarters?

[William Lucia:]

Actually, yes. I mean, of course, it depends on the complexity of the project, right. And there are times that make sense for us to come in. And if a big health plan says, HMS, we like what you do, but we're going to put you in position three, so that means they've given two other auditors a chance to look at the work in the first six months. We still may bid and work in that position, because if we're finding what other's have left on the table, that's a real positive for us. But that takes some more complex implementation, right. We have to, I'll use some kind of mundane words, but we have to match off against their findings, make sure we're not pursing the same records. The implementation just is more complex than some of the others. But yes, our goal is to dramatically reduce it. We've restructured the process, so that rather than it functionally moving through the organization, it's solely contained in an implementation team, so to speak. So from soup to nuts, the account manager has access to technical developers, business analysts, subject matter expertise all-in, what you may consider an implementation part. In fact, physically they're located as such. So it really helps drive communication internally and with our customers. And we do believe, we'll continue to see a dramatic reduction in implementation times in 2016.

[Mohan Naidu:]

Jeff, maybe one last question for you. When we look at the state segment revenue, are you starting to see the renewed contracts coming to revenues or like the pricing impact or how should we look at the decline in the state revenues? I know that you guys had some one-off revenues in 2014 that could be a comp issue here as well. But how should we look at renewals and the renewed pricing in the revenue?

[Jeffrey Sherman:]

Yes, I'd say on balance for the contracts that have been reprocured and that we've won, we haven't seen any significant change in pricing or scope on those projects. To the extent that they've been renewed, they would be flowing into revenue. When we started the year, the main driver of the forecast, a decline in state revenue was just a big ramp up we saw in Medicaid growth in 2014. So keep in mind, the state growth was Medicaid expansion, averaged about 20% across all states in 2014 and then states that expanded, it was 30%. So as we were doing initial CAV work for those lives that was driving revenue growth in '14 that we did not expect to reoccur in 2015. We did see some of that lower in the first couple of quarters, but as we looked at a projected increase of 5% to 6% enrollment for 2015, the change was really driving from that fall off and growth between 2014 and 2015.

[Operator:]

Our next question comes from Elizabeth Blake of Bank of America.

[Elizabeth Blake:]

Jeff, you were mentioning ICD-10 is potentially leading to some delays for your business in December. What's contemplated in the guidance here, as it relates to that issue? Is it safe to assume that you have some cushion there?

[Jeffrey Sherman:]

Yes, I think, as I said, we haven't seen any material impact yet. So we do have some contingency there for ICD-10. At this point, we're not expecting it to be a big material impact, but that certainly is subject to change if something happens that we're not aware of between now and the end of the year.

[Elizabeth Blake:]

And then you were calling out some additional expenses related to clinical reviews on the PI side. How should we think about your administrative cost trend going forward?

[Jeffrey Sherman:]

Well, as we continue to do more work, we should expect cost to continue to ramp to help service that work. So we've added expenses for nurses and coders, as I said. But we're also continuing to look at additional cost opportunities and efficiencies, as we head into next year as well. But incremental revenue, particularly in the PI side, will drive incremental costs as well to help service that business.

[Elizabeth Blake:]

But the $2 million you're calling out an incremental costs, I mean you wouldn't characterize those as one-time?

[Jeffrey Sherman:]

Correct.

[Operator:]

Our next question comes from Frank Sparacino of First Analysis.

[Frank Sparacino:]

Just a real quick for me. Jeff, just following-up from your comments earlier on the state government side of things. I guess, for longer-term obviously understand the dynamics this year in terms of the business being flat. But longer-term when you look at that, what should we kind of expect that a business that's really not going to grow? Any thoughts there?

[Jeffrey Sherman:]

Yes, so we haven't given guidance yet for 2016. Historically, it's been a low single-growing business, as lives grew and as costs went up. So for 2016 we'll be providing guidance, as Bill noted, on our fourth quarter call. And you are going to have to continue to factor in migration of lives from traditional fee-for-service Medicaid into the managed care side. So that trend, we don't necessarily expect to -- most of the lives, we believe have already moved. But we are also seeing some trend of sicker patients that were historically managed on fee-for-service moving into the commercial side. So that could have an impact on state growth in the future as well.

[Operator:]

There are no further questions at this time. I'd like to turn the call back over to, Bill Lucia, for any closing remarks. End of Q&A

[William Lucia:]

I want to thank everybody for your attendance, your continued interest in HMS and all of your questions. And we'll look-forward to speaking again on our call in February. Thank you.

[Operator:]

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