HMS Holdings Corp
Q2 2013 Earnings Call Transcript

Published: 26 Jul 2013

[Operator:]

Good morning, my name is Kevin and I'll be your conference operator today it. At this time, I would like to welcome, everyone to the HMS Holdings Corp. Second Quarter 2013 Earnings Call. [Operator Instructions] I would now like to turn the call over to Jzaneen Lalani, HMS Holdings. Ms. Lalani, you may begin.

[Jzaneen A. Lalani:]

Good morning, and thank you for joining us today. As you know, we distribute our earnings release through our website, hms.com, under the Investor Relations tab. Under that tab, you will also find the supplementary slides that accompany our call today. This call is also being webcast. Please click on Events & Presentations under the Investor Relations tab to access the webcast. We will make a replay of the call available on our website later today. Before I turn the call over to Bill, let me remind you that some of the information presented today regarding the company's future expectations, plans and prospects are 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 report 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, July 26, 2013. And the company disclaims any intent or obligation to update any forward-looking statement as a result of developments occurring after today's call. During this call, we will also be referring to several non-GAAP measures. The press release issued this morning includes a reconciliation of these measures to GAAP measures and is available under the Investor Relations tab on our website, hms.com. With that, I'll now turn the call over to Bill Lucia, President and CEO of HMS Holdings.

[William C. Lucia:]

Thank you, Jzaneen. Good morning, everyone, and thank you for joining us today. I'll be hosting the call this morning along with Walter Hosp, our CFO; and Maria Perrin, our Chief Marketing Officer. This quarter, more than any in our recent past, reflects the market changes impacting our company and the shifts in products and market mix we're experiencing. But as we'll explain during the call, 1 quarter does not create a trend and we are affirming our full year guidance. And while our current financials don't reflect historical growth rates, the investments we've been making position us to achieve stronger revenue growth and margin expansion in 2014 and '15. Now I'll turn the call over to Walter for a review of our financials. And then I'll discuss sales, including the status of Federal procurements we spoke about last quarter. I'll also update you on our commercial market strategy and provide my thoughts on HMS' strategic outlook. Walter?

[Walter D. Hosp:]

Thank you, Bill. And good morning, everyone. I will start by walking through our P&L and key financial items for Q2 and then provide a deeper dive into the revenue growth rates we saw for our major business areas in the quarter. Second quarter revenue was $125.8 million, up 4.8% over the prior year. This compares favorably with the consensus estimates for the quarter of $123.9 million. Year-to-date revenue was $242.4 million, up 6.6% versus the prior year. I will go deeper into our revenue development for the quarter in a moment. Looking now at expenses for the quarter, total cost of services were $88.7 million, an increase of $9.1 million or 11.4%. The growth of expenses in excess of revenue growth is in part due to incremental costs necessary to support the implementation of many new RAC and RAC-like contracts and continued long-term spending to strengthen our infrastructure. I would also mention that we are focusing on our cost structure and reshaping our organization to have the right level of resources commensurate with the market opportunities. This will result in greater investment of resources in growing areas and lower resources where appropriate. Compensation expenses related to the cost of services was $46 million for the quarter. As a percentage of revenue, this expense was 36.6% versus 33.3% in the prior year. Growth in this line item is attributable to an increase in headcount of 247 employees over the same quarter last year to 2,627 employees. Of this increase, 30 positions were in the SG&A area, and the majority of additional positions were added to support the implementation of Medicaid RAC programs, growth in Medicare RAC transaction volumes, and increased investments in IT and infrastructure development. Data processing expenses increased 15%, or $1.2 million over the prior year to $9.2 million. This increase is related to hardware and software upgrades, plus an increase in expenses resulting from the movement of our data center out of New York City to a co-hosted facility in Texas. A portion of these expenses are nonrecurring. Occupancy cost increased $0.6 million to $4.8 million, an increase slightly as a percentage of revenue from 3.5% last year to 3.8%. We completed in the quarter a downsizing and relocation of our New York City office beyond the moving of our data center. This will reduce our New York City occupancy cost by approximately 2/3. The financial benefit of this downsizing and relocation will begin to show in our third quarter results. Direct project costs decreased 7.1% or $0.9 million year-over-year to $12.3 million, primarily due to lower temporary personnel expenses. We have begun a shift of employees from temporary employment status to full-time status, which reduces direct project costs and increases compensation costs. This shift will continue into the second half of 2013. Other operating costs increased $1.7 million or 27.8% year-over-year to $7.6 million. A large part of this increase was related to increased professional fees for subcontractor and temporary staffing. Amortization of intangibles associated with acquisitions was $8.7 million for the quarter, an increase of $0.6 million year-over-year. This increase was primarily due to new intangibles related to our acquisition of MRN in December of 2012. SG&A expenses increased $1.9 million or 12.7% versus last year to $16.8 million. Much of this increase came from increased legal and consulting expenses, as well as small increases in compensation, data processing and occupancy expenses. Income taxes were $6.7 million for the quarter compared to $8.7 million for the same quarter last year. The effective tax rate for the quarter was 39.1% versus 40% last year. The decrease is primarily due to state taxes and apportionments. Net income for the quarter was $10.4 million, a decrease of $2.6 million compared to the same period in 2012. Fully diluted weighted average common shares outstanding for the second quarter was 89 million shares. Fully diluted GAAP net income per share was $0.12 compared to $0.15 in the prior year quarter. The $0.12 compares to a consensus forecast of $0.13. Adjusted EPS was $0.20 for the quarter versus $0.23 in the prior year. This compares to a consensus forecast of $0.21. I would also note that we ended the quarter with cash and cash equivalents of $131.5 million, with cash-on-hand of yesterday of $145 million. On a year-to-date basis, operating income of $35.6 million was down 14.4% from prior year-to-date, and net income of $17.4 million was down 13.1% from prior year-to-date. Net cash from operations was $35.9 million for the first half of 2013 versus $36.6 million through the second quarter of last year. We also made principal payments on our outstanding debt balances of $33.8 million in the current year period. We'll now take a closer look at revenue growth in the quarter. The first point I would like to make on this slide is that although our total revenue growth rate is in line with expectations, across our markets and products, we have an extremely wide range of growth rates, both positive and negative. If you compare this quarter's growth rates to the first quarter of this year, you would see significant line by line changes in the growth rates from quarter-to-quarter. I would also go one step further and tell you that we expect very different and generally higher rates of year-over-year growth in the third quarter. This is because each part of our business has a different growth story and is in a different stage of growth. Also, as we had mentioned, there is significant lumpiness to our business on a quarterly basis, requiring adjustments for this lumpiness in both current and prior year quarters to calculate meaningful growth rates. This results in quarterly growth rates being a poor indicator of both annual growth and long-term value creation. More on this after we walk through each line item. As I mentioned, total revenue for the quarter increased 4.8% year-over-year to $125.8 million. If we adjust for both our Federal business and HDI, this year-over-year growth rate is minus 2.6%. Looking at revenue growth from a market perspective, year-over-year growth in our Medicaid market was minus 1.4% in the quarter. The total Medicaid market is divided into our State Government and Medicaid Managed Care or MCO market. As you can see from a highly contrasting growth rates of minus 9.7% for State Government versus the 17.5% growth in MCO, we continue to see in our results, the impact of the shift in lives from Medicaid fee-for-service to Medicaid managed care. This transition of lives will continue, but the rate of transition is expected to slow as we reach 2014 because the number of lives transitioning in 2013 is well below the number of lives transitioned in 2012. Additionally, the product revenue mix in this market is changing as we increase revenues from RAC and RAC-like services to both states and managed care. And although the growth of Medicaid has slowed, Medicaid expenditure growth typically exceeds GDP growth, which is generally on the rise. Our third quarter forecast will call for the resumption of growth in State Government and acceleration of year-over-year growth in MCO. Our Federal business decreased 34.5% in the quarter year-over-year. We are still being impacted from certain Federal contracts that we chose not to rebid, but which we had to cancel when we acquired HDI. We expect to also see resumption to growth in this market in Q3 as we lap the year-over-year impact of these contract losses. Our HDI revenue growth was 44.2% year-over-year. This result was above expectations and came from growth in both Medicare RAC and the commercial client parts of the business. However, here we expect the year-over-year growth rate -- year-over-year rate of growth to decline in Q3 due to current contract transition issues in the Medicare RAC program. And Bill will describe that more later. Looking at our revenue growth in the quarter from a product perspective, Medicaid COB decreased by 8.3% in the quarter. Significant lumpiness in both prior and current periods will result in year-over-year growth rates that will swing from 5.2% in Q1 to the minus 8.3% you see in Q2 to an expected higher positive growth rate in Q3. None of these individual quarterly growth rates are indicative of the annual growth we see for 2013. We are, however, still impacted in this area from the significant changes in the Medicaid program, namely, historically low Medicaid expenditure growth and the transition of lives to Medicaid managed care. We anticipate that this picture will change in 2014 as we benefit from the Medicaid expansion under the ACA. Our program integrity products across the entire company grew 28.6% year-over-year in the quarter. Now this includes both the HDI and the Federal markets in this definition, and if we adjust for these 2 areas, program integrity growth from the quarter was 26.2% versus 19.9% growth rate in Q1 of 2013. Hereto, we have an uneven quarterly revenue growth rate due to the mid stage implementation of Medicaid RAC and RAC-like contracts. We expect to see continued high growth rates of growth for the year, but could see some fluctuations of this growth rate in subsequent quarters. My summary to this slide would be a strong word of caution on annualizing the growth rates we are showing in this quarter, and in subsequent quarters, even as most of these growth rates improve. They are certainly valid indications of what has happened in the quarter, but because of all the change and transition that is going on in our company and in our markets, a clear line of sight of future results cannot be obtained from any one quarter. I would close my comments with saying that we believe we are broadly on track with our guidance for the year and so we affirm our current guidance for 2013. I would also mention that at the Q3 earnings call in October, we will be providing our 2014 guidance for the first time. That concludes my review and I will now turn the call over to Bill.

[William C. Lucia:]

Thank you, Walter. I'll start with a review of our key sales in the State Government market. As you might have read in our recent press release, the Ohio Department of Mental Health and Addiction Services recently awarded a competitively bid contract to Permedion, our wholly-owned subsidiary. Permedion will administer the utilization review program for inpatient and community behavioral health services, including prior authorization services. To secure this work, we leveraged our decade-long relationship with Ohio, our local presence in the state, and our success performing behavioral health audits for other states. According to the Kaiser Family Foundation, the currently uninsured population with mental health conditions will soon become eligible for Medicaid or commercial health insurance through the exchanges. So the likelihood of an increase in total mental health costs is high. We anticipate the need for HMS' expertise in performing behavioral health utilization management and auditing to grow accordingly. We were also awarded dependent eligibility contracts from the city of Boston and the Illinois Department of Central Services. This product line is proving to be a market entry point for serving states and local government agencies beyond Medicaid and assisting them in controlling their health benefit costs. In Medicaid Coordination of Benefits, we extended our contract with the state of Iowa and added these services for the Texas long-term care population under the Department of Aging and Disability Services. In 3 states

[Operator:]

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

[Ryan Daniels:]

On the Medicare RAC. It sounds like you're in confidential discussions, I don't know how much you can share on this, but can you just give us a view for what you're currently doing today? I know they didn't extent the ability to mail letters, so I'm assuming that, that business has slowed down pretty dramatically, thus far in the third quarter, so any color you can offer there?

[William C. Lucia:]

Yes, that's a good question. We are actually letters -- new medical request letters to providers ended at the end of June. So that was the last time we mailed new letters out. Of course, we're always working through a portfolio claims that are in audit process. So we continue to maintain that staff and are working through that process as we are in these confidential negotiations with CMS to continue providing services through the end of this agreement.

[Ryan Daniels:]

So there's still some potential that you keep providing some RAC services to Medicare up until the transition point or there's a new award, is that the way we should think about it?

[William C. Lucia:]

Well, I mean, I'll give you our position on it and then it's really up to CMS and the CMS contract's office to have further discussions about it and come to a conclusion. But we've been very vocal with CMS and the fact that this program, obviously, has been very successful, and albeit there are challenges from providers, it really doesn't make sense to insert an arbitrary provider audit holiday and disrupt the program and the infrastructure for this program. Because they will be re-procuring these contracts and the 4 recovery audit contractors that are in place. If they rewin those contracts, need keep the staff employed, if not, with a very knowledgeable staff about the program and the potential overpayment. So we're looking for a hopeful outcome from those contract negotiations. And I think there is an opportunity that continue -- for continued work, but we really can't comment on that further.

[Ryan Daniels:]

Have they given you any timeframe when they might come back with the end of these negotiations, or is that all up in the air?

[William C. Lucia:]

Well, everything is always up in the air just because government contracting has its unique characteristics. But I do believe that the stakeholders at CMS do want to get the contract transitions resolved and the new procurement out. So I'm hoping that this will be resolved in our current quarter.

[Ryan Daniels:]

Okay. And then 1 more, somewhat follow-up to that. But if the demand letters aren't going out anymore, I understand you're still doing audits that are in this system at present, but are you starting to shift some of your auditors and your work force over to the Medicaid RACs, which are being implemented given the slowdown that will inevitably come because you're not mailing letters right now?

[William C. Lucia:]

Yes. I mean, we're not at the point where the staff itself has been impacted, but we have, throughout this year, opportunistically shifted staff from HDI to HMS to support the growing Medicaid RAC environment and the new clinical audits that we'll be performing in that segment.

[Ryan Daniels:]

Maybe a couple real quick ones for Walter now. How about -- just how much -- do you have the onetime cost in the data processing due to the move to Texas, so we can get a better feel for the run rate?

[Walter D. Hosp:]

No, I don't have that broken out. It's not -- it's probably not material enough to do an adjustment for that. But hold until we report third quarter because we have a number of one-time costs related to this move and some other cost adjustments that we've been referring to in rightsizing that we'll talk about in Q3.

[Ryan Daniels:]

Okay. And then any color -- last question on the direct project cost, you hit a little bit, but that was down nicely. It's about as low as we've seen any time over the last few years, is that early manifestation of some of these cost-reduction initiatives?

[William C. Lucia:]

Yes. But don't -- again, don't annualize that drop. Again, some of these is just transition, so it's offsetting where you have lower cost there as we take some temporary staffing we make them full-time employees, and you have higher cost in the compensation line. So that shifting will occur, it's ongoing. There are, overall, savings from that as well, because the decrease in the direct expenses is greater than the increase in the compensation expenses. Again, in the third quarter, we'll be able to talk about this in a packaged way, so that you'll be able to make the one-time adjustments.

[Operator:]

Our next question comes from the Dave Windley with Jefferies & Company.

[David H. Windley:]

RAC. I'm sure you'll get lots of questions on that 1, I'll add 1. And that is, if CMS knows that -- or has a sense that the procurement timeline from when they originally planned to make these awards is pushed out, what would be their reasoning for not also extending the timeline that you could send out letters? Why would they not link the deadline date to the timing of the awards -- the new timing of the awards?

[William C. Lucia:]

That's actually a very good question and one that we've pondered ourselves and I think all the RACs have. I guess, the best way to answer this is -- and what we've learned through this and the large Medicare secondary payor contract is that government contracting is really not a science, maybe more an art, but some decisions are arbitrary. I would say, in this case, that CMS is really dealing with -- they're struggling to also deal with the challenges from the provider community, how some of those challenges might change regulations. But I do believe they have the best interest of the program in mind and are seeking to find the best resolution. I'll remind you that the Medicare recovery audits or Medicare audit contracts really have been -- the RACs have been the first contingency fee program that CMS ever introduced. And contingency fee contracting, as contracts end and rolls to new ones, there are existing portfolios to consider, there's appeals in process. There are quite a lot of things that are different than typical cost plus contracting, which has always been the federal government's way to procure services. So I think they're really struggling with those transitions, but I think they agree that it's in no one's best interest to really stall the program.

[David H. Windley:]

And on the timing, I guess, do you think that -- you mentioned in your prepared remarks that they planned -- or you planned to get a look at the revised language in the RFQ. Do you think that the timeline is going to conclude and winners be named and awarded by the end of the current contract period? I mean, what kind of timeframe are you thinking is reasonable now?

[William C. Lucia:]

I mean, it's always difficult to pinpoint exactly what will happen when and the process. But if we're in contract negotiations now about how to handle the transition of the current contracts, my guess is that CMS will conclude that. And upon conclusion of that, we'll have better insight on the how to provide the corrective action on the original procurement. My guess is, there will be a quick turnaround, there was on the original RAC procurement and proposals. So it is conceivable that -- and clearly, there is enough time that procurement and resolution of protest will happen prior to the expiration of the existing contracts, which is February of 2014.

[David H. Windley:]

Okay. And then last question, I'll jump off. On Medicaid COB, Walter, in your comments, you talked about, I think, the state portion returning to a positive number in the third quarter and the MCO portion moving to a higher positive number. So I wanted to understand what gives you confidence about those improvements sequentially?

[Walter D. Hosp:]

Yes. As you know, we have the benefit of seeing line by line, each product area, each client area, which obviously, the external world does not have that benefit. So our forecast are not based upon extrapolating existing trends, but very, very detailed forecast, and the year-over-year comparisons to those as well. So I refer to lumpiness, which can be retroactive recoveries in one quarter over another, just a collection of things that made it in one quarter. It didn't make it in one quarter, it spilled over into another quarter. So that -- the rise that I'm referring to -- to positive growth in the third quarter is developed from very detailed account level, revenue forecast, right? And again, the conclusion of that is that in the third quarter, we should be positive and you should see a healthy growth rate out of MCF.

[William C. Lucia:]

And just a reminder, Ron, quarter 2 2012, we had a few significant one-time events that were positive. Typically that comes in the form of large claim settlements with an insurance carrier on behalf of a government client, so that skews the quarters and provides some of that lumpiness.

[Operator:]

Our next question comes from Richard Close with Avondale Partners.

[Richard C. Close:]

With respect to the commercial opportunity, I was wondering if you guys could sort of peg what the potential market opportunity is for commercial, as well as go over maybe the margin differential versus your, I guess, public or government book of business?

[William C. Lucia:]

Richard, this is Bill. I'll take a stab at answering that. So we -- I guess, the best way for us to look at the market potential is really working from overall spend down through estimated percentage of errors in the market, and then trying to figure out some form of market capture. I'd say, our analysis on that is a little preliminary because there is no body that statistically measures the number of errors -- percentage of errors in the commercial health insurance industry. I mean, AMA does it, but that may be a little one-sided. And I don't think commercial carriers are necessarily reporting their error rates, either internally or externally. So what I would say is, if we're looking at a program that's -- or a group of programs that's basically trending to $1 trillion a year in annual spend. And we even are very conservative by adding a 5% error rate across-the-board, which is lower than the current error rates that the Federal government assumes for Medicaid and Medicare. It's a significant number of overpayments, opportunities for coordinating benefits or potential fraud, waste -- other areas of fraud, waste and abuse. So I'd say, in that market, very similar to HMS' historical market, probably 80% to 90% of the business will be done on a contingency fee, with the balance being done on a fixed fee per member per month or hourly consulting fees depending on the type of contract. So it's really hard to determine both market capture rate year-over-year and the actual potential. But if I were to put it in -- if I am now to summarize what I just talked about, I would say that it has the potential over a number of years to achieve the size of our current book of business in the managed care side or State Government. I mean, it is that significant of a market. The challenge that we have as we're entering it is, we are either augmenting existing vendor services or we're totally replacing other vendors, and we've been successful in both.

[Walter D. Hosp:]

And Richard, to your margin profile question. Well, first where it is similar with the rest of our business is that the investment, as Bill that mentioned, it's mostly contingency-fee type work, although not exclusively. To do that, you have the same buildup of the operation to support this, the contract implementations, the margin degradation that starts in the beginning, because you're -- under contingency fee, you're spending money in building it up and then get the revenue flows that come and then you ride up the ramp for margins. So here again, the growth rate of profitability that comes from this group is going to be changing and evolving over time like many of our other markets that we've described in government and elsewhere. At the end of the day, on a sort of stabilized basis, pricing is higher in this marketplace, but there's also higher cost associated with customization and very specific type nature of commercial clients. But at the end of the day, it's better margins, than say, Medicaid RAC work, but it may not be as attractive as Medicare RAC work because of the size and scale that you have there. So it should be attractive margins for us, but I wouldn't peg them outside of the range of the portfolio that we have and the differences in our operating margins that we see across different spaces.

[Richard C. Close:]

So when we -- that was very helpful. If we look at the sales pipeline, I don't know how you guys determine pipeline, but maybe the composition, would you say that commercial now is maybe a greater percentage of the overall pipeline versus the state or, I guess, government-related business?

[Maria Perrin:]

Yes, this is Maria Perrin. We are seeing an acceleration of the commercial pipeline and it is now larger than our state government pipeline, although, you will notice state government deals tend to be larger in size, especially if they are across entire Medicaid program or entire State Health Plan program, but in general, the number of deals are significantly more in commercial than state government.

[Walter D. Hosp:]

And Richard, towards that end, because there's a growing component of commercial here, when we give our 2014 guidance in the next quarter, we may be adjusting how we describe commercial in a separate component here and provide some more insight and clarity as to how that component contributes to the overall position of the company here.

[William C. Lucia:]

Yes, and this is Bill, I'll add one more comment. We really are starting to see the blending of those markets. There's a little blurring of the lines. A number of our Medicaid health -- we had considered in the past, really Medicaid-only health plans are entering the health insurance exchange market. We think that's a real positive for us because it's an existing client that has become accustomed to our services, and as volume increases -- their new commercial line, it will flow through our systems. So it's becoming more and more difficult to separate government sponsored health care -- health plans and commercial health plans, and I think as the ACS further implement it, that will continue.

[Richard C. Close:]

Okay. And then I guess, final question for me, any thoughts with respect to, I guess, legislation or maybe changes in the regulatory environment on inpatient and outpatient? How much maybe that, as a -- issue, is impacting the timeline on the Medicare RACs or whether you've had any discussions with the regulatory community in and around inpatient, outpatient billing?

[William C. Lucia:]

That's a good question, Richard. Clearly, one of the biggest issues that has been presented by the American Hospital Association and the hospitals across the country is the current policy around the inpatient, outpatient and Part A, Part B RAC reviews, denials and appeals of those claims. What I would say is, this is probably a considerable issue that CMS is dealing with. They are trying to introduce appropriately new policy surrounding this that all parties can understand, both providers, administrative law judges, all of the other processors throughout the Medicare system, and of course, the Medicare RACs. While that's impactful to the RAC program, ultimately, I will tell you that CMS has been consistently operating this program with new -- I guess, I could call it the same as we mentioned Medicare RAC, new auditing scenarios being approved at a very regular pace and in fact, a very efficient pace. So I believe that the opportunities in Medicare across-the-board to find additional recoveries are significant. We are clearly, as you know, still auditing, in general, less than 2% of all records across the nation. That's a very small percentage and significant findings are still there beyond just the inpatient, outpatient claiming that is under scrutiny right now.

[Richard C. Close:]

Okay. Just one follow-up based on your comment right there. In talking about the new audit scenarios, I just want to make sure, since the document requests ended at the end of June, have you received any approvals for any new issues in the month of July? And then second question on that is, during this transition period, were you not essentially allowed to request any more documents after June? Are you still able to do the automated claims for the Medicare RAC?

[William C. Lucia:]

I probably can't give you a specific of an answer on that. But I can tell you that we have -- we always have a backlog of new scenario and audit initiatives in process at CMS. We're not running -- we are not requesting new records or doing new additional reviews until the contract transitions are finalized. My hope would be that once they're finalized, it will be, to a certain degree, though I'm sure there will be limitations, we'll be business as usual, so that we can continue to perform significant -- and achieve significant results for the programs. There will be changes, I'm sure, around the edges, and we'll accommodate based on that. But I really can't give you further insight into it, particularly because we're going through this confidential negotiation process.

[Operator:]

Our next question comes from Jamie Stockton with Wells Fargo.

[Jamie Stockton:]

I guess, just first, Walter, could you give us a sense for how big Medicare RAC is within the HDI business today? And maybe when you look at its growth rate, I know -- I think you guys said that it was strong year-over-year as well as kind of a non-Medicare RAC business within HDI. But I would assume that the Medicare RAC growth rate was slower just because of the transition that is occurring right now, is that accurate?

[William C. Lucia:]

Well, what we said before is that in 2012, approximately 80% of HDI revenues were from the Medicare RAC. That proportionality -- and then 20% from commercial. That proportionality can change from quarter-to-quarter as we're going forward, but we're clearly seeing growth year-to-date in both of these segments here. So I don't want you to think that, right now, that there is an unusual amount of growth in commercial that's offsetting the RAC growth. Now, in subsequent quarters, that can change because of what we've described in what's going here with the procurement and how it may interrupt the flow of work on that going forward. But year-to-date, that relationship is somewhat solid.

[Walter D. Hosp:]

And I'd like to add a further comment to it. As Maria said, we have significant sales pipeline in the commercial line of business. HDI has won a number of commercial contracts over the last 12 months, and in this current fiscal year -- but because of the process to implement a complex clinical review, the enhanced data requirements, the policy and rules established with chief medical officers at health plans, those are a relatively long implementation process before revenue ramps up. So I think we'll see the commercial market for those services continue to ramp up through 2014 and beyond.

[Jamie Stockton:]

Okay, and then maybe just as a follow-up to that, Walter, the Medicare RAC reserve that you talked about. I think last quarter you said it was like $32 million, including the portion that is offsetting receivables. Is it still around $32 million at this point that you might release part of that as you're going through this transition?

[Walter D. Hosp:]

So in our balance sheet, you would see $10.9 million in short term for the reserves for appeals and $25.3 million in longer-term, for a total reserve of $36.3 million. So we have grown it. We do expect it to grow throughout the year. And again, that's just our policy of, as we get new revenues, taking off a percentage of those 4 and adding to the reserves. As we -- the reserve itself is a -- is something we've commented on before as an item that could have adjustments to it as a result of changes to the existing contract. So I don't want to create a scenario here of certainty, by any means, but there is a play on that reserve that will happen commensurate with this contract efficiency resolution as CMS refers to it. In our guidance we had talked about reducing that reserve potentially up to $8 million. I won't say that, that is the most likely scenario. Something like that could still happen, but what I have to do is step back and say, we gave you net guidance of a reduction of our initial HDI revenue guidance around $15 million. We would hold at this point as we're affirming guidance. And we'll have to wait and see how that rolls out, but it is clearly a block of -- this block of reserves is something that can be impacted as the resolution of this contract occurs.

[Jamie Stockton:]

And then just my last question. There was the mention of reshaping the cost structure as the environment evolves. I know you guys are -- it sounds like going to talk more about that on the September quarter call, but should we interpret that as you looking to use more third-party resources to become more flexible from a cost standpoint? And that will be my last one.

[William C. Lucia:]

That's a good question, this is Bill. I mean, using third-party resources is always an option. I mean, if there's a function that we think another entity could do faster, better, cheaper, we'd be happy to look at that as a consideration. But in reality, we're going through our entire company and adjusting resources based on where the market and product realities are. We've also -- we are intently focused on applying more operational sciences around the delivery of our coordination of benefits services. It's an area, as you know, has historically grown very rapidly. And now, we're in a point where while that business will regrow with the implementation of the ACA, it'll revert back to some significant growth rates. We want to take this opportunity to reengineer many of our processes. So I think what we'll see is more application of technology, establishing better internal metrics, and as I said again, applying more operational sciences to our process. So it will be a blend of many different endeavors. And we'll be happy to talk about that next quarter.

[Operator:]

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

[Brooks G. O'Neil:]

Just a couple of quick questions. First, I was curious, I know you've tried to be conservative with the guidance in the past in taking out some of the areas where there were some uncertainties. So I just want to clarify, as you think about the reaffirmation of your current guidance, are there any areas where something material needs to change between now and the end of the year for you to hit the guidance that you're affirming today?

[Walter D. Hosp:]

Brooks this is Walter. When we said initial guidance, and as we adjusted along, we're adjusting for real-time circumstances, but clearly with the RAC, the CMS RAC contract -- Medicare RAC contract that we've been discussing and potential changes from that, we have taken a view of the number of different scenarios and taken what we view as a highly -- the most probable scenario coming out of that, but there's a range of outcomes that can occur throughout the rest of this year that we really can't see. So we think we have a reasonable set of assumptions and a number going with that. But until we see the -- until we actually sign on the line, and all the RACs do, we could have adjustments to our guidance still in the second -- in the third and fourth quarters. Now having said that, from where we are, we feel confident reaching the overall numbers. We may get them there in a different mix from what we have said at the end of -- well, when we first set this revised guidance, but we still have confidence enough to affirm our guidance here on the aggregate numbers.

[Brooks G. O'Neil:]

That's very helpful. And then just curious, it sounded to me, if I'm understanding it correctly, like your opportunity with United Healthcare, in particular, could be quite significant. Is there any way you can help us think about the magnitude of what that new relationship, that I think Bill discussed, might be in '14 or '15 or beyond?

[William C. Lucia:]

This is Bill, let me take that question. The commercial marketplace is an interesting one in that we are -- we augment the internal operations at a commercial client. And at an any given point, they really may have operational challenges internally or other significant issues like making sure that they're taking the most opportunity from the Affordable Care Act. And so that's how a lot of our sales happen. But because they're also, in many cases, publicly-held entities, we've kind of taken a pretty bright line that will talk about our new contracts, our expansion, the relationships that we formed in the industry, but we really can't comment on the size of those transactions. It's just an agreement we've established with our customers, and we think it's a good best practice.

[Operator:]

Our next question comes from Frank Sparacino with First Analysis.

[Frank Sparacino:]

Bill, Walter, just curious, any positive or negative developments as it relate to the Medicaid RAC marketplace? I know and I think it was May timeframe, and there was a rule related to the Medicaid Fraud Units, and some potential changes there, but just trying to figure out if there's anything noteworthy in that marketplace, which would impact or potentially impact the ramp in the second half of the year?

[William C. Lucia:]

I'll take that, this is Bill. There's really been no new negative or positive development. I mean, I think we've been consistently saying this is a kind of slow, lumpy process, and once you've seen 1 Medicaid RAC, you've seen 1 Medicaid RAC. I think what you're mentioning too about the Medicaid Fraud Control unit is that they now are -- have the capacity and funding to start doing some data mining, potential analysis of claims on their own versus really responding to referrals, I think from the Medicaid agency or other parties. And ultimately, we look at that as an opportunity. We have a very sophisticated pre-payment and/or data analysis, predictive analytics and fraud, waste and abuse platform that does help customers and the Software-as-a-Service model do some of those same things. So ultimately that's -- we think it's a market opportunity for us. I will tell you that the Medicaid RAC market will continue to evolve. And let me give you 1 other little flavor on that market. As you've seen in the press, there's quite a bit of outcry from providers on Medicare RAC. And we -- and where we do agree with providers is, the process for auditing across all Medicare program -- all Medicare audits should be more efficient and automated for providers. That's the approach we're trying to take in the Medicaid RAC arena. We apply a lot of technology and provider-friendly tools for that. But once you get it to Medicaid, you're dealing with providers who may be in the state legislature and in even locally-politicized environment. So I think we're going to continue to see this sort of lumpiness in Medicaid RAC. What gives us real promise about the market is, there will be states that really want to use this as a tool and that RAC-like services will continue to grow as they have across commercial market entities.

[Operator:]

Our next question comes from Bret Jones at Oppenheimer.

[Bret D. Jones:]

I'm still a little confused on exactly what's going on in the Medicaid COB business. And I just want to make sure I understand this correctly. From the sound of it, it sounded like it's a relatively tough comp you had. Some onetime settlements that impacted 2Q '12, but correct me if I'm wrong, there was also some slippage due to anti-5010 in 2Q '12, and I just want to see if I can get a clean number for where -- how much of a one-time impact we saw a year ago in this quarter?

[William C. Lucia:]

Brad, this is Walter. It's true, there's those adjustments and you would on the positive side that we had fluctuations last year going from the data management, the 5500s and the D.0 issues. We hesitate breaking that down to give a -- just a fully-adjusted growth rate for all changes because every quarter, there are changes and lumpiness. And to get that growth rate, again, and I went through it rather extensively here, it's very, very hard to peel that back and say, this is a growth rate that's indicative of where the business is going. You really have to look at it more than one quarter and look at the overall trends on these things, factoring in that there's changes back and forth. So again, I hear your question. It makes perfect sense from an analytical perspective, but we can't every quarter, break down every variation that happens in that quarter along with variations that happened in the prior year. And I think that would be almost a focus in futility given where we are in the cycle.

[Bret D. Jones:]

Okay. No, that's fair. And I understand that. And so that kind of preempts me from asking the next question, which was going to be, with the onetime catch -- would there be any onetime catch-ups from anti-5010 in this quarter? But it sounds like without the onetime...

[Walter D. Hosp:]

That I could tell you no. There's no catch-up for that.

[Bret D. Jones:]

Okay. And then I just wanted to...

[Walter D. Hosp:]

We've essentially got that issue behind us as we reported last quarter.

[Bret D. Jones:]

Okay, great. And then I just wanted to get a sense, in terms of the visibility that you guys have into the COB number. I wondered, are you still guiding to 6% for the full year? Is that sort of what's embedded in your guidance?

[William C. Lucia:]

Yes. And -- but to my question -- to my answer to Brooks' question earlier on is that, in aggregate, we're still -- we're reaffirming the guidance there. As we move forward here, there can be additional adjustments to these different components of our business because of, well, all the stories that we've just been telling. There's a lot of change and a lot of transition going on. So these are -- the answer to your question is yes, it's still targeted at 6%, but there's variability around that number and every other growth number that we give you for each parts of our business.

[Bret D. Jones:]

The 8% down this quarter really kind of caught me off guard, and I just wanted to -- I want to see where that compared with what you are thinking when you're initially setting that 8% and what's -- if that caught you off guard as well, I'm just wondering how confident are you that we're going to see this significant reversal? Are you seeing things in the underlying trends, there's specific states where you're seeing the FFS to MCO transition starting to ease?

[William C. Lucia:]

Well, there are broader trend issues that we see, but I referred to earlier is that we have the benefit of seeing account by account, line by line, product by product that the outside world doesn't see. So again, our forecast are very granular. And some of these lumpiness I'm referring to in the adjustments and what happens in a quarter with a particular client that may build up revenue and take it out of 1 quarter and push it into the next. These are the sort of things we have transparency on that we can provide to the street. So again, I can tell you what it's based upon, and it's based upon these very detailed forecast, and that gives us comfort. I would not go out on a limb here and talk about the change in growth rates in these parts of the business if we didn't feel we had reliable detailed forecast to that regard?

[Bret D. Jones:]

All right. One last quick one and I'll get off. Just wondering, the amount of backlog you have within the Medicare RAC in terms of medical records that you have that you're still working through, how long does that carry through in terms of revenue RAC?

[William C. Lucia:]

This is Bill, it -- usually it carries us through for quite a few months. Of course, the revenue declines over those months and it all -- also tied to CMS establishing a final date by which we can submit claim adjustment. So -- but typically, that portfolio would carry us through at a reasonable rate for a few months.

[Operator:]

I'm not showing further questions at this time. I'd like to turn the conference back over to our host for closing remarks.

[William C. Lucia:]

I would like to thank you, all, today for joining our call and we do look forward to speaking with you again and reporting on our third quarter results.

[Operator:]

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.