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Performant Financial Corp (NASDAQ:PFMT)

Q1 2014 Results Earnings Conference Call

May 08, 2014, 5:00 pm ET

Executives

Rich Zubek - Investor Relations

Lisa Im - Chief Executive Officer, Director

Hakan Orvell - Chief Financial Officer

Analysts

Tyler Scott - Wells Fargo

Michael Tarkan - Compass Point

Suzy Stein - Morgan Stanley

Aaron Singh - Credit Suisse

Toby Wan - Obsidian Research

Operator

Good afternoon, and ladies and gentlemen, and thank you for standing by. Welcome to the Performant Financial Corporation's 2014 first quarter earnings conference call. During today's presentation, all parties will be a listen-only mode. Following the presentation, the conference call will be open for questions. (Operator Instructions). As a reminder, this call is being recorded today, Thursday May 8, 2014.

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

Richard Zubek

Thank you, operator. Good afternoon, everyone. By now you should have received a copy of the earnings release for the company's first quarter 2014 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 as 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 tables attached to our press release.

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

Lisa Im

Thank you, Rich. Good afternoon everyone and thank you for joining us for our earnings call. Today I am going to provide you with an overview of our operational results for the first quarter and then after Hakan will walk you through our financials performance during the quarter. Afterwards we will open the call for your questions.

During the first-quarter, we reported strong revenues and adjusted EBITDA growth of 19% and 53% respectively compared to the prior year period. This performance is a reflection of not only our technological capabilities but also all of the employees' best performance and the hard work they put in on a daily basis and I want to thank them for their dedication.

As we look specifically at our key markets during the first quarter, student lending represented approximately 67% of our total revenue. WE received total loan placements of $1.4 billion, which is consistent with our expectations and largely flat with the volume of placements we received during the fourth quarter of 2013. Compared to the first quarter of last year, student lending revenues grew by over 18% to $39 million.

In early April, the Department of Education announced that Performant was among the list of vendors that qualify for Phase 2 of the Default Collection Service contract rebid process. However last week, the Department of Education issued an announcement notifying the offerers that had advanced to Phase 2, that the due date for subsequent proposals was suspended until further notice. We do not anticipate that this will be of adverse impact to our operations this year as there are contract extensions available.

As it relates to our guaranty agency contract, last quarter we indicated to you that the federal budget act reduced the compensation received by guarantee agency for rehabilitating a loan and that there was uncertainty surrounding what the potential revenue impact will be to Performant. We have been in discussion with these clients and while some are still contemplating the magnitude of the fee reduction, we have heard from others. Based on our conversations, we believe that our previous expectation of an impact of $5 million to $15 million on revenue and adjusted EBITDA is still appropriate.

As a reminder, any changes to the guarantee agency compensation structure won't be implemented until July 1, 2014, which also coincides with the introduction of income based repayment opportunity at guarantee agency. Historically student lending has been a predictable contributor to our revenue that provides our company with consistent growth. Longer term, we expect student lending will continue to be a big growing industry with strong secular growth.

There continues to be exceptional benefits to getting a higher education degree. According to recent findings published by the Bureau of Labor Statistics, the median salary for an individual with a college diploma is 70% higher than for someone with just a high school education. Furthermore, the unemployment rate for individuals with a college degree are at about 4% compared to 7.5% for individuals with only a high school diploma.

Our healthcare revenues increased 32% year-over-year to $13.6 million and our net claim recovery volume during the quarter was $120.3 million. There has been much discussion around the issue of short stay claims or those lasting less than two midnights over the past few quarters and what the impact of not being able to audit such claims would have been on our business. I am pleased to report that we were able to achieve positive strong results without the benefit of revenues related to short stay issue, which was historically a significant portion of our healthcare revenues.

This demonstrates that although we benefited from being able to audit issues related to short stays, our business is not solely dependent on the inclusion of this one claim type. Currently there are over 700 claim types that have been approved to audit by CMS and as we demonstrated, we have actively shifted our focus towards other areas of payment errors in lieu of growth associated with two midnight rule.

last quarter, we discussed that we have recently signed a new contracts, including some MSAs with multiple contract opportunities with four of the six largest commercial healthcare payers in the U.S. All of these contracts are in the implementation or ramp-up state at this point. While revenues during the quarter from these contracts were minimal, looking forward we anticipate that these commercial contracts will contribute between $5 million to $15 million to our healthcare revenues in 2014 which is a ramp-up year and we expect a more significant contribution in 2015.

Lastly, we have a strong balance sheet and we are actively pursuing a range of business development opportunities that will enhance our technological platform and further diversify our business.

Now, I would like to turn the call over to Hakan to walk you through the financials. Hakan.

Hakan Orvell

Thank you, Lisa, and good afternoon, everyone. We are pleased with our financial results for the first quarter. Today we are reporting revenues of approximately $58.6 million, an increase of 18.8% year-over-year, net income of $6.3 million or $0.13 per diluted share, adjusted EBITDA of $17.4 million, an increase of 53.2% year-over-year.

Student lending continues to represent the largest component of our revenue mix and grew by $6.1 million or 18.% compared to the first quarter of last year. First quarter placements were $1.4 billion which is down from $1.7 billion in the first quarter of 2013 but in line with $1.5 billion in placements the company received in the fourth quarter of 2013.

Revenues, as a percentage of placement volume, in the first quarter was 2.7% compared to 1.9% in the prior year period. The second largest component of our revenue mix, healthcare, increased $3.3 million or 32.1% to $13.6 million compared to the first quarter of last year. The increase in healthcare revenues was primarily due to our ability to leverage our technological capabilities and continue to identify improper payments not related to short stays or the two midnight rule.

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Net claim recovery volume increased by $29.9 million or 33.1% to $120.3 million. Our claim recovery fee rate was 11.3% compared to 11.4% in the prior year period.

Revenues from other markets. Revenues from other markets in the first quarter were $5.6 million compared to $5.8 million in the prior year period.

Moving on to our expenses. Salaries and benefit expense in the first quarter was $24.8 million, an increase of 3.4% as compared to $24 million in the prior year period. Other operating expense for the quarter was $20.3 million, an increase of $1.4 million primarily due to increased subcontractor expense and the utilization of contact entries.

For the first quarter 2014, our reported net income was $6.3 million or $0.13 per diluted share compared to net income of $1.8 million or $0.04 per diluted share in the prior year period. Adjusted net income in the first quarter was $7.6 million or $0.15 per diluted share compared to $4 million or $0.08 per diluted share in the prior year period.

Fully diluted average outstanding shares were 49.6 million shares in the first quarter 2014. Our adjusted EBITDA in the first quarter grew 53.2% to $17.4 million compared to $11.4 million in the fourth quarter of 2013, while adjusted EBITDA margin was 29.7% compared to 23% in the prior period.

Our effective tax rate in the first quarter of 2014 was 41.6% and cash flows from operating activities in the first quarter of 2014 was $14.3 million compared to $2 million in the first quarter of last year.

Turning to our balance sheet. As of March 31, 2014, we had cash and cash equivalents $90.7 million. Our total outstanding debt as of March 31, 2014 was $130.6 million. The sequential decrease in outstanding debt of $2.7 million reflects scheduled payments on our long-term debt.

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

Lisa Im

Thanks, Hakan. As we indicated last quarter, given the ongoing contract renewal process at CMS, guarantee agency retention reduction and implementation of new commercial healthcare contracts, 2014 is not expected to be a typical year for Performant, but rather one that is more transitional in nature. Specifically related to the CMS contract renewal process, on April 23 the Government Accountability Office issued a decision denying the multiple protests filed on the recovery audit contract.

Given this decision, we are hopeful that CMS has a clear path to begin awarding regions under the new contract. As a reminder, we have not been able to request new medical records to audit since February 21 of this year, but we continue to work with inventory received with June 1 being the last date new claims can be submitted on the current contract.

Although 2014 is going to be a transitional year, we remain focused on identifying opportunities that foster our long-term growth and customer diversification. One such example is our advancement within the private payor space.

We are reiterating our full year revenue and adjusted EBITDA guidance that we provided in February. We continue to expect that revenues will be in the range of $200 million to $240 million and adjusted EBITDA in the range of $47 million to $55 million. We remain confident in the outlook of our business for 2015 and beyond as we continue to grow our business.

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

Question-and-Answer Session

Operator

(Operator Instructions). Our first question is from Edward Caso of Wells Fargo. Please go ahead.

Tyler Scott - Wells Fargo

Hi, guys. This is actually Tyler, on for Ed. Thank you for taking my question. Just to get on the RAC contract right away here. We heard some rumblings maybe that there might be another protest filed by the competitor even after this GAO protest decision came out. Do you know if there is a protest out on it right now?

And then sort of on top of that, with your current employees on the RAC contract, what kind of flexibility? Do you have to move them to some of your commercial projects? Any color on that would be great. Thank you.

Lisa Im

Sure. This is Lisa. So there is not another protest but what's in the public domain is that CGI filed a lawsuit in a federal court filing an injunction which essentially, from what we were able to tell, it appears that it is the same issue of payment terms and commercial practices. So we do not yet know the outcome of that and we probably wouldn't speculate on that, but it's essentially the same as the protest they filed which was denied by the GAO.

We remain hopeful that CMS will be able to award the contract in the near future but I think we get to see what happens to that lawsuit. In the meantime, we have diverted many of our medical staff to the commercial business. But as of yet, we have not had a deleterious effect that we continue to find ways for them to apply their experience as we spin off those businesses.

Tyler Scott - Wells Fargo

All right. Great. So on that, with the lawsuit now filed, does that mean that CMS is not going to be able to award the contract until that issue is resolved or could they potentially award the contract while that's going on?

Lisa Im

We don't believe they can award the contract but I will try to get confirmation on what the process will be.

Tyler Scott - Wells Fargo

Okay. That's great. Thank you very much for taking my questions.

Operator

Thank you. The next question is from Michael Tarkan of Compass Point. Please go ahead.

Michael Tarkan - Compass Point

Thanks. So I know you are confident that you are going to win your region under the RAC renewal. I am just wondering what your level of confidence is potentially also taking down the home-health or DME contract? Thanks.

Lisa Im

Well, we remain hopeful. We believe we submitted a very strong bid. We have great expertise that we have applied to both our response and to the results that we have driven on the RAC contract on the DME side. So I think its difficult handicap that at this point, but we are obviously, Michael, we are hopeful that we will be successful there.

Michael Tarkan - Compass Point

Okay. On the commercial opportunity, I know you have talked about $5 million to $15 million this year. Can you just help us with maybe what that could look like maybe three years out or five years out? Just how are you thinking about that in terms of really how big that can get in that sort of intermediate time frame? Thanks.

Lisa Im

I think I would rather frame it up by reiterating, we had some market research done through various firms. We believe that the market itself is about $1.7 billion per year spend on program integrity. That's both internal and vendor management and vendor fee. If we look at that, what we obviously are targeting is some share gains in that commercial space of meaningful size, each share point being targeted above $17 million in revenue.

So as we look outward, it is our objective to be very competitive and to provide incremental value to those payors in the commercial space to be able to gain some share points as you look outward three plus years.

Michael Tarkan - Compass Point

Do you think there's a potential, and I am not asking you for guidance, but in terms of how much share you could potentially pull down? Could this be something where in three, four years from now, we could be looking at, I don't know, 4% or 5% market share?

Lisa Im

We are surely targeting that kind of share growth and what will be important is, obviously as we start on these contracts, to show differentiated results and incremental value, as I mentioned.

Michael Tarkan - Compass Point

Okay. Thanks, and then one last one. I noticed in the new tax extenders bill in Congress, there is a provision in there that I think requires the IRS to outsource their debt collection. I am just wondering, I know you guys were on the pilot program, I believe, and I am just wondering if you see that as an opportunity down the road, if it could be meaningful? Any color on that would be helpful. Thanks.

Lisa Im

Yes. It's an interesting opportunity. We have not opined on that and certainly as it comes to fruition, as you might know, we are one of four vendors on the U.S. Department of Treasury contract with the Financial Management Service division. We are also the only contractor to have been on this contract since the inception of program in 1997. So certainly we believe that if this is a program that does get pushed through, it certainly presents a very nice opportunity as we look down the road. It's down the fairway [ph] of what we have always done historically for our federal agency clients.

Michael Tarkan - Compass Point

Understood. Thanks for taking my questions.

Operator

Thank you. Our next question is from Suzy Stein of Morgan Stanley. Please go ahead.

Suzy Stein - Morgan Stanley

Hi. There have been a couple of new student-loan proposals recently. One which would allow refinancing and the other which focused on different types of income-based repayment. How would those impact your business?

Lisa Im

We believe those would be a positive impact. Those are all borrower-centric programs. They are designed to help borrowers with their payment processes. So as we look at benign programs to help borrowers pay into the program, we believe that those will continue to be something that we can help our clients to play in the market with defaulted student loans as well.

Suzy Stein - Morgan Stanley

Okay, and then what drove the quarter-over-quarter increase in salaries?

Hakan Orvell

I would say that that that's largely volume driven costs that matched [ph] with the higher revenue.

Suzy Stein - Morgan Stanley

Okay, and then Lisa, I think you alluded to business-development activities that you are pursuing. Does this relate to things that you have already announced, like commercial healthcare? Or was this meant to relate to something else?

Lisa Im

No. These are aggressive pursuit of business development opportunities we are yet to announce.

Suzy Stein - Morgan Stanley

Okay. All right. Thank you.

Operator

(Operator Instructions). The next question is from Aaron Singh of Credit Suisse. Please go ahead.

Aaron Singh - Credit Suisse

Hi. Thank you for taking my questions. I was wondering if you guys can comment on the new claim areas that you are focusing on. Can you tell us what the biggest claim area for you might be at this stage?

Hakan Orvell

Yes. Look, I would say it's pretty much all over the map. We have over 700 issues that we are allowed to approved to audit and again as we look at over the last few two quarters that we have precluded from auditing inpatient type of the procedures. So it's pretty much all over the map as far as the type of orders that we are doing.

Aaron Singh - Credit Suisse

Okay. Got it. On the CMS contract, I was wondering is there any possibility, I think the first question was getting to this, is there any possibility of new protests delaying the award? I guess my question is more on, is there any time line that these protests have to be filed under? Or can the RFQs be protested at any point up until the award date?

Lisa Im

I believe the time line has passed since the issuance of the RFQ. What I referred to earlier was not a protest by CGI, because those protests have been denied by the GAO but this is a lawsuit in federal court with the same issue. But the time for protest is past.

Aaron Singh - Credit Suisse

Okay. Understood, and one final one, if I may. Switching back to the student-lending side of things. Do you have any insight as to whether terms will be relatively consistent or is it too early to say? And do you have a view of the placement-fee rate being the same at this stage?

Lisa Im

It is pretty early on in the procurement process. Historically the fees have been, I would say, pretty consistent contact to contract. We were speculating but at this time we would not speculate there to be any material changes in fees.

Hakan Orvell

And as we look at the placement fee, our placement fee was about 2.5% in 2013. So we expect that that rate should remain pretty constant here again this year.

Aaron Singh - Credit Suisse

Okay. Thank you so much.

Operator

Thank you. The next question is from Toby Wan of Obsidian Research. Please go ahead.

Toby Wan - Obsidian Research

Good afternoon, guys. Just quickly on the student lending Department of Education contract, that Phase 2 delay, what was the cause of that again? I know the timing, I think, is still indefinite suspension, but I am just kind of curious as to the cause behind that, if you have any insight?

Lisa Im

What is publicly available is, there were a number of protest by vendors who were not selected to move on to Phase 2. One of those vendors filed a lawsuit. Again the lawsuit is really similar to a protest in terms of content and objection. So that's eventually what the protest was.

Toby Wan - Obsidian Research

Okay. Does that have the same adjudication process that is in place on the RAC side of the business?

Lisa Im

Yes. It absolutely does. But keep in mind that on the Department of Education contract, the procurement process runs in the background. So in no way those would impact operations.

Toby Wan - Obsidian Research

Right. Absolutely. Good distinction. Thank you.

Operator

Thank you. We have no further questions in queue at this time. I would like to turn the floor back over to management for any closing remarks.

Lisa Im

Great. Thank you very much. We just want to reiterate both our guidance for 2014 and that we are really actively engaged in pursuing the range of business development opportunities looking to further diversify and strengthen our business. And with that, again, we want to thank you very much for the time that you spent with us today.

Operator

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time and thank you for your participation.

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