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

HMS Holdings Corp. (NASDAQ:HMSY)

Q4 2008 Earnings Call

February 20, 2009 9:00 am ET

Executives

Robert M. Holster - Chairman and Chief Executive Officer

William C. Lucia - President and Chief Operating Officer

Walter Hosp - Chief Financial Officer

Analysts

Richard Close - Jefferies & Co.

Corey Tobin - William Blair & Co.

Tony Perkins - First Analysis

Carter Malloy - Stevens, Inc.

Charles Strauzer - CJS Securities

Gregory Williams - Sidoti & Company

Operator

Good morning. At this time, I would like to welcome everyone to the HMS Holdings Corporation fourth quarter and full year 2008 earnings call. (Operator Instructions). Mr. Holster, you may begin your conference.

Robert M. Holster

It’s a pleasure to have you join our fourth quarter and full year 2008 earnings call. I’m Bob Holster, Chairman and CEO of HMS Holdings. I will be hosting the call along with Bill Lucia, our President and COO, and Walter Hosp, our CFO. The slide presentation designed to complement the conference call may be found at 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 yesterday evening’s press release and the Safe Harbor statement on slide #1 of the presentation.

HMS finished a solid 2008 with a very strong fourth quarter financial performance. For the quarter, revenue was up 26% and exceeded $50 million for the first time. An EPS of $0.26 was up 73% from the prior year quarter. To start off this morning, Walter Hosp will take you through how we achieved that financial result; then Bill Lucia and I will talk about the next big step in our organizational evolution and one we have been preparing for quite some time. We will cover operational highlights for the quarter which saw some important contract wins and talk about how what’s going on with the economic environment and how the fiscal stimulus package affects our prospects. Finally, Bill will talk about our growth strategy and how that translates into revised 2009 guidance, and then we will take your questions.

Walter Hosp

HMS posted yet another record quarter of financial results in Q4 2008. Revenue for the quarter was a record $52.4 million, an increase of $10.7 million or 26% from the $41.7 million reported for the same quarter of 2007. Nearly all areas of the company contributed to this growth with the largest contributions coming from our government business which grew 29% in the quarter. Our Medicaid managed care business or MCO grew at a somewhat slower pace of 17% in this quarter due to comparisons against an exceptional quarter in 2007 and the timing of revenues which can pile up or delay revenues in any given quarter. MCO was up very strongly for the year which I will address momentarily.

Turning to the expenses for the quarter, the first item to note is that we have changed our presentation of expenses to now include a separate line for sales, general, and administrative expenses, or SG&A. Although we have been using our historical expense presentation format since becoming a public company in 1992, a standard 3-year review of our financial reporting with the SEC was conducted in the second half of 2008 which resulted in the SEC staff requiring us to break out SG&A expenses ongoing. I want to note that no other material changes or restatements resulted from the SEC review. A reconciliation of the new presentation format to the prior format for the years 2006 through 2008 is provided in the 8-K filing being made today.

As this change is simply a reallocation of certain expenses from each of our operating expense lines into the SG&A line, there is no historical impact or future operating income impact on net income. SG&A includes expenses related to our corporate departments such as finance, compliance, human resources, government relations, and executives, and the marketing and sales functions across the company. It does not include the client facing customer support functions which provide operational support on a daily basis.

With the new format, we will first cover the total cost of services, then SG&A, which together add up to total operating expenses. Total cost of services for the quarter was $34.1 million, an increase of $6.3 million or 22% compared to the $27.8 million in the same quarter last year. Compensation expense related to the cost of services of $15.6 million increased $2.7 million or 21% from the same quarter of the prior year.

Total company average headcount for the quarter was 913 employees, an increase of 171 employees or 23% above the average headcount for the fourth quarter of 2007. Data processing expense of $3 million increased $0.3 million or 11% from the prior year quarter. More than half of this increase was from higher software expense associated with platform upgrades.

Occupancy costs of $2.8 million were relatively stable with an increase of only $0.1 million or 3% from the prior year. We expect this line to fluctuate in the future as we continue to optimize our space across the country and consolidate even further into our Irving, Texas facility. Direct project costs of $8.7 million increased $2.3 million or 36% from the same quarter of the prior year. The increase here mainly had to do with subcontractor expenses on the Florida account. We are working down the remaining recoveries under the contract. This activity will continue to the end of April 2009, however, most of the recovery activity was completed by year end.

Amortization of intangibles of $1.2 million for the quarter was approximately the same as in the prior year quarter, but a bit higher due to intangibles added from the acquisition of Prudent Rx. SG&A expenses were $6.9 million for the quarter, an increase of $0.6 million or 10% from the comparable period last year. As a percent of revenue, SG&A expenses decreased to 13.2% from 15.1% in the prior year. Operating income for the quarter was $11.4, an increase of $3.9 million or 51%, versus Q4 ’07. Operating income margin for the quarter was 21.8% versus 18.1% in 2007.

Net interest expense was $0.2 million for the quarter, down $0.2 million, versus the same quarter last year. This was due to higher interest incomes from cash balances and lower interest expense from lower debt levels. Incomes taxes were $4.2 million for the current quarter for an effective tax rate of 37.4%, compared to $3.2 million with an effective tax rate of 43.8% for the same quarter last year. Our lower tax rate for the quarter resulted from utilizing a loss carry forward from a divested business that will not be available in future periods, and from an entity restructuring completed at the end of 2007, which has lowered our state tax rate and which recognizes our allocations for greater geographic spread of our business. I will provide more on the annual tax rate in just a moment.

Our net income for the quarter was $7.1 million, an increase of $3 million or 75% from the fourth quarter of 2007. Fully diluted weighted average shares outstanding for the quarter was 26.9 million shares. Fully diluted EPS was $0.26, up 73% for the quarter, compared to the $0.15 reported for last year. Cash EPS for the quarter was $0.32. Looking at the full year income statement, revenue for 2008 was $184.5 million. This result was 26% above revenue of $146.7 for 2007.

For the year, our government business was up 16%, while our MCO business was up 80% and recorded approximately $34 million in revenue. Total operating expenses for the year was $147.8 million, a 25% increase over 2007. Compensation expenses related to cost of services was $60.6 million or up 31% over 2007 as total company headcount averaged 846 full-time employees, a 27% increase over our full year in 2007. Although this expense growth was higher than revenue growth, it is partially offset by lower compensation expense growth of only 20% in the SG&A areas of the company.

All other service expenses grew below our 26% revenue growth rate with the exception of other operating costs which were $10.8 million or up 66% versus prior year. Most of this increase came from increases in the non-payroll contract personnel hired for programming verification support related to increased transaction volumes and consultants working on platform upgrades, and we also had higher levels of travel-related expenses related to increased business activity.

SG&A expenses for the year of $22.1 million were 8% higher than the prior year, resulting in an SG&A as a percentage of sales of 12%, a full 2% lower than the prior year at 14%.

Operating income for the year was $36.7 million, an increase of $8.4 million or 30% which resulted in a full year operating margin of 19.9% compared to a 19.3% operating margin for 2007. Net interest expense decreased almost $1 million to $0.8 million for the year. A full year tax expense of $14.6 million resulted in a 40.6% effective tax rate for 2008 versus a 43.7% effective rate in 2007. As we will not have the benefit of the one-time net operating loss we utilized in Q4, we are guiding that an effective tax rate of 41% to be used for 2009.

Net income was $21.4 million for 2008, up 43% for the year. Fully diluted outstanding shares were $26.8 million for 2008 and fully diluted EPS for the year was $0.80 versus the $0.57 in 2007, an increase of 40%. Cash EPS for the year was $0.98.

We now turn to our balance sheet and look at our general financial condition at December 31, 2008. Our cash and cash equivalents were $42.9 million, having grown from $31.6 million at the end of Q3 2008. At close of business yesterday, we had over $55 million of cash on hand. This cash continues to be invested in federally insured money market accounts or in accounts that make direct investments in US treasuries. We have not been subject to any valuation adjustments in our cash investments. Accounts receivables of $45.2 million grew 14% from year end 2007. The number of day sales outstanding at year end decreased to 78 days compared to 88 days at September 30, 2008.

On the liability side, accounts payable, accrued expenses, and other liabilities were $22.9, an increase of 6%. Total debt outstanding at year end was $17.3 million, $6.3 million lower than at the end of 2007. We continue to make our principal repayments of $1.575 million each quarter. There still have been no borrowings under our $25 million revolving credit facility, and for 2009, we anticipate that existing cash balances and funds generated by operations will be sufficient for all our cash needs.

Looking at the statement of cash flows for the year ended 2008, cash provided by operations increased to $30.9 million, an increase of 16%, compared to $26.6 million in the same period last year. Cash used in investing activities was $11.4 million. Purchases of property and equipment and software development were $6.9 million. We also had the acquisition of Prudent Rx which utilized $4.5 million. Cash provided from financing activities of $8.5 million consisted of principal payments on the term loan of $6.3 million, offset by $4.2 million received from stock option exercises and $10.5 million for the tax benefit from disqualifying dispositions. We expect that given our outstanding pool of unexercised stock options, our cash taxes will continue to benefit substantially from disqualifying dispositions into 2009. However, we also expect to pay increasing amounts of cash taxes this year. We are currently estimating cash taxes at $10 million for 2009.

EBITDA was $14.5 million for the fourth quarter and $48.5 million for the full year. Adjusted EBITDA was $15.7 million for the fourth quarter 2008 and $52 million for the full year. EBITDA margins for the year were 26% and adjusted EBITDA was 28% for the year. These were similar margins to the prior year. We had provided a reconciliation of EBITDA and adjusted EBITDA to net income in the press release on the conference call slide. Please refer to them for a more detailed explanation of these measures.

That concludes the financial results of our presentation.

Robert M. Holster

As you noted from the press release this morning the Board of Directors of HMS has elected Bill Lucia, Chief Executive Officer, effective March 1, 2009. Naming Bill as CEO was a natural next step in a process that actually dates back to the BSPA acquisition in 2006 and for which Bill has been groomed for even longer. We knew by 2006 that HMS had the potential to grow into a much larger and most sophisticated organization and undertook a number of steps to prepare for that outcome. Bill will talk in a few minutes about the specific organizational building blocks we have put in place in preparation for this transition.

But first, let met tell you a little bit about Bill and his background. Bill, who is 51, comes from the insurance industry where he took on a series of successively more senior operational jobs culminating in his position as Chief Operations Officer of Celtic Insurance. He moved to HMS more than 12 years ago to become General Manager of our electronic data interchange business. In 2001, he was named President of HMS, Inc., our cost containment division which had only a little more than $20 million in revenue at the time, but even then was the kernel that we felt had more potential than anything else that HMS did at that time. Sure enough, Bill and the executives he either developed or attracted to the company, began to grow HMS, Inc., very rapidly to the extent that by the end of 2005 we were able to dispose off the last of our provider revenue cycle and systems businesses and concentrate on the coordination of health insurance benefits and program integrity services that will generate more than $200 million revenue in 2009 and that is almost a tenfold increase in revenue in that division that we have referred to in the press release.

Bill was named President and COO of HMS Holdings Corp., in 2005 and has strategic insight, product knowledge, and energetic leadership which have been the keys to HMS’s rapid and profitable growth since. Now, Bill and I have worked together in a complimentary way for almost 10 years now, and I think it is important to emphasis that while Bill is taking the helm, my experience and perspectives are not going to be lost to the organization. I will remain as Chairman of the Board of Directors for at least two more years and will be available not only to advise Bill and Walter, but to help in very specific ways with areas in which I have a lot of experience including corporate development, legal, regulatory affairs, and management of relations with the investment community.

There is always a lot of speculation surrounding a CEO change, so let me speak very plainly about this. As an investor; and my perspective is primarily of that of an investor, I think that with 700,000 shares invested option, I am the largest individual share holder of HMS, I want the company to have the very best leader for this stage of its life cycle, and that’s Bill Lucia hands down. He is closest to the intersection of what the client needs, what the services we either offer today or are rapidly putting in place. Frankly, I want to spend my time putting our balance sheet to work by following up on M&A activities. Nothing specific is forcing this leadership change, but we all understand that the simple passage of time makes change inevitable in every business, and Bill and I and our board felt that business was in good shape and that it made sense to trigger the succession plan we have been working on for these years. We are extremely fortunate to have talented, qualified, and yes, I should add, younger executives in place to hand the torch to.

William C. Lucia

Thank you for those kind words, Bob. I am very thankful for the confidence that Bob and the Board of Directors have placed in me and extremely excited to get started as HMS’s new CEO and helping to take the company to the next step. As Bob mentioned, we have been building our executive team over the past couple of years. It’s a team poised to take our strong platforms to the next level.

Let me talk about HMS’s most senior executives and give you a brief overview of their backgrounds. What’s compelling about this team is that it blends long-term HMS experience with long-term DSPA experience and significant executive credentials from outside our company. Many of you have met or talked to Walter Hosp, our CFO, and you already know the tremendous value he has brought to HMS. Walter joined us in June 2007, bringing over 15 years experience in senior financial positions at very large publicly traded companies. Before he joined us, Walter was Vice President and Treasurer of Medco Health Solutions and also served as Chief Financial Officer of Ciba Specialty Chemicals and President of their business support center. He brings big company experience to HMS, helping us prepare for the growth ahead.

Maria Perrin who leads our government business joined HMS in 2007, bringing over 10 years of P&L and marketing leadership at large corporations. Maria was most recently Senior Vice President of Sales at Performant Financial Corporation, a business process outsourcing firm focusing on federal and state agencies. Prior to that, Maria managed large P&Ls and finance for a number of Fortune 100 companies. Maria has been instrumental in expanding the HMS brand into the federal market and building and expanding our government relations function.

Christina Dragonetti who leads our commercial markets business has been with HMS for over 20 years serving in multiple roles in marketing, corporate strategy, and product development. Christina developed the RSG product line and was responsible for the formal launch of HMS’s brand in the Medicaid Managed Care market. That business as you know has grown from a few million dollars of revenue in 2005 to over $34 million in 2008 and continues to help fuel our high growth rate.

Sean Curtin leads the operations functions supporting all of our client facing units. He also leads product management for coordination of benefits, bringing over 10 years of experience in this market. He joined HMS through the acquisition of the SPA where Sean was responsible for managing half of their entire business including our largest client, New York Medicaid. He also built and managed the company’s child support and Veterans Administration markets and product line.

I think this shows you the depth and diversity of skills in HMS’s most senior chain, but this is only the very top of the organization. HMS has a strong bench of executive talent managing our clients, products, and operation. We do have the right leadership team in place to continue our success.

Talking about sales, the sales environment for HMS has never been better. We continue to expand in each and every of our markets. During the fourth quarter, in our state market, we re-won contracts with two of our largest customers, California Medicaid or Medical and New York Medicaid, through the office of the Medicaid Inspector General of New York. Both of these were competitively bid and both include expanded scope.

We also added two brand new government clients again through competitive procurements. The District of Columbia Medicaid awarded us a contract to perform third party liability services, and we’ve recently been notified by Minnesota Medicaid that we were the selected bidder and will soon be negotiating a contract with them. This last award validates our ability to sell to virgin states, those who have never before acquired these services. Alabama and Pennsylvania signed extensions to our existing contracts, and we expanded the scope of services we provide to Georgia and Oklahoma.

In our Managed Care marketplace, we added Aetna’s Medicaid plan, Citrus Health, Sentara’s Optima Health plan, and Royal Health Neighborhood Health plan in New York. We also expanded our opportunity with AmeriHealth Mercy as they added South Carolina plan and Care First as they added their Arizona plan to our contract. These MCO sales added almost 500,000 new lives to our Managed Care lives under contract, and we now serve 92 health plans.

In the federal states, we were re-awarded our insurance identification work for the VA under a new competitively procured and expanded blanket purchase agreement, and five of the VA’s VISNs or Veterans Integrated Service Networks have now awarded HMS’s contracts to perform commercial claim recovery services.

I think what’s equally important to new sales and the expansions that I’ve talked about is the markets growing adoption of HMS’s program integrity Services. Just to take a step back, remember, coordination of benefits which traditionally has been our core service offering represents about 80% of our 2009 revenues. This service of course seeks to identify and recover from third party insurance. program integrity, our newer service line, is expected to be about 20% of ’09 revenues. Now, this service seeks to assure that claims are paid accurately. We believe that market potential in both Government and Managed Care is large and relatively untapped.

In the Government space, the Medicaid programs in California, Idaho, Nevada, and New York have all approved HMS to perform specific types of provider audit services. We are also beginning to perform clinical review services for New Jersey Medicaid, and Indiana Medicaid reordered HMS a contract to perform our Prudent Rx pharmacy cost containment services.

In our Managed Care market, we have won the opportunity to perform provider audits for Aetna’s Medicaid lives and Royal Health and Citrus Health, and WellCare has awarded us a contract amendment to begin clinical review and medical bill audit. We are very excited about the increased adoption of our newest service line, and believe that this will make a significant contribution to revenue in 2009 and beyond.

Bob will now talk a little bit about the macro-environment impacting HMS.

Robert M. Holster

As we’ve discussed at length at recent conferences, the overall operating environment in which we are functioning is extremely favorable for HMS’s long-term prospects.

Earlier this month, unemployment reached 7.6% as the economy continued to lose jobs at a rate of more than 600,000 per month. Most observers are predicting a rate that will be close to double digits by the end of 2009, and I think as most of you all are aware, there’s a strong correlation between unemployment and the growth in Medicaid beneficiaries and expenditures that in turn drives HMS’s continued growth.

The legislative initiatives that have been viewed as potentially important to HMS are now beginning to fall in place. Earlier this month, SCHIP expansion was signed into law, potentially adding 4 million lives to a program we serve directly in some states and through Medicaid in others.

Last week, the Federal Stimulus Package was passed with $87 billion in increased federal matching funds that will be provided to states over the next two years. That’s money that will not only help handle the increased load on the Medicaid program that unemployment is generating, but will relieve some of the fiscal pressure on state governments that has been weighing on the program.

Further, the Stimulus Package includes more than $24 billion in subsidies for corporate payments and newly out-of-work Americans. The COBRA funding potentially affects us in at least two ways; first, expands the pool of coverage that underpins our coordination of benefits business; second, it expands our opportunity to help states manage employment insurance premium programs for Medicaid beneficiaries that have access to insurance through an employer; and finally, as you might have gleaned from Bill Lucia’s comments about recent new business, we’re seeing the improved selling environment that comes from intense federal interest and cost containment coupled with the need of states for recoveries that by and large because of our contingency pricing model don’t require scarce appropriated funds.

I want to emphasize that while the Medicaid and insurance coverage funding included in the Stimulus Package is extremely positive for HMS’s long-term outlook, we expect those programs to take several quarters to work their way through unemployment compensation, Medicaid enrollment, Medicaid spend-down and claim adjudication cycles.

We’ll make 2009 projections the way we did 2008 with growth in our government core with more rapid growth in MCO and with a good deal of help, particularly in 2009, from the new program integrity product offerings. It’s actually not until 2010 that we expect to get the kick out of the stimulus package.

William C. Lucia

Well, as you know, HMS has been growing at a compound average rate of at least 18% since 2001, and as we mentioned today, we well exceeded that growth rate in 2008.

While we’re still attempting to determine exactly when the Federal Stimulus Package will positively impact HMS, we should also talk to you about why we’re confident that we can maintain our existing high rate of growth. First and foremost, we continue to phase-off against a very large and relatively untapped opportunity. CMS estimates that over 10% of Medicaid claims are paid in error. That amounts to about $40 billion of claims paid in error per year, and the recoveries in savings generated by HMS now represent less than 10% of that $40 billion, and most of our current recoveries come from our coordination of benefit services. Coordination of benefits is only one in many error types that CMS is concerned about.

It’s also important for you to understand that our new program integrity services help impact most of the other claim payment errors in Medicaid. So, as we previously outlined, our clients are now buying more of these services from HMS.

I’d like to also remind you about the 4 major strategies we deploy to assure high growth. First, we continue to add lives under contract each year. Medicaid covers about 50 million of our systems, but that number is expected to grow at least 2% per year. HMS services now impact about 33 million lives, about 20 million in state-run fee for service programs and about 13 million in Medicaid Managed Care plans. We added 3 million new lives in 2008, and we are well on our way to add approximately that number again this year.

The second major way we grow is to ride the Medicaid growth wave. Medicaid spends on average about 8% more each year, and this growth rate has been consistent and relatively predictable since the very inception of the Medicaid program. CMS estimates this growth will continue well into the next decade. This growth wave is a built-in baseline for HMS because of the contingency nature of our revenue.

The third way we grow is to expand the products and services we offer our clients. We’ve done this both through internal product development and through acquisition. We’ve developed premium assistance products and provider audit services, and we’ve added clients and services through acquisitions averaging one acquisition a year since 2006. Our goal is to acquire one or two additional firms this year as we continue to expand our service offerings.

Now, the fourth way we grow is perhaps the most important; we up-sell to our existing customers, those customers who have come to trust HMS and depend on our consistent and reliable cost containment services. They know that these results are not easily replicated internally or by another vendor, and as you know, most of our initial contracts are for a very limited scope of services. So, there is a lot more a client may chose to let HMS do, and in this time of great fiscal pressure, HMS clients are buying more from us as described in our earlier discussions.

In summary, these are the reasons why we are enthusiastic about the enormous opportunities facing our company and while we’re confident about our ability to maintain this high growth rate.

You’ll note on this slide that we have revised 2009 guidance upward to $218 million in revenue and fully diluted GAAP earnings per share of $1. Based on 2008 results, the revised guidance for 2009 would be up year-over-year 18% in revenue consistent with our average historical growth rate and 25% for fully diluted GAAP EPS. The guidance also assumes a 41% effective tax rate for the year as Walter mentioned earlier.

We look forward to 2009 with anticipation of another record year of performance, but mindful of all we have to do to execute during the year.

Thank you very much, we’ll now be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Richard Close with Jefferies & Co.

Richard Close - Jefferies & Co.

A quick question, with respect to the stimulus package and the states getting money, just want to maybe dive down a little bit deeper on that front, and then SCHIP expansion as well, with the increase in these programs, I guess would seem that maybe you guys are at a disadvantage as the states are getting more money and what not, just go over why you benefit again from the stimulus and why may be you’re not at a disadvantage there.

William C. Lucia

When you look at the FMAP increase and the additional $86 billion that are going to states, and you also read state newspapers in capitals, you notice that these dollars are really going to help close Medicaid budget gaps which exist in every single state in the union. What it’s doing is keeping states from cutting provider rates, from changing eligibility guidelines; in fact, one of the restrictions to these funds is that you have to not have limited eligibility guidelines in any way and if you have rolled back those cuts so that you can use these dollars. So, this influx of money really only helps them through state fiscal year 2010, so, let’s keep that in the backdrop; really helps them keep the program afloat and bring more people in. Will they administratively use some of these dollars to do some other things in the agency? Yes, they’ll probably bolster their enrollment eligibility and case workers out in the field who have to handle all these enrollments as many states are backlogged, but as the dollars continue to build, the cost containment activities at the back end or at the front end continue to be extremely important to these states.

Robert M. Holster

You don’t see that replacing our activity whatsoever. In fact, our states are very interested in figuring out how to use our services so that when the federal funding stops, it’s a good program to replace.

Richard Close - Jefferies & Co.

And then, just walk us through on the COBRA side of things; do you think that if COBRA is being extended that may be that’s a disadvantage in terms of people switching over to Medicaid or slowing down that switch to Medicaid; if you could walk through that and how that benefits you as well.

Robert M. Holster

We’re actually excited about the COBRA opportunity. I mean, COBRA today, HMS does two different things when it comes to COBRA; we see COBRA when someone is in Medicaid, so they have the money to pay for their COBRA premiums, they are in Medicaid and Medicaid pays the co-insurance and deductible or uncovered services from their COBRA insurance. So, we are coordinating benefits with people on COBRA today. The second, and we think as a growing opportunity is the fact that because the federal stimulus covers helping people pay their COBRA premiums, will also help states pay COBRA premiums. States have an ability called premium assistance or health insurance premium payment which is another name for it to help people pay their COBRA premiums so that they stay on COBRA, primary services are covered by that COBRA plan or that group health insurer, and Medicaid is just a wrap-around, and in two states, there are four large programs in the nation that do premium assistance, we manage two of them, Texas and Massachusetts. So, we think there will be an increased opportunity in the COBRA coordination going forward.

Richard Close - Jefferies & Co.

And then, with respect to, recently read an article on self-audit providers doing self-audits; CMS I guess is encouraging self-audits prior to CMS maybe looking into things with respect to I guess that’s program integrity, do you see any type of increase in self-audits by the providers themselves diminishing the opportunity for you guys on the state level or on the federal level on program integrity?

William C. Lucia

We don’t work in the provider business office; I can’t say that we see that but I can tell you that providers obviously have to be compliant and providers spend a lot of time and money attempting to do that, but there are too many areas in the complex claim quoting system and billing, there are too many things to go wrong, and from the results of our audit providers, we were able to electronically audit data as to a provider who has already self-audited come in and find millions of dollars, we believe that this is not going to have a negative impact on our ability to grow program integrity. Remember, there isn’t just one or two errors out there. There are thousands of different error types and it’s very hard for the providers themselves to capture all of that.

Richard Close - Jefferies & Co.

Okay. Just one final question would be; I know you don’t give quarterly guidance, but obviously you made a lot of investments in the first quarter of last year, led to a much lower operating margin, I think in the 14% range, and this year when I looked at sort of where the street is, obviously implying about 40% year-over-year growth in earnings, and I think optically that looks like a huge number, and I’m wondering if you could express any comfort in terms of where the street is on the first quarter?

Walter Hosp

You’re correct in saying that we don’t give quarterly guidance. So, I have to carefully word this. First let me state that we had seasonality in our first quarter. Our sales last year dropped around 6.5% sequentially from the fourth quarter of the prior year and that’s the best reference point I can give you in terms of the first quarter this year. So, we think it’ll come in around that level, but we’ll have to wait and see. In terms of overall profitability for our internal planning, we do see a corridor of growth that could incorporate the reference points you had for the earnings. So, I’m not shying away from that, but I’m saying there’s certainly a band around the reference point that you have.

Richard Close - Jefferies & Co.

Ok. Just really quickly, obviously raising the ’09 guidance here at the beginning of the year is definitely a bullish sign from our perspective. You guys must have a significant amount of confidence in your business as we sit here today.

William C. Lucia

We’re not only confident about the opportunities that we face, and I think as I mentioned, they’re very large and relatively untapped, but we think we have developed an excellent delivery mechanism, an executive team that can take the company forward, and we do have albeit it’s not probably going to hit us so strongly until 2010; we do have some wind in our sales from the Federal stimulus and the increased unemployment. So, we’re excited, I have to tell you, we have a lot to execute.

Operator

Your next question comes from Corey Tobin with William Blair & Co.

Corey Tobin - William Blair & Co.

Let me start with a housekeeping question. You didn’t necessarily guide the EBITDA, but is there any range or loose kind of guidelines you’d like to for where EBITDA should shake it up for 2009?

Walter Hosp

We traditionally give an adjusted EBITDA, but we’re recognizing that that’s not as far with a number, but if you’d like a number for ’09, that’s in the $64 million range.

Corey Tobin - William Blair & Co.

That’s for adjusted or for non-adjusted?

Walter Hosp

Adjusted EBITDA.

Corey Tobin - William Blair & Co.

A couple of other things. You mentioned Florida and some expenses related to that rolling through until, I think you said April, just curious, when do you anticipate the revenue from Florida will start to roll off, around the same time?

William C. Lucia

It has actually been rolling off not as aggressively as we had thought because we don’t think it’s being replace that quickly. So, what we’re doing is working as many accounts as quickly as we can to make sure that the state has some recovery revenue, but April 30th is the end of the run-out period. So, after April 30th we won’t have any opportunity to generate additional revenue for the state. We have it due this quarter and a little bit into the next.

Corey Tobin - William Blair & Co.

Shifting topics; any update with respect to Medicaid Integrity Programs at the Federal level?

William C. Lucia

Many people know that they have issued Task Order 3. It’s a very very small task order financially and scope. We are one of the bidders. So, we’ll look forward to seeing the outcome of CMS’s selection, but Task Order 2 is going very well and we’re initiating audits and we’ve got a great program that we’re working with CMS on.

Corey Tobin - William Blair & Co.

The activity from that program will pick up here in 2009 or is it more of a 2010-2011 timeframe?

William C. Lucia

Hard to say, I mean, there are a lot of building blocks in that program between building joint operating agreements with state Medicaid agency and Medicaid fraud control units in each state; so there are a lot of building blocks that has to be overcome first, and then the audits begin, but after the audits are done, there’s a long period of time of working with the states to implement new solutions. So, it’s really hard to say whether they will ramp it up or not.

Corey Tobin - William Blair & Co.

Great. And finally, on the opportunity front, we’ve all seen the high wins in California budget pressure; do you think that’s going to open up additional opportunities for you there beyond the scope expansion that you just secured in the contract extension?

William C. Lucia

We always hope so. California is a happy client. We have a very collaborative relationship with them. We do as much as we can together where it does not negatively impact the state employee union and that’s typically the biggest issue in many of our states, but we have constant dialogue with California about expanding the types of services we can provide.

Operator

Your next question comes from Tony Perkins with First Analysis.

Tony Perkins - First Analysis

The growth in your MCO business in Q4 was slower, you said, due to a harder comp, but you expect that growth to be a significant driver in ’09. So, can you explain why we shouldn’t be concerned about that growth slowdown in Q4?

William C. Lucia

The biggest change in Q4 was really a mix of business and whether we had enough backlog implementation that went through at the same time, and what we experience in a way, we’ll see some of this in ’09 as we continue, but we won’t see it at the same pace, is that we got through most of the backlog. As I just said, we sold about half a million lives, so we have that backlog to implement. So, you’ll see peaks and valley, so to speak in 2009, but we’re still expecting it to grow about 40% next year. And that’s what I’d consider same-store sales where we factored in some program integrity sales, but we’re seeing a pretty rapid adoption of those services. So, we’re pretty comfortable that we’ll be able to see that growth rate in MCO.

Tony Perkins - First Analysis

A question on the cross selling traction for program integrity services in Q4; at what level is that and should we expect that traction to stay about the same in ’09 or increase from the Q4 levels?

William C. Lucia

I can tell you what I’d like to see happen, but as I said, the market has been an early adopter of our services. We expect probably two years figuring out how our program integrity services would be delivered, and quite frankly, it’s a very fragmented market. There’s a lot of very small firms that do unique things. We are really creating what we believe how the market should think about program integrity, and we think from creating that value proposition will get greater sales. So, as I mentioned, we’ve got about 20% of our revenues in 2009, budgeted revenues, are expected to come from program integrity, and our focus in M&A is to continue to fill that gap of services to provide our clients.

Tony Perkins - First Analysis

One quick question on guidance. You’d mentioned that there are some forecasts for double-digit unemployment by the end of ’09; can you give us some sense of where guidance is based on, what level of unemployment?

Walter Hosp

The guidance of $218 million which is an 18% increase off our reported 2008 numbers was based off the CMS Actuary growth rate. That has underlying growth rate of about 8% for the year. So, we built our forecast and now we’ve done some revisions in that. We have a very modest component in that related to the growth of unemployment and the increase from that. As Bob mentioned in his earlier comments, we see most of this as a 2010 phenomenon. That’s where we’re going to get the benefit.

Robert M. Holster

Let me just supplement that by saying we used the CMS Actuary and growth rate as a basis in expenditures, as the basis for our forecast. Implicit in that was about 5.5% unemployment rate.

Operator

Your next question comes from Carter Malloy with Stevens, Inc.

Carter Malloy - Stevens, Inc.

I know it’s too early, but have you been able to get a sense of any successes or really lack thereof of your competitor in Florida?

William C. Lucia

We don’t like to talk about our competitors, but we don’t know what their success has been. We do know that the recoveries from PPO are still coming in for months. The agency did issue a report recently about the different recovery or cost containment programs they have and it did mention that due to the loss of their old TPL bender HMS, they no longer are able to go after all the overpayment recoveries they used to in their program integrity suite. So, out of the net you might be able to get more information than we can.

Robert M. Holster

But I think it’s fair to supplement that by saying that we won eight consecutive competitive procurements in our core coordination of benefits business since the Florida loss.

Carter Malloy - Stevens, Inc.

On guidance, just to be clear, the implied unemployment rate underneath there is 5.5%; are you guys including in your new guidance the new wins and scope expansions?

William C. Lucia

Yes. Our guidance includes new wins, scope expansion, always a certain amount of stretch for our sales teams; so all of that’s in there. The only thing as Bob had mentioned earlier, we have to remember that unemployment to Medicaid, the actual gap between when that happens, there is no hard science on it yet, and while we track that and are tracking it, even the Kaiser Family Foundation did this same study for the last big recession and they cited all the reasons why it’s very difficult to determine when those people will get into Medicaid, but it could be anywhere from six months to a year.

Operator

Your next question comes from Charlie Strauzer from CJS Securities.

Charles Strauzer - CJS Securities

Just a couple of quick questions; if I can clarify in Q4, little higher revenue than was expected and if you back out the tax rate basically the EPS would have been in line with your raised guidance, so the differential there is the higher expense on the competition line, is that correct?

William C. Lucia

Yes, it’s in other lines as well, but it was, as you know, we have our expenses go up with transaction volumes, and that’s at the core of what’s related to them.

Charles Strauzer - CJS Securities

Was there anything that would go away once Florida ends in April that would bring some of those lines back down a little bit?

William C. Lucia

There’s a component of expense related to Florida; clearly that would go away, as well as the revenues with it, but everything else would be considered ongoing.

Charles Strauzer - CJS Securities

Okay. Bill, just on pushing for a bigger picture little bit here; I mean, most of the questions have been answered without the benefit from what’s going on in the economy and the stimulus packages, but talk a little bit more about your needs in terms of maybe potential plucking acquisitions; are the pieces of your business that you could probably find nice acquisitions to complement your business versus the organic growth model, you think that could be done this year?

William C. Lucia

We are continuing to look at these tuck-in acquisitions. Most of them do center around program integrity services and finding some unique skill sets or technology that helps us expand more rapidly into that market space. A lot of the companies are small, they’re relatively small, they are not very large players that we think would be great bolsters to HMS, but we’re continuing to look for opportunities, and as I mentioned earlier, we’re hoping that this year we will acquire another one or two firms primarily focused in this area.

Charles Strauzer - CJS Securities

Okay, and then lastly Bill, if you look at some of the states, they just do everything themselves, are you finding them being more receptive today given the crisis that’s ongoing about talking to you about potentially watching an RFP towards outsource some of that work to you?

William C. Lucia

At this point the Minnesota state has never outsourced any work in this arena, and they finally did this year. I think that we’re seeing in every re-procurement, a broader scope of services being asked for and that we’re seeing states more willing. You’ve got to remember that we’re a workforce extender for state. So, when a state is told that they have to cut jobs they can easily move work over to HMS or not cut jobs if they have a chance to add jobs they again get a chance to move work over to HMS and redeploy that staff. So, we’re seeing a more open environment from that perspective.

Charles Strauzer - CJS Securities

And have you seen any other new RFPs come out of states that have not done outsourcing?

William C. Lucia

Not in the coordination of benefits arena, but we have in other areas, and we’re actively looking at these other areas with a lot of interest.

Operator

Your next question comes from Greg Williams with Sidoti & Company.

Gregory Williams - Sidoti & Company

Just had a couple of quick questions, most have been answered here. You guys did a good job of free cash flow generation and you mentioned, I think DSOs improved 10 days; was there anything specifically driving the DSO improvement?

Walter Hosp

We just had a very good quarter of cash collections which exceeded even the increased revenues that we had there. We typically in the fourth quarter get a lot more cooperation with our clients and quite frankly internally there is a greater focus on it to meet incentives. So, that’s typically a very strong cash collection quarter for us.

Gregory Williams - Sidoti & Company

Just a general question on program integrity. Obviously, it’s a compelling offer to states, but is there any risk in the fact that it requires upfront appropriations as opposed to the contingency fee that you see on the coordination factor side. With upfront appropriations, I know it says dollars enrolment for state, but they might not be thinking that rationally?

Robert M. Holster

Program integrity services are sold on both per collect or per unit of service basis, but they also, particularly where they entail recoveries are sold on a contingent fee basis. And we are very very consciously trying to expand scope in our government clients in particular where there is a contingency fee procurement framework in place. So, you shouldn’t assume that program integrity is necessarily impeded by the fact that some portion of it might be priced on an unit award basis.

Operator

We have now reached the amount of time for questions. I’ll now turn the call over for closing remarks.

William C. Lucia

Thank you everyone. I look forward to working with each of you coming up in the future and joining our next conference call.

Operator

This concludes today’s 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!

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. Q4 2008 Earnings Call Transcript
This Transcript
All Transcripts