Q2 2023 Performant Financial Corp Earnings Call
Participants
Rohit Ramchandani; CFO; Performant Financial Corporation
Simeon M. Kohl; CEO & Director; Performant Financial Corporation
Unidentified Company Representative
George Frederick Sutton; Partner, Co-Director of Research & Senior Research Analyst; Craig-Hallum Capital Group LLC, Research Division
Jacob Michael Stephan; Research Analyst; Lake Street Capital Markets, LLC, Research Division
Presentation
Operator
Good morning, ladies and gentlemen, and welcome to the Performant Financial Corp Second Quarter 2023 Earnings Conference Call. (Operator Instructions) This call is being recorded on Tuesday, August 8, 2023.
I would now like to turn the conference over to [Jeff Elliott], Performant Investor Relations representative. Please go ahead.
Unidentified Company Representative
Thank you, operator. Good afternoon, everyone, and thank you for joining us today. A press release was issued earlier this afternoon outlining the company's results for the second quarter of 2023 and can be found on the Investor Relations section of the company's website, performantcorp.com.
Before we begin, I'd 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, all 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.
On today's call will be Simeon Kohl, Chief Executive Officer; and Rohit Ramchandani, Chief Financial Officer. With that, I'd like to turn the call over to Simeon. Simeon?
Simeon M. Kohl
Good afternoon, everyone, and welcome to Performant's second quarter 2023 earnings call. I am pleased to report yet another quarter of remarkable progress toward our core objectives, including new implementations and continued growth in our commercial business. Healthcare revenues grew 10% in Q2, featuring growth in both our claims and eligibility businesses. While our government contracts did experience some sluggishness, their fundamentals remain strong and set us up well for the second half of the year. Let me provide some additional context.
We often refer to our government contracts as the pillars of our business. These programs serve as marquee initiatives, placing Performant in a unique position of national leadership in healthcare program integrity while also providing healthy revenue opportunities. Though this continues to hold true, these contracts are subject to the dynamics of the broader CMS ecosystem, which at times are beyond our direct control.
In the CMS MSP program, we continue to operate the premier national center for identification and recovery of MSP payments from payer entities. In our Q1 call, we reported having witnessed a decline in workable inventory stemming from Section 111 reporting, but we also noted that demand volume had begun returning to expected levels at the end of the quarter. While the decline from Q1 was still working its way through the demand life cycle during Q2, we are now seeing inventories and recoveries return to historic levels.
Our RAC CMS programs also had lower volumes due to the extended public health emergency, which restricted inventories. With the expiration of the public health emergency on May 11, we are seeing claims volume return to our inventory and expect to be operating at pre-PHE levels later this year. Additionally, our newly awarded Region 2 contract recently commenced operation, and we anticipate being able to provide more detail on this program by the end of this year.
In terms of our commercial business, both eligibility and claims revenue enjoyed strong double-digit year-over-year growth rates in the first half of '23. I am also excited to report that our efforts to compress the implementation cycle continue to bear fruit as we implemented 11 additional commercial programs in Q2, bringing our 2023 total to 22 implementations, which surpasses the total number of implementations we completed in all of 2022. We believe this implementation cadence leads the market. But more important is the value that these implementations represent. We anticipate that these 22 programs will deliver an estimated $11 million in annualized revenues at steady state. These commercial implementations, along with the healthy pipeline of additional implementations slated for the latter half of this year, provide clear visibility toward accelerated revenue growth.
We've discussed this previously, but our proprietary analytic technology remains a key driver of our differentiated results, employing machine learning to deliver consistent, high-quality findings for our clients. As our business continues to grow, we are continuously investing into further product innovation to drive greater client value and to increase efficiencies. The development of artificial intelligence, AI, is one such innovation, serving as a natural extension of our significant experience with machine learning. We are excited by the early results we are seeing from integrating AI with our own analytic platform. Current pilots have already shown promising opportunities for greater efficiencies, which should lead to increased margins without sacrificing our commitment to quality, which is central to maintaining Performant's brand.
As an aside, given performance significant CMS RAC footprint and the strong upward trajectory of our commercial business, I want to emphasize that Performant is optimally positioned to benefit from the expansion of the Medicare market, particularly through our Medicare Advantage offerings. According to a recent publication by the Kaiser Family Foundation, total federal spending on Medicare is forecasted to grow 80% by 2032. Coupled that with a 43% projected increase in Medicare Advantage enrollment rates by 2030, and we are confident that Performant is neatly situated to take full advantage of this shifting Medicare landscape in the years to come.
In closing, our sales pipeline remains robust. Our cadence of new implementations continues to underscore our ability to win and execute on opportunities in this large and growing industry. And as our government programs leave the PHE behind and our dozens of newly implemented commercial programs mature, I am confident that Performant is well positioned for continued success.
With that, I'll hand it over to Rohit Ramchandani, our Chief Financial Officer, for a discussion of the financials. Rohit?
Rohit Ramchandani
Thanks, Sim. As Sim shared, we remain energized about the strategic traction and key wins we continue to achieve. While we did see some sluggishness in our government accounts, this is not reflective of the fundamentals of those programs. Anticipating these levels should bounce back and given the demonstrated success of our commercial accounts, we remain assured of our overall vision and progress toward achieving our long-term goals. With that, let's dive into the quarter's results.
Total company revenues in the quarter were $25.5 million, which included healthcare market revenues of $23.9 million. Our customer care/outsourced services business accounted for $1.5 million in revenues for the quarter. As a reminder, we anticipated our customer care revenues to decline sequentially until the restart of the federal student loan programs. That being said, this quarter's results reflected a steeper decline than both we and our client had anticipated.
On a positive note, the programs are expected to restart in the latter half of this year. With that, we anticipate the renewed possibility of growth within customer care that will likely remain at the sub-$2 million mark for each quarter for the remainder of 2023. Though the margin impacts are quite muted in comparison to what our healthcare market revenues drive, this near-term expectation could have a modest impact to EBITDA; call it roughly $0.5 million. We believe we'll have a much clear picture as to the future of our customer care market revenues as we close the year.
Revenue from eligibility services for the second quarter were $14.1 million, representing an increase of roughly 14% year-over-year. Our efforts to diversify our commercial eligibility offerings and implementations have continued to bear fruit as the commercial eligibility growth has significantly outpaced that of our mature eligibility offering with CMS.
As a reminder, we were re-awarded this key government contract as the Medicare secondary payment Commercial Repayment Center for a period of up to 6 years this last December, which is a key part of our government anchor strategy. This, coupled with the rapid expansion of our commercial programs, currently provides us with confidence in a bright future for our eligibility market offerings and results.
Revenue from our claims based or claims auditing business was $9.8 million for the second quarter. This represents 5% growth year-over-year. Similar to what we saw within our eligibility market revenues, our claims-based commercial programs showed much stronger growth than our government programs, which had continued impacts from deflated PHE-related volumes, as Sim detailed earlier. We may see this, in fact, continue through the third quarter, though we anticipate returning to higher volume operational levels later this year. This, in combination with the ramp-up of RAC Region 2 and contributions from the HHS OIG contract, should drive notable growth within government programs as we look to 2024.
While the first half results were a bit shy of expectation, we maintain visibility to achieving our healthcare annual revenue guidance of $105 million to $110 million. We are excited about our strong growth rates and growth rate potential and our ability to deliver quarterly records for healthcare market revenues this year.
Furthermore, I'd like to highlight the continued run rate value additions from our ongoing implementations. As Sim mentioned, the 22 implementations from the first half of 2023 alone should be worth over an estimated $11 million in annualized revenues at steady state. Overall, we have a lot of exciting revenue focused and have operational efforts underway. The continued ramp of prior year commercial implementations alongside those newly announced, the calendar of implementations ahead of us, the growth from RAC Region 2, the HHS OIG contract and a return to normalcy of existing government programs. These all provide a solid foundation for continued growth into 2024 and beyond.
At this stage of the year, we are also comfortable in providing annual guidance for the customer care market revenues of $6.75 million to $8 million for FY 2023. This combines with healthcare markets for total revenue guidance of $111.75 million to $118 million for 2023.
Operating expenses in the second quarter were $29.1 million, which is roughly flat in comparison to Q2 of last year. We've seen year-over-year growth in salaries and benefits as our investments into our healthcare market growth primarily take the form of headcount increases. As we look to future quarters, we expect our salaries and benefits expense line to continue growing alongside healthcare revenue growth.
With regard to our other operating expenses, one of the biggest drivers of the year-over-year decrease has been our initiative to manage our physical footprint as we continue to adapt to working in a remote world and manage our expenses.
Our EBITDA for the quarter was negative $1.3 million, which was slightly below expectation, given the slowdown impacts from our healthcare and customer care market revenues. We estimate that gross margin remains around 40%. This is in line with what we have previously shared and we continue to see room for expansion. We remain well capitalized to tackle our organic growth initiatives with roughly $15 million in unrestricted cash in addition to a strong base of current assets. We do have our eye on flexibility for all avenues of growth, and we'll continue to take steps to ensure we maintain flexibility and available capital should the right opportunities present themselves.
As you'll note from Sim's commentary and what we are seeing financially within our growing healthcare operation, we are very excited to continue delivering growth, enhancing our product offerings, broadening our market footprint and expanding our EBITDA margins. All of this is well within our reach as we continue executing against our contracted offerings and is further bolstered by our growing sales pipeline and business development initiatives.
Operator, would you please open up the lines for questions.
Question and Answer Session
Operator
(Operator Instructions) Your first question comes from George Sutton from Craig-Hallum.
George Frederick Sutton
Sim, I wondered if you'd walk through these 22 implementations and talk about it in a broader sense competitively. Why are you winning this amount of business? What is unique about what you're doing versus what's happening more broadly in the macro?
Simeon M. Kohl
Yes. Look, I think it's a combination of a few factors and we've talked about this before. I think the first is, I think payers generally appreciate our vast relationship with CMS and how that provides just such great visibility into the national landscape of claims and emerging trends. I think the second is our technology, and you heard that in my prepared remarks, our technology and its ability to kind of consistently produce high-quality findings. And as we talk to payers, it's often discussed how high quality and low provider abrasion is the #1 priority for most program integrity initiatives.
And then finally, it's our ability to add value regardless of the size of payers. So whether it's a national plan of 10-plus million covered lives or a small plan with under 100,000, we can adapt our offerings to drive meaningful value regardless of the number of covered lives. And so we've talked about it before with kind of these bespoke solutions and being able to leverage that national landscape and drive value to an under 100,000 member plan. And so I think the momentum that we have in the industry and some of these payers are recognizing the unique capabilities that Performant has amongst its competition.
George Frederick Sutton
Relative to that adoption of the platform, can you talk about where things stand on your middle market effort in terms of pipeline? And same with respect to the SaaS offering?
Simeon M. Kohl
Yes. So look, I'll take the latter one first. We continue to -- as we talked about innovation -- I mentioned AI -- we've talked about previously how we think that a self-service data mining option is going to be very valuable. We're hearing more and more feedback from payers in the industry that are looking for that type of a solution. We continue to invest in that, building out that capability, working through actually a pilot that's informing some of the investments that we're making on that front. George, I don't have a specific date yet in terms of a launch timing, but it is and continues to be a #1 priority for us.
And we will continue and are in terms of focusing on the mid-markets. You heard the announcement we had a while back with Priority Health. That continues to go quite well and help us with regards to thinking about tailoring that type of an offering to other similar payers. So we're seeing more and more opportunity for our sales teams to share the success of those types of opportunities and it's driving a broader pipeline opportunity for us in the small -- in the mid player.
George Frederick Sutton
Okay. Finally for me, you mentioned compression in the implementation cycle and things you're doing to compress that. Can you just talk about what you've been able to accomplish there? What does that mean in terms of numbers like the timing of an implementation?
Simeon M. Kohl
Sure. Yes. So look, right, when we talk about 22 implementations in the first half of the year, 21 all last year, we said coming out of Q4 that one of the things that we're focused on internally is just driving greater efficiencies. We've got a good pipeline of both sales opportunities and already booked implementation signed contracts. And so for us, getting those products launched, getting those opportunities launched as soon as we possibly can aligns well with our client objectives.
And so as we think about making efficiency gains, it really is about how do we adapt our workflows, how do we drive greater efficiencies and all the things that we do internally with client data, client onboarding, how do we get our account management teams, educating payers for some of their internal initiatives that they need to tackle on their end. And then we are making some investments in technology, just pure block and tackle technology that allows us to do things more quickly. And so all of those things have come together nicely and I think underscore our ability to deliver 22 new implementations in the first half of the year, and we expect that cadence to continue.
Operator
Your next question comes from Jacob Stephan from Lake Street.
Jacob Michael Stephan
Congrats on the nice implementation progress here. When we think about kind of the $500,000 annually per commercial implementation, is that a good way to think about the 20 implementations you completed in 2022? Or is that different?
Rohit Ramchandani
Jacob, yes, that's not a terrible way to think about it. I think as we've shared historically, a given implementation can range on the hundreds of thousands on the low end to a few million on the high end. And so I can't tell you that it's exactly the same average, but it's probably pretty close for the 21 implementations from 2022.
Jacob Michael Stephan
Okay. And so the $11 million annualized, can you just help us think about how that kind of lays out over the model, the implementations you completed earlier this year, maybe just kind of the revenue breakdown how we see that progress quarterly?
Rohit Ramchandani
Yes. So I think at its core rate, what it does is, I think, hope to serve for more proof points against our growth expectations and our guidance now and what we will be guiding in 2024. In terms of how they layer in, it will depend on the type of implementations. As I think we've discussed, if it's a net new logo, the ramp-up may take a little longer versus an existing client. And then for claims-based opportunities, it's probably somewhere in the year 2 or 3 mark that you've reached a steady state whereas on the eligibility side, it's probably more like a year, 1.5 to 2 where you're seeing it reach that steady-state point. So if you think about a given quarter's implementations, that ramp-up will reach steady state, is kind of a waterfall and then all be at once.
Operator
There are no further questions at this time. I'll turn the call over to Simeon Kohl. Mr. Kohl, you may proceed.
Simeon M. Kohl
Thank you. And thanks, everyone, for attending today's call. We always appreciate your continued interest in Performant and we look forward to speaking with you again at our third quarter earnings call in November. Thanks much.
Operator
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Thank you.
