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HMS Holdings Corp. (NASDAQ:HMSY)

Q1 2008 Earnings Call

May 5, 2008 9:00 am ET

Executives

Bob Holster - Chairman and CEO

Bill Lucia - President and COO

Walter Hosp - CFO

Analysts

Charles Strauzer - CJS Securities

Richard Close - Jefferies and Company

Whit Mayo - Stephens Inc.

Operator

Good morning. My name is Cynthia and I'll be your conference operator today. At this time, I would like to welcome everyone to the HMS Holdings Corporation First Quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. (Operator Instructions).

I would now like to turn today's call over to Bob Holster, Chairman and CEO. Please go ahead, Sir.

Bob Holster

Thank you, Cynthia. Good morning everyone. It’s a pleasure to have you join our first quarter 2008 earnings call. I'm Bob Holster, Chairman and CEO of HMS. I'll be hosting the call along with Bill Lucia, our President and Chief Operating Officer and Walt Hosp, our Chief Financial Officer. 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 this morning's press release under the Safe Harbor statement on the Slide 1 of the presentation. HMS got off to a fast start in the first quarter of 2008 with revenue up almost 21% from the first period in 2007. As those of you who follow us closely know that first quarter is typically our weakest operating income quarter of the year, and 2008 is no different in that regard.

We come out of the fourth quarter of the prior with a high level of spending, having launched a batch of new initiatives, and we have a normal seasonal dip in sequential quarterly revenue. As a consequence, our operating margin drops in this quarter to 15%. That's something we expected, we are very comfortable with our full year guidance of revenues of $170 million. That’s up 16% for the full year. Adjusted EBITDA of $49 million, up 21% for the full year, and EPS of $0.73, up 28% for the full year.

Now Walter Hosp will take you through our financial statements, Bill Lucia will update on new business, and then I will comment on some of the changes we are seeing in our market place.

Walter Hosp

Thank you Bob and good morning everyone. HMS posted a solid quarter of financial results in Q1 '08, consistent with our projections for the year. Revenues for the first quarter of 2008 increased 20.8% to $38.9 million, versus the first quarter of 2007. Much of this growth came from yet another strong quarter of performance from our Medicaid managed care business, which doubled year-over-year. That's largely attributable to the fact that we are seeing more rapid growth in managed care lives than we anticipated.

Although growth in total Medicaid expenditures is developing roughly as we expected, as is our total revenue. We have tracked a total of approximately 4 million lives or almost 10% of total Medicaid lives that up until the last four years have moved from fee-for-service into managed care. With our now much larger footprints in the MCO space, we are increasingly indifferent to which side of the equation a life shows up.

Total operating expenses for the quarter were $33.3 million, an increase of $6.9 million or 26% compared to $26.4 million in the same quarter last year. Our operating expenses generally grows steadily throughout the year, and in the first quarter in particular, we get the effective carrying over peak prior year spending into our seasonally weakest revenue quarter. And included in Q1 spending are a number of recently launched long-term initiatives, that don’t show up clearly in the individual expense lines, but are important for our future prospects.

By way of few examples, during the quarter, we spent approximately $600,000 more on marketing and government relations than in the prior year, focusing on developing a clear brand identity for HMS, and are increasing the effectiveness of our lobbying at the state and federal level. During the same period, we incurred incremental cost of approximately $400,000, associated with moving staff and consolidating operational functions in our new and ultimately lower cost Irving, Texas processing center.

We spend roughly an incremental $600,000 on outside consultants, who are assisting us with configuring our data processing resources to support continued rapid growth. The launch of our Program Integrity product line with related infrastructure cost, cost us several hundred thousand dollars during the quarter.

Looking at the individual expense lines, we see the compensation expense of $16.6 million increased $3.5 million from same quarter of the prior year. We ended this quarter with an average headcount of 787 employees, a 29% increase over the 608 employees at the end of the prior year quarter.

Data processing expense of $3 million increased $0.8 million from the prior year quarter. Additional software expense associated with platform upgrades and upgrading of telecommunication lines contributed to a substantial portion of this increase.

Occupancy costs of $2.6 million increased $0.6 million from the prior year, a result of the expansion in the number and size of our locations, particularly our New Irving, Texas location.

Direct project costs of $5.5 million increased $0.3 million from the same quarter of the prior year. As a percentage of revenue, direct costs were 14.2% compared to 16% in the prior year.

Other operating costs of $4.5 million were $1.6 million higher than the same period of the prior year. Almost 40% of this increase resulted from additional non-payroll temporary health expenses in our service vendors and the largest part of that was for programming. Remaining increase came from professional and consulting expenses, travel, office supplies and local municipal charges.

Amortization of intangibles associated with the BSPA acquisition was $1.2 million for the quarter, the same as the quarter last year.

Net interest expense was $0.2 million for the quarter versus $0.6 million for the same quarter last year, which is due to lower debt levels and our higher cash balances than in the comparable period.

Income taxes were $2.3 million for both the quarter and the prior year. The effective tax rate is now 42% versus 43.6% for the same period last year, reflecting a lower state tax rate as our business and operations are distributed this year across relatively more tax advantage states.

The above resulted in net income for the quarter of $3.2 million versus $3 million for the same period in 2007, a 6.8% increase. The weighted average common shares outstanding for the current quarter were $26.8 million. Fully diluted net income per share was $0.12 per share versus $0.11 per share for the same period last year.

We now turn to the balance sheet and look at our general financial condition at March 31, 2008. Our cash and cash equivalents were $16.7 million, a decrease of $4.6 million from the end of 2007. Our cash continues to be invested in taxable money market accounts with the major money center bank. We have not had any valuation adjustments in these investments. We normally experience a drop-off in cash in Q1, as we pay down year-end liabilities, including annual bonuses, and then balances build throughout the remainder of the year.

Accounts receivable were at $42 million, an increase of $2.3 million from the end of December 2007, due to the seasonally consistent slower collections. Accordingly, the number of day sales outstanding at year-end increased to 97 days compared to 86 days at the end of 2007. We expect improvement in this measure in the second quarter of this year. We had $22.1 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. For the remainder of 2008, we anticipate the cash balances and funds generated by operations will be sufficient for our cash needs.

Looking at the statement of cash flows for the quarter-ended March 31, 2008, cash used by operations was $2.6 million compared to cash provided by operations of $0.9 million in the same period of the prior year. The $2.6 million cash used by operations was comprised of net income of $3.2 million, non-cash charges of depreciation and amortization expense of $2.9 million, non-cash share-based compensation expense of $0.8 million and a change in prepaid assets of $0.7 million, was offset by the seasonal increase in the amounts of accounts receivable of $2.3 million and a decrease in accounts payables of $8 million, of which approximately $6 million was related to annual bonus payments and compensation expenses accrued during the year.

During Q1 2008, cash used in investing activities was $2.2 million, which were primarily purchases of property and equipment. Cash provided from financing activities of $0.2 million, consisted of principal payments on the term loan of $1.6 million, offset by $0.8 million received from stock option exercises and $1 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. We do not expect to pay a higher level of cash taxes, until perhaps late in the second half of 2008. This, however, is dependent upon continued stock option exercises, which we do not control.

Adjusted EBITDA was $9.3 million for the quarter, an increase of $0.6 million or 6.6% over the same period of the prior year. This was our fourth straight quarter of generating adjusted EBITDA in excess of $9 million.

EBITDA is defined as earnings before interest, taxes, depreciation and amortization. Adjusted EBITDA represents EBITDA adjusted for share-based compensation expense.

And now that concludes our review of the financial results and the financial position of the company. Bob?

Bob Holster

Thanks Walter. Bill Lucia is now going to take us through new business brought in-house during the quarter.

Bill Lucia

Thank you Bob and good morning everyone. I am happy to record on one of the best sales quarter I can remember. First, HMS won a re-procurement in California for workers compensation third party recovery. Both the northern and southern regions were rebid, and HMS won both. Federal regulations required State Medicaid Agencies to conduct matches with workers compensation file to identify third party coverage claims paid by Medicaid that were either duplicated by worker comp payments or should have been covered by workers compensation. The contract is for three year through January 2011 and has two one-year extensions.

We also received a six-month extension of our third party liability contract with the Florida agency for healthcare administration. Since, we have a six-month processing tail on that in Carolina contract, this means that our Florida revenue stream has secured well into the second quarter of 2009.

We are very excited to have received a number of other extensions in our state business, including in West Virginia, Wisconsin, Missouri, and Michigan. Up selling to our existing state client base has been brisk, with total expansion in several contracts, to name a few Connecticut, Nevada and North Carolina. These scope expansions will be implemented in quarter two, three and four. Scope expansions can be anything from adding pharmacy recoveries, or that recovery has been previously restricted or adding our credit balance and other program integrity projects.

And in New Jersey, HMS was recently awarded a large scope expansion using our partner, Public Consulting Group to help deliver services and conduct comprehensive Medicaid Compliance Audits for 60 of the New Jersey Acute Care Providers that have outpatient partners. The scope of work will focus primarily on completing both on-site and desk reviews for all Medicaid available costs within hospital outpatient departments, and the project commences this month.

On the managed care side, we also had a very good quarter with both brand new clients acquired and significant up-selling. We now have 11.3 managed cared lives under contract with 8.2 million of them generating revenue as of the end of the first quarter. We recently signed a contract with CalOptima for pharmacy and medical recovery services, adding almost 300,000 lives to our membership. CalOptima is county-organized health system serving Medicaid members in Orange County, California. We also expanded our relationships with a number of clients including Centene where we added pharmacy and medical recovery to our existing scope of work and Molina where we added our California plant as well as pharmacy recovery in Ohio and Indiana.

And we also added plants in new states or contracts of WellCare and UHC. Our Managed Care customers are getting some embraced our programming integrity services and we've initiated medical bill audit projects with one of our major clients. We see this as a significant area of growth as our MCO customers see the value of identifying and recovering inappropriately paid medical expenses. Our MCO clients whether for profit and publicly held, or not for profit are keenly aware of the impacts that our cost containment services can have a medical loss ratio and earnings.

We continue to believe that the physical pressure that states are under is contributing to an improved selling environment for HMS. According to a survey by the Center for Budget and Policy Priorities at least 27 states will see budget short falls for the 2009 fiscal year, which starts July 1 in most states. This improved selling environment also means that states will continue to use managed care as a way to contain Medicaid cost, and HMS is benefiting from the organic growth our MCO clients are experiencing.

I'll now turn this back to Bob.

Bob Holster

Thank you, Bill. As I noted at the outset of the discussion today, for 2008 we are continuing to project that HMS revenues will grow 16% to $170 million, that adjusted EBITDA will grow 21% to $49 million, and that fully diluted GAAP EPS will increase by 28% to $0.73. All that guidance implies a full year operating margins of about 20%, although and as we demonstrated in the first quarter, there are going to be fluctuations quarter-to-quarter in that operating margins.

As Bill and Walter have described, we had a very strong quarter both in terms of revenue growth and in terms of new business and scope expansions with existing clients. That's extremely positive for HMS for the balance of 2008 and well in to 2009. We are learning to be careful about adjusting guidance before we have another quarter of data to base our projections on. Our analysis of the 2008 pay claims data that our customers provide us. This data covers more than 90% of the Medicaid program. Suggested Medicaid is growing approximately at 6% annual rate, which is consistent with historical growth rates, CMS projections, that is about what we expected when we constructed our 2008 plan.

What has changed though is that virtually all of that growth is coming from managed care rather than from fee-for-service Medicaid. Given the extent of our penetration of the managed care side of Medicaid, we feel fairly neutral about the change in mix. But it may wind up meaning that our managed care business grows faster than the approximately 50% rate we talked about earlier this year, and that our fee-for-service business grows a little more slowly than below teen's rate that we've also described.

It's going to take another quarter of monitoring data that will determine what the full year impact is going to be. It's also worth noting that we haven't seen anything in the data yet that suggest the state level cost control measures that fill the news are reducing spending or conversely that recession-driven unemployment is accelerating spending growth. Medicaid just continues to chug along at the growth rate it has exhibited for most of the last decade.

I also want to note that we are seeing an increase in competitor activity in our marketplace as we expected and as our financial plan for 2008 reflects. Maximus and ACS bid in Florida and we believe probably elsewhere. In just the past week we learned on Monday that Florida intended to enter into a contract with ACS. On Tuesday, we protested. On Wednesday, the state signed an extension of our contract that will generate revenue into the second quarter of 2009 as Bill noted.

But I'll remind everyone the competition is not something new to HMS. Our compound organic revenue growth rate for the last five years has been of 18.6% and for virtually all of that period we have faced intense competition. We believe that we are years ahead of any potentially competitor in terms of experienced track record, access to data, reference base and in terms of having achieved the economies of scale that have made our services a relative bargain for state agencies.

As Bill suggested earlier when he talked about the Florida extension, we don't anticipate that in Florida or in any other state, there is a procurement outcome that would affect our revenues for the second quarter of 2009 during the balance of 2008.

We will now be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Charles Strauzer with CJS Securities.

Charles Strauzer - CJS Securities

Hi, good morning.

Bob Holster

Good morning, Charles.

Charles Strauzer - CJS Securities

Just following on that last part about Florida and ACS and they were awarded and you protested. Can you give me a little bit more color on that, is it more of a protest based on what factors? And then also in '09, when that contract extension expires, is it going to be another rebate or what is the process going to look like then?

Bob Holster

Here is what I can tell you and you can go to Florida procurement and (inaudible) websites and you can see pretty much what we know. Last month it was announced that there had been three bidders, HMS, ACS, and Maximus. Maximus was disqualified. HMS was ranked number one going into negotiations and then the agency announced that they had had a negotiation with ACS and there was an intent to award. We didn't have negotiation with the agency. We protested the next day, signed the emergency extension of our contract. Protest in Florida and this is still an ongoing protest now, proceed pretty expeditiously, taking anywhere from several weeks to several months and what the agency and state do at the conclusion of that process is up to them.

Charles Strauzer - CJS Securities

Got it. And any sense of why they were ranked highest?

Bob Holster

We were ranked highest. The state indicated that its intent to award to ACS was based on a negotiation.

Charles Strauzer - CJS Securities

Got it. Okay, great. And then just looking at the compensation expense line again, Walter, seasonally that usually dips a little bit with the drop in seasonal revenue, but you had a little bit of a pickup sequentially from Q4. I know although you had temporary help expenses, what were some of the components for the higher comp expense there?

Walter Hosp

Well, the comp is mainly driven just by higher headcount, which I quoted earlier that keeps driving up. We are now at a more stabilized base going forward. We may still see some other incremental increases to it, but the other non-permanent, the temporary help expense I was alluding to before in the other operating costs.

Charles Strauzer - CJS Securities

So it would be safe to assume that we can build from this compensation number or may be take other down a little bit as a temporary help winds down, correct?

Walter Hosp

It's all volume driven, and we anticipate much higher volumes than what we experienced in the first quarter here.

Charles Strauzer - CJS Securities

Got it, okay. Thank you very much.

Operator

Your next question comes from Richard Close with Jefferies and Company.

Richard Close - Jefferies and Company

Yes, really quick. On the managed care side and fee-for-service, you said you are pretty much indifferent there, but don't you have a -- or on the managed care side, is there any other more, potentially a more profitable business for you?

Bob Holster

Throughout our business, we're generally allocating fixed cost to different product lines. We think of our state and managed care businesses as roughly equivalently profitable. With states, you have larger scale. But I wouldn't want to make any kind of a pronouncement about the profitability of one line versus the other. We're quite pleased with both of them.

Richard Close - Jefferies and Company

Okay. And then when we think about the pipeline, I mean clearly you added a good amount of business and expansion of scope in several states. But when we look at the pipeline of potential new business through the remainder of this year, what are your thoughts there in terms of the quantity, the quality and the competitive environment within your pipeline, whether its different kind of business than your typical co-ordination of benefits and what not?

Bill Lucia

Richard, this is Bill Lucia. I think we've a very healthy sales pipeline in all sectors of our business. In our typical state government business, we are experiencing more opportunities for our Program Integrity services and our medical cost management services that we are delivering under [Permedian] it is the number of procurements that reflect that currently.

In our managed care arena, we are both focusing on what are now the mid-sized carriers and smaller carriers in this market. And as I mentioned increasingly up-selling expanded services to those customers, and we are seeing expansion in our other smaller but growing markets in our [quality] services and our services to the Military Health care systems. So it's a very strong sales Q this year and I think the interesting thing is it’s a very diverse mix of business. So we will see different competitors, but we think we are very well established to gain ground.

Richard Close - Jefferies and Company

Could you say the pipeline currently is greater than it was a year ago?

Bill Lucia

The sales pipeline today is greater and more diversed than it was a year ago.

Richard Close - Jefferies and Company

Okay. And on the competition side though, Program Integrity could be a more competitive business than your co-ordination of benefits, your core business. Is that the case?

Bill Lucia

That is the case. Program Integrity is going to have great many competitors, but we believe the opportunity is large enough to stand large numbers of entrants to the business. And I just point out that in terms of the environment as was noted back during our prepaid comments of, we think that the physical pressure that the states are under today and are likely to be under for quiet sometime to come is making them better listeners with respect to the kinds of revenue generating and cost saving opportunities we proposed for them. We also believe that in managed care in particular, our services are reaching the status of the best practice and we don't anticipate a slow down in having managed care lives.

Richard Close - Jefferies and Company

Okay. And then with respect to the potential, Florida I guess, it's going to be under (inaudible) here for a little while, while the process works itself out. You mentioned that you have the extension through October and then you will still tail through I guess Spring or April or sometime frame on that front. Let's say hypothetically that Florida goes away beginning sometime late second quarter, third quarter of 2009. What do you think now that whole is from Florida potentially, and based on the commentary on the pipeline its sounds like you have potentially more than enough to fill that hole?

Bob Holster

Let me try to respond. The list that Bill worked through in terms of new business opportunities closed this quarter, exceeds in revenue value - our revenue from Florida in 2007. Florida is experiencing as our many steps, a swap between fee-for-service and managed care. We did about $8.4 million in revenue in Florida last year. But it timely got after the second half of 2009 and we will pass our processing table in Florida. In the worst case, we would expect that the fee-for-service component will be running at a lower rate than that. So, it could create based on the size of business we anticipate being in 2009 and without meaning throw out formal guidance, we'd expect to be somewhere in the 200 million revenue range. We are talking about closing up 2% to 3% gap.

Richard Close - Jefferies and Company

Okay. And then just finally, would you say you are confident in your business and the prospects today than a year ago?

Bob Holster

Unquestionably yes. We've had significant development on the managed care side obviously. We see a political environment that is not espousing changes that would offer any risk to our business. We see healthcare cost having packed in other year of 6% to 7% growth, and as we indicated the Medicaid paying client data is telling us we are still on that same track. So, from a macro standpoint, we feel that we have never been in better shape.

Operator

(Operator Instructions). Your next question comes from Whit Mayo with Stephens Inc.

Whit Mayo - Stephens Inc.

Thanks, good morning. Just with respect to Florida, again just to make sure we had this right. How much did Florida contribute in revenues in 2007, I know it's not nearly a largest state anymore?

Walter Hosp

$8.4 million.

Whit Mayo - Stephens Inc.

Okay, great. And just with regards to what sounds to be a mix shift right now and sort of the fee-for-service lives to managed care. Most of the managed care payors have talked about higher medical cost trends over the past quarter and the hospitals are sort of seeing that, in a general sense, they all tend to be discussing sort of an uptick incentive in just managed care volumes right now. Can you talk a little bit of maybe looking at just the amount of claims information that you guys are seeing flow through your Q just irrespective of just the shift in lives from one bucket to the other?

Bob Holster

What we are seeing in fee-for-service is very little increase in the claim volumes or dollar value. What we're seeing in managed care, varies carrier-by-carrier, but it's in double digit increases in dollars paid. It's that managed care spending that -- when we say Medicaid at about 6% rate of increase, we believe it's all being averaged up by the managed care from what otherwise be flat. I don't want to imply greater accuracy than we have. We have the spending dollars on both the fee-for-service and managed care side. We don't know always have the headcount that precisely matches up against those dollars.

Whit Mayo - Stephens Inc.

What would be your sense that maybe just looking at utilization trends overall in the managed care area that would be ticking up right now?

Bob Holster

Yes.

Whit Mayo - Stephens Inc.

Okay. Just want to make sure. And looking at the managed care lives, can we get -- I don't know if you gave up the revenue number for what that segment contributed within the quarter?

Bob Holster

What we've said is that it doubled from our first quarter of 2007 number. It was precisely a double.

Whit Mayo - Stephens Inc.

Okay. I can back in to that. And Bill looking at your states right now, how many of the 40 states would you say you're providing some level of Program Integrity or medical cost services right now?

Bill Lucia

I would say that about a third of the states receive some form of Program Integrity services. What we call Program Integrity services. So it could be anything other than a coordination of benefits, overpayment, recovery or audit. They have not necessarily been procured through department of Program Integrity or fraud waste and abuse within the state. So we think there is a much larger opportunity even in that third where we are performing some of those services to expand.

Whit Mayo - Stephens Inc.

And within that third, would you say that those were some of the larger states, the New Jersey's, New York's the Florida's or with those be some of the combination of large and fall states, just trying to get a sense of how that third compares to the dollars overall?

Bill Lucia

It's a mix.

Whit Mayo - Stephens Inc.

Just a mix?

Bill Lucia

The couple of our large states will continue to ask us to provide more services and there are great opportunities for mining data to look for abnormalities in our claims processing and some of the small states are very progressive too. So it's really a mix between the two.

Whit Mayo - Stephens Inc.

Okay. And just looking at the state procurement cycle, how many additional states do you have contracts coming up for rebid over the next 12 months?

Bill Lucia

We've got anywhere between four or five. I just caution you with that and that we've been saying kind of a record number of extensions too, sort of extensions beyond the typical period. So while we have four or five up for reprocurement probably over the next nine months, some of those may end up just being expensive.

Whit Mayo - Stephens Inc.

Okay. And just maybe one final question. Just Walter and in terms of CapEx for the year, how should we think about that?

Walter Hosp

Well, we gave guidance last quarter of around $8 million number.

Whit Mayo - Stephens Inc.

Okay.

Walter Hosp

I think that's still good.

Whit Mayo - Stephens Inc.

Okay. That's all I got. Thanks guys.

Operator

Your final question comes from Charles Strauzer with CJS Securities

Charles Strauzer - CJS Securities

Hey, just one quick follow-up. Maybe Bill this is for you. Just a little bit more color please on some of the federal opportunities with the first task order being led out and you have had the chance to kind of do a little bit of a postmortem there. What are the some of the kind of the machinations you're seeing within the bidding processes and some of the--? When you look at the kind of the mindset of CMS that and the awards that have been made, are you adjusting the way you're bidding for future task orders that are out there?

Bill Lucia

I really can't comment on the mindset of CMS, but I can tell that we've been told that number between 2 to 5 additional task orders will be less over some relatively short of period, meaning over the next 12 months. So, we are still confident that this opportunity in the Medicaid integrity contracts arena. We also think that our states will require assistance from us, when they are under the federal audit and they need some better data mining expertise to help them, actually go and do the recoveries from the providers. And then on the other federal fronts, the Medicaid recovery audit contract is, CMS has said that that is expected to be awarded in May. So we still believe there is a great opportunity in the federal market for HMS and we're still pursuing it.

Charles Strauzer - CJS Securities

Got it. And the last part you just talked about, Bill the one that is coming up in May, is that for an additional state if I'm correct into the program?

Bill Lucia

That’s a Medicare we are at and it's being expanded from three regions to four, but all of them are being reprocured.

Charles Strauzer - CJS Securities

Got it. Okay, great. Thanks.

Operator

At this time, there are no further questions. I would like to turn the call back over to management for closing remark.

Bob Holster

Thank you all for participating in the call and we look forward to speaking with you next quarter. Thank you.

Operator

Ladies and gentlemen, this concludes today's HMS Holdings Corporation first quarter earnings conference call. You may now disconnect.

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Source: HMS Holdings Corp. Q1 2008 Earnings Call Transcript

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