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Edited Transcript of PFMT earnings conference call or presentation 9-May-17 9:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Performant Financial Corp Earnings Call

Livermore May 16, 2017 (Thomson StreetEvents) -- Edited Transcript of Performant Financial Corp earnings conference call or presentation Tuesday, May 9, 2017 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Hakan L. Orvell

Performant Financial Corporation - CFO, VP and Secretary

* Lisa C. Im

Performant Financial Corporation - Chairwoman and CEO

* Richard Zubek

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Conference Call Participants

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* Michael Matthew Tarkan

Compass Point Research & Trading, LLC, Research Division - Director of Research and Senior Research Analyst

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Presentation

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Operator [1]

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Thank you for standing by. This is the conference operator.

Welcome to the Performant Financial First Quarter 2017 Earnings Conference Call. (Operator Instructions)

I would now like to turn the conference over to Richard Zubek, Investor Relations. Please go ahead Mr. Zubek.

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Richard Zubek, [2]

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Thank you, operator. Good afternoon, everyone.

By now you should have received a copy of the earnings release for the company's first quarter 2017 results. If you have not, a copy is available on our website, www.performantcorp.com.

Today's speakers are Lisa Im, Chief Executive Officer; and Hakan Orvell, Chief Financial 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 comparable GAAP measures 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 - Chairwoman and CEO [3]

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Thank you, Rich. Good afternoon, everyone, and thank you for joining us for our earnings call.

We are off to a solid start during a pivotal year as we continue to focus on our diversification of revenue, continuous improvements in productivity and management of expenses.

We are in the very early startup stage of the IRS and CMS contracts.

Our commercial healthcare KPIs are growing according to plan.

Our customer care business continues to grow above plan.

And student loan business, excluding the Department of Education, is growing as we gained share with a couple of large Guaranty Agency clients.

Q1 revenue and EBITDA were $33.1 million and $2.8 million, respectively. With this, we are reiterating our guidance for 2017 revenue and EBITDA in the ranges of $125 million to $145 million and $10 million to $13 million, respectively.

Overall, Q1 revenue declined $5.2 million versus prior year, largely due to the wind down of placements from the Department of Education contract, and to a lesser extent, the gap between wind down of the old CMS Region A and startup of the new Region 1 and Region 5 contracts.

Operating expenses were lower than prior year by $600,000 (sic) [$1.5 million] or about 2% (sic) [4%].

As we look specifically at the key market; total student lending revenues were $24.5 million, which is down $5.1 million versus prior year.

We had moderate growth from other clients of $600,000, but this was offset by the ED runoff.

Healthcare revenues of $1.6 million is down versus the prior year by $1.1 million due to the prior recovery audit contract end.

Revenue from other operations was $6.9 million, up $1 million from prior year and $2.8 million sequentially.

As we said in our Q4 earnings call, we are encouraged by the continued growth in this business as we progress in 2017.

With that, I'd like to turn the call over to Hakan to walk you through the financials. Hakan?

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Hakan L. Orvell, Performant Financial Corporation - CFO, VP and Secretary [4]

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Thank you, Lisa, and good afternoon, everyone.

Today, we're reporting results for the first quarter with revenues of $33.1 million; net loss of $3 million or $0.06 per share; and adjusted EBITDA of $2.8 million.

Beginning with our student lending business; revenues totaled $24.5 million, a decrease of $5.1 million compared to the first quarter of last year.

During the quarter, the Department of Education accounted for $1.7 million of revenues while Guaranty Agencies generated $22.9 million.

These amounts represent declines of $5.7 million and an increase of $0.6 million, respectively, when compared to the first quarter of 2016.

The decrease in our student lending revenues is largely a reflection of the company not being a primary Department of Education contract and that we haven't received new student loan placements from the department since April 2015.

[As it relates] of the Department of Education contract award, the GAO issued its decision in late March, sustaining both of our protests. It is still unclear what remedial action the DOE will take, but the GAO determined that the process was flawed and recommended that the DOE, at a minimum, reevaluate the RFP process.

Regardless, even with a very near-term contract award, we will not anticipate this contract to have a material impact on our 2017 results.

With respect to our Guaranty Agency results, we benefited primarily from strong placement volumes that we received in the middle of last year.

Student loan placements during the first quarter of 2017 totaled $0.7 billion, up from $0.6 billion in the first quarter of 2016.

Our healthcare revenues in the first quarter were $1.6 million compared to $2.7 million in the first quarter of last year.

Revenue from our work with the Centers of Medicare and Medicaid was $0.1 million, down from $1.2 million in the prior year period.

And our commercial healthcare business generated revenues of $1.6 million, an increase from the first quarter of 2016, where we generated $1.5 million.

Lastly, our other markets generated revenue of $6.9 million in the first quarter compared to $5.9 million in the prior year period.

Both our CMS contract, as well as the contract with the IRS, are still in the early stages of implementation. We expect that the audit scope will initially be limited on these contracts. However, longer term, we believe that these 3 contracts will contribute materially to our overall results.

Moving to our expenses. Salaries and benefits expense in the first quarter was $20.7 million, a decrease of 3% compared to $21.3 million in the prior year period.

Other operating expense for the quarter was $13.4 million, a decrease of 6.4% compared to the first quarter of 2016, primarily due to reduction in volume-related cost and other completed cost-reduction initiatives.

We remain committed to improving our productivity, executing on our business development initiatives and thoughtfully engaging in expense restructuring.

For the first quarter of 2017, our reported net loss was $3 million or $0.06 per diluted share compared to a net loss of $0.1 million or $0.00 per diluted share in the prior year period.

Adjusted net loss in the first quarter was $1.9 million or $0.04 per diluted share, compared to an adjusted net income of $2 million or $0.04 per diluted share in the prior year period.

Fully diluted weighted average outstanding shares was 50.3 million shares in the first quarter of 2017.

Our adjusted EBITDA in the first quarter was $2.8 million compared to $7.4 million in the same period last year.

Adjusted EBITDA margin was 15.1% (sic) [8.6%].

Our effective income tax rate changed to negative 12.3% for the 3 months ended March 31, 2017, from 47.7% for the 3 months ended March 31, 2016.

Our effective tax rate is largely impacted by the company being closer to breakeven and the impact of permanent differences and state taxes, which creates the fluctuations we're seeing over the past few quarters.

Cash flows from operating activities in the first quarter were $0.4 million.

Turning to the balance sheet. As of March 31, 2017, we had cash and cash equivalents of $27 million, and our total outstanding debt was $51.8 million, reflecting our continued focus on paying down our long-term debt.

Lastly, as we mentioned last quarter, the company initiated a process of evaluating our options as it relates to the refinancing of our debt that becomes due in March of 2018.

As we do not yet have anything to announce in this regard, we have entered into a 90-day extension of our current facility, which extends the loan maturity to June 2018. And we have also paid down an additional $7.5 million on our outstanding loan balance.

This extension provides us additional flexibility to pursue the best available options.

Now I'll turn the call back to Lisa for some concluding remarks.

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

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Thanks, Hakan. Our strong performance for our student loan clients allowed us to gain market share which resulted in strong Q1 placement of $683 million, which is up 17% versus Q1 of 2016. This will benefit the latter part of 2017 and early 2018.

We also won a re-compete of the Treasury contract. It's a 5-year term, broken into annual renewals, similar to most other federal contracts. We are the only vendor to have served on this contract since its inception in 1997.

We also completed preparations for, and in April began, the startup of the IRS recovery contract and both Region 1 and Region 5 CMS recovery audit contracts.

While in very early stages, we believe these will be strong, long-term programs. And in a time when federal government agencies are looking for ways to reduce expenses, these programs achieve that objective through generating returns with a success fee-based structure.

The IRS program is a pay-for in the Highway Transportation Bill, which targets a $2.4 billion return to the government within a 10-year time frame.

With regard to the CMS contracts, we continue to be cautiously optimistic that a methodical restart can be the platform to higher audit limits given the estimated 11% error rate of total Medicare spending and 46.3% error rate for Durable Medical Equipment, according to the CMS [served] report.

Operationally, we continue to make progress on enhancing productivity across all of our businesses.

Our healthcare operational KPIs are on planned target. And in addition to launching the CMS RAC operation, we also launched 10 new healthcare audit programs with current customers.

For the balance of 2017, our focus will be to accelerate commercial client implementation, further operationalize and expand RAC audit scope, and launch several new products in the current customer base.

In our customer care operation, we will continue to execute on the existing contracts, but we are also working toward increasing our customer base from the commercial market.

As you know, the GAO sustained our protest on the Department of Education contract. Since then, other companies have filed suits against the Department of Education related to the old contract and to the procurement process.

The court issued a preliminary injunction, which runs through close of business on May 22, 2017, at which time, there should be some kind of progress update.

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) The first question is from Michael Tarkan of Compass Point.

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Michael Matthew Tarkan, Compass Point Research & Trading, LLC, Research Division - Director of Research and Senior Research Analyst [2]

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Just regarding the CMS RAC contracts and the IRS contract. I know the -- you have the expense buildup coming on now. But at what point do we -- should we expect revenues to start kicking in on those 2 contracts more meaningfully?

Hello?

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Operator [3]

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Pardon me. I had muted the presenters' lines. My apologies.

(technical difficulty)

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Michael Matthew Tarkan, Compass Point Research & Trading, LLC, Research Division - Director of Research and Senior Research Analyst [4]

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I'm not sure if my initial question went through. But just regarding the IRS and CMS RAC contracts, I'm just wondering sort of when we can expect revenues to start picking up. I know the expenses are coming on now. But just, when is revenue going to start picking up more meaningfully?

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Hakan L. Orvell, Performant Financial Corporation - CFO, VP and Secretary [5]

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Yes. Before we respond to your question, I just want to make 2 corrections from my opening remarks. First, our adjusted EBITDA percentage was misstated at 15.1%, 1-5 point 1. The correct number is 8.6%. Secondly, we stated that operating expenses decreased by $600,000 or 2%. The actual decrease is $1.5 million or 4%. So just wanted to state that first.

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Lisa C. Im, Performant Financial Corporation - Chairwoman and CEO [6]

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With respect to when we should start seeing revenue, Mike, we obviously had -- we're just in the early stages, but we should start seeing revenue for both contracts materialize as we head into the latter part of third quarter and certainly fourth quarter. Keeping in mind that there is, at least for the CMS RAC contracts, there's going to be a 5- to 6-months' delay in revenue recognition. So the revenues for this year are softer than obviously as we roll into 2018. With the IRS, we've just started. So they started with very low volume and want to make sure the program is right. But the intent is, assuming all goes well, that there will be material increases in the folks whom we're allowed to contact over the next few months. So we should certainly learn more as we get through this quarter, and we'll -- we can provide more information about how we think that's shaping up as we move through the first few months of both contracts. But we do expect revenue in the fourth quarter of this year.

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Michael Matthew Tarkan, Compass Point Research & Trading, LLC, Research Division - Director of Research and Senior Research Analyst [7]

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And then just the follow-up on the RAC side. I know it's early, but any sense for sort of the magnitude of the revenues coming through maybe in 2018? Are we talking about sort of looking back at 2016, that $6 million or so from CMS? Or how quickly can we get back to something more material than that?

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

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Well, I think we have to think about them as 2 entirely separate contracts. So if you think about the landscape of complex care auditing for a regular region; again, it just depends -- our expectation for revenue will depend on how quickly CMS ramps up our ability to audit the percentage of provider claims. If we look at the National Durable Medical Equipment and Home Health and Hospice contract, the entities that we're auditing are actually not providers, they're a supplier. So we are currently in the process of trying to work with CMS to understand how quickly we can ramp on that particular contract, which we think is very different from, clearly, auditing hospitals and health care facilities. So at this time, we're still working with them. But if you look back on the old recovery audit contract, keeping in mind those audits for Durable Medical Equipment and Home Health and Hospice did not include short stay issue, which was an issue in the old contract. So this is a bit, I would say, a simpler form of audit. And in the old contract, I think without a lot of effort, there was probably close to $15-plus million, maybe $20 million or so in revenue per year. So we're -- obviously, we can't give you an estimate of what we think 2018 is, but we do think that they're 2 very different contracts. And the combination will be something that we look to assess as we walk down the path here.

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Michael Matthew Tarkan, Compass Point Research & Trading, LLC, Research Division - Director of Research and Senior Research Analyst [9]

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Okay. On expenses, how much flexibility do you have to still limit the expense growth? And in conjunction with that, do you have the ability to preserve adjusted EBITDA, or EBITDA being positive while you ramp these contracts on a quarterly basis?

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Hakan L. Orvell, Performant Financial Corporation - CFO, VP and Secretary [10]

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Yes, Mike. We're being very mindful, as you know, as we've been in the past as well, in being very careful as we ramp up costs associated with the new contracts and really look to align them to the extent possible with the revenue coming in. So that's definitely our target as we look at things going forward to, again, control the cost to the extent possible there.

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Michael Matthew Tarkan, Compass Point Research & Trading, LLC, Research Division - Director of Research and Senior Research Analyst [11]

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Okay, I mean, I guess, just more specifically, do you expect EBITDA to stay positive as we move through '17 on a quarterly basis, and even into '18, assuming no changes to the Ed collection contract?

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Hakan L. Orvell, Performant Financial Corporation - CFO, VP and Secretary [12]

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As we're looking at it right now, yes.

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Michael Matthew Tarkan, Compass Point Research & Trading, LLC, Research Division - Director of Research and Senior Research Analyst [13]

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Okay. And then, I guess my last question is -- I know the trend with the Department of Education is certainly encouraging. I guess, how much -- and I know you're trying to be patient here, but how long can you afford to wait on the Department of Education before really starting to look at maybe strategic alternatives for the company?

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

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Well, I think we -- as you know as we stated, we actually should know probably a lot more in the very near future. We -- you've been following, I'm sure, and you've read through all the different court arguments and where the protests are. And the Department of Education, from what we have understood from publicly reported sources, are supposed to come up with a mitigation or a remediation plan by the 22nd of May. So I think we're going to have -- we obviously want to wait and see what that is. But at the board level, we are always discussing what the strategy for the company should be, relative to capital structure. So, as with many other public companies, it is an ongoing discussion that we have at board level.

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Operator [15]

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(Operator Instructions) There appear to be no further questions. I'll turn the call back over to management for closing remarks.

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

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Thank you. As we've actually discussed in the past, you know that our company culture, we build it on intense client focus, and we do strive to provide our best value performance to our clients. You see some of that evidenced in the share gains that we've had in quarter 1. And as we think about the go-forward strategy on the IRS and other contracts, it's also very important for us to engage constructively with consumers, which we think is a part of a very healthy program.

Through these efforts, we believe we can continue to strengthen our competitive advantage. As we go through this year, we'll continue to focus on innovation and technology, people and process and, of course, compliance, in order to continue to build our business across all of our practices.

And before we go, I want to again thank our clients for letting us serve you and thank our employees for bringing your best efforts to our organization. And thank you for being with us today.

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Operator [17]

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Ladies and gentlemen, this concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.