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Performant Financial Corp (NASDAQ:PFMT)

Q4 2012 Earnings Call

February 28, 2013 5:00 pm ET

Executives

Jeff Guzman – Investor Relations

Lisa Im – Chief Executive Officer and

Hakan L. Orvell – Chief Financial Officer

Analysts

Suzanne Stein – Morgan Stanley

Julio Quinteros – Goldman Sachs

Edward Caso – Wells Fargo Securities

Kelly Flynn – Credit Suisse

Robert Napoli – William Blair & Company

Michael Tarkan – Compass Point

Richard Cheever – SunTrust Robinson Humphrey

Operator

Good afternoon, ladies and gentlemen, thank you for standing by. Welcome to the Performant Financial Corporation’s Fourth Quarter and Full Year 2012 Earnings Conference Call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions) As a reminder, this conference is being recorded today, Thursday, 28 of February, 2013.

I would now like to turn the conference over to Jeff Guzman with Investor Relations. Please go ahead.

Jeff Guzman

Thank you, operator. Good afternoon everyone. By now, you could have received the copy of the earnings release for the company’s fourth quarter and full year 2012 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 the risks and uncertainties that 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. 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 the most directly comparable GAAP measures and this table is attached to our press release.

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

Lisa Im

Thank you, Jeff. Good afternoon everyone and thank you for joining us for our earnings call today. Before discussing our results for the fourth quarter and full year, I would like to review recent and notable events. In January, we completed an equity offering of 9.2 million shares which has allowed us to expand the quality and breadth of our institutional shareholder base, and has enhanced the daily trading volume and liquidity of our stock.

Hakan will discuss our results in greater detail, but at a high level we are very pleased to report our continued strong financial performance both in Q4 and for the full year 2012. Today, we are reporting revenues of approximately $56 million in the fourth quarter and $210 million for the full year, increases of 31% and 29% respectively year-over-year.

Adjusted EBITDA in the fourth quarter was approximately $17 million and $70 million for the year. Adjusted EBITDA margin for the fourth quarter was 31% and 33% for the full year. Adjusted earnings per diluted share was $0.15 in the fourth quarter and $0.64 for the full year.

Starting with our student lending business, during the fourth quarter, student lending represented over 60% of our total revenues and continues to be driven by spaces of defaulted loans from both channels of the federal program, the Department of Education and the guaranty agency. We have a long history of working with borrowers and as a percentage of default of student loans continue to raise, now 9.1% as of the latest two year cohort data. We are well positioned to work with these borrowers to help them regain current status.

As most of you know, the majority of our student lending revenues come from rehabilitating deposit loans. A profit by this borrower makes nine consecutive monthly payments thereby making the loan of performing assets. Performance received the success fee on each payment and on the remaining balance of their loan once rehabilitated.

As we discussed on our third quarter earnings call, the Department of Education has been dealing with the technology upgrade that significantly reduced student loan placements to the first nine months of 2012. The Department of Education is seriously has made significant progress in resolving this issue which is evidenced by more than $1.1 billion in loan phases that we received from the Department of Education during the fourth quarter compared to less than $200 million during the third quarter.

In addition to the improved loan placement volume, the progress on their technology upgrade allowed us to recognize $2.5 million in deferred revenues that we reported on our balance sheet at September 30, 2012. Another recent development on the student lending side of our business relates to income date rehabilitation for IBR rehabilitation or IBR program.

The Department of Education has recently encouraged that all of its current vendors who work with borrowers and get service with IBR program. These programs reduce the burden of the monthly payment by modifying the repayment schedule based on the borrower discretionary income. We view this trend as the growth opportunity for performance as we expect that there will be an increase in the number of deposit student loans that will become eligible for rehabilitation, because more borrowers will be able to make qualified payments.

As part of this trend we have been advised that the Department of Education is contemplating changes to its contractual arrangements with its recovery vendors. Although the specific nature of these changes were made uncertain, for example, the Department of Education may call on its vendors to do additional work tracking down documents related to income verification. It could also elect to modify the contingency fees related to defaulted student as a response to the expected increase in overall volumes.

While there is scope any changes made aren’t clear, we are cautiously optimistic that IBR will have a net positive effect on our business. We anticipate that the Department of Education will issue its RFP for the new recovery contract in the near term. While we are not in a position to speculate on the details, we are confident that our strong performance on each and every one of those past four contracts over the past 22 years will serve us well and being reselected as one of the vendors on the new contract.

Finally, and I’ll talk about this more in a moment. But in addition to working with the Department of Education on student loan recovery, we were also recently awarded a new payment recovery contract with the department. This highlights our strong institutional relationship with the Department of Education, leverageable technology platform and our ability to expand and diversify our business via new contract wins.

Turning to our healthcare business, we had a very strong fourth quarter and some trouble claim recovery volume growth 120% compared to fourth quarter of 2011. This represents our fifth consecutive quarter of both volume and revenue growth, and reflects the significant progress we have made ramping up on the contract. Since 2009, we have grown our healthcare revenues from less than 1% to over 25% of total revenues in 2012. This growth is a testament to our robust and versatile technology platform.

During 2012, our total recovery to CMS was approximately $0.5 billion. Total healthcare revenues were $54.7 million. Overall, we have now recovered a total of approximately $700 million of CMS since we started on the contract in 2009. As a reminder, our contract with CMS is a success stage model. So we are paid based on the dollar amounts of improper payments that we are able to identify and recover. We recognize revenues when the provider pays CMS or incurs an offset against future Medicare claims. The revenue to recognize are net of our estimate of claims that will be overturned by appeal following the company’s payment the provider.

Similarly to the third quarter, our results in the fourth quarter do not reflect any revenues associated with recovery activities involving periodic interim payment provider or PIP providers as CMS is working on a technology solution to automate the processing of claims involved in these providers. We estimate that this issue has delayed our recognition of approximately $6 million in revenues in 2012. Overall, PIP hospitals account for approximately 20% of the hospitals in region A.

When you look at the audit results of these hospitals, we find that our results in these hospitals are very similar to the audit findings across our non-PIP hospitals in region A. As such, we expect our results at PIP hospitals to be exactly the same as those as standard hospitals. In January of 2013, CMS began processing a small portion of the PIP claim manually and as a result we will recognize only a small portion of revenues associated with these manually processed claims. In the first quarter of 2013. However, we expect the issue will be resolved and that we will be able to recognize the entire $6 million in delayed fixed revenue during 2013.

CMS is in the process of implementing the necessary changes to its system that would allow these claims to be processed automatically and allow us to recognize the bulk of these 2012 revenues. While we believe that this delay is temporary, we do not expect automated processing of these claims to begin during the first quarter of 2013. We have continued to receive a number of questions regarding the CMS contract renewal process and timing of the upcoming RFP.

Although we do not have a specific time span regarding the RFP for the contract renewals, CMS has indicated that an RC will be forthcoming in the near term and that they expect to follow-up with the final decision shortly thereafter. We are confident that our performance on the current contract and our prior recovery experience places Performant in a strong position heading into the contract renewal process.

Finally, with successful activities in other markets, we continue to look for opportunities to expand within our current markets while seeking new opportunities to employer technology enabled services platform and recovery experience to new market. Recently, we announced a strategic relationship with Magellan Health Services to offer payment integrity recovery services to Magellan's commercial, specialty, pharmacy customers.

During 2012, we worked with Magellan on a pilot program involving select customers and we received very positive feedback. As a result of this program, Magellan and Performant enlisted to role off the upgrade to the entire specialty pharmacy customer base in 2013. We're very enthusiastic about expanding our relationship with Magellan and serving the specialty pharmacy market. We have refined our recovery services over many years in multiple industries, so meeting this unmet market demand is the natural fit with our long-term growth strategy.

As I mentioned earlier, Performant was recently awarded a contract by the Department of Education to serve as its payment recapture contractor. Under the terms of this contract, we will leverage our proprietary data mining technology to conduct a payment recapture audit of goods and services contracted by the Department over fiscal years 2007 through 2012. The total value of this portfolio which excludes student loan totaled approximately $9 billion for the entire period or about $1.5 billion annually.

To be clear, this concept excludes grants from student loans and is separate from our current long-standing relationship with the Department of Education providing recovery services for defaulted student loan. It represents an ancillary growth opportunity for us. Under the terms of the contract we will identify, evaluate and report the root causes for contracts overpayments and support the recovery of improper payments.

With that, I would like to turn the call over to Hakan, who will now walk you through the financials. Hakan?

Hakan L. Orvell

Thank you, Lisa, and good afternoon everyone. As Lisa mentioned, we were very pleased with the results for the fourth quarter as revenues increased 31.3% year-over-year to 56 million. The largest component of our revenue mix is student lending which grew by $3.5 million or 11.4% compared to the fourth quarter of last year. The increase in student loan recovery revenues is largely due to our recognition of $2.5 million in deferred student loan revenues outstanding from the third quarter from the Department of Education they have not been previously caused us during price periods due to the department technology system upgrade. Fourth quarter basements were 2.2 billion, up 45.1% year-over-year and a sequential increase of 65.9%. This significant increase is the result of receiving in excess of $1.1 billion in loan placements from the Department of Education during the quarter. We expect to begin to recognize a benefit from the improved basement volumes in the second half of 2013.

As a result of the increased basement volume, revenues as a percentage of basement volume was 1.58% compared to 2.05% in the prior year period. As basement volumes increased to normalized levels, we expect to see revenues as a percentage of basement volumes to return to more normalized levels as well.

The second largest component of our revenue mix healthcare increased 8.5 million or 119.1% to $15.7 million compared to the fourth quarter of last year. The increase in healthcare revenues was due to high claim recovery volumes from our RAC contract with CMS, mostly in recovery volume increased by $75.6 million or 120.5% to $138.4 million. Our clean recovery CMS with l 1.3% compared to 11.04% in the prior year period.

Cumulative to third quarter, the revenues we’ve been able to recognize under the RAC contract to date do not include our auditor recovery work involving Periodic Interim Payment Providers or PIP providers, in our region in the north-east. PIP providers are reimbursed through different processes, and in fact our client is building process are making certain system adjustments in order to have these claims processed. This system issue has had most significant impact on us, because we have a disproportionate concentration of PIP providers in our region.

Estimated accounts were approximately 20% of the Medicare spend in our region and we were unable to begin ordering these providers until April of 2012. During April we identified a significant amount of improper payments to PIP providers, but these payments have not yet it in process by CMS.

As a result, we have not recognized any revenues from identified improper payments to PIP providers in our region, but have incurred expenses relating to the claims. We estimate that this delayed our recognition of more than $2 million in revenues in Q3, and approximately $4 million in revenues in Q4. This brings the total delayed revenues from PIP providers to over $6 million at year end.

It’s important to remember that because we have already incurred expenses related to this delayed revenue, when we are able to recognize these revenues we estimate that over 70% will drop through our pre-tax earnings. CMS is currently employing a manual system to processes claims as we do not expect to recognize a majority of these revenues until at least the second quarter of 2013. We are confident that this delayed is only temporary and we fully anticipate that our work with PIP providers will further contribute to our growth opportunities in 2013 and beyond.

Revenues from other markets, other revenues grew by 27.4% primarily due to a new default aversion services contract that started in May 2012. Revenue from this contract was slightly lower than Q3 2012 primarily due to having worked through the initial loan placement. With that also expect future quarters to be at a lower run rate than booked in the third quarter as we continue to just work the ongoing loan placement.

Moving to our expenses, salaries and benefits expense was $23.6 million, an increase of 41.6% as compared to $16.6 million. This increase was primarily due to hiring of new entries to provide services under our RAC contract to CMS, an increase in expenses associated with the engagement of additional software engineers consist of the integration of a recently acquired software license. And an increase in expenses associated with the hiring of additional administrative MP.

Other operating expense for the quarter was $18.3 million, an increase of $4.2 million. This was primarily due to an additional $1.5 million of subcontracted expense incurred in connection with increased services provided under our RAC and MSA contract. In addition, we have public company cost in Q4 of 2012 of approximately $400,000 and miscellaneous other volume related operating expenses.

For the fourth quarter of 2012, our reported net income was $6 million or $0.12 per diluted share compared to net loss of $2.4 million when net loss per diluted share of $0.10 in the prior year period.

Adjusted income in the fourth quarter was $7.1 million or $0.15 per diluted share compared to $6.6 million or $0.15 per diluted share in the prior year period.

Fully diluted average outstanding shares increased to 48.8 million shares in the fourth quarter of 2012 reflecting the increase of stock options along within increase in the company's share price making the unexercised options more diluted.

Our adjusted EBITDA grew 20% to $17.4 million compared to $14.5 million in 2011 period, well adjusted EBITDA margin was 31.1% compared to 33.1% in the 2011 period.

Turning to the full-year, overall revenue grew 28.9% to $210.1 million driven by year ending growth of 8.1% to $132.4 million, healthcare growth of 154.1% to $54.7 million and other revenue growth of 21.3% to $22.9 million.

Net income for the full year was $23 million or $0.44 per diluted share, well adjusted net income grew 22.7% to $30.6 million or $0.64 per diluted share. Our adjusted EBITDA grew 20.4% to $69.6 million and our adjusted EBITDA margin was 33.1%. Our effective tax rate for 2012 was 42.24%, this is slightly higher than what we had expected due to a one time tax impact of approximately 2% on our effective tax rate related to a nondeductible advisory agreements that were terminated. Cash flow provided from operations in 2012 was $37.8 million compared to $28 million in 2011.

Turning to the balance sheet, as of December 31, 2012 we had cash and cash equivalents of $37.8 million. Our total outstanding debt as of December 31, 2012 was $147.8 million, a sequential decrease in outstanding debt of $2.8 million with respect to scheduled payments in our term debts. As of December 31, 2012 net accounts receivable totaled $23 million, compared to $19.4 million as of December 31, 2011. Overall days in the accounts receivable were approximately 43 days compared to 38 days at December 31, 2011.

Let me turn the call back to Lisa for some concluding remarks.

Lisa Im

Thanks, Hakan. As we look ahead, we feel very good about the trends in our business. We are seeing strong growth and normalized loan placement volumes from Department of Education and we continue to ramp up and demonstrate improved results on the Medicare RAC contract. Additionally, we have been able to span the use of our technology platform to win new contract as demonstrated by our recent contract win with the Department of Education.

Overall, we expect to build on our positive momentum and for 2013 to be another strong year. As such, we anticipate revenues for the full year 2013 to be in the range of $252 million to $265 million or 20% to 26% revenue growth and adjusted EBITDA to be in the range of $81 million to $85 million implying an adjusted EBITDA margin in the low to mid 30% range. While we are confident in achieving these results, we do expect the timing of our financial results to be more heavily weighted to Q2 and beyond for a number of reasons.

Given the impact of these one-time timing issues that we're going to provide you with some additional clarity on our expected first quarter results, however, it is not our intention to continue to provide quarterly guidance on a regular basis going forward.

First, as we’ve discussed the majority of our student lending revenues are achieved via loan rehabilitation which is a nine month process. Although student loan placement volumes increased from Q1 to Q2 in 2012, we received the significant portion of those loan placements in late quarter two of 2012. Given this timing, we anticipate recognizing the bulk of the revenues from those placements during Q2 of 2013. Moreover, as the Department of Education start up our placements during Q4 of 2012, we will not see the related rehabilitation revenues until Q3 and Q4 of 2013.

Second, our fourth quarter student lending revenue result included $2.5 million from the recognition of higher margin deferred revenue, which will not be repeated in the first quarter. Third, as a result of Hurricane Sandy, we were unable to submit request for medical records on hospital providers in the states of New York, New Jersey, and Connecticut for 30 days or 60 days if a provider was located in a federally designated disaster area. We are no longer suffered to these delays and have since returned to normal operation in all of our states and region. However, we expect that this will delay a portion of the revenue that we would normally have recognized in Q1 of 2013 into Q2 of 2013.

As a result of these timing considerations, we expect Q1 revenues to be sequentially down in the mid-teens as compared to Q4 of 2012. While these issues will impact our first quarter 2013 results, these are delays in revenue recognition from the first quarter to subsequent quarters and not lost revenues. As a result, we expect many of these timing differences impacting Q1 revenues to be resolved in Q2 and Q3 losing significant revenue and EBITDA growth in these fourth. We remain confident in our ability to execute our plan in 2013 and generate full year annual revenues and adjusted EBITDA in the ranges previously described.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question is from the line of Suzanne Stein with Morgan Stanley. Please go ahead.

Suzanne Stein – Morgan Stanley

Hi. You mentioned significant progress on improving the technology issue with the Department of Education, but I was under the impression that was firstly resolved by the end of the year, should that not happened and I guess what’s the expected timing on getting that completely resolved?

Lisa Im

It's Lisa. As we think about the go forward, the technology platform is fully implemented, but we just have a little bit of quankiness in the sense that it's not operating as smoothly as Department of Education would like. That said, as we saw in Q4, our placements are available ready to go, they are funding rehabilitation. The remaining item to be perfectly Frank is all of the previous payments during the conversion have yet to be fully reconciled, so there is some cleaning up of the Department of Education is still doing and then as we go forward we have some minor issues with reconciliation, but in large to be – technology implementation is completed.

Suzanne Stein – Morgan Stanley

Okay. And then – thanks for the information on the new department of education contract. I guess I'm just trying to understand how big this can be for you from a revenue standpoint and how much of that is embedded in the 2013 guidance, so what's the timing in terms of when you would see revenue from that?

Lisa Im

We would anticipate implementing it sometime Q2, Q3. We would start to – we think see revenues late Q3 to Q4. We at this point do not know how big the opportunity is on the total auditable dollar amounts of $9 billion and as we get into this year a bit more and start the analysis, we’ll have clear visibility.

Suzanne Stein – Morgan Stanley

Give me only one contracted on that?

Lisa Im

Yes.

Suzanne Stein – Morgan Stanley

Okay, thank you.

Operator

Thank you. Our next question is from the line of Julio Quinteros with Goldman Sachs. Please go ahead.

Julio Quinteros – Goldman Sachs

Great. Hey guys, so just to may be to kind of keep picking on some of these other revenues and thinking about the ramp and the potential of some of these, so it sounds like, I mean you guys still have to work through the modeling and understanding what this is. Any color may be on around the fee rates in this new DOE contract, and also on the other contract that you mention as well with Magellan. How quickly can you ramp those revenues up relative to kind of the basic, I think, I’m not familiar with this at this point?

Lisa Im

On the Magellan opportunities we’re offering the recovery service to their various participants in the specialty pharmacy program. That should be a fairly straightforward process of implementation, but our assumption Julio is that we would take a few months to implement these contracts which is why when we give mid-term guidance. We talk about margins in the low-to-mid 30 building in again a bit of investment upfront before revenue is recognized.

Julio Quinteros – Goldman Sachs

Okay. So I guess just exclusively the guidance that you just gave us for revenues in 2013 doesn’t have explicit built-in assumptions for either Magellan or the new DOE contract or it does?

Lisa Im

Generically we have a very small assumption for new business.

Hakan L. Orvell

And this time you can say that it is included in the range, I mean the range of $250 million to $265 million.

Julio Quinteros – Goldman Sachs

Sure, understood. And then on the expense side, am I continue just go back through the levels of expenses that you are carrying through right now, of some of the delays as it relates to PIP and any other kind of special callouts that you can sort of point to that would be kind of sort of extraordinary expenses that eventually would go away as you are able to kind of begin the recognized revenues?

Hakan L. Orvell

Sure , as we look at the PIP revenue which now is up to approximately $6 million, $4 million in Q4 alone. We anticipate that once we recognized this revenue would be in excess of 70% that would go to the EBITDA line. So again we've incurred the expense for the activities associated with PIP, so that's a significant item that we would get the benefit for and the way that we projected right now will get that benefit and starting in Q2 of this year.

Julio Quinteros – Goldman Sachs

Understood. Okay. Thank you.

Operator

Thank you. Our next question is from the line of Edward Caso with Wells Fargo. Please go ahead.

Edward Caso – Wells Fargo Securities

I apologize on (inaudible) cold. So I have just two quick questions, guidance on the tax rate for 2013 and recent secondary offering we have no proceeds, the seller pick up only with your related cost?

Hakan L. Orvell

Let me take that. First of all as we look at our tax rate, our effective tax rate as I stated was 42.24% in 2012, which includes the one-time impact of 2%. So we expect absent any other changes that we're going to be just north of 40% to around 40.25%. And we as look at the secondary there was a small portion that was absorbed by the company associated with that sell was less than $1 million, but the other cost were incurred by sellers.

Edward Caso – Wells Fargo Securities

Thank you.

Operator

Thank you. Our next question is from the line of Kelly Flynn with Credit Suisse. Please go ahead.

Kelly Flynn – Credit Suisse

Thank you. Couple of questions. First of all, Lisa you said the revenue might be down sequentially mid-teens versus Q4, just want to clarify, you're talking in percentage terms not absolute dollar amounts?

Lisa Im

Correct.

Kelly Flynn – Credit Suisse

Okay, great. Thanks. And then also the tax rate, the 2% impact, how can that you said related to that advisory agreement? Was that in the fourth quarter?

Hakan L. Orvell

It was not all in the fourth quarter; it started in the second quarter.

Kelly Flynn – Credit Suisse

Okay. For the fourth quarter, I can see your tax rate is 46%, do you agree that was higher than expected due to the same issue or was there anything else going on?

Hakan L. Orvell

Yeah. The primary issue as we look at the higher tax rate for the year is 2%. There was also some impact as we did the state tax rapprochement work for the year which then typically gets down at the end of the year. And just based on the state mix that drove up our state taxes by about – I think it was about 0.5% or 1%. So that’s one of the impact that we had during Q4.

Kelly Flynn – Credit Suisse

Okay. Great. And then for the PIP revenue, I think you talked about manual processing going on in the first quarter. You expect a little bit of revenue. How much revenue do you expect roughly in Q1 and do you expect that whole $6 to come back in Q2 or more gradually for the rest of the year?

Hakan L. Orvell

As we look at the manual process that started beginning of January, we expect a small portion would be recognized and by smaller we estimate somewhere around the $1 million of PIP revenue during Q1. We are optimistic that CMS is going to be able to put this automatic fixed and that would enable to recognize a significant portion of the remaining part starting in Q2. So Q2, we expect to break as a big part of that $6 million that is sitting out there from 2012.

Kelly Flynn – Credit Suisse

Okay, great. And then lastly, Lisa I just wanted to ask you for little more detail on this new Department of Ed contract, you've talked about goods and services, can you just explain exactly where it is? It sounds like your auditing their procurement of goods and services kind of totally unrelated to the loan program, is that right or any more kind of qualify?

Lisa Im

Yes, that is correct. That is correct.

Kelly Flynn – Credit Suisse

Okay.

Lisa Im

Totally unrelated to the student loan program.

Kelly Flynn – Credit Suisse

Okay. Is this team of goods and services procurement on it is this something do you think you could take to other parts of the government for bad luck of better returns?

Lisa Im

One of the opportunities that we discussed last year with the market was the heavy focus from Congress on federal agencies developing and implementing recovery audit program fashioned after the success of CMS. The recovery audit program, so as we look at 2012 and frankly the focus on payment integrity and avoiding wage and recouping way in central government spending has become a much bigger push by congressional folks to extend were towards the end of 2012 that was even heavier legislation put in place really accelerating and emphasizing the overall payment integrity process across all federal agencies. So we do expect other data federal agencies to come out with RFPs to really focus on again developing and implementing a program for recovery and audit.

Kelly Flynn – Credit Suisse

Okay, that's great. Thanks a lot.

Operator

Thank you. Our next question is from the line of Robert Napoli with William Blair. Please go ahead.

Robert Napoli – William Blair & Company

Thank you, good afternoon. Another question on perhaps if I could. You generated $4 million of recoverable revenue in the fourth quarter on PIP. You expect to collect $1 million to the manual process, but does that mean, I mean, are you guys generate another $4 million of revenue so at the end of the first quarter you can have $9 million of recoverable revenue. So what you like, my question is I guess, what is the trend on the PIP? And then what are you expecting, when you are expecting PIP revenue to be recognized as earned. What you have in guidance for 2013 on PIP revenue?

Lisa Im

Sure Bob. We’re going to answer this in two parts. One is I’d like to talk, just refresh on the PIP providers what our audit findings are very similar to audit findings across non-PIP hospitals. But as you think about volume metrics and the opportunity for the PIP portion in Region A, you can think 20% of hospitals are PIP we’re finding very similar result, so that gives you a sense of how to think about the overall recovery and errors that we are finding. Now I let Hakan actually speak to be accounting piece of it.

Robert Napoli – William Blair & Company

Okay.

Hakan L. Orvell

Sure. You are correct Bob that again we are working into this year with $6 million worth, it’s been an excess of $6 million worth of PIP revenue. We estimate $1 million in Q1 there is additional recoveries that we have done on the PIP, on the PIP providers that are continuing during Q1. So I don’t have any number to give you as far as with the estimated additional PIP revenues that is being generated during Q1, or that we expect to generate during Q1. But if you look at this going forward, again we estimate that the automatic fix would be put in place here during Q2 and that this will be a contribute to our overall growth during 2013 as we look at the activities surrounding which represents again over 20% of approximately 20% of the Medicare spend in our region.

Robert Napoli – William Blair & Company

Okay, the PIP losses, if they look at the fourth quarter recoveries you had essentially on an ongoing basis that would be 20% higher approximately given the (inaudible) finding in proper payments the other 80% of your market?

Hakan L. Orvell

Actually by the way I would look at it, I mean as we look at our healthcare revenue on the RAC contract, it was approximately $15.7 million in Q4 which did not include any PIP revenue at all. So you could – one of the assumptions you can do is, go upside 15.7% and then grow 20% higher.

Robert Napoli – William Blair & Company

20% higher.

Hakan L. Orvell

That's right.

Robert Napoli – William Blair & Company

Okay. And then just on the student loans of your placement volume how much of that was from GA versus Ed?

Hakan L. Orvell

Ed was about $1.1 billion.

Robert Napoli – William Blair & Company

Okay. And do you expect the GA continue to grow and are using any consolidation in the GAs, but then affect you one way or another?

Lisa Im

We do anticipate some growth in defaulted volume and we're seeing – we're not seeing a lot of consolidation in guarantee agencies yet, and that market is one that we think we’ll probably the smaller guarantee agencies – we anticipated would be the one consolidated into larger one they will hang on, and I think we’ll probably start to see some of that this year.

Robert Napoli – William Blair & Company

Okay. With regard to the Medicare RAC business, how much of our business are you subcontracting and you expected to do more or less and I know the contracts are towards the RFP is coming, but if you give me a feel for subcontracting portion of your business and how that's trended?

Lisa Im

So, one of subcontractor is PRGX and to the extent that they are auditing about 18% of Medicare sale through one specific Mac, their contribution is less than that, but that's about volume of claims that they are reviewing. As we look forward to the new RAC re-compete contract we do not anticipate having subcontractors of that magnitude on that re-compete.

Robert Napoli – William Blair & Company

Okay. And that's less profitable, I mean subcontracting clearly is how much less profitable to non-subcontracting?

Lisa Im

That's correct.

Robert Napoli – William Blair & Company

Okay. And if you had any inclination from CMS on the contract and how it's going to be handled on you said you expect that quick turnaround is that basically – so we would hear something this year and mid this year and surely after submit your RFP?

Lisa Im

What we know about is that is the priority, re-compete with CMS and so we're anticipating that they will try to get the re-compete done in a timely fashion. They have not conveyed to us any specific timeframe officially regarding the RFP for contract renewal, but they have told us it’s a forthcoming in the near-term and they will make a decision shortly thereafter.

Robert Napoli – William Blair & Company

Okay. Last question the (grant and student) relationship, how was that progressing? Are you seeing any type of pipeline of opportunity go through the grant Thornton joint venture for partner?

Lisa Im

Yeah. We are working with them to develop a pipeline.

Robert Napoli – William Blair & Company

Okay. Great thank you very much.

Operator

Thank you. Our next question is from the line of Michael Tarkan with Compass Point. Please go ahead.

Michael Tarkan – Compass Point

Thanks for taking my question. Can you talk a little bit more about the changes to income based repayment, I guess this is going to trying to get out is, when specifically where you notified from Department of Ed that you may get to use this as the rehabilitation tool. I thought that if you had already mentioned this, but are you currently using IBR as a rehabilitation tool?

Lisa Im

Yes, we are currently using IBR as a rehabilitation tool. And Department of Education has started to emphasize that program in the later half of 2012.

Michael Tarkan – Compass Point

Okay. And are you getting paid regular contingency fees at this point if you rehabilitate along with IBR?

Lisa Im

That is correct.

Michael Tarkan – Compass Point

Okay. And then kind of follow-up, I’ve seen a lot of proposals recently in Washington about making IBR default option for borrowers basically right as they enter repayment. I was just curious you got any thoughts on that, those proposals?

Lisa Im

As you might know the IBR program on the non-defaulted side has been in place since I believe February 2009. So it’s not a new program on the un-defaulted side. As we look at the participation of borrowers on the front-end side or the un-defaulted side of student loans, it has not had great traction and partly because of the kind of the documentation required in order to participate in the IBR program. Also as you probably know the IBR program allows forgiveness of the loan balance after 20 years of payment and the balance of the remaining balance is forgiven for which the borrowers taxed. So it's just hasn’t gotten I think as much traction on the front-end as we are finding on defaulted student loans and probably because it is really a great vehicle to help borrowers become current.

Michael Tarkan – Compass Point

Right. I guess if they relax some of the qualification Red Tape we’ll it, would you expect an impact there just go directly into income data payment before they even to follow because that’s something you are concerned about or is no your radar screen if they either promote the program or maybe relax some of the criteria to get into the program?

Lisa Im

Yeah, no. You are asking me to speculate. So if I were to speculate and think the criteria get far more relaxed and maybe more participants in the IBR program that said you probably also know default volume is that an incredible all-time high on the overall inventory that is out. So I think from a growth standpoint, I'm not sure that we view as a negative to the growth profile that we put forward.

Michael Tarkan – Compass Point

Understood. And then I guess I just had one more, can you talk a little bit about the vintages of the loan that you're seeing right now through GAs and through Department of Ed, what years were those originated? Are those post six or seven or eight months or they are more recent months?

Lisa Im

I don't have the data in front of me to the best of my recollection. I believe they are not more recent.

Michael Tarkan – Compass Point

Okay, thank you very much.

Operator

Thank you. Our next question is from the line of Richard Cheever with SunTrust. Please go ahead.

Richard Cheever – SunTrust Robinson Humphrey

Hi, thanks for taking my call. I was hoping, something you could maybe parse outs the $1.1 billion placement from Department of Ed, do you have a sense how much of that was backlog versus what you would I guess what would be a normal run rate for the quarter?

Hakan L. Orvell

Sure, let me add to the – take a look at some of the numbers that I have on in. Clearly significant part of it is the backlog that we have experienced with Department of Education as we look at on a normal basis they would – we would be looking at, and if I go back to last year when we had normal placements from Department of Education you would be under the [definite] of around $300 million to $400 million that we would get on a quarterly basis.

Lisa Im

2011…

Hakan L. Orvell

For 2011, correct beginning of 2011.

Richard Cheever – SunTrust Robinson Humphrey

Okay. So the big chunk of that 30%, 25%, 30% of that was, I’m sorry there is a reverse about $100 million of the placement than it’s likely due to backlog?

Hakan L. Orvell

It’s catch up, yeah as we mentioned I guess during the third quarter of 2012 we got less than $200 million from Department of Education. So clearly there is a significant catch up here that we didn’t – which again I mean as you look at that that placement of $1.1 billion or $2.2 billion for the quarter as you look at the nine monthly process that would impact our results very positively as you look at the Q3 timeframe.

Richard Cheever – SunTrust Robinson Humphrey

Right. And then on the salary and benefit line you highlighted a couple of things that drove, it looks like about 300 basis point increase from last year. Can you kind of parse out how much of the increase is due to new hires in the RAC program, versus I think you mentioned the software implementation, is that more of a one-time event, is that implementation compete?

Hakan L. Orvell

That implementation is complete as far as our software license that we’ve repurchased earlier in 2012. But as you look at our salaries and benefit, I mean we continue to invest in our business for future long-term growth to re-investing in the business both on the student lending side. But as you look at Q4 in particular, we had noted that as it relates to the RAC contract. And we are ramping on the RAC contract in a hiring, lowest core business so forth to facilitate that growth. That’s a large portion of the overall increase that we are seeing in salaries and [related].

Richard Cheever – SunTrust Robinson Humphrey

And are you still having success may be sort of sort of cap in those market or is there that market…?

Hakan L. Orvell

We’re having no issues as far as continuing to hire and grow business they require staffing to support the growth that we look at.

Richard Cheever – SunTrust Robinson Humphrey

Okay, thank you.

Operator

Thank you. Our next question is a follow-up from the line of Julio Quinteros with Goldman Sachs. Please go ahead.

Julio Quinteros – Goldman Sachs

Hey guys, just may be to go back and think through a little bit of this other revenue and also time that to new business development capabilities I think as we’re kind of looking at our model we had some base assumptions for health and for student and obviously all the drivers for that. But in part that’s interesting I guess just thinking about what you guys can do outside of that so obviously Magellan and this new DOE contracts and maybe, can you just help us walk-through your business development capabilities and then maybe from an operational perspective what you guys are capable look sort of on boarding sort of on a normal annual year basis in terms of new contracts. Anyway to sort of think about that how that back flow through the other revenue line-item here?

Lisa Im

Magellan would be a healthcare type of contract. So let me focus first to all on the on boarding question that you have. One is that, it’s a relatively straightforward in our real house type of new contract. We have great capacity to on-board, numerous contract. So for example if there is a healthcare recovery contract, that’s a core competency that we have. So we would not struggle with on boarding numerous contract of the type.

In a contract for example that's an audit recovery contract for another type of federal agency that will be highly technology related by in terms of analytics and it will use our big data platform and analytics capability in order to drive results for our clients. Now that will take a little bit more time upfront as we load the data and work with our clients and define the metrics of the analysis that we need to conduct. But so that will take a little bit more time upfront, but when we think about in the real house kind of core competencies that would be a fairly – I mean we've got a great deal of expansion capability there.

Julio Quinteros – Goldman Sachs

Got it.

Lisa Im

And when we think about business development and growth as you see from what we've released we are using clearly channel partners, as well as a strong large organizations with guest in very specific areas of our foundational market. Magellan is one of those strong players in the healthcare market.

Julio Quinteros – Goldman Sachs

Got it. So how many business developments are there in the organization now?

Lisa Im

If you think about overall sales force, we have several dozen sales force folks and specifically at a higher level for business development. We have three or four individuals focused partially on sales, largely on business development.

Julio Quinteros – Goldman Sachs

Okay, great. Thanks.

Operator

Thank you. Our next question is a follow-up from the line of Kelly Flynn with Credit Suisse. Please go ahead.

Kelly Flynn – Credit Suisse

Thanks. I was hoping you could revisit that $2.5 million revenue that you're talking about that I guess kind of pulled into Q4 from Q3. Can you go over again what exactly that was and I'm just not understanding why you don’t see that again in Q1 if it relates to the revamping of the technology issue of the department?

Hakan L. Orvell

Sure, Kelly. We were impacted last year as you know by the technology change of the Department of Education. I added an impact in two ways. One way was that we were not getting the normal amount of placement that we would expect which we touched on earlier. The secondary impact that we had was in our ability to recognize revenue on the completed rehabilitation process. So we were not able to recognize any rehab revenue for the Department of Education in Q1. We started to recognize it in Q2, and in Q3 we had $2.5 million worth of rehabilitation revenue still on the book on the balance sheet in deferred revenue. That was fully recognized during Q4. So as we look at the rehabilitation process, that is now working and we have been able to recognize the backlog of loans that we are sitting out there.

Kelly Flynn – Credit Suisse

Okay, right. Fair enough.

Hakan L. Orvell

Yeah. And then we do have, you are going to see on our balance sheet that we do have some deferred revenues still under the Department of Education, on the balance sheet and what that relates to is that we were notified by the Department of Education we were entitled to performance bonus for our performance during 2012. And we build that out and we had gotten that paid, but we still need to go through this reconciliation process as Lisa mentioned earlier, before we can recognize that revenue. That’s the primary amount that is under deferred revenue right now.

Kelly Flynn – Credit Suisse

Okay. When do you think you will recognize the performance bonus?

Hakan L. Orvell

We anticipate that’s going to be during Q2. It’s possible to come through in Q1, but we are anticipating that it will come through in Q2. That’s why we complete the reconciliation process.

Kelly Flynn – Credit Suisse

Okay, great. And then for the student lending business, what do you consider to be a normalized year-over-year revenue growth rate as we think about 2013? Can you give us a sense of where you think that growth might come in?

Lisa Im

When we look at overall growth what we’re anticipating is something similar to what you saw in growth in 2012 versus prior year. And part of that as you think about the flow of inventory as we come back to the flow of inventory that’s normalized for Department of Education. While that started in Q4 of 2012, it will continue through 2013 and as you know, the nine-month rehabilitation process will put much of that benefit in 2014 year.

Kelly Flynn – Credit Suisse

Okay. So when you say the same growth rate as 2012, you are talking about the student lending revenue?

Lisa Im

Yeah.

Kelly Flynn – Credit Suisse

Okay. Right that’s helpful, thank you very much.

Operator

Thank you. And we have no further questions at this time. I will turn it back to Lisa Im for any closing remarks.

Lisa Im

Great. And again as we look ahead, we feel very good about the trends in our business and we do expect to continue build on the positive momentum. I expect 2013 to be another strong year for us. And we again want to thank you for joining us. We appreciate your time and attention.

Operator

Ladies and gentlemen this concludes the Performant Financial Corporation’s fourth quarter and full year 2012 earnings conference call. Thank you for your participation. You may now disconnect.

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