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Edited Transcript of PFMT earnings conference call or presentation 7-Nov-17 10:00pm GMT

Thomson Reuters StreetEvents

Q3 2017 Performant Financial Corp Earnings Call

Livermore Nov 13, 2017 (Thomson StreetEvents) -- Edited Transcript of Performant Financial Corp earnings conference call or presentation Tuesday, November 7, 2017 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jeffrey R. Haughton

Performant Financial Corporation - COO

* Lisa C. Im

Performant Financial Corporation - CEO & Chairwoman

* Richard Zubek

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Conference Call Participants

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* Brian Dean Hogan

William Blair & Company L.L.C., Research Division - Associate

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Presentation

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Operator [1]

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Ladies and gentlemen, greetings, and welcome to Performant Financial Corp. Third Quarter 2017 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Richard Zubek. Thank you, you may begin.

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Richard Zubek, [2]

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Thank you, operator, and good afternoon, everyone. By now you should have received a copy of the earnings release for the company's third quarter 2017 results. If you have not, a copy is available on our website www.performantcorp.com. Today's call will be led by Lisa Im, Chief Executive Officer; and Jeff Haughton, President and Chief Operating Officer.

Before we begin, I would like to remind you that some of the comments made on today's call, including our financial guidance, are forward-looking statements. These statements are subject to risks and uncertainties, including those described in the company's filings with the SEC. Actual results may differ materially from those described during the call. In addition, all forward-looking statements are made as of today and the company does not undertake to update any forward-looking statements based on new circumstances or revised expectations. Also non-GAAP financial measures discussed during this call are reconciled to the most directly (inaudible) statements in the table attached to our press release.

I would now like to turn the call over to Lisa Im. Lisa?

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Lisa C. Im, Performant Financial Corporation - CEO & Chairwoman [3]

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Thank you, Rich. Good afternoon, everyone, and thank you for joining us for our earnings call. If you haven't already, please find the financial packet on our website that locks to our financials in more detailed form. This is a practice that we're adopting going forward as we believe that you are more than capable of reviewing the financial table of our results at your own pace. On this call, and all future calls, we want to talk about the factors impacting our business today as well as on a go forward basis.

We'll start with updates in our Student lending business then move to healthcare and other businesses. We will spend a few minutes on key metrics towards the end of the call. As we announced back in June, Great Lakes has terminated our student loan recovery contract. The transition of our Great Lakes student loan inventory began in October and as a result of this change, we now have a contract to act as a recovery subcontractor for Navient to provide recovery services for both the Great Lakes portfolio as well as Great Lakes' recently acquired USAF and NELA portfolios, which are about 50% larger than that of Great Lakes. Under this arrangement, we expect to start recovery services for 25% of the legacy Great Lakes portion of the portfolio and in the next 6-month we expect to receive a small percentage of the USAF, NELA portfolio. There is some ability under the contract to gain share through performance versus competition including against Navient's affiliated companies. The contract does not have a termination date, but contains standard language allowing for termination at the discretion of Navient to tell what this contract will mean for us going forward. Although, we are hopeful that over time it will offset a significant portion of the revenue lost when our contract with Great Lakes was terminated. In addition, as you may have recently read, Nelnet announced that it will acquire Great Lakes' student loan servicing company or the Great Lakes Educational Loan Services, Inc., a subsidiary of the Great Lakes guaranty agency. The guaranty agency is the not-for-profit chartered agency who is responsible for the federally guaranteed student loan portfolio. It can enter into servicing contracts and portfolio management contracts. The guaranty agency likely had a servicing contract with Great Lakes Educational Loan Services, Inc. to service the student loan portfolio. The Nelnet announcement does not impact us in the short-term given the already occurring transition of recovery services on the Great Lakes portfolio. And we are not yet certain as to whether it would create opportunity for us over the longer term. Within our other Guaranty Agency business, we're seeing a decline in defaulted portfolios as those portfolios age and there is a larger percentage of borrowers within those portfolios, about 25%, who have loans which were previously rehabilitated. Based on the current regulation a loan can only be rehabilitated once, so our opportunity to work with those borrowers is more limited. This will begin to impact the churn of inventory to revenue as we look forward into 2018 and beyond. Over the past year, we've mitigated this impact through productivity gains and will continue to utilize technology to increase productivity. Furthermore, we will have to continue to grow recovery through material revenue gains from contracts such as our tax recovery contracts with the IRS (inaudible) New York and successfully apply our recovery services to additional commercial markets.

With respect to the Department of Education, on October 19, the department notified the Court of Federal Claims that they have completed a reevaluation of their resubmitted contract proposals. We have no further details and do not know what to expect regarding timing of contract awards or the ultimate outcome.

Placements during Q3 were $647 million, which is down 4.7% versus prior year quarter 3, and down 27% sequentially versus quarter 2. The quarter 3 decline versus quarter 2 is similar to what we saw last year between the 2 quarters. Revenues from student lending were $19.8 million of which only $600,000 are from the old Department of Education contract. Excluding the Department of Education, student lending revenue is down 3.6% versus prior year and 26.8% sequentially. This again is due to the timing of placements between quarter 2 and quarter 3 in 2016.

I'll now turn the call over to Jeff Haughton, our President and Chief Operating Officer to discuss healthcare and other market revenues.

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Jeffrey R. Haughton, Performant Financial Corporation - COO [4]

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Thanks, Lisa. Our healthcare revenue continues to increase as we execute against the growing number of contracts in various stages of implementation. Specifically, we generated $1.8 million of commercial healthcare revenue in Q3 of 2017. This is a 43% increase versus the third quarter of 2016. Revenue sequentially is still a little lumpy due to the timing of our revenue recognition as well as the early stage of several of our contracts, but we do expect that (inaudible) time as we look out over the next several quarters.

Beginning of 2017, we've added 9 new commercial healthcare clients and 15 new audit and recovery programs. Many of these programs have been recently implemented and due to the requisite time to ramp up audit volume and the subsequent revenue recognition cycle, we have a limited impact to 2017 revenues, but they are expected to contribute to a greater extent in 2018. We're also very excited about the recently awarded Medicare Secondary Payer Commercial Repayment Center contract or what we refer to as the MSP contract. This contract transition process is taking place as we speak, and we look to begin operations under this contract in early 2018.

While we are not giving any specific guidance until we've started in earnest on this contract, we do note that Centers for Medicare and Medicaid has published results for the MSP program annually including reporting the administrative costs, which over the last 2 fiscal years have ranged from approximately $18 million to over $24 million annually. We believe that the majority of these costs represent contingency fees paid to the MSP recovery contractor. Several of our commercial programs entail coordination of benefits recovery from Medicaid and as a result are highly complementary with the work we'll perform under this new MSP recovery contract.

Regarding the CMS recovery audit programs, we began work under our Region 1 and Region 5 contracts during the second quarter of 2017. We're starting to see revenue from these contracts and we expect that they will continue to increase in the coming quarters. However, CMS is taking the cautious approach to increasing the size of the RAC program. And although, the scaling of claim volumes has begun for Region 1 work. The Region 5 national contract remains under the document request limit of 0.5%. With Medicare improper payment errors still estimated to be above 10%, we hope CMS will accelerate expansion of this important program.

Switching from healthcare to our other revenue line, we're seeing growth through a handful of new contracts. Specifically, our customer care business is driving most of this revenue growth and we expect it to grow in 2018 as well. Within this customer care business, we are providing non-recovery call center services as well as other back office, outsourced services to support our client's business and their customers. We see an opportunity to further drive growth in this area and as a result, we've made some modest investments to develop a strong pipeline of commercial clients to drive diversification and growth over the long term. Finally, our other revenue line also reflects growth from our IRS recovery contract and other state tax recovery contracts.

With that, I will turn it back over to Lisa.

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Lisa C. Im, Performant Financial Corporation - CEO & Chairwoman [5]

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Thanks, Jeff. Touching on expenses. Our expenses of $34 million were below sequentially by $2.5 million or 7%. They were higher than prior year quarter 3 by $3 million mostly due to business mix. Specifically, $1.4 million was due to customer care revenue growth requiring higher employee count. $900,000 was due to higher subcontractor fees on the MSA business for which revenue is almost entirely offset by payments to subcontractors and about $400,000 was due to higher outside vendor costs for legal and audit fees. Total year, we are reiterating our guidance for revenue in the $125 million to $145 million range and adjusted EBITDA in the $10 million to $13 million range.

In the earnings press release, we also announced the promotion of Jeff Haughton to President and Chief Operating Officer. In this expanded role, Jeff will continue to be responsible for operations and for working with his team to build revenue across all the company's businesses. During his tenure at Performant, Jeff has been a key leader helping to guide the company through a period of difficult headwinds and in executing on our strategy to vigorously rebuild the business. The Board of Directors is confident that Jeff's experience and deep knowledge of the company's business will prove instrumental towards strengthening the company's revenue base while executing across both growing newer businesses and challenging legacy markets. Furthermore, Jeff's knowledge of the capital markets will prove to be of strong asset as the board continues to evaluate potential strategic alternatives.

With that, I'd like to open up the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Brian Hogan from William Blair.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [2]

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A quick question on the other revenue line. And you called out the customer care, and you know it's growing fast. I guess -- can you give me a little more details on that line? Is the year-over-year delta in the other revenue solely driven by the customer care, just a little bit of IRS? I mean, just basically how big is the other, the customer care revenue and how fast is it growing, and can that continue into 2018?

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Jeffrey R. Haughton, Performant Financial Corporation - COO [3]

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It's a great question Brian. So on the customer care side, I would say that the majority, call it, 60%, 70% of that revenue growth is coming from the customer care fees, the rest is, the IRS is in there. There is a couple of other smaller clients in there as well on the tax side. But the majority is the customer care fees. And we're going to expect to see growth in 2018 because there is additional programs we're adding to that. Overall, you're going to see the run rate impact in 2018 of programs that we've just put in place there, right? So you'll get the full year benefit as well. And to do that, there is a lot of headcount we had, which is what is reflected in some of the expenses that Lisa walked through earlier. As you think about what's driving expenses in Q3.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [4]

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All right. And in the IRS contract, is there still a ramp anticipated? How fast have you changed your expectations of how big it can be?

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Lisa C. Im, Performant Financial Corporation - CEO & Chairwoman [5]

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It's still a slow ramp. I think as we've mentioned in the past, operation folks at IRS have been very concerned about making sure that the quality of the service that the vendors are providing is beyond reproach. And so far, the service level that the vendors are providing have met or exceeded their expectation. So we are working with them to try to improve the flow of business. We're hoping as we complete this year and (inaudible) in '18, we'll see a greater opportunity for a bigger volume flow. But we don't know, but we are constantly talking to them and we are again proving our results and showing that the quality of work we're doing is exceptional to what their standards are. So we are hopeful, Brian, that we will have more information as we go into 2018.

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Jeffrey R. Haughton, Performant Financial Corporation - COO [6]

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Yes, and from an ultimate size perspective, so that speaks to kind of the ramp and the time from an ultimate size perspective. There is still a large opportunity in terms of inventory that's out there. And it will come down to what the IRS and what the legislation requires and what folks want in terms of what's ultimately realized.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [7]

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Shifting to the healthcare. I guess we'll start with the commercial healthcare. You did mention it was lumpy, it was down quarter-over-quarter, but you mentioned a nice new contract or a new client that you added throughout the year and we haven't seen really any of the revenue benefit from that. I guess -- can you elaborate on the pace of the ramp of the commercial healthcare. Looks like maybe an exit 2018 run rate as you kind of ramp up, just kind of trying to frame the size of that business.

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Lisa C. Im, Performant Financial Corporation - CEO & Chairwoman [8]

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Well, as you know, we're not giving guidance on 2018 on this call. But we can tell you that sequentially, particularly given what we're ramping in the last, I would say, last probably 2 months to 3 months, we feel very good about a multiple of what we're seeing this year in a meaningful way. And largely because as we talked about the MSP contract and recovery and that process is really in our wheelhouse of strength and as Jeff mentioned, this actually dovetails in 2 contracts that we have in the commercial market, where we're doing a similar kind of coordination of benefits work for Medicaid programs and -- which are run by a commercial mission. So these again, these are not timeliness in terms of how long do they take to ramp. But it's really a matter of us getting started on the contracts, which we have in the last couple of months. So we do think that 2018 will be a material multiple of what we're seeing this year.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [9]

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Interesting. And then the CMS healthcare kind of the (inaudible) essentially. The ramp that (inaudible) mentioned Region 5 was maybe a little slow because of the amount of audits you can actually do. I guess, what can the run rate be? Can it get back up to historical levels eventually, at I guess peak levels given you have 2 contracts now? Just kind of talk about that business.

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Lisa C. Im, Performant Financial Corporation - CEO & Chairwoman [10]

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Yes, I think longer term, we -- it's definitely going to be a meaningful contract. I don't know that we can get back up to -- as you remember, in the last recovery audit contracts, there were revenues that were pretty meaningful just based on one regional contract. I think as we look at the program going forward, it definitely will be a lot more diversified in terms of the types of audits that we're doing, but we do think that as it steps up and the audit concepts get approved and CMS feels more and more comfortable with the work that recovery auditors are doing with the providers. And with the audits that we're conducting, we do think that they will be amenable to opening up the program, to maybe include all of the different types of audits. And certainly, the percentage of documents that we can request particularly if we look at DME and Jeff mentioned that the Medicare error rate is over 10% -- well, in durable medical equipment, it's over 40%. So we are obviously, working very closely with the client to try to get this contract ramped up to a level where they feel comfortable with our work and where we feel like we're having a meaningful impact helping CMS reduce that volume of errors.

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Jeffrey R. Haughton, Performant Financial Corporation - COO [11]

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Yes, another thing I'd add to that is, if you look at how it's played out this year. We started those programs, CMS was very prescriptive in terms of the approved audits that all of the contractors could conduct. And it was a defined amount of -- and types of audits as Lisa mentioned. So we have been working to diversify that. The way it also played out is, on those audits, there was also a conditional set of volumes that they wanted you to work through first and review kind of how the programs are developing. So I think from a development perspective, and how those audits have gone and managing all of the appeals process, again, it's a good start to the program similar to IRS. And it's a question of, okay, how does that evolve with ramp from here? But that's some of the limiting factors as we think about where we are from the start in April.

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Lisa C. Im, Performant Financial Corporation - CEO & Chairwoman [12]

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Yes, and I think we'll have more visibility as we work through the next few months. And keeping in mind, Brian, that we just -- we literally just started the program and second quarter was very, very small, volumes, and a very cautious methodology from CMS. We will definitely have a bit more visibility as we work through the next few months.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [13]

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All right. And then shifting to the student lending business. The guaranty agency placements, how much of those were from Great Lakes?

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Lisa C. Im, Performant Financial Corporation - CEO & Chairwoman [14]

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I don't have that actually right in front of me. I can certainly get back to you on that volumes, the percentage -- the proportion of volume from Great Lakes. I just don't have it handy.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [15]

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All right, do you have the revenue that was tied to the Great Lakes? And maybe that kind of break that up with...

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Lisa C. Im, Performant Financial Corporation - CEO & Chairwoman [16]

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Hold on. We're just looking for it. Let's see, I don't it -- I don't have it for the last quarter, but again keep in mind that the revenue tied to Great Lakes from the last quarter would have been associated directly with (inaudible) we received last year. So let me follow up with you on your specific question.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [17]

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Sure. I guess, ultimately what I'm going to get to is what the ultimate impact from Great Lakes is going to be from a revenue perspective. Obviously, you have -- you mentioned 25% of the -- from a subcontracting perspective and on the legacy Great Lakes, if you will, and then USAF portfolio, you get a small portion of that increasing over time. And I guess, the goal would be ultimately to replace what you lost, I guess, through the subcontract. Is that -- do you think is that possible?

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Lisa C. Im, Performant Financial Corporation - CEO & Chairwoman [18]

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I think over time because we definitely will have the opportunity to compete with the companies that are on that contract and really most importantly, we will be competing directly against the Navient affiliated organizations. So I think over time, we definitely will. I do think that there is a clearly -- the objective is to drive the greatest amount of recovery percentage versus the inventory that's placed. So I think over time, we'll have an opportunity to (inaudible) build that back up. As you mentioned, the USAF and NELA portfolio, that business is actually 50% larger than the portfolio of Great Lakes. So even a smaller percentage, [taking growth] from that will be a meaningful growth.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [19]

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Great. And then there are (inaudible) kind of mentioned the Navient, obviously there are competitors to Nelnet. And then you mentioned that Nelnet acquiring the Great Lakes portfolio. I guess to me it would seem like a big opportunity for you over the long term to be the Nelnet servicer. But does that move the way to think about it? Or is that too much of a speculation at this point?

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Lisa C. Im, Performant Financial Corporation - CEO & Chairwoman [20]

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Well, I think it is certainly speculative, but I do agree and I think the market recognizes Nelnet and Navient are both competitors on the (inaudible) contract as well as in other aspects of business. So as I mentioned, it's a little early for us to understand fully what an opportunity might look like but certainly, if there's an opportunity in the future, we will be pursuing it.

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Operator [21]

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(Operator Instructions) Ladies and gentlemen, it appears we have no further questions in queue at this time. I'd like to turn the floor back over to management for closing comments.

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Lisa C. Im, Performant Financial Corporation - CEO & Chairwoman [22]

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Thank you, operator. We want to thank you for being with us today on this call and as always we thank our clients for letting us serve them. We believe that they are certainly at the heart of our objective and everything that we do. I want to also thank our employees who bring their best to our organization every day and for all of the hard work and commitment that they bring to Performant. Thank you again.

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Operator [23]

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Thank you. This does conclude our teleconference for today. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day.