Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Bob Holster – Chairman and CEO

Walter Hosp – CFO

Bill Lucia – President and COO

Analysts

Richard Close – Jefferies

Jeremy Lopez – William Blair & Company

Tony Perkins – First Analysis

Greg Williams – Sidoti & Company

Kyle Evans – Stephens

Charles Strauzer – CJS Securities

Corey Tobin – William Blair & Company

HMS Holdings Corp. (HMSY) Q3 2008 Earnings Call Transcript October 31, 2008 9:00 AM ET

Operator

Good morning. My name is April, and I will be your conference operator today. At this time, I would like to welcome everyone to HMS third quarter 2008 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator instructions) I would now like to turn the conference over to Mr. Holster. Please go ahead, sir.

Bob Holster

Thank you, April. Good morning, everyone. It’s a pleasure to welcome you to our third quarter 2008 earnings call. I'm Bob Holster, Chairman and CEO of HMS, and I'll be hosting the call along with Bill Lucia, our President and Chief Operating Officer, and Walter Hosp, our Senior Vice President and Chief Financial Officer. The slide presentation designed to complement the conference call may be found in our website at hmsholdings.com. Please see the Quarterly Results page under Investors and click on the link to the webcast.

We'll be making forward-looking statements in the course of this call, so please refer to the list of qualifiers included in this morning's press release and the Safe Harbor statement on slide one of the presentation. This morning we’ll begin by asking Walter Hosp to take us through the third quarter financial statements, Bill Lucia will update you on new business developments, and then I’ll comment on how we are affected by the present economic backdrop and on our new guidance.

Walter Hosp

Thank you, Bob, and good morning everyone. HMS posted a new record quarter of financial results in Q3 '08. Revenue for the third quarter of 2008 increased to $49 million, an increase of 30% versus the third quarter of 2007. Revenue growth was both a little stronger than expected and broad based. Our revenue from our government clients grew over 17% in the quarter. And Medicaid managed care or MCO business recorded its first quarter of revenues above $10 million. Program integrity revenues grew approximately 23% in the quarter versus the prior year. Total operating expenses for the quarter were $38.2 million, an increase of $8.2 million or 27% compared to the $30 million in the same quarter of last year.

Looking at the individual expense lines, we see that the compensation expense of $19.3 million increased $4.9 million from the same quarter of the prior year. We ended this quarter with an average headcount of 864 employees, a 30% increase over average headcount of 665 employees in the prior year. Compensation expense is somewhat inflated due to conversions of temporary personnel to permanent positions, and due to incremental 123R stock option expenses.

Data processing expense of $3.1 million increased $0.4 million or 16% from the prior year quarter. Additional software and hardware expenses related to upgrades contributed to most of this increase. Occupancy costs of $2.8 million increased $0.6 million or 27% from the prior year quarter, a result of the new and expanded office space opened during the past year.

Direct project cost of $7.3 million increased $1.6 million or 28% for the quarter year-over-year. And as a percentage of revenue, direct project costs were 14.9% in the quarter. Other operating costs of $4.6 million increased $0.6 million or 16% versus the same period last year. Amortization of intangibles associated with the BSPA acquisition was $1.2 million for the quarter, approximately the same as the prior year quarter.

Operating income for the quarter was $10.8 million, an increase of $3.1 million or 40% in the prior year quarter. Operating margin was 22% for the current quarter, and we continue to guide to approximately 20% operating margins for the full year 2008. Net interest expense was $0.2 million for the quarter versus $0.3 million for the same quarter last year, which is due to lower debt level and higher cash balances than in the comparable period.

Income taxes were $4.4 million for the current quarter compared to $3.2 million for the same quarter in the prior year. The effective tax rate remains at 42% for 2008 versus 43.6% for the third quarter last year. This resulted in net income for the quarter of $6.1 million versus $4.1 million for the same period in 2007, a 48% increase.

The fully diluted weighted average common shares outstanding for the quarter was 26.8 million. Fully diluted net income per share grew 44% to $0.23 per share versus $0.16 per share for the same period last year. For the nine months ending 2008, revenues are $132.1 million, a 26% increase for the same period year-over-year. Fully diluted earnings per share were $0.53 for the first nine months of 2008.

We now turn to our balance sheet and look at our general financial condition at September 30, 2008. Our cash and cash equivalents increased by $6.7 million from the end of June to $31.6 million at the end of September. As of the close of business yesterday, we had $37 million in cash and cash equivalents. The increase in cash balances was after paying $4 million in the third quarter to the acquisition of Prudent Rx, a pharmacy audit firm based in Culver City, California, and an important addition to our program integrity offering.

Our cash is invested in money market accounts that are guaranteed by the Federal government or invest solely in Federal securities. Accounts receivable was $48 million and has increased with the growth of revenues. The number of day sales outstanding at quarter-end decreased to 88 days as compared to 91 days at the second quarter end of 2008.

We had $18.9 million of debt outstanding at quarter-end from our original $40 million term loan. We continue to make principal repayments of $1.575 million each quarter. There still have been no borrowings under our $25 million revolving credit facility during the quarter. And this facility does not expire until September of 2011. For the remainder of 2008 and for 2009, we anticipate that existing cash balances and funds generated by operations will be sufficient for all our plans and cash needs.

Looking at the statement of cash flows, one can see we are generating very strong cash flow. Cash provided by operations was $15.8 million for the nine months ended September 30, 2008, with $9 million generated in the third quarter alone. Cash provided by operations for the nine months was comprised of net income of $14.3 million, non-cash charges and depreciation and amortization expense of $8.8 million, stock-based compensation expense of $2.4 million, and a decrease in prepaid assets of $1 million. This was offset by an increase of accounts receivable of $7.4 million and a decrease of accounts payable and accrued expenses of $2.7 million, and an increase in deferred taxes of $0.6 million.

During the first nine months of 2008, cash used in investing activities was $9.7 million, which was comprised of $5.6 million of purchases of property, equipment and software and $4 million for the acquisition of Prudent Rx. Cash provided from financing activities of $4.2 million consisted of $1.6 million received from stock option exercises and $7.3 million for the tax benefit of disqualifying dispositions from stock option exercises, offset by principal payments of our term loan of $4.7 million.

We expect that given our outstanding pool of unexercised stock options, our cash taxes will continue to benefit substantially from disqualifying dispositions. However, we did experience a lower level of stock option exercises during the third quarter, together with higher levels of profitability. So we have begun making estimated cash tax payments. In the third quarter, we made a $1 million estimated tax payment and expect the level of between $10 million to $15 million in cash tax payments in 2009. This level of cash tax payments is heavily dependent upon the level of stock option exercises, which is something we do not control.

Adjusted EBITDA was $14.6 million for the quarter, an increase of $3.9 million or 36.4% over the same period of the prior year. The adjusted EBITDA margin was 29.8% for the quarter. This was yet another strong quarter of generating adjusted EBITDA, and so we are revising our 2008 full year guidance from $50 million to $52 million. EBITDA is defined as earnings before interest, taxes, depreciation, and amortization. Adjusted EBITDA represents EBITDA adjusted for share-based compensation expense.

That concludes our review of the financial results and financial position of the company. Bob?

Bob Holster

Thank you, Walter. Bill Lucia is now going to updated you on business developments during the last quarter.

Bill Lucia

Thank you, Bob, and good morning, everyone. Quarter three proved again that the selling environment is a very healthy one for HMS. We continued to hold on to our base through competitive plans [ph] and expansions. We competed for and re-won our Connecticut PPO contract for an additional four years, and with an expanded scope for provider audit services. The states of Delaware, Maine, and Michigan, all extended their contracts with us. And our DRG review contracts in Colorado was extended for an additional year.

We are also adding new business across multiple markets. In Texas, we were successful on a competitive bid for two substantial initiatives serving the state Medicaid program. Both a real-time pharmacy cost avoidance service and an implementation and support of the health insurance premium payment program covering 5,800 lives with the goal of covering 13,000 over the next three years.

We added three new plans to our managed care customer base, bringing our total sold lives to 12.4 million. At the Federal level, CMS awarded HMS a Medicaid integrity contract task order to examine over-payments and audit Medicaid providers in 11 states comprising the Dallas jurisdiction. We are pleased to be recognized by CMS as an organization with the sophistication and abilities to support the new Medicaid integrity program and look forward to leveraging this qualification in sales to states and health plans.

In each of our markets, we are consistently expanding scope. And our managed care clients, now reaping the benefit from HMS’s services, are reaching out to us for additional cost containment initiatives. We’ve recently expanded scope in a number of our large clients, including UnitedHealthcare, Keystone Mercy, WellCare, and AMERIGROUP. And in this quarter, we expanded the scope of services we are performing for the states of Nevada, New Jersey, New York and Pennsylvania.

In general, the macroeconomic environment continues to play its fiscal duress on our government clients, which in turn generates opportunity for HMS. Our managed care clients also see HMS as a risk free solution in helping them drive down costs. Our cost containment and program integrity solutions play an increasingly significant role for our clients.

I’ll ask Bob to talk in more detail about the macro factors. Bob?

Bob Holster

Thank you, Bill. We believe the economic backdrop for the remainder of 2008 and for 2009 will support continued strong demand for HMS’s services. As we’ve noted in a number of conferences and calls this year, the unemployment rate is the most important leading indicator of growth in the Medicaid program and growth in the Medicaid program was one of the most important drivers of HMS’s revenue.

Seasonally adjusted unemployment at the end of the third quarter was 6% versus 4.7% a year ago and is projected by many sources to reach in excess of 7% in early 2009. It’s not surprising that the CMS actuary reported earlier this month that Medicaid spending is again growing at a rate of approximately 7.9% and should rate reach $364 billion in spending this fiscal year. The same report indicates that the number of Medicaid beneficiaries is expected to reach 50 million this year, and that well over 60 million people will have been enrolled in Medicaid at some point during the year, almost one in five persons in the United States.

Medicaid has clearly surpassed Medicare as the government healthcare program enrolling the largest number of beneficiaries. Virtually all of our state clients have reported that they will be in deficit this fiscal year. And the deficits are extremely large, over 12 billion in New York, 10 billion in California and likely to go higher. Even individual cities like New York and Philadelphia are reporting deficits in excess of 500 million. As a result, clients are increasingly focused on cost containment, and that means more new program integrity procurement opportunities and more willingness to expand the scope of existing engagements to incorporate cost saving ideas.

As you may have gleaned from Bill Lucia’s comments a moment ago, we are already seeing the results of that increased focus. We don’t think the election results are likely to have a significant impact on Medicaid growth over the next year. Irrespective of what candidates might propose to do, significantly modifying or reigning in the government healthcare entitlement programs, keeping in mind that Medicaid is actually Title 19 of the Social Security Act takes Congressional action and state legislative action. And despite state level rhetoric about budget cuts, states are very reluctant to cut Medicaid because all the cuts really accomplish is to substitute state-funded charity care for federal Medicaid matching funds, because the patients don’t go away.

What is much more likely to actually drive Medicaid growth is unemployment. CMS is 7.9% Medicaid expenditure growth assumption, which we used in our planning for 2009, assumes only a 1.2% growth in the number of Medicaid beneficiaries each year. And based on the relationship of unemployment rates and Medicaid growth rates that we’ve observed in earlier recessions, we believe this may turn out to be too conservative an assumption.

Moving on to guidance. As you know from our press release this morning, HMS is raising guidance for 2008 and providing initial guidance for 2009. As the slide indicates, we now project that for full year 2008 we’ll generate $181 million in revenue, $52 million in adjusted EBITDA, and $0.77 of fully diluted GAAP earnings per share. Implicit in the guidance is that Q4 will look a lot like Q3. That was revenue of about $49 million and EPS of about $0.23.

Our operating plan for 2009 projects that HMS revenue will grow to approximately $214 million, up 18% from 2008. If we achieve this objective, 2009 will be the eighth consecutive year that our cost containment business has generated organic growth in the 15% to 20% range. We expect operating margin to improve slightly from a little better than 20% to a little better than 21%. We are projecting that adjusted EBITDA will increase to $62.7 million and that GAAP EPS will increase from 2008’s projected $0.77 to $0.96, a 25% improvement.

Let me be a little more specific about this $0.96, because First Call was out there with a mix of GAAP and cash EPS numbers. Our $0.96 of GAAP EPS for 2009 translates into $1.17 of cash EPS if we deduct tax effective FAS 123R and intangible amortization charges.

Now we expect that all the markets we serve will contribute to growth in 2009, and that’s our state agency business, our Medicaid managed care plans, and federal agencies. We further expect a program integrity, which we’ve given a lot of management focus on investment over the last couple of years, really step up in 2009 to join our coordination of benefits services as an important driver of future HMS growth, hopefully following the path that our managed care services placed over the last couple of years.

That’s it for our prepared presentation. And we’re now happy to take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Your first question comes from the line of Richard Close with Jefferies.

Richard Close – Jefferies

Hi. Couple questions here. Bill, maybe if you could comment a little bit on the scope expansions. I think you said New York, New Jersey, Nevada, and – was it North Carolina?

Bill Lucia

Pennsylvania.

Richard Close – Jefferies

Oh, Pennsylvania. Okay, sorry. Now when we think about scope expansions and obviously I guess that helped contribute the 17% in your growth in your government business. Where do you guys stand when you look at all your state clients? How do you view your penetration within those existing states?

Bill Lucia

Richard, this is the kind of difficult modeling topic that we always talk about and that our – and I’ll give you the range of examples. So in New Jersey, at any given time, we may be performing 32 unique different projects ranging from third party liability through different types of program integrity, whereas in California, we may be performing three unique types of projects. And it’s very difficult to kind of answer the question of what’s our level of penetration across the entire market. It’s a little easier for us to get to the percentage of expenditures that we recover in a specific state and then internally model up from there to give our accounts reps target.

Bob Holster

I will add though that the target seems to be increasing. When we look at acute care expenditures across the Medicaid program and include the premiums for managed care, which are directed primarily at acute care services. Approximately 200 billion of the 364 billion projected FY 2009 Medicaid spend is on the acute care services component. We presently recover for our clients about 1% of their acute care spending in aggregate, which suggests that we have quite a ways to go even to get to 1% of current acute care spending levels, given that only about two-thirds of our revenues now are related directly to those acute care spending levels.

Richard Close – Jefferies

Okay. Even in states like New Jersey you still have room to go in your opinion.

Bill Lucia

Most definitely. And New Jersey is one of the clients that is very – that we have a very collaborative relationship where we are always presenting new projects that are based on the results of our data mining claims. And that’s where a lot of our growth comes from year-to-year.

Richard Close – Jefferies

Okay. And then just a follow-up on the scope expansion, I think you mentioned New York. Can you give a little bit more detail of that scope expansion in New York, exactly what service it is? And obviously New York is on the re-procurement list here. So I’d be interested to know a little bit more about that scope expansion and how that transpired.

Bill Lucia

Well, I won’t give you all of the details, but I’ll tell you a little bit about what happens on a monthly basis in all of our states, but particularly our largest clients. HMS has very sophisticated data mining capabilities and algorithms that we run against our claims database for a client, and when we find anomalies, we present those to the state and we go through a very thorough betting process with the different stakeholders in the state. And those are the types of projects that we see. We are able to get approval from states like New Jersey, New York, Nevada, and others to perform. And they are typically provider over-payment recoveries. There is probably – there are a number of other smaller states where we’ve expanded this quarter, but these were the larger ones that had a larger impact on HMS long-term.

Richard Close – Jefferies

Okay. But I mean, it’s – we can view it as obviously a positive and maybe your efforts on the re-procurement side that you are adding business with someone you’re in a bid process with.

Bill Lucia

Well, I mean, there is a lot of ways to look at it. We are very – we are obviously very hopeful that the New York contract will be – it will be a favorable outcome. But remember, New York is one of the states that probably has the largest budget deficit in the nation. So HMS brings a very risk free approach to bringing dollars back during this fiscal crisis.

Richard Close – Jefferies

Okay. And one final question and I’ll let other people jump in here. But Bob, just go over your comments. I think you said on the guidance that on the Medicaid side you’ve looked at or factored in a – what was that? 1.2% increase in beneficiaries?

Bob Holster

What I said is that the CMS actuary is projecting a 7.9% increase in Medicaid spending and that we had incorporated that thinking in our plan. In the actuary’s number, there is an assumption that beneficiaries are going to increase by 1.2% per year. And my comment was that, given the current economic climate, that assumption may prove to be right. If we see significantly higher Medicaid enrollment as a result of unemployment, it will have a favorable effect on our results.

Richard Close – Jefferies

And then just I guess a follow-up on that. You’ve gone through past increases in unemployment and discussions on trying to control Medicaid spending or control Medicaid enrollment, how have you faired through those previous times when there has been that rhetoric and that movement in unemployment?

Bob Holster

Well, there was the same rhetoric in 2001, 2002 employment. When unemployment grew, we saw a sharp positive reaction in Medicaid spending. I think it moved to double digits in both of those years. You can never be sure that the next move will be like the last one, but we do think there will be an increase and we do think all of the rhetoric surrounding proposed Medicaid budget cuts will come to naught for the reasons I mentioned. You don’t want to substitute state-funded charity care for partially federally-funded Medicaid expenditure.

Richard Close – Jefferies

Okay, thank you.

Operator

Your next question comes from the line of Corey Tobin with William Blair & Company.

Jeremy Lopez – William Blair & Company

Good morning. Thanks for taking my call. It’s Jeremy for Corey. Congrats on a good quarter. Wanted to hit – to follow on Richard a little bit, in terms of – actually to shift a little bit from the Medicaid integrity task order that you guys have recently won, I’m wondering was that kind of under your belt now? When do you expect additional task orders? When do you anticipate CMS to come out with additional task orders going forward? Obviously you guys feel like you are well positioned going forward?

Bill Lucia

Corey, this is Bill Lucia. I believe CMS will be issuing its next request for proposals on task order three during the first quarter of the year.

Jeremy Lopez – William Blair & Company

Okay, great. And with respect to the guidance, I’m wondering how do we think about Prudent Rx in terms of the contribution both in Q4 and going into next year? Are you guys – I believe it’s about 1 million a quarter in terms of revenue, is that the right way to think about it? $1 million per quarter in revenue?

Walter Hosp

Jeremy, it’s Walter. Prudent is a little bit larger for 2009. It’s a business that we reported in our press release that has about $4 million in revenues. So we’re projecting a bit higher than that in 2009. And the business generates comparable margins to the rest of our business.

Jeremy Lopez – William Blair & Company

Okay, great. And sorry if I missed this, but what are your tax rate assumptions in the guidance for Q4 and next year?

Walter Hosp

For Q4 – for all of this year, it’s 42%, and for next year as well as 42%.

Jeremy Lopez – William Blair & Company

Okay, thanks.

Operator

Your next question comes from Tony Perkins with First Analysis.

Tony Perkins – First Analysis

Good morning. With the growth in the program integrity, do you expect to continue acquiring to augment that program?

Bill Lucia

Well, we are – Tony, this is Bill Lucia. We are always interested in looking at program integrity bolt-ons. So these would be additional services that we basically do a build-buy analysis and determine whether it’s worth it for us to build a unique service offering or potentially acquire it. So we are always open for looking at opportunities.

Tony Perkins – First Analysis

Switching on – on a different note, on the competitive environment, I know with Florida and then New York – fees in New York and California etcetera, you have some competition for the state Medicaid programs. But do you experience competition for the MCO business?

Bill Lucia

There is competition. Some of the same competitors are in the managed care business. There is probably a few more competitors, smaller audit firms, subrogation firms that serve the commercial and managed care space predominantly and don’t serve to government space.

Tony Perkins – First Analysis

Okay, thank you.

Operator

(Operator instructions) Your next question comes from Greg Williams with Sidoti & Company.

Greg Williams – Sidoti & Company

Good morning, guys. Thanks for taking my call. Bill, you mentioned – and I guess Robert as well, state pressures, they are all in duress, equals opportunity for you guys. But is there any risk of maybe states – they have been shortsighted before and they could be shortsighted now, maybe try to put pressure on the contingency fees that you guys see?

Bill Lucia

I think there is – I mean, there are two positive things about the contingency fee market. One is, states realize that we are incented to provide as many recoveries as possible. So there hasn’t really been pricing pressure as much on the contingency fees. But remember, our contingency fees are in the single digits. They are pretty low to begin with. So, one of the positive things about continuing to do business with HMS is, we continue to wrap additional services around under that one low-single contingency fee.

Bob Holster

I’d just point out in addition that contingency fees generally are not appropriated funds in the state budgets or projects are self-funding. To the extent that programs are competing for limited funds, we are not necessarily in that competition and not as vulnerable to cut back a reduction. And going back to the earlier comments about what we’ve experienced in earlier recessions, we tend to do better rather than more poorly in times of state fiscal duress.

Greg Williams – Sidoti & Company

Okay, thanks. And just one other question, just maybe remind us the timeline would look like with the California and New York procurements, and the size of business you had with them last year?

Bill Lucia

I think the procurements are expected to be wrapped up clearly in the fourth quarter. By the end of the year, we are hoping that both states make a decision, and looking forward to possibly that happening in November.

Greg Williams – Sidoti & Company

Okay. And then the size of those contracts last year if you can give that?

Bill Lucia

Yes, New York was reported in our Ks, one of our larger accounts, that last year was around 13 million, 14 million. And California a medium size account because of limited scope related to it. So I think around $4 million, $5 million in revenues there.

Greg Williams – Sidoti & Company

Okay. Thanks, guys.

Operator

You have a follow-up question from the line of Tony Perkins with First Analysis.

Tony Perkins – First Analysis

Yes, hi. Bob, a follow-up question. You mentioned that you do not see a change in your business due to a new administration in the next year. I’m curious of thoughts past that – you know, let’s go two, three years out, I know it’s challenging, but I’m curious what your thoughts are on potential changes to maybe the MCO business on a state level and how a new administration might approach that?

Bob Holster

We think that there won’t be much of an impact because we think there will be primarily legislatives sparring around whoever settled proposals seem to reign in 2009. In years subsequent to 2010, we don’t see a deterioration of the environment from the present environment because the growth rates in Medicaid are to some extent preordained by the way the enabling legislation is structured. We would see under a democratic White House though, we believe, substantial expansion of both the Medicaid program and the alternatives available under group health plans. And since we live at the intersection of group health and Medicaid, we think that it would create a more favorable environment than even the one we face today.

Tony Perkins – First Analysis

Thanks for your insight, Bob.

Bob Holster

Thank you.

Operator

We have a follow-up from Kyle Evans, Stephens.

Kyle Evans – Stephens

Hi, good morning, guys.

Bob Holster

Hi.

Kyle Evans – Stephens

Walter, when I look at the guidance for next year, it implies about a 60 basis point improvement in adjusted EBITDA. What are some of the leverage that could have you above or below that we should be watching for next year?

Walter Hosp

Well, first off, I’d just say that our guidance for next year is a result of a bottom-up budgeting process that we go through and really try out actual individual accounts. Now, in general, as of this year, as Bob was pointing out with the trends there, Medicaid expenditures are higher than what we forecast. That’s going to filter through the revenues, adjusted EBITDA and EPS as well. That and a better selling environment than what we had planned for. But just to reiterate, the guidance – 2009 guidance over our 2008 guidance, which we’ve just revised, as you know, that’s for an 18% growth in revenues and that’s after accounting for the loss of Florida as well. So that’s a healthy number.

Kyle Evans – Stephens

Yes, it is. I agree. I heard you mentioned the lives sold – and I apologize, I missed the slide, and if you gave the other data, I apologize for making you repeat. But what were the lives generating in the revenues from MCO in the period?

Walter Hosp

The lives sold were at 12.4 million at total, and that includes both new lives added and then organic growth from our clients. So that’s really the lives that we have in our database, and we’ve got about $9.5 million generating revenue at this point.

Kyle Evans – Stephens

Okay. And what was the dollar figure in the period?

Walter Hosp

For the quarter, we recorded over $10 million now, first quarter – first time that MCO recorded a $10 million quarter.

Kyle Evans – Stephens

Okay. Any news on Minnesota?

Walter Hosp

Minnesota’s process has been a little long in the procurement, but I believe that Minnesota has a multi-stage procurement. First stage is passing technical qual [ph]. Second stage is passing a side-by-side analysis, sort of a quick – they give us some data and we do the matches, and that’s how we’ll compare vendors. So I think that we’re still waiting for that spell [ph].

Kyle Evans – Stephens

Okay, great. Last one for Bob maybe, you gave an update, a rough projection earlier in the year for the contribution of fee-for-service versus MCO versus program integrity and some of the other pieces of the business. And I know that you had maybe slower than expected growth in fee-for-service in the first part of the year that’s accelerated and very rapid growth in MCO. Could you kind of give us an updated view of what the revenue pie is going to look like at the end of this year, please?

Bob Holster

Obviously our MCO business would be substantially larger going into next year. And we don’t have the precise product line breakout in front of us, but it will be between 20% and 25% of our business. The Federal component of our business will still amount to slightly more than two-thirds – excuse me, the government component of our business will amount to slightly more than two-thirds of the total 214. We expect program integrity, if we pull the pieces out of our market facing units and look at it as a product line to be north of $35 million in total revenues next year, if that gives you some help in getting a sense of the program integrity product line’s progress. We expect all our lines to be growing, though. We saw a little stutter step in government growth during the first quarter of this year. But if you look at the first quarter of this year and assume that in general we’re processing claims that are six to nine months old, we were processing with – what was hitting revenue in our first quarter was related to dates of service for the period during which Medicaid growth was pretty flat. Medicaid growth re-accelerated. And so we expect – we don’t expect that little bit of lag that we might have seen in government early in this year to continue. It’s up there and growing very close to the rate of the business at large.

Kyle Evans – Stephens

Great. Thanks, that’s very helpful.

Bob Holster

You’re welcome.

Operator

Your next question comes from Charles Strauzer with CJS Securities.

Charles Strauzer – CJS Securities

Hi, good morning.

Bob Holster

Hi.

Charles Strauzer – CJS Securities

Most of my questions have been answered. Just a couple of fine tuning questions. Walter, you had talked about kind of an artificial rise in comp expense in the quarter, do you expect that to be down in Q4?

Walter Hosp

No, no, I didn’t mean to say as an artificial rise. I just said that they were inflated because – two factors. One is that we are increasingly moving temporary employees over to full-time employment. We have a program of that. So that realigns the way you see expenses in our income statement. And then we also – it was in 2006 that we started recording the 123R stock option related experience. And we’re still not at a continuous state period. In other words, we’re still adding each year incremental options from that incremental 123R expense. So, that’s not something that we want to annualize every year going into the future. We’re going to be reaching a steady run rate going into next year.

Charles Strauzer – CJS Securities

Got it. And then kind of picking up off of that, what are the assumptions we should take into our model for next year for FAS expense and amortizations?

Walter Hosp

Well, roughly about $5 million of amortization of intangibles and a similar amount for stock option expense.

Charles Strauzer – CJS Securities

Got it. And also any large CapEx plans for next year?

Walter Hosp

Not terribly large, no. We’ll expect to spend around the $7 million to $8 million range on that, similar to what we did this year.

Charles Strauzer – CJS Securities

Got it. And Bob, just talk to us a little bit if you can about – you’ve got a fair amount of cash in the balance sheet. Obviously, you are paying down – you continue to pay down the remaining portion of your debt. What are the main parts for the cash right now? And kind of given the uncertainty, are you seeing – when you do look at some acquisitions, are you seeing valuations getting more reasonable?

Bob Holster

Well, it’s hard to say. We don’t look at so many transactions that you can generalize about valuations. We are hopeful that we’ll be moving into a climate in which the companies, largely private companies that would be our targets, are reasonably priced. We are happy to have a healthy slug of cash on the balance sheet. We’ll probably add some more in the vicinity of $30 million to $35 million cash in for a tax payer to that balance next year. And of course, we still got on tapped our $25 million line of credit. While we have a very healthy capital structure, the lending/borrowing environment is pretty flaky now, as people know. And so we think it’s a real advantage to have a balance sheet that without further help can take on pretty sizable M&A activity, at least if we’re in the category of bolt-ons, of the sort Bill was talking about earlier. So right now we’re happy to let the cash build.

Charles Strauzer – CJS Securities

Excellent. And then, Bill, can you just give us a quick rundown of the – kind of like a calendar of the re-competes that are kind of coming up, starting with New York and California you see in Q4? You said that – what’s coming up next year that we should keep an eye on in terms of re-compete?

Bill Lucia

You know, we only have – we have a couple states that are up for re-compete next year. We have a couple of our smaller ones that are coming up. And then probably around the middle of the year, we have Maryland and West Virginia that will be re-competed, and towards the end of the year, the State of Michigan and Missouri. So that’s assuming that none of those states feel the pressure to have a – feel the economic pressure to decide that they are going to go beyond their limits and extend even further, which sometimes states do.

Bob Holster

And let me add to that, Charlie. This was the year in which we had a number of our 800-pound gorillas up for bid. Once we get past this, we are into a pretty light procurement schedule. I’d also point out that our projected growth for next year, 18%, and that’s net of having lost Florida this year. I think should suggest the people that the business is of a size now, and with the scope of service that permits us to take a hit from time to time without really interrupting our growth trajectory. And that’s a real change from a year or two ago.

Charles Strauzer – CJS Securities

You’re right. That’s actually a major change. And excellent. Thank you very much.

Bob Holster

You’re welcome.

Operator

Your next question comes from Richard Close with Jefferies.

Richard Close – Jefferies

Yes, just really quick. Just remind us, in the past, haven’t you given the upcoming year’s guidance in December or early January, so you’re giving it a little bit earlier this year?

Bob Holster

We gave revenue guidance at this time last year. I think we then gave EPS guidance a little bit later. But I think you can assume that this is going to be a pattern going forward. We had a game-changing merger in 2006 that for the next 15 months or so made us a little bit cautious about how we guided. We feel more comfortable with our planning process now. We feel more comfortable with the way the businesses have been integrated. And so we can be a little farther out in front with our forecasting than we might have been in earlier years. We still anticipate that our guidance is going to be annual. We still anticipate that we can get varied quarters from time to time just because of the project nature of our business.

Richard Close – Jefferies

Okay. And then just so I’m not off-base here, given your managed care revenues, saying that they are $10 million plus, looking at that on a historical basis and I guess versus the second quarter, it seems there that your year-over-year growth is accelerating. Am I correct in that?

Bob Holster

It may have accelerated for the quarter. We had a particularly strong MCO performance, but we’re also getting the benefit of lots of implementations. I think you should be careful about extrapolating the MCO growth rate from kind of the three-digit levels it’s performing at now. We’ve built significantly more conservative assumptions into our 2009 plan.

Richard Close – Jefferies

Okay. So when we look at 2009, you are taking a conservative stance on your managed care business, I guess a conservative stance on the growth – potential growth in the Medicaid beneficiaries. So there is a pretty good deal of conservatism based in the numbers or the initial ’09 guidance that you’ve sort of present – well, you have presented us today?

Bob Holster

We’re not trying to be artificially conservative. I think we’re trying to be realistic. And our projections in the past I think tended to be fairly durable. We’d like to keep it that way.

Richard Close – Jefferies

Okay. Thank you. Congratulations again.

Bob Holster

Thanks.

Operator

Our next question comes from Corey Tobin with William Blair & Company.

Corey Tobin – William Blair & Company

Hi, just a quick follow-up with respect to scope expansion. I’m wondering if you can comment at all with the California re-procurement out there, if there is any scope expansion – or meaningful scope expansion embedded in that RFP.

Bill Lucia

This is Bill. There is a little bit of scope expansion embedded in it. I believe in California it’s an opportunity to help them reduce their drug rebate receivable, maybe specific to a certain line of drug classification. And it’s work we’ve done in other states.

Corey Tobin – William Blair & Company

Yes. And you’ve commented – kind of alluded to this with an earlier question, but what percentage of your contracts are flexible with states that give you sort of the opportunity to do scope expansion without formal procurement? Like, for example, California let you find program integrity opportunities or is that something you would have to go through a formal process to get paid for?

Bill Lucia

Most of the states have flexibility in their contracts. Not all the states interpret that flexibility the same way. So in some states, we do have to actually go through formal amendments to add different scope of services. In other states, as long as we stay within the pricing guidelines and parameters in the contracts, they are pretty flexible. It’s really different state-by-state though.

Corey Tobin – William Blair & Company

Would you say – just generally speaking, is it half or just in very broad terms, is it a larger number?

Bill Lucia

I would say half are flexible in their approach to contracting, and maybe that number creeps up as they have greater financial duress in the cost of doing procurements. It becomes greater and the cost of managing additional contracts becomes greater.

Corey Tobin – William Blair & Company

Okay, thank you.

Operator

At this time, there are no further questions. Mr. Holster, are there any closing remarks?

Bob Holster

No, we’d like to thank everyone for calling in. We appreciate their interest. Thank you.

Operator

This concludes today’s HMS third quarter 2008 earnings conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: HMS Holdings Corp. Q3 2008 Earnings Call Transcript
This Transcript
All Transcripts