HMS Holdings Corp. (HMSY) CEO Bill Lucia on Q3 2019 Results - Earnings Call Transcript

Nov. 01, 2019 5:40 PM ETHMS Holdings Corp. (HMSY)
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HMS Holdings Corp. (NASDAQ:HMSY) Q3 2019 Earnings Conference Call November 1, 2019 8:30 AM ET

Company Participants

Robert Borchert - SVP, IR

Bill Lucia - Chairman & CEO

Jeff Sherman - CFO

Conference Call Participants

Ryan Daniels - William Blair

Matthew Gillmor - Baird

Jailendra Singh - Credit Suisse

Jamie Stockton - Wells Fargo

Richard Close - Canaccord Genuity

Donald Hooker - KeyBanc

David Windley - Jefferies

Charlie Strauser - CJS

Daniel Grosslight - SVB Leerink

Stephanie Demko - Citi

Vikram Kesavabhotla - Guggenheim Securities

Operator

Ladies and gentlemen thank you for standing by. And welcome to the HMS Third Quarter Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions]. Please be advised that today's conference is being recorded. [Operator Instructions].

I would now like to hand the conference over to your speaker today Robert Borchert. Senior Vice President, Investor Relations. Please go ahead, sir.

Robert Borchert

Thank you, Victor, and good morning everyone. Joining me are Bill Lucia, our Chairman and Chief Executive Officer and Jeff Sherman, our Chief Financial Officer. This call is being webcast and could be accessed via the Investor Relations section of our company website at hms.com.

Today's press release highlighting our financial results is posted on our IR website. Bill and Jeff will first provide their perspective on our recent financial operating results and business outlook and then we will open the line for questions. We ask that you please limit yourself to one question and one follow-up, so we can get through the full queue in a timely fashion.

I’d like to remind you that the financial results reported today and in this morning's press release are preliminary and are not final until the Form 10-Q for the third quarter ended September 30, 2019 is filed. Some of the statements we will make today are forward-looking in their nature based on our current expectations and our view of our business as we see it today. Such statements, including those related to our updated full year 2019 financial guidance, future financial and operating performance and future business plans and objectives are subject to risks and uncertainties that may cause actual results to differ materially. As a result this should be considered in conjunction with the cautionary statements in today's press release and the risk factors described in the company's most recent SEC filings, including our Form 10-K.

Finally, we may refer to certain non-GAAP financial measures this morning. Reconciliations of these measures to the comparable GAAP measures are included in our press release posted to our website.

With that, I'll now hand the call over to Bill.

Bill Lucia

Thank you, Robert, and good morning everyone. HMS did post mixed results for the third quarter versus a strong quarter this time last year. With revenue and adjusted EBITDA down year over year but cash flow is up significantly. Through the first 9 months of 2019, our total revenue increased 4.6% with the adjusted EBITDA up 16.5% including the reserve releases in both years and investing gains this quarter. We continue to generate strong cash flow with year-to-date operating cash flow up 60% from a year ago on a comparable basis. This significant cash generation is enabling us to invest in our IT infrastructure and product capabilities in order to support our future growth.

Overall we remain confident in the trajectory and strength of our business given our year to date performance, recent expansions of client work and very strong contract signing in Q3 across all lines of business. With respect to each of our service lines we have mentioned on past calls the potential for quarter to quarter variability which on the whole impact us favorably in Q2 and negatively in Q3. COB revenue did decline 10.5% when compared to one of the strongest COB quarters ever in the third quarter a year ago. This year over year decrease can also be attributed primarily to the timing of recoveries related to certain customers. And as we have said in the past, we have good visibility on an annual basis. While our quarterly COB revenue can be lumpy as third party carriers do treat our Medicaid COB claims differently than original claims from providers. Their systems at times we're just not prepared to handle the lines of claims or eligibility transaction we generate. This is not a new phenomenon on COB but it's important to understand that we cannot control the precise timing of third party activity.

The key point is that the revenue opportunity in COB is not lost and we expect this revenue to rebound in the fourth quarter. We currently anticipate mid-single digit revenue growth for COB for the full year as we had originally planned. We continue to work on having our COB growth by leveraging machine learning and automation and through product development such as our real time insurance identification an eligibility verification solution.

Payment integrity delivered another strong quarter with revenue up 11.1% from Q3 last year as we're seeing encouraging trends in this solution adoption within our existing client base for both commercial and government programs. Of course our PI business opportunity is supported by the CMS heightened industry focused on program integrity as announced in the last two weeks by administrator [indiscernible].

Our population health revenue in the most recent quarter was essentially flat on a year over year basis but up 8.8% sequentially from our second quarter. Our consumer engagement platform Eliza continues to be the primary driver of our PH revenue, which today is still primarily a volume driven transactional business. We are working to balance our sales efforts between the signing of longer term recurring revenue agreements and shorter term transaction oriented services and revenue.

And in the beginning of 2019 we integrated he PHM sales into our overall commercial sales force. This approach unfortunately did not work as we had planned; we have not attained our sales targets so far this year. As a result we are refining our go to market strategy and rebuilding a sales team focused solely on PHM which includes hiring both new sales leadership and talent. To be clear we continue to gain traction in the market and our sales pipeline for PH is solid.

We did sign our second at risk Eliza deal this quarter with a large national payer. In which we have upside revenue potential based on the achievement of certain key performance indicators including improvements in Eliza scores and our ability to close gaps in care through appointment scheduling. A number of our recently signed contracts are much more complex but also recurring in nature so revenue will ramp and then be recognized over a longer period of time.

We also continue to build awareness of our PHM capabilities what their state clients. In fact our interactions with certain state leaders have led these specific discussions about how HMS can help with programs designed to increase childhood immunization rates, reminders the Medicaid members to complete their eligibility redetermination and very critical initiatives like reaching out to individuals on life sustaining medication impacted by adverse weather events. Most recently we signed her first contract in which a customer will pair both our risk stratification and analytics solution alley with our set care management platform. And we have another similar sale pending. This win is a great example of why we acquired that [indiscernible] which is the predictive and prescriptive analytics engine with Eliza.

Our algorithms and analytics use historical claims and social determinants of health data to identify high and rising risk members as early as the point of enrollment so how plans can proactively engage members from day to prevent high cost event. It's also why we believe Eliza is distinct from other risk stratification tools. Our ability to connect high and rising risk with care management and consumer engagement places HMS in a very strong competitive position to help our customers actively manage their members care.

Our Eliza analytics then inform us how the engagement is executed from the wording of the message to the mold used to communicate, took the timing of the outreach and at scale.

Additionally in early October we invested in MedAdvisor, a leading digital medication management company in Australia. This alliance with our strategy to continue to evolve HMS population management capabilities in the US but also advance our international growth initiatives in Australia and the United Kingdom and nurture continued innovation to improve clinical outcomes. We intend to pair the MedAdvisor medication management software platform with our PHM solution as part of this strategic relationship.

In summary for the quarter we believe our recent sales momentum and strategic investment combined with very positive market trends offer numerous opportunities for growth and support our outlook for the remainder of 2019 and into 2020. We will remain focused on delivering on our clients expectations to continue to help them to cross curve and improved clinical outcomes and quality. Jeff will not provide additional details on our third quarter performance Jeff.

Jeff Sherman

Thank you, Bill and good morning. While our financial performance in Q3 was not up to our expectations we did deliver solid quarter in terms of cash flow and we currently anticipate sequential revenue and earnings growth in Q4. As Bill mentioned, our business model has the potential for some quarter to quarter revenue variability which is why we provide annual guidance and remind you not to extrapolate anyone quarters performance as a trend. For COB specifically we currently expect revenue to rebound in the fourth quarter.

Year to date on the service line basis COB revenue was up 2.5% compared to the same period a year ago, PI increased 9.1% excluding the reserve really and PHM revenues up 5.8% during the same period. This implies that overall we are trending below our initial guidance for revenue growth communicated back in February.

Year-to-date our adjusted EBITDA margin expanded 110 basis points when you exclude this quarter investment gain and the reserve release it in both the years. This is in line with our long term expectation based on the inherent operating leverage over business model. Third quarter 2019 adjusted EPS was $0.30 per diluted share versus $0.31 per diluted share in Q3 a year ago. This quarter included an adjusted EBITDA benefit of $7.7 million and an adjusted EPS benefit of $0.6 per share from an investment gain we recognized in Q3 related to our investment in InstaMed following that company's sale back in July.

Adjusted EPS this quarter also included about $1.7 million of deal related costs or a penny a share in our adjusted EPS. Our cash flow in the quarter remains strong with operating cash flow of 9.3% to $34.8 million compared to the third quarter of 2018. Year-to-date operating cash flow of %$112.9 million increased 60% from a year ago on a normal basis adjusting for a settlement payment last year and its higher than any full year of operating cash flow in the company's history.

Quick cash and cash equivalents$281 million and total debt return $40 at September 30, 2019. We continue to have a very strong balance sheet and liquidity profile. This is after a $36.6 million acquisition of [indiscernible] September funded with cash on hand. As Bill noted in early October we made a $7.5 million investment in MedAdvisor a leading digital medication management company in Australia for approximately 13% ownership stake in this publicly traded company. This investment launched a strategic relationship in line with our strategy to evolve our PHM capability and advance our growth initiatives. We remain focused on executing our business plan at a high level and our capital allocation strategy continues to be geared towards investing in our IT infrastructure and enhancing our product and sales capabilities. We are continuing to focus on potential acquisition opportunity and will move forward with the transaction if it meets our strategic and financial criteria.

In addition our Board of Directors has authorized to repurchase of up to $50 million of the company's common stock on a discretionary basis for a period of up to two years. We plan to be opportunistic in our approach to share repurchases. We updated full year 2019 financial guidance today to take into account our recent performance and outlook for the remainder of the year. We now expect our total company revenues of $630million to $640 million. This would be year over year growth of 5.4% to 7% when you include the reserve releases from both years. This implies Q4 revenue of $167 million to $177 million when we currently expect COB, PI and PHM to show growth both sequentially and on a basis.

We're now projecting full year adjusted EBITDA of $182 million to $187 million represents growth of 12.3% to 15.4% over 2018. Similar to revenue we are including investment gain this quarter and the reserve release in both years and we're now projecting full year 2019 net income on the being a range of $89 million to $94 million which would be year over year growth of 61.8% to 70.9%.

Additional details on our revised outlook for the year were provided in this morning's press release, now posted on our website which will help address more detailed modeling questions. As we close the year we will continue to focus on delivering positive results for our clients and for our shareholders. Bill now offers some concluding remarks and then we'll be ready for questions. Bill?

Bill Lucia

Thank you, Jeff. We do believe the overall industry environment should continue to be a tailwind for HMS. The CMS continues to heighten its focus on program integrity and we will leverage our significance payment accuracy experience to expand COB and PI services to both commercial and Medicare advantage plans. Recent data from Kaiser Family Foundation highlighted that the uninsured rate has been rising since 2017 and now approximately 15 million uninsured individuals are eligible for either Medicaid or other subsidized marketplace insurance coverage.

HMS is very well positioned to provide services to government and managed care organizations as efforts continue to get these uninsured populations covered including the 20 state that plan some type of Medicaid eligibility expansion in fiscal year 2020. Additionally the Keiser report showed many state have a plan focused on pharmacy cost containment, Medicaid buy in, opioid misuse prevention and other payment accuracy and quality initiatives that are aligned with their offerings. These are solid indicators of the current and future business opportunity for HMS as we continue to help move the healthcare industry forward. HMS has a large footprint across both the government and commercial market place. This clearly stepped up apart from our competitors as we are uniquely positioned to deliver increased value and innovative solutions across a large set of diverse client and partner.

In closing we remain committed to both organic and inorganic growth and I am confident the entire HMS organization is up to the task of delivering enhanced value for our customers. I'd like to thank our employees, our Board and our shareholders for their continued support.

Operator we are now ready for the first question.

Question-and-Answer Session

Operator

Q - Ryan Daniels

Good morning guys, thanks for taking the question. Bill hope you could provide a little bit more detail on the population health management business. Can you talk a little bit more about the sales force restructuring kind of what the initial call was in integrating that with the existing sales team and then what did occurred to drive sales and how the new reorganization there will in your view help going for based on the pipeline?

A - Bill Lucia

Thank you, Brian. So we do have a strong pipeline by the way, I should reiterate that and had strong sales closing in Q3. But I think what we decided early on was that we were consolidated primarily under our commercial sales team and that we would attempt to train the entire team and account management team on the, what are pretty unique complexity of the PHM business. While we do sometimes sell to the same buyers, I think what we found was that we needed a different type of individual to sell the PHM product line, we needed people who are most in understanding the quality measures that health plans focus on the unique programs that we can deliver and then of course a fair amount of this is also a technology which is not always the case with our COB and PI services. When we realized that we were not getting the track and we had anticipated we decided to regroup. Build a new sales force focus solely on PHM sells and particularly knowledgeable about the integration of the three products that we are now delivering and you could imagine LE is a very complex sale because of this predictive and prescriptive analytics and importation of social determinants of health, you really do need a different type of sales person for that and so we chose to do that and recruit a leader over PHM sales and have that report directly into our division President who leads the population health management business. So we're starting to see that only fruits of that change but that we should expect to see more volume from that and more cross sell activity in balance of the year in 2020.

Q - Ryan Daniels

Okay so is that build out fully complete at this point and are we seeing that still the marketing spend reflected or they're still a number of hires leadership for direct sales the kind of what's the size of the team how far along are you in the process of establishing that new group?

A - Bill Lucia

Yes I don't know the exact size of the team but we are still building out the team. So we're still interviewing and hiring and it's not to say that we're we are not leveraging our existing customer base. We have sold to existing HMS client that previously had not use either [indiscernible] so we have done that but and we will continue to drive those leads from our account management team but we're not done completing the build out of the sales team. With that said we did have a strong Q3 sales closing our contract closing quarter and as we said before for most of our PHM. Products particularly it’s a pretty fast from closing your contract to revenue generation, it may go lot up over time but it's a pretty fast implementation.

A - Jeff Sherman

Yes. And then I would just add our PHM products continue to be well received by our clients and prospects in the market, so we are optimistic about the growth potential for this service line given the breath of opportunities and what we consider to be a multi-billion market. In our care management product, we are up 30% year over year in the first 9 months of the year, so we are seeing traction here obviously smaller numbers but I think the three products combined, we believe there's a very good opportunity. Ellie as we came into risk ratification product we expected there was going to be a slower ramp as Bill noted we are getting some traction in state market which we knew was going to be a much longer sales process but getting more traction with Ellie and some winds we build momentum as we head into 2020.

Q - Ryan Daniels

Okay, thanks a lot guys.

Operator

Thank you. And our next question will come from a line of Matthew Gillmor from Baird. You may begin.

Q - Matthew Gilmour

Thanks for the question. I wanted to ask about the COB performance I appreciate you had a difficult comp this quarter, I think Bill also mentioned there were some payers that had some system issues processing the volume of the COB claims, I was hoping if you could provide some more details about what causes delays and was that specific to subset of payers or was it more of a broad based trend?

A - Bill Lucia

Thanks, Matt. This happens relatively consistently in our business but sometimes it paddles on as of had in Q3 of 2017. So we had I’m not going to name paddlers but we have a PBM whose system was not capable of managing the volume of eligibility verification that we push through. Now that's very important to us because our clients while we get data on a daily weekly or monthly bases our clients really wants to verify very detailed information about a policy whether it's a pharmacy benefit or medical benefit and it get down to group number and pharmacy I'm going to use some weird words but PC and then if that's specific. To be able to load that into our client system we verify and if they can't handle our verification transactions that volume and need to consider with 40 plus state and a couple hundred Medicaid plans, we are processing a lot of volume because people coverage changes frequently.

So that happened we had another PBM that was not capable due to system limitations of processing all of our clients, so doing out, I don’t know a 1000 claims a week or something that’s very low volume for us and then a couple payers typically they are large regional payers, that have problems or their systems for Medicaid claims shutdown and then we process again this is where we don’t loss the revenue we process the backlog when their system is ready. So we unfortunately had more of that in this quarter and then we typically do and what happens after they turn the final back on or turn the tap back on is basically we catch up. And sometimes in a rapid fashion, sometimes not so rapid in the fleet out over couple of quarters because they're processing systems are still you know they can only x number of claims per week. So that happened a little more in Q3 and obviously a lot less in Q2 based on our Q2 performance.

A - Jeff Sherman

And I would just add, recall the sate occur in 2018 we had a very strong Q3 in COB and we are up 8% year to date three quarters and we finished the year up about 3.8% it also happened in 2017 when we had a week Q3 and finished the year with a strong Q4. So I think as Bill said it's not a new phenomenon, there are quarter where we have more of this go against us our Q3 was certainly that way a lot more than we expected but we do expect it to rebound in Q4 and still respect COB overall to be up mid-single digit in line with our original expectations.

Q - Matthew Gilmour

Thanks for that and then I was hoping just if you could, have you seen any other trends accelerate as earlier in the fourth quarter or just bigger picture looking at the business and normally you see when you have a service lower period one quarter tends to bounce back. Just want to see if you had visibility into some of those claims processing accelerate here in the fourth quarter.

A - Bill Lucia

We have a lot of work going on in the client by client base now we look at a client by track it that way. We're actually looking at them some new ways of doing some of our work that can help some of the backlog that that have occurred introducing more automation or technology into it. So I would say at this point knowing what we know we expect to see a rebound in Q4 and we it very detail, basically on a client specific basis. And we remain confident that we will see rebound in Q4 at this point.

Q - Matthew Gilmour

Okay, thanks very much.

Operator

Thank you. And our next question comes from the line of Jailendra Singh from Credit Suisse. You may begin.

Q - Jailendra Singh

So want to follow up on the previous question, I mean you guys talking about the short fall in third quarter to quarter to quarter variability in your business but at the same time you guys actually reduce your full year revenue outlook by essentially the same amount as the miss in the quarter so are you actually are reflecting any reversal or recovery of the third quarter revenue shortfall in Q-4 or is it more just being conservative that let's assume that just whatever $19 million, $20 million shortfall in third quarter does not reoccur in fourth quarter. Help us reconcile those comments around the business?

A - Bill Lucia

Well there are two component, COB was what the principal driver of the revenue shortfall for us. PHM population health management business was the remainder, so I would say roughly about 2/3 of the shortfall is related to COB and the remainder for the most part majority of it was on the PHM side from our own expectations. We've already address the PHM side with, so the PHM side we expect to see growth in there but to the extend we were short there in the quarter. We won't expect that to catch up for the year. And then on the COB side, as Bill said, we'll see some of that come back in Q4 and then we'll see some of that bleed over, probably into the next year because at times, the real -- there are still so many volume of claims that the carriers can process and then finally I would say, we are expecting in our applied guidance, revenue of $167 million to $177 million. Each would be -- each of those ranges would be almost a single largest revenue quarter we had. So we do expect a pretty strong rebound in revenue in Q4 and from the COB side, we'll get some of that back with some of it could bleed into the following year.

Q - Jailendra Singh

Okay and then my follow-up. I've been having some concern in the marketplace around Medicaid illegibility verifications having impact on Medicaid enrollment and utilization frame. Have you seen that having any impact on your business, especially in COB segment? Any thoughts, that will be helpful.

A - Bill Lucia

No, we've really not seen. Medicaid enrollment has not grown as fast but we have not seen an impact -- a negative impact on the volumes that we -- so our key indicator -- our leading indicator is claims spent, dollars of claims and number of claims coming through our systems and number of lives, right? We've not seen any big data in that as we process month-to-month. Now some of it is because we continue to get increased scope, classic spend what we're able to do. We may get additional lives. So a client turns on their CHIP population, they may in the past have restricted us from pursuing the eligible and now get them. Those in our data fee, but we also have states that are expending some Medicaid eligibility. Some as more broad, like a general legislation in Canada and you thought how they're a waiver in front of CMS that was on the ballot actually this year and past to expend much more broadly than initially proposed. So we continue to see expansion in some states more broadly and other states on specific populations. So I don't think -- I think we continue to outgrow. We will continue to outgrow. Our revenue will likely outgrow the patient's Medicaid enrollment. And I think it's primarily because you have to remember there is always turn. People move on and off Medicaid, they move between health plans and they move on and off commercial insurance or employers insurance. All of that turn creates revenue activities for HMS.

A - Jeff Sherman

And I would just add, the most recent data shows Medicaid enrollment actually down 2% off year-over-year. We're expecting COB revenue to grow in the mid-single digit. So our yield activities are continuing to drive revenue there. Our COB revenues broken into costs and orients, where we find other coverage and then when we find other coverage, other half is recoveries, we continue to see great opportunities that will cover more dollars for where we find the policy and can go back 3 years and so. There's opportunity there. The technology investments we're making are continuing to help drive higher returns are yield there and that remains a focus as we are in the Q4 and 2020. Continuing to invest in those yield activities.

Operator

And the next question will come from line of Jamie Stockton from Wells Fargo.

Q - Jamie Stockton

I guess, maybe just to follow up on some of these other questions on COB. It sounds like you guys are saying that there isn't really any shortage of demand. The issue is from a shortfall standpoint on the client's side at all. Is that correct?

A - Bill Lucia

I mean -- look we have scope changes that happen almost quarterly. But net-net, every quarter of every year, the scope changes. That has to be positive of us, right? Because whether you're a state or you're Medicaid plan, which is on way certain margins, you really want to bring those dollars back or you want to make sure you're being as innovative as possible and rejecting those claims early on and getting the provider to build a -- the commercial payer endurer and typically a payer that paid that provider more. So it's a win-win for the healthcare system. But we've been doing COB for 40 years and in that 40 years, while we've grown the business significantly, for 40-year old service -- technology-based service business to continue to grow it mid-single-digits, while the enrollments not growing, we are going to see lumpy quarters. But we've seen lumpy quarters in the past in this business and it will continue. I don't expect that this will always be a smooth line and again, it's because we don't control the behavior of third parties.

A - Jeff Sherman

And this is -- this continues to be a very high ROI product for both our commercial and government customer day needs. So I think on a demand side, given the ROI we deliver, we haven't seen a slowdown in demand. This is more in the claims execution side, where, again, we don't always control the data piece coming in when we get data from carriers and we can't control the processing timing per se on a quarter-to-quarter basis, but again at the end of the day, it's federal law that they process these claims. So we still see opportunities to continue to get better and recover more dollars.

A - Bill Lucia

And I think we have bucketed this or I guess in general, we've talked about this being Medicaid COB, but in reality, COB -- the COB opportunity, while in Medicaid continues to grow, is strong in both the commercial and Medicare markets. And so this year, we've had some good successes in helping our clients in their part D COB, which we will be expanding that in our sale activity to part D plans as well as Medicare Advantage and then eventually a product offering that will serve the commercial-to-commercial COB market. So COB is a, I hate to call it this, a gift that keeps giving because we are the experts in it and we plan to expand it into market areas.

Q - Jamie Stockton

And then the buyback, I mean this is just kind of a technical, the old program was expiring and some capital allocations standpoint. You guys are still going to disproportionally focused on M&A?

A - Jeff Sherman

I mean Jim, we still continue to review -- view our share repurchase program as an important component of -- just as proven in catalogue, allocation of strategy and consistent with our overall commitment in building shareholder value. I mean, our cast for resistibility to continue to invest in our business, continue to do rigid acquisitions and we'll be opportunistic on share buyback side. In the last 4 plus years, we've bought back over $90 million stock, over $7 million shares at an average price of below $13 a share. So I think we've been a good deployer of share buybacks and we've been opportunistic and I would expect over time, we'll be opportunistic as well with this buyback program.

Operator

And our next question will come from line of Richard Close from Canaccord Genuity.

Q - Richard Close

Jeff, I was curious, I appreciate the breakdown of 1/3, 2/3 on the revenue shortfall. Is that how you think about the EBITDA as well, in terms of shortfall there, in terms of 1/3 p of population health than the remaining COB?

A - Jeff Sherman

We don't generally break it down by a product-level basis, Richard. We said based on the PHM, particularly Eliza had margin similar to the company's overall blended margins and COB is a high margin product for us as well. So clearly, with the majority to revenue shortfall in COB that that had impact on earnings in the quarter. In our revised guidance, if you went to our revised guidance and our previous range was 185 to 190 or now at 182 to 187 with the revenue shortfall. So we are continuing to see good margin performance and good leverage on the revenue we're generating. Q4 last year was our highest margin quarter for the year. But as I said in my prepared remarks, we're still at 110 basis points and margin to the first three quarters of the year, normalizing for the reserve of this end-of-game we have in the quarter. So we are continuing to get leverage on our revenue and we expect that that trend will continue into 2020. The thing is we're doing to drive yield, investment in technology that are allowing us to become more efficient on the processing side and generate incremental yield and revenue for -- or allow us to continue to drive margins, we believe in the fourth quarter as well as into 2020 and beyond.

Q - Richard Close

And then with the respect to the population health and the sales force restructuring or building an independent or specific sales force there. Do you think this changes the timelines associated with move -- trying to move the business from a volume or transactional perspective to a subscription? And just any thoughts on how we should think about that revenue model trending over time.

A - Jeff Sherman

So I would say with the Eliza piece, which is the biggest piece of the PHM revenue today. We are still seeing the subscription model sales. We are expecting those to grow. I would say, for the exact care of management and any risk stratification product, those are principally, if not, entirely subscription model sales now. Except was a software model as we bought it and when we bought it and now we're moving that sale more into the subscription model. So I think, our view is still the seldom, as a combined package over time in a subscription model, where we're headed but the subscription sale we expect on the Eliza side, it is going to come from existing customers. We don't expect we're going to sell that into a new customer without the ability to prove what our capabilities can do.

Operator

And our next question will come from line of [indiscernible].

Q - Unidentified Analyst

So you talked a lot about those strong sales closings and pipeline. I know it's a little bit early but can you give us some thoughts about growth in 2020, specifically in just terms of general sort of guideline?

A - Jeff Sherman

Yes, we'll give guidance, Steve, in February. We certainly think we're positioned for continued growth as we head into 2020. As I look at where we're at, we had a similar quarter 2 years ago in the third quarter of 2017. I think the company is much better positioned today evident to the following fiscal year, given just the overall, what we view as strength in market position and COB are merging growth in payment integrity and I think just the product offering in market acceptance we're getting for PHM. And as I said earlier, we expect to be able to continue to expand margins as well. So I think we're optimistic heading into 2020. That we'll be able to continue to grow and see margin expansion, we'll give more specifics as we give guidance in February.

Q - Unidentified Analyst

That's fair. And one other question on PHM and rebuilding a stand-alone sales force. Were there individuals who moved into the larger sales organization and who will now move out or do you have to -- is it really a full rebuild going out and rehiring or hiring new people?

A - Bill Lucia

Well we don't -- I mean what we did, we do have a staff of sales people. It's just not as large as we've liked and we did have -- we didn't necessarily have people who move around, I mean, they move in the PHM from other areas. We just consolidate it on to a single leadership and it didn't get the focus that's needed. Again because the sale is pretty complex. I mean the thing that I like about it is and we did say this from we bought Eliza. It will take a while for our state clients to see the value of some of our PHM product line [indiscernible] to probably a half of those in states this year, I've got about five lined up in November alone, who have interest in talking about how we can help them move the needle on the CMS scorecard, which are basically heated scored and they're often around things that are very important as MediKids [ph] getting flu shots, very important thing to happen this time of year, raising childhood immunization rates, making sure people have a more electronic way to be reminded that they have to go to their Medicaid eligibility redetermination instead of sending them stuff in the mail, they get to 10% response rate. So the state market is just starting to become a market where -- and of course the sales cycle -- there's longer because of a more structured procurement process and we have hired a state market subject matter expert in the space that we will be deploying to help in presale and sales support activities. So I think we feel very strong about the product line and its fit but we just didn't -- we did not take the right moves, in terms of consolidating the sales team and now we're fixing that.

A - Jeff Sherman

And then on the state side, about the quarter of the lives are in traditional pay for service, Medicaid. But the states are still managing on -- half the cost. So the states are still managing the really sick patients and are not using much or any technology to do that. So I think our ability to help them manage population that's failed, we've got population health management solutions. It's going to be a very attractive.

Q - Unidentified Analyst

And when do you think that you -- the majority of that rebuild will be done?

A - Jeff Sherman

I would say in -- yes we're looking to be done with the rebuild in Q4 and expect that as those people come on board and become part of the sales process that we'll see quite a [indiscernible] in 2020.

Operator

And our next question comes from the line of Don Hooker from KeyBanc.

Q - Donald Hooker

Just want to get maybe some thinking around the VitreosHealth acquisition and collaboration with Medivizor. In my mind, should I think about that being a tailwind to revenue growth in as near as 2020 or is this going to be kind of a longer-term revenue synergy story?

A - Jeff Sherman

Yes. We've been working with Vitreos over the past year plus and they had been really the predict [indiscernible] component of our restratification product Eli. And so as we view that comprehensive sales approach now with Eli and fully integrate Vitreos. It's certainly going to be part of our growth story for Eli in 2020 as Bill said, we are just continuing the early ramp of the restratification product. I think most importantly for us as we have talked with some of the large national payers as well as some of the states that Bill has been meeting with, there really is not a product similar to this in the marketplace and when you combine that with our ability to -- once we have restratify to actually help engage patients to actually change their behavior to improve clinical outcomes, that's what we think we're well positioned -- uniquely positioned from both our client base and our product offering to see traction here.

A - Bill Lucia

And I will just add. Particularly when it comes to the investment in Medivizor, that was for a numerous reasons. One, there is a significant -- it's an international problem of people -- of medication adherence. And there's clearly a lot of stakeholders interested in that. First of all, the quality and outcomes for the patient, but also Pharma is very interested in making sure, particularly in nations, where they don't get paid as much as the U. S., very interested in making sure people are taking their drugs and refilling their prescriptions. So medication adherence is a global issue and we think with our investment in MedAdvisor we can address that better in the U.S. and also help address that internationally by also plugging in our lives and Elli risk analytics into the solution. So it is a multi-year plan. We're in this for the long game. This is not -- I know we get measured quarter-by-quarter but we're in this for the long game and we believe we have the trifecta in population health management and it's just going to take some time for these very complex sales to come to fruition both in the U.S. and in Australia and the U.K. which are the other markets we'll be focusing on.

When you -- we think about the MedAdvisor investment in the U.S. Interestingly, based upon what they've done in Australia there's really 3 potential customer segments. There's big pharma that's interested in seeing medication adherence improve. There's the large national chains. Equally important, if not more important for us and say health plans, making sure patients are taking their medication so that just opens up. It's a very complementary product to our lives outreach and offered -- it really opens up an interesting opportunity for us in the U.S. and then also it gives us the channel to expand our population health management offerings internationally.

Q - Donald Hooker

Super and maybe my follow up would be on the payment integrity area, which seems like you had some nice numbers there in the quarter. It's good to see that. Maybe love to hear kind of high-level view of the competitive environment there may be in the context of some united and another player. Any anything to talk about their competitively?

A - Bill Lucia

Well, the United slash off their acquisition of Equian really doesn't impact us much because we do very little what you consider traditional payment integrity with United. They are a coordination-of-benefits customer but Equian doesn't do Medicaid coordination of benefits. So that really hasn't impacted us. Our traditional competitors in the payment integrity space have continued to be the same competitors we've talked about in the past. And we just -- it's an area where we just continue to invest in technology invest in the account management framework around that business and get better at delivery; that's our goal.

A - Jeff Sherman

I think as we look at the total addressable market for payment integrity, we still think is $5 billion to $6 billion-plus and so there's a lot of white space opportunity to capitalize on there, both with our historical client base and the Medicaid -- managed Medicaid side. Medicare Advantage, we still see a lot of opportunities there. The rack continues to perform well for us. We have been getting more audits approved than the other rack auditors. We're continuing to see new audit scenarios approved there and are expecting to continue to see growth on the rack side. So really in all 3 of our market segments. It's federal with the CMS rack, managed Medicaid and the stateside. In Medicare Advantage, we're seeing opportunities for payment integrity and are optimistic we'll continue to see growth there as well.

Q - Donald Hooker

Super. Thank you so much.

Operator

Thank you. And our next question will come from the line of David Windley from Jefferies. You may begin

Q - David Windley

Good morning. If I'm interpreting your comments correctly, your sales force build out here in PHM is an ad as opposed to the kind of reassignment of existing. Could you quantify how much additional cost or investment you're planning to make in the sales force where you think that would be?

A - Jeff Sherman

I don't think it -- at the end of the day, I think it's going to be material. Some of it is just bringing on different talent [indiscernible]. I think there could be a little bit of incremental cost. It would not be material to the overall P&L activity for us. I think we're -- and we're certain that bringing on those costs are going to drive the revenue and more than pay for themselves.

Q - David Windley

Got it. Sticking with PHM, has a pattern formed at all in terms of which of the three products captures the attention and the imagination of a new potential client? Or is that something that perhaps with leading into sales force kind of forms this pattern after this rather than already?

A - Bill Lucia

That's a good question, Dave. Eliza is something -- Eliza member engagement is something that really all clients, really -- I would say anybody who's either managing risk or needs to communicate effectively with patients or members at scale. So think about even a large healthcare system could benefit from Eliza. But even public health could benefit from Eliza. It's one of the areas we're starting to have conversations. The key behind Eliza is not only we do it at scale, about 1.5 million outreaches a day but we also have the behavioral science back behind it. So that has always when you really uncover the -- when you dig into that at a detailed level with purchasers, they understand why they cannot do that and they can't do with just a robot call company. In fact, that's been the brightest bulb in Australia in our dialogue there. But I have to tell you when people actually see Elli, they get an understanding of the predictive and prescriptive side of it and they understand that we incorporate social determinants of health to better prescribe who are those patients that they should focus on now to avoid cost and or poor outcomes.

People are very excited about it. The challenge is when you don't have a sales force used to selling a clinical analytics product, it's a little difficult. And so you can only take so many subject matter experts out on a sales call so that's the critical component. We believe that -- And of course, as Jeff said, sale is up 30% year-over-year, so we're having good success with that product line. We believe the integration of the 3 across a number of what I'd say small and mid-sized top plans and MMSOs and IPAs is going to be very, very attractive. But Elli, once it's in front of a customer, most of them have said their existing analytics programs can't compare. Now the challenge is getting enough of those types of analytics salespeople out in the market, both at the state and commercial level. It's one of the reasons we announced a couple of months ago that we've brought in a new chief analytics officer to lead that product line because we've seen the value of it. And he's been very, very intimately involved in sales and go-to market strategy on that product.

Q - David Windley

Got it. Very helpful.

A - Robert Borchert

We got several people are still in the queue so we're going to try and get everybody in but if you can limit to one question and one follow-up, please. Thanks.

Operator

Thank you. And our next question comes from the line of Charlie Strauser from CJS. You may begin.

Q - Charlie Strauser

Hi, good morning. Just a couple of quick ones for you. Are you expecting any one time benefits in Q4 that's included in your guidance?

A - Jeff Sherman

No, we're not. The guidance doesn't anticipate any one time benefits in Q4.

Q - Charlie Strauser

Got it. And then also direct project costs as a percentage of revenue seem to kind of have a little spike in the quarter despite the declining revenue year-over-year. Any further thoughts or color behind that?

A - Jeff Sherman

It's mainly driven by some additional temporary work we brought on to help on some specific projects. And when we have some of these technical challenges, sometimes we are -- we do try to bring in some additional staff. If we're not being able to process things automatically we'll bring in some temporary help to do that. That was the main driver on that cause line.

Q - Charlie Strauser

Great. Thank you very much.

Operator

Thank you. And our next question from the line of Daniel Grosslight from SVB Leerink. You may begin.

Q - Daniel Grosslight

Hi, guys, thanks for taking the question. Jeff, I want to pick up on a comment that you made that at the midpoint of guidance it implies that you're going to have one of your best quarters on a growth basis ever. It sounds like you are pretty confident in the COB rebound to mid-single digits. But that still leaves about a 15% growth hole to reach your guidance here. And from your commentary, it sounds like most of that is going to have to come from payment integrity. Just curious how confident you are that payment integrity is going to really have a strong 4Q and how much visibility you have into that line specifically?

A - Jeff Sherman

I'd say one of the things we've seen in payment integrity is we are seeing our inventory of claims to be reviewed, continues to increase. So we've got a strong inventory where we actually have the medical record in-house to actually work and have seen good success in getting new edits approved. PI is always an area where we have edits that we've submitted to customers, including our commercial and CMS, where we know there's findings but we have to go through an approval process. Some of those approval processes are more complex and bureaucratic than we would like at times, but we are seeing good traction there and getting more audits and edits approved and that's certainly contemplated on our PI revenue growth that we're expecting in Q4.

Q - Daniel Grosslight

Got it and then just one quick one on the PHM side. As I understand the budgetary cycle of most states and large plans it seems like they make most of their vendor decisions in 3Q. So if you're building the PHM team up this quarter, probably it won't start till the first quarter of 2020. Does that mean that PHM is really a 2021 revenue opportunity?

A - Jeff Sherman

Yes. I think on the PHM side, in particular, we always see the back half of the year generally have more opportunities as payers look to close gaps in care so there's not a beginning of the year sales cycle per se for closing gaps in care on our engagement side of our business. I think we continue to have sales really in all product lines in each of the quarters this year. I do think to our earlier comment and bills note on the government side, the procurement process for states can be a 12 to 18-month process. And so getting in front of the state with some capabilities you have may lead to an opportunity the next time they re-procure. So I'd say that's more of a state-driven phenomenon than it is a commercial-driven phenomenon.

A - Bill Lucia

The only thing I would add is, remember, star ratings just came out. So we impact star ratings as well. So plans that didn't do as well in star ratings, some of it related to what are the self-reported customer satisfaction scores, hawks and cat scores. There's other areas where we impact star rating. Well, typically a gap and care closure sales cycle happens in Q3 and Q4. We impact star rating so we're still selling into those Medicare Advantage plans in Q1 and Q2 that we can impact their future star rating. It's a year-long sale cycle. And of course, all of the other things that we've introduced this year, our crisis management program, our incentive management program, all of those things are starting to get traction beyond just health plans, but also attention in the state market.

Q - Daniel Grosslight

Got it. Thank you.

Operator

Thank you. And our next question on the line of Stephanie Demko from Citi. You may begin.

Q - Stephanie Demko

Hey, guys, thank you for taking my question. With the ideas there's nothing you can do to change the internal systems at your payer clients, are there any investments you can make on your end in the COB business to help make your claim submissions more digestible for some of these players?

A - Bill Lucia

Actually, our claim submissions are more digestible for these payers than probably anyone who attempts to compete with us because 90-plus percent -- 95% of the claims we send to a third party is electronic. That doesn't mean they process them electronically. We do know that some carriers take our electronic file and then print them to paper because their system can't adjudicate a Medicaid reclamation claim. So there's not a lot we can do. We do work very, very closely and arm and arm with the large PDMs and the large payers to make sure that whatever we send them is as easy for them to process as possible. Unfortunately, they still have processing issues and as Jeff said, one of the areas that we spent temporary labor on this quarter was the fact that a large PDM could not handle our verification transaction so we needed to have people manually do that work. But we're very, very accommodating; work with payers all the time to see what we can do to help them in that process. And then there are some payers that just at the end of the day cannot and will not process these claims but legally are required to and we end up doing negotiated settlements. And those take a while. They can move from quarter-to-quarter, but at any given time, we have two or three payers' settlements that we're working on.

Q - Stephanie Demko

Understood. And does that cause some the lumpiness in the business?

A - Bill Lucia

Could you repeat that question?

Q - Stephanie Demko

For the -- just a quick follow up on that one. When you talk about payers' settlements, is that why we will see some lumpiness in the business outside of just this claims volume?

A - Bill Lucia

It's part. Yes. I mean, we could anticipate in any given quarter that we're closing two or three settlements, and they don't close because of various reasons. The actuarial department doesn't like the claim sample we send them. We sent them a new claim sample. We're negotiating back and forth and we're doing it on behalf of our client. So we get the state involved in the negotiation, we get potentially the Medicaid health plan involved. But I just -- I kind of want to reiterate for everybody. This is not a new phenomenon. This is something again, having done this work, of course, on a much larger scale now but for 40 years, we've seen this. Harking back to third quarter 2017, same set of challenges that we talked about and we rebound in Q4. So I think it's a -- look, you can't compare our COB business with anybody else. So I know it's difficult to say can we extrapolated a trend from that? You really can. We're the experts in this space. And we've seen this before and we know how to overcome it. So it's just a process that is part of the business.

Q - Stephanie Demko

All right, understood. Then on the PHM side of things. This is primarily a subscription business model with a live basis. So was there some compression on the PMPM or any attrition to call out that was driving the revenue down year-over-year? Or was this just a function of the non-subscription sales falling through?

A - Bill Lucia

No, it was more the non-heightened transaction scale sales, not coming through because we didn't have a qualified sales force to actually make those sales. And a combination of the fact that we -- well, we didn't expect to have a surge in LA sales. We have a higher sales queue with LA now than we ever have and it's unleashing more knowledgeable salespeople on that product.

A - Jeff Sherman

The revenue is actually up to, Stephanie year-over-year in 3 quarters and for Eliza which is the biggest component of the revenue. Say the majority of Eliza revenue is transactional in nature. Now we generally characterize it as recurring transactional because we do the same work typically year-over-year in terms of closing gaps in the sale. Overall, the business is up. It's just not up as much as we expected it to be up.

Q - Stephanie Demko

Got it. Thank you for the clarification, guys. Appreciate it.

Operator

Thank you. And our final question will come from the line of Vikram Kesavabhotla from Guggenheim. You may begin

Q - Vikram Kesavabhotla

Thanks for taking the question. Just a quick one on PHM. It sounds like you'll be mostly done hiring at the end of Q4 but is there anything to offer in terms of the timeline it takes for those new hires to get fully ramped up? And at what point in 2020 do you think you'll be at full productivity in terms of the broader sales effort in that business? And then just as a quick follow up on a capital appointed side, you're given the acquisition you made in the strategic partnership, any update around what the areas of focus are for M&A in terms of building out the platform? Thank you.

A - Bill Lucia

So let me start with the sales team. So look, I will tell you that we are always opportunistic to bring in strong talent. Building our bench across all of our product lines is always important. Will we finish building the team to the degree we want it to by the end of the quarter? We hope so. But in reality you have people waiting for year-end bonuses at other companies so it couldn't bleed into Q1. But we're not look -- we're looking for people who have experienced either selling this type of product or experience selling clinical analytics into health plans and at risk providers. So we expect that their learning curve will not be as steep. It will be pretty quick. And we're also bringing in additional subject matter experts to augment the sales team. So I think that we'll see next in 2020, a rebound from the sales activity in the PHM space because we'll be well prepared for it. And then on the acquisition side, we are very focused on acquisitions in really any of our product areas, whether it's COB payment accuracy, payment integrity or PHM. And we're active in all those areas looking at both products that we can plug-in or markets that we can expand to with product acquisitions. And like Vitreous, we'll be opportunistic, where we see a technology that we believe moves the needle for our product lines.

A - Jeff Sherman

And we continue to have a very active pipeline as Bill noted, so we're continuing to manage that and look at that and continue to expect that we'll be making strategic acquisitions over time. Just hard to predict the timing.

Q - Vikram Kesavabhotla

Okay, great, thank you.

Operator

Thank you. And I'm not showing any further questions at this time. I'd now like to turn the call back over to Mr. Lucia for any closing remarks.

End of Q&A

Bill Lucia

I want to thank everybody for attending the call. We are looking forward to speaking to you again on our fourth quarter call. Have a great weekend.

Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.

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