HMS Holdings' (HMSY) CEO William Lucia on Q2 2014 Results - Earnings Call Transcript

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 |  About: HMS Holdings Corp (HMSY)
by: SA Transcripts

HMS Holdings (NASDAQ:HMSY)

Q2 2014 Earnings Call

August 08, 2014 9:00 am ET

Executives

Eugene V. DeFelice - Executive Vice President, General Counsel and Corporate Secretary

William C. Lucia - Chief Executive Officer, President and Director

Joel Portice - Division President of Government Solutions and Corporate Strategy

Gilbert D'Andria -

Analysts

Elizabeth Blake

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

Jeffrey Garro - William Blair & Company L.L.C., Research Division

Richard C. Close - Avondale Partners, LLC, Research Division

Bret D. Jones - Oppenheimer & Co. Inc., Research Division

David H. Windley - Jefferies LLC, Research Division

Frank Sparacino - First Analysis Securities Corporation, Research Division

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

Operator

Good morning. My name is Tariya, and I will be your conference operator today. At this time, I would like to welcome everyone to the HMS Holdings Corp. Q2 2014 Earnings Call. [Operator Instructions] I would now like to turn the call over to Gene DeFelice from HMS Holdings. Gene, you may begin.

Eugene V. DeFelice

Good morning, and thank you for joining us today. As you know, we distribute our earnings release through our website, hms.com, under the Investor Relations tab. Under that tab, you will also find the supplementary slides that accompany our call today. This call is also being webcast. Please click on Events & Presentations under the Investor Relations tab to access the webcast. A replay of the call will be available on our website later today.

Before I turn the call over to management, let me remind you of some of the information presented today regarding the company's future expectations, plans and prospects is considered forward-looking statements under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

These statements are based on the company's current expectations and actual events may differ materially from those expectations. We refer you to the company's filings with the Securities and Exchange Commission, including our Annual Report on Form 10-K and our quarterly reports on Form 10-Q, which identify important risk factors that could cause actual results to differ materially from those contained in the company's projections or forward-looking statements.

All information on this call is as of today, August 8, 2014, and the company disclaims any intent or obligation to update any forward-looking statements as a result of developments occurring after today's call.

During this call, we will also be referring to certain non-GAAP measures. The press release issued this morning includes a reconciliation of these measures to GAAP measures and is available under the Investor Relations tab on our website, hms.com.

On the call today is Bill Lucia, our President and CEO. Also on the call is Joel Portice, who is President of Government Solutions and Corporate Strategy.

Bill will provide a review of our second quarter financial results. Joel will follow with a strategic update and an overview of key government sales in the quarter. Bill will conclude with a discussion of the positive impact the Affordable Care Act continues to have on our business. And then we will open the call for your questions.

Bill?

William C. Lucia

Thank you, Gene, and good morning, everyone. I am pleased to report that total revenues in the quarter just concluded, excluding Medicare RAC, were the second highest in company history, topped only by the fourth quarter of 2012.

As anticipated, the positive benefits of the ACA, including a growing Medicaid population and increased demand for our solutions from all payers, continues to fuel our business. Sales were strong in both our state and commercial markets. Our largest product line, Coordination of Benefits, showed healthy growth in the quarter due to Medicaid expansion and internal product yield improvements.

In addition, our ongoing cost restructuring initiatives contributed to the improved earnings picture this quarter.

Touching now on some of the highlights from our income statement for the second quarter. Excluding Medicare RAC, revenue was $105.3 million, up 6% year-over-year and up 12% compared to last quarter. Total company revenue for the quarter decreased $13.2 million compared to the second quarter of last year, primarily because the Medicare RAC revenue decreased from $26.8 million in the same period last year to $7.3 million in the period -- in this period. Our total operating expenses declined $5.4 million, or 5% year-over-year, despite $2.7 million of onetime items, largely severance related, incurred in the quarter. Those savings are the result of an ongoing and concerted effort to improve efficiency across the entire business.

Earnings per share for the quarter was $0.07 and adjusted earnings per share was $0.14, both well ahead of the prior quarter. Both net income and adjusted EPS would have been $0.02 higher without the negative impact of the onetime items in the quarter.

Adjusted EBITDA of $29.2 million for the quarter was 22.4% higher than the first quarter.

Cash and cash equivalents as of June 30 were $95.9 million, and we ended up the quarter with $197.8 million in borrowings under our $500 million revolving credit facility.

Next, I'd like to highlight the growth we are experiencing in our Coordination of Benefits, or COB, product line across both state and commercial markets. COB revenue was up 9% year-over-year and up 16% compared to last quarter. We are seeing an improvement in COB revenue as a result of new lives entering the Medicaid program and the operational product yield improvements we put in place some time ago. Our Program Integrity business, without Medicare RAC, was flat this quarter, although we expect growth to accelerate meaningfully in the second half of the year as we complete implementations of new sales already closed.

From a market perspective, our State Government revenue was up 4% year-over-year and 6% compared to last quarter, despite the ongoing challenge of lives transitioning to managed care.

Our commercial market revenue increased 14% year-over-year and 20% compared to last quarter. These improvements were due primarily to the increase in the number of Medicaid lives and new contracts that began to generate revenue in the quarter.

Overall, revenue, excluding Medicare RAC, was strong across-the-board in the second quarter, which strengthens our confidence that we can achieve our growth projections for the year.

That concludes our financial highlights. Before finishing the prepared portion of today's call, I've asked Joel to speak briefly about the HMS growth strategy. Since joining the company about 8 months ago, he has brought renewed vigor and focus to efforts by the entire executive team to identify and move forward on the best pathways for continued profitable growth across all of our products and markets. Joel?

Joel Portice

Thanks, Bill. As you pointed out, this was a very good quarter for HMS for a number of reasons. Expansion of Medicaid remained a major growth driver in our State Government and commercial markets. As states and managed care plans address their challenge of quickly absorbing significant new memberships, they are actively seeking cost containment and risk management solutions to help them manage this population.

In the State Government market where we serve 46 states, plus the District of Columbia, we saw solid evidence of heightened interest in our products even as fee-for-service lives continue to migrate to managed care. Sales activity in the quarter included brand-new sales, reprocurements and contract extensions across 9 states.

In New Hampshire, we were awarded a contract by the state to administer their Health Insurance Premium Payment Program. HMS will help the state manage its Medicaid expansion population and performing outreach to new applicants to determine whether they were also covered by employer-sponsored insurance.

Also in the quarter, the state of Texas awarded us a subcontract to provide asset verification services, evidence of a growing need for another of our products as states endeavor to come into compliance with the federal requirement to perform automated data matches with financial institutions for their dual eligible populations.

We also won competitive reprocurements in 2 states, Idaho and Minnesota, for Medicaid Coordination of Benefits.

As we enter the second half of 2014, our pipeline in both the state and commercial markets remains strong. In each successive quarter, we are seeing the benefit of sole contracts coming online.

In addition to targeting resources to produce profitable opportunities presented to us by the ACA in the overall growth in our markets, our strategy includes ongoing analysis of acquisition opportunities that could strengthen our existing business and market position.

Last quarter, Bill spoke to you about the vast amounts of data in our possession and the growing depth of our analytic capacity. As part of our growth plan, we believe there are significant opportunities to leverage those data assets for the benefit of our customers, helping them to manage risk and lower costs. We have the opportunity to enrich our customers' data through differentiated analytical models and provide them with measurable value they can quickly consume and apply to their operations. Though we are early in the planning process and specific product offerings are not yet formulated, we believe we are better equipped than any other organization to create value for our customers, utilizing their own data.

Additionally, we are focused on product engineering initiatives to ensure that we are advancing our product portfolio and developing innovative plans to meet the changing needs of the marketplace and to further improve our competitive position as the provider of the broadest set of cost-containment services in the industry. This strategic focus gives us confidence that government and commercial payers will continue to look to HMS for innovative solutions to address today's challenges and tackle the evolving complex health care system.

Now I'll hand the presentation back to Bill.

William C. Lucia

Thanks, Joel. I want to touch briefly on the continued impact of Medicaid growth on our business and the growth in our commercial market.

This quarter, the increase in Medicaid enrollment in states across the nation contributed to revenue growth in both our State Government and commercial markets, which were up 4% and 14%, respectively, compared to the second quarter of last year. In addition, our COB product line was 9% higher this quarter than the second quarter of last year.

The Congressional Budget Office estimates that the ACA will result in 8 million new Medicaid and CHIP members in 2014. According to CMS, more than 80%, or 6.7 million, of those individuals have already enrolled in Medicaid and CHIP as of May 31.

In the second quarter, HMS saw 1.5 million additional new Medicaid enrollees in our eligibility files, bringing the total number of new Medicaid lives in our data warehouse to 4.5 million, a 50% increase over last quarter.

We expect to approximate the CBO number over the coming months as more members enroll and states work through processing backlogs.

With Medicaid membership expected to grow substantially between now and the end of the decade, we believe that Medicaid expansion will continue to serve as a significant organic growth driver for our business well into the future.

Now moving to the commercial market. As Joel discussed, many of our large carriers continue to face significant business pressures due to the ACA and they are seeking our broad set of solutions to help them manage risk. Today, we serve 7 of the 10 largest insurers in the nation and over 200 managed care plans. With a large existing footprint in the commercial space, we expect meaningful growth to come from the sale of new products to existing customers.

Our land-and-expand strategy is working. In the second quarter, alone, we added new products to 7.8 million lives or about 11% of the 70-plus million commercial lives we have under contract. Clients added a range of services, including Coordination of Benefits; Clinical Audits; Credit Balance Reviews; and Fraud, Waste and Abuse services. As we discussed last quarter, the value of these scope expansions depends on the specific service being delivered. Once a newly added service is fully implemented, per-member per-year revenue ranges from $1.50 to $6.50.

The commercial market will expand and we anticipate that it will be the largest growth driver for HMS. Three factors are key to that growth: most of the new Medicaid lives are enrolling in managed care plans; Medicare Advantage will continue to grow as a result of aging baby boomers selecting health plans in place for traditional fee-for-service; and the previously uninsured will gain coverage through the exchanges. As the commercial risk market grows, it will increasingly require cost-containment services to mitigate new risks and other business challenges related to the ACA and our clients' new membership.

Before I close, let me touch on the Medicare RAC reprocurement process. Though timing of new contract awards remains uncertain, the announcement by CMS earlier this week of its intent to modify contracts with current recovery auditors to allow for a limited number of fee-for-service claim reviews is a positive development. Equally encouraging is the statement on the cms.gov website that CMS remains hopeful that the new round of recovery auditor contracts will be awarded this year. The limited restart to the audit program will not likely have a material impact on our 2014 revenues, but we continue to believe that recoveries from the RAC program are critical to the financial sustainability of the Medicare trust fund and we look forward to the award of the new contracts by year-end.

Meanwhile, we continue to focus on the rest of our business, which is healthy and growing and which accounted for 94% of revenues in the second quarter. The markets we serve and our clients are growing. Importantly, our largest service offering, Coordination of Benefits, resumed healthy growth this quarter, benefiting from both increased Medicaid enrollment and internal product yield improvements.

In short, HMS has just completed a successful first half of the year. Fueled by the ACA and a strong sales pipeline, we believe we are well positioned to continue growing throughout the second half of 2014 and well into the future.

Finally, we are on track to achieve our margin expansion goals as we continue to improve our cost structure, reallocate resources toward higher growth areas, improve product yields and reengineer our infrastructure.

All of these factors together reinforce our confidence in a strong finish to 2014 and make us increasingly enthusiastic about the future of our business.

Now I'd like to open up the call to questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Robert Willoughby of Bank of America.

Elizabeth Blake

This is Elizabeth Blake in for Bob today. So you talked about the potential opportunity in the future to perhaps monetize the data trove that you have. I guess I realized those offerings aren't formulated yet, but maybe any thoughts on how exactly you would monetize that and how far away is the opportunity. If the one after is something like this today, could you get it to them next year?

Joel Portice

So this is Joel. We are actively involved with our customers on coming up with the right type of solutions for them and so we really do see this as an important step. It's to work with our customers and help define those solutions. And so we're not ready to really speak about the timing of how we'll monetize and productize these assets, but it is well underway and our customers are receiving our feedback very positively.

Elizabeth Blake

Okay, great. And you -- I saw you reiterate the guidance for the non-RAC business, but I guess you didn't go into Medicaid COB, specifically. Are you still comfortable with the 8% to 10% number, as well as the 25% to 30% number for commercial?

William C. Lucia

Yes, Elizabeth, we are. We believe that we'll continue to see this ramp through the second half of the year because of the increased lives that are being added from the ACA.

Elizabeth Blake

Great. And just a quick one. Any updated thoughts on the CFO search?

William C. Lucia

Well, we've made very good progress and we expect to make an announcement next month, if not, sooner.

Operator

And our next question comes from the line of Jamie Stockton of Wells Fargo.

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

I guess, maybe the first one on Medicare RAC. Obviously, I know you guys may not have a tremendous amount more color than we do on what's going on, but is it your expectation that if we get a decision on the CGI lawsuit, I guess, by next week that CMS will go ahead and award contracts, assuming that the decision doesn't inhibit that in a pretty quick manner?

William C. Lucia

Well, I mean, that would be our hope. But since we're not party to the litigation, we really don't know how the lawsuit's progressing and obviously can't comment on that. But I think we would repeat what CMS said, is that they're hopeful they can get the contracts awarded this year.

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

And then maybe on rebuilding services around the lives -- the Medicaid lives that have transitioned to managed care, where do you feel like we are in the evolution of that? I guess, maybe to use a baseball analogy, what inning are we in as far as your efforts to try to rebuild services around those lives that have transitioned?

William C. Lucia

I guess, if we use the baseball analogy, we're probably in the second inning. And what I mean by that is we have, on an average, our clients on the managed care side have purchased about 1.5 services from us per account versus on the State Government side where it's well over 5. So it's really a long process. But why we're enthusiastic about it is that we have -- there's such a demand in the market and there are challenges and you can see this from the reports of the managed care plans. There are challenges with the increased absorption of these new members, Medicaid and exchange-related, and they are seeking cost-containment solutions. So we're very bullish on that opportunity.

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

Okay. And then my last question, the onetime expenses, can you just give us some more color on what those were and where they -- you may have said it and I missed it, but were they in the SG&A line? It seems like it was up some -- like $1 million sequentially on an adjusted basis.

William C. Lucia

Yes, and it was really primarily based on severance-related expenses, which is why we spiked it out because it really is, we believe, onetime. I'm not saying that we wouldn't have additional expenses like this in the future, but we think we have most of that behind us.

Operator

And our next question comes from the line of Jeff Garro of William Blair & Company.

Jeffrey Garro - William Blair & Company L.L.C., Research Division

I was hoping you could kind of quantify the impact of Medicaid expansion on COB revenue? I assume that some of the added life contracts with a per-member per-month basis while others might involve retrospective audits and those wouldn't have an immediate impact. So just trying to get a handle on the exact impact this quarter and how we should think about the momentum for this driver going forward.

William C. Lucia

I'm going to -- thanks, Jeff, that's a good question. I'll give you a little bit of color on that. As we said, we haven't fully reached all of the new lives that CMS has reported for our state customers or managed care customers. But -- and this is going to be a little bit of a little guess work, but I'll give you some information. Probably about 2/3 is related to Medicaid expansion. The other 1/3 is really related -- 2/3 is related to Medicaid expansion and new sales and the other 1/3 is related to our product yield improvements. But I think we're going to see continued growth on the Medicaid COB side because it takes 3 to 6 months for us to accumulate the claims incurred by these new members. And probably, we'll start to see, in a small way, that impact in Q3 and it'll increase in Q4 on the retrospective side and also be a good wind in our sails in 2015.

Jeffrey Garro - William Blair & Company L.L.C., Research Division

Great, that's very helpful. Then, also on the revenue line, I wanted to ask if there's anything we should think about in terms of seasonal impact in Q2? For instance, I know you might conduct audits on a biannual basis in -- like Q2 and Q4. So was there anything like that in the quarter? Or should we expect the top line momentum that you saw from Q1 to Q2 continue into Q3?

William C. Lucia

I think you will start -- we really, for the most part, have de-seasonalized, I think, our revenue. It just -- it doesn't have the annual impact in Q4 that it used to from a -- the part of our recoveries on behalf of Medicaid from Medicare used to be an annual event. That's now seasonalized, sort of, throughout each quarter. Of course, as our sales come online and implementation through the year, we will see growth, but I don't think we'll see necessarily as lumpy quarters. And of course, you'll see very little Medicare RAC revenues in the balance of the year.

Jeffrey Garro - William Blair & Company L.L.C., Research Division

Great, that's helpful. And then one last one, if I could. I was hoping you could help us with comparing the metrics you gave on the commercial footprint last quarter versus this quarter. Last quarter, you talked about the 6.3 million lives added to the footprint over the prior 6 months. And this quarter, you disclosed products were added to 7.8 million lives in the quarter. So I guess my question is was this more of a cross-selling quarter? And how do those metrics compare? And by talking about products added, are you saying those are fully implemented? Are those kind of in the backlog that you'll still need to implement in the second half of the year?

William C. Lucia

This quarter was more of a cross-sell quarter. That said, we have new clients in the pipeline. So net new accounts in the pipeline for commercial. But this was a cross-sell quarter. The revenue reflects -- the current revenue and our revenue for the balance of the year reflects both implementations that have -- and completed and implementations that will go online through the balance of the year. And the revenue ranges that we talked about really depends on the scope of services that were sold to those customers. But we are -- we have a number of contracts that have been sold, both new and expansion, that are in implementation at this point.

Operator

And our next question comes from the line of Richard Close of Avondale Partners.

Richard C. Close - Avondale Partners, LLC, Research Division

Just to follow up to those last questions. Exactly how many lives on the commercial side are revenue generating at this moment?

William C. Lucia

Richard, that's a good question and I don't have an answer to that. I would say probably about -- well, I don't want to guess. I'd rather get that information and do that in a follow-up.

Richard C. Close - Avondale Partners, LLC, Research Division

Well, then, how many lives in total on the commercial side?

William C. Lucia

There's a little over 70 million that are -- that we're working through that have been sold or in implementation.

Richard C. Close - Avondale Partners, LLC, Research Division

Okay. On the Coordination of Benefits on the state level, why don't you help us out with respect to the competitive marketplace there, how you feel about your competitive position on state Coordination of Benefits? What is the rebid outlook look for or schedule in terms of maybe in the remainder second half of 2014, but also 2015? What should we be keying on the state COB?

William C. Lucia

So we talk about this all the time, but we see competition every day in each one of our product lines and we take it very seriously. All that said, we think we have the most competitive and effective solution and so we offer the best value on the industry. From the balance of this year, there are probably -- it's less than 5% of our total revenue that's up for reprocurement. And next year, we have a few of our state contracts up for reprocurement. The one that we did ask [ph] most about, of course, is New Jersey. That contract has been extended through the end of October and we're awaiting the RFP.

Richard C. Close - Avondale Partners, LLC, Research Division

And New York?

William C. Lucia

New York has a 1-year optional extension. The contract runs through January 2015. They have a 1-year optional extension through January 2016. And historically, the state has always exercised its options. We do expect the New York RFP probably in the fall of 2015.

Richard C. Close - Avondale Partners, LLC, Research Division

Okay. Are you hearing any rumblings of any competitors coming into to compete against you, guys? Are you seeing anyone new in these reprocurements?

William C. Lucia

I'll repeat what I said before. We always see competition, but I don't want to give a competitor -- I don't want to talk about competitors on our call. I don't want get them any information or even credence that they're viable. We see competitors every day. Again, we are the most effective solution in the market, so we bring the best value.

Richard C. Close - Avondale Partners, LLC, Research Division

And then just final point on this, there has been talk out there in terms of, I guess, people questioning whether states can do this themselves. And any thought process you guys have on that?

William C. Lucia

It's really like any service that a state would outsource. And in fact, harking back what we said 3 years, our biggest competition in the past have been states because the states want to keep jobs and states need to employ unions [ph] , too. But in reality, there are some of these services states can do. Unfortunately, they need the vast amounts of commercial eligibility data and the processes that make this more effective. And in reality, on a contingency fee basis, it is much more effective to outsource this. So yes, there are some of these functions that are done by states and we either are -- we're a typically a come behind to our state, if not fully performing the service for the state.

Operator

And our next question comes from the line of Bret Jones of Oppenheimer.

Bret D. Jones - Oppenheimer & Co. Inc., Research Division

Bill, I wanted to go back to the comment you made in terms of the RAC restart not having a material impact to revenues in 2014. I just want to make sure, is that because there's a significant delay from the time the audit starts in revenue recognition? Or is it just because of a limited claim type [indiscernible] audit?

William C. Lucia

The initial scope is really on some automated, semi-automated and then a very select number of audits that CMS will allow. So it's more so related on the type of audits versus the timing.

Bret D. Jones - Oppenheimer & Co. Inc., Research Division

Okay. And then can you help us with that timeline? So if we do get a restart, if we think they were to come back to you today and say, you can restart, how long does it generally take from the time you start your audits to when you can recognize revenue?

William C. Lucia

It's typically about 3 months. Now that's -- and that's on the restart. We may see some earlier. As we said before, we've kept a contingency of staff working on new audit development because that new audit development is applicable to both Medicare -- our Medicare Advantage clients and some of our commercial business. So we think that we'll have a running start, but it's typically about 3 months.

Bret D. Jones - Oppenheimer & Co. Inc., Research Division

Okay, great. And then just one other question I had was the government PI programs, they're going to consolidate several programs. So I'm just wondering, is there any risk to your business that we should be aware of as we roll into 2015 due to the consolidation of these programs? Or maybe even if you were to win a second RAC region, would you have to walk away from some ZPIC work as you did in the past?

William C. Lucia

That's a good question. CMS' plans are to consolidate ZPICs, Medicare Integrity contractors and Medicare/Medicaid or the Medi/Medi projects into what's called a UPIC. We believe UPICs are an opportunity for us. And while we may be faced, depending on the regions that we -- regions or regions we win in the Medicare RAC, we may be faced with a different bidding strategy on UPICs, but we believe UPICs are an opportunity for our federal business.

Operator

Our next question comes from the line of Dave Windley of Jefferies.

David H. Windley - Jefferies LLC, Research Division

On Medicare RAC, Bill, I wondered if you could comment on timeline, and in specific, if I think about CMS' posture on this as we've moved along through this painful process, they had kind of shut down the current program with an intention to create a clean break between the old contract period and the new contract period. How do I think about restarting kind of the old structure even in a limited way and the potential for a near-term contract award? In other words, if they wanted this clean break, it would seem that they don't see contract awards coming for quite some time or they wouldn't have restarted it and created this potential kind of overlap. How do you think about that?

William C. Lucia

Well, I guess, I would remind everyone that it is a contingency fee contract, right, so -- and RAC recoveries are dipping. So I think CMS is just as concerned about the integrity of the Medicare trust fund as we are and Congress is. So I think they -- it's important that they keep the Audit Program running. If, in this case, we see the restart of the program even on a limited basis as a positive sign. So they believe -- or their statement is they're hopeful to get the contracts awarded in 2014. But other than what I said that I believe that it's both driven by CMS, potentially Congress in making sure the program has -- is following as much -- is doing as much as they can to assure integrity, but that's about all we know. So...

David H. Windley - Jefferies LLC, Research Division

Right, okay. I just wanted to get kind of your perspective on that issue. On cost structure, I believe your severance charge that you've highlighted related to a reduction of cost structure in the RAC or supporting the RAC program, could you give us a sense on what the costs look like, either with that charge or without, whichever way you like, but what the RAC supporting costs look like sequentially. I'm trying to kind of figure out what RAC looks like and therefore what x RAC looks like on a margin basis.

William C. Lucia

Yes, so the first thing I'll comment on is we've been very disciplined about our staff furloughs and expenses related to the RAC contract. But we've also been balancing that with the new commercial contracts that we've been onboarding. So we're balancing the staff reductions with the increase in both new commercial contracts and expansion of commercial contracts to do RAC-like or RAC services. In terms of the actual expenses, that, from a quarterly basis, related to RAC, I'm going to -- Gilbert D'Andria is in the room. I'm going to ask him to comment on that.

Gilbert D'Andria

So we don't do segment reporting. So we don't really have that level of detail from an expense perspective. So what I would expect for the non-Medicare RAC business, the overall operating expense to go up a little bit because we expect the revenues to do the same. But the delta, that additional revenue that comes is very favorable and a high-margin business for us. So I think that's going to upgrade itself. On the Medicare RAC, like I said, we don't have that clear line, if you will. But having said that, just like Bill said, is that we are very disciplined in terms of making sure that we are getting the best benefit out of the staff that we have currently.

David H. Windley - Jefferies LLC, Research Division

Okay. And if I could just ask a last one on commercial. When you talk about kind of the penetration in state contracts of, say, an average of over 5 products and the commercial being more like 1.5, is that differential reflective of functions that managed care companies have in-house and therefore they're only buying, say, the more advanced products? Or is it that you have -- there are products that you sell the states that the managed care companies don't have in-house and could still buy from you?

William C. Lucia

Well, it's really a combination of both. So many of the things we do, a managed care company does have the staff that does it, very similar to state Medicare programs. But they find a very compelling solution, particularly on the contingency fee model, to be able to outsource these functions or augment them. And remember, we -- this is all we do. So we're heavily focused on the clinical analytics, the financial analytics and the audit programs, and in many cases, a commercial health plan sees that we can do it more cost effectively. So it's a combination of both. We don't -- similar to the state market, we rarely see a plan bringing our services in-house once they're onboarded. So I think -- and the other major factor as we've discussed is there's just a financial impact that the ACA is having on carriers across the nation and they're seeking new solutions from us.

Joel Portice

This is Joel. What I would add to that is it's also, I think, a function of where we are in the evolution of our emphasis in that segment of the marketplace. And so as we continue to focus, engage with our customers on these opportunities, we would expect to see that delta between the number of products in the state and the number product in commercial to be -- to look different as we continue to focus there.

Operator

And our next question comes from the line of Frank Sparacino of First Analysis.

Frank Sparacino - First Analysis Securities Corporation, Research Division

I just wanted to follow up on the, Bill, the 70 million plus commercial lives. What's the actual number that's not Medicaid managed care?

William C. Lucia

That's a good question. We really haven't broken them down that way, but I would say -- and I'm going to give you a ballpark number. I would say about 2/3 of that population is Medicaid managed care and about 1/3 is Medicare Advantage and commercial. The Medicaid managed care, of course, is growing with the lives entering the Medicaid program and the Medicare Advantage and true commercial is growing with our sales.

Frank Sparacino - First Analysis Securities Corporation, Research Division

Okay. Is there anything else to note on the Medicare Advantage population or the other commercial part of that? Obviously, Medicare Advantage continues to grow as a program. But are you seeing anything different in those 2 segments per se?

William C. Lucia

I think the same comment that I made about just carriers being challenged with the ACA implementation, the new taxes and fees, new MLR guidelines. There's just an opportunity for them to outsource or augment the services that will help them better manage this risk and the costs that they're incurring. And we make a significant impact on our large commercial clients.

Operator

And our next question comes from the line of Brooks O'Neil of Dougherty & Company.

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

I have a couple of questions. I recall in the old days that Walter used to talk about reserve release possibilities and I was just curious if there was any of that in the quarter on the Medicare RAC.

Joel Portice

None. We have not put any reserve dollars into the P&L and we don't intend to do that either. And if we were to do it, we would specifically identify that in our financials. So we don't want to pollute our EPS in any shape or form.

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

Yes, that's perfect. I was just trying to be sure I understood. I have a sense that, historically, or most, maybe before this week, CMS had indicated the real possibility for the RAC awards to be in August. And I'm curious if you have any perspective on why it's pushed back at this point.

William C. Lucia

Yes, I think I can't really give any more information because I don't know more than you do publicly. I think the gating factor for CMS is the resolution of the lawsuit that is currently filed. And when that resolution happens, there will probably be more clarity into the timing of the awards.

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

Okay, that's perfect. I'm curious if you can provide any background on the 8-K, I think you filed it yesterday or the day before, related to the indemnification for the directors related to legal costs.

Eugene V. DeFelice

So this is Gene DeFelice, General Counsel, and this is a routine matter for a public company. A substantial number of public companies do this for their boards and executive officers. There's no precipitating event that's driving it other than just good governance. And it was a decision that was approved by the board, along with some other governance stuff that is positive for the company.

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

Perfect. Any chance you could give us a sense for the recurring revenue or earnings power of the company without Medicare RAC at this point? Obviously, you guys have talked quite a bit about new business coming in and I'm very cognizant of that, but I'm trying to get a sense for the recurring nature of the business as you see it today.

William C. Lucia

I think that -- I think we haven't yet completed our forecast and clearly discussed our outlook on 2015. But I think the factors that I will point to are the significant growth in the Medicaid population that will improve our top line, and in many ways, particularly for our COB business, comes with minimal incremental costs; the continued growth in our commercial business, fueled by new sales, expansion sales and that market growing. So we're very bullish about the growth on the top line. And we have been extremely conscious of engineering efforts across the business to keep our costs down, so we expect to continue to see margin improvement. We've talked about 5% to 6% improvement on the non-Medicare RAC business this year. I can't tell you what it'll be next year, but we will be striving to continue to see margin improvement in that business.

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

Excellent. And I think I heard you say, Bill, limited impact for the Medicare restart this year, and that probably applies to any impact for 2015 at this point based on just the restart alone.

William C. Lucia

Yes. I mean, the restart, we believe, will have limited financial impact this year. Of course, it depends on the audits that are approved by CMS. And depending on the timing of the new awards, that may go into next year or not. So it really depends on the timing of the new awards.

Operator

And at this time, I'm showing no further participants in the queue. I would like to turn the call back over to Bill Lucia for any closing remarks.

William C. Lucia

I'd like to thank everyone for joining our call today. A reminder that a replay of this call will be posted on our website later today. Thank you.

Operator

Ladies and gentlemen, thank you for participation today's conference. This concludes the program. You may now disconnect. Everyone, have a great day.

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