Performant Healthcare Inc (PHLT) 2014 Q2 法說會逐字稿

Presentation

Good afternoon, and ladies and gentlemen. Thank you for standing by. Welcome to the Performant Financial Corporation's 2014 second quarter earnings conference call. During today's presentation all participants will be on a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions) As a reminder, this call is being recorded today, Thursday the 7th of August, 2014.

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

Thank you, operator.

Good afternoon, everyone. By now you should have received a copy of the earnings release for the Company's second 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 table attached to our press release.

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

Thank you, Jeff.

Good afternoon, everyone, and thank you for joining us for our earnings call. Today I'm going to provide you with a brief overview of the key developments enacted during the quarter and then Hakan will walk you through the details of our financial results, after which I'll discuss our outlook for the remainder of 2014 before opening the call for your questions.

I'm very appreciative of the continued partnership opportunities from our clients and proud of the hard work from our team in delivering these second quarter results. We reported overall revenues and adjusted EBITDA of $57.4 million and $16.7 million, respectively.

As we look specifically at our key markets, during the second quarter student lending accounted for revenues of $40 million, which is up approximately 1.6% sequentially and down 10.9% from the 2013 period. This result is largely reflective of the timing of loan placements. During the second quarter of 2014 we received total loan placements of $1.9 billion, compared to $1.4 billion from the first quarter of 2014.

With respect to the default collection services contract re-bid process with the Department of Education, we have been operating under an extension of the current contract and we are still waiting on an award decision. Over the past few months there have been a number of announcements as it relates to the contract re-bid process. Keep in mind that the Department of Education avoids disruption by continuing to operate the contract while procurement processes the ones in the background. Based on the latest timeline, this (inaudible) unrestricted contracts are due on July 23 with an expected award date occurring in September of 2014 and actual work on the new project commencing in April of 2015. We do not anticipate that this delay in the award timeline will impact our operations and we expect that it will largely be business as usual until the new contract begins.

Historically, student lending has been a predictable contributor to our revenue and has provided the Company with consistent growth. Longer term, we expect student lending will continue to experience strong secular growth.

Turning to our healthcare business, we are still awaiting announcement of the CMS Recovery Audit Contract award. As you know, we had expected the award would have been made by now, but they have been delayed by pre-award protests. And following the denial of those protests, now a lawsuit in the Federal Court of Claims that seeks an injunction against the award and change it to the payments terms in the new contract. We understand that CMS (inaudible) to the court that it will not award contracts at issue with the litigation any earlier than August 15th, the date the court issues a final decision on the merits of the case, or the date the case is dismissed, whichever comes first.

Due to the continuous delay in the awarding of new recovery audit contracts, earlier this week CMS announced they are looking to initiate contract modification to the current recovery audit contracts to allow the recovery auditors to restart (inaudible) to be done on an automated basis. (Inaudible) number will do complex reviews of topics selected by CMS. We believe this step underscores the public policy enforcement of its programs and the cost savings it drives to the federal government. That said, based on the amount of time that is required for (inaudible) engage providers, we anticipate this decision will have a limited impact to our top line in Q4 of 2014.

Our healthcare revenues decreased 17% sequentially and 37% year over year to $11.3 million and our Net Claim Recovery Volume during the quarter was $100.2 million. We view this as a solid result given the significant restraints imposed in connection with the contract transition process and excludes all short (inaudible) and periodic (inaudible) providers. Remember that February 21st was the last day we could request new medical records from providers and June 1st was the last day we could submit new claims.

With respect to our commercial healthcare contract, we continue to initiate the implementation process and (inaudible) on this opportunity. Additionally, we continue to have a strong balance sheet and we are actively pursuing a range of business development opportunities that would enhance our technological platform and further diversify our business.

Before I turn the call over to Hakan to walk you through the financials, I'd like to announce that our Chairman of the Board, Dr. Jon Shaver, will retire effective August 12, 2014. Jon has been Chairman of our Board of Directors since June 2007 and he has served in various board and executive roles at Performant and (inaudible) since 2000. I've known Jon for 12 years and we've shared a number of great experiences throughout our careers. We will miss Jon and wish him the very best in retirement. The Board has elected me to take on the Chairman role in addition to my current responsibilities as CEO.

Hakan?

Thank you, Lisa, and good afternoon, everyone.

We are pleased with our financial results for the second quarter. Today we are reporting revenues of approximately $57.4 million; net income of $5.9 million or $0.12 per diluted share; and adjusted EBITDA of $16.7 million.

Student lending continues to represent the largest component of our revenue mix and totaled $40.1 million, a decline of $4.9 million compared to the second quarter of last year. However, Q2 of last year benefited from some favorable (inaudible) timing issues in combination with revenue from an initial placement from a specialized performing contract with one of our leading guarantee agencies.

Second quarter 2014 placements were $1.86 billion, which is higher than the $1.26 billion we received in the second quarter of 2013, and an increase of $416 million from the $1.4 billion in placements we received in the first quarter of 2014. Revenues as a percentage of placement volume in the second quarter was 2.2% compared to 3.6% in the prior-year period.

Our healthcare revenues in the q were $11.3 million compared to $18 million in the second quarter of last year. The decrease in healthcare revenues was primarily due to the contract wind down of the CMS RAC contract in advance of a new contract ramp up.

While our claim recovery volume decreased by $59.6 million to $100.2 million and claim recovery (inaudible) remained flat at 11.3%.

Revenues from other markets. Revenues from other markets in the second quarter were $6 million compared to $6.2 million in the prior period.

Moving on to our expenses, salaries and benefit expense in the second quarter were up slightly at $24.3 million compared to $23.9 million in the prior-year period. Other operating expense for the quarter was $20.4 million, a decrease of $2.5 million, primarily due to costs associated with our Q2 2013 (inaudible) offering and volume related costs.

For the second quarter of 2014 our reported net income was $5.9 million or $0.12 per diluted share, compared to net income of $11.2 million or $0.23 per diluted share in the prior-year period. Adjusted net income in the second quarter was $7.2 million or $0.14 per diluted share, compared to $13.1 million or $0.27 per diluted share in the prior-year period.

Fully diluted weighted average outstanding shares were 49.7 million shares in the second quarter of 2014.

Our adjusted EBITDA in the second quarter was $16.7 million compared with $27 million in the same period last year. Adjusted EBITDA margin was 29.1% compared to 39% in the prior-year period.

Our effective tax rate in the second quarter of 2014 was 41.8% and cash flows from operating activities in the second quarter of 2014 were $21.1 million compared to $19.3 million in the second quarter of last year.

Turning to the balance sheet, as of June 30, 2014 we had cash and cash equivalents of $81.5 million. Our total outstanding debt as of June 30, 2014, was $116.7 million. The sequential decrease in our outstanding debt of $13.9 million reflects payments on our long-term debt.

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

Thanks, Hakan.

As we've previously stated, we expect 2014 to be a transitional year and that certainly remains the case today. However, we are very optimistic about the longer-term trends that are occurring in our industry. As (inaudible), we have gained a (inaudible) visibility on the business and I will now provide an update to our 2014 guidance.

First, as it relates to our guarantee agency clients, we previously indicated to you that the Federal Budget Act reduced the compensation received by guarantee agencies for rehabilitating a loan and, as a result, that there was uncertainty surrounding the potential financial impact to performance. We now have improved clarity around the new fee arrangements with our guarantee agency clients and we expect the impact to our 2014 revenue and adjusted EBITDA to be near the midpoint of our previous expectation of $5 million to $15 million.

Second, as part of our guidance we have seen a tiny start of the new CMS contract. However, given the ongoing (inaudible) in the [multi-venue] contract, it is now clear that there will be no revenue from the new contract included in our 2014 results. We expect that there will be approximately a 4- to 6-month period until we start to recognize revenue under a new contract after the awards are made.

Third, and previously discussed, we signed contracts with (inaudible) with four of the six largest commercial healthcare payers in the US. While we believe that this market opportunity is significant, we are seeing a slower ramp of prospects than we originally anticipated. As a result, we expect revenue generated from these contracts in 2014 to be at the low end of our previous range of $5 million to $15 million. We remain optimistic regarding the long-term opportunities from these contracts and we expect a meaningful contribution in future years.

In total, with regard to our full-year 2014 guidance, we are tightening our expected revenue range to $200 million to $220 million and have also tightened our outlook for adjusted EBITDA to a range of $48 million to $52 million.

We remain confident in our future outlook as the long-term trends in the markets we operate in remain very robust. of our business for 2015 and beyond, as we continue to grow our business.

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

Thank you. (operator instructions) Bob Napoli, William Blair.

Thank you. Good afternoon. What are -- I guess, Lisa, are you have discussions with CMS? What do you expect on August 15th? Do you expect there to be an announcement or a placement of -- are they giving you any indication of what will happen and when they would make those awards?

Hi, Bob. We're actually not in active discussions. As you know, this is an active, ongoing procurement. But what we do know from the court's document is that on August the 15th the -- it is the date court issues the final decision on the merits of the case. So what we believe we should see on the 15th is a decision either to -- for the plaintiff or a dismissal of the lawsuit and that will allow CMS then to make a decision on what they have to do. So clearly, if the lawsuit is upheld for the plaintiff, we believe that CMS will then have to re-release the RFQ. If it is dismissed, then we believe CMS may be able to continue on with the award.

Okay. It looks like you're holding onto your staffing, your expenses. Your comp expenses are relatively flat so you're holding onto the staff through this process?

Bob, I mean if you look at our staffing during Q2, it's (inaudible) to remember as well that we are continuing to work on the old contract. We worked on the old contract all the way up through the beginning of June and so that's one factor. The other part as you look at Q2 is that we have -- we've had favorable placements (inaudible) defaulted loans from our (inaudible) lending clients. So if you look at that volume, we had staffed up a little bit to work at an increased volume.

Okay. And then just on that increased placement volume, what is the mix of that? I mean that was a pretty good level of placements (inaudible) versus (inaudible).

Yes. It was a good quarter. The (inaudible) placement was about $900 million and then close to a $1 billion from guarantee agencies.

Do you have any visibility into placements in the back half of the year?

Nothing specific at this point. But as you've seen over the past quarters, it tends to be pretty steady on a quarter to quarter basis.

Great. Thank you very much.

Edward Caso, Wells Fargo.

Hi, there. It's actually Tyler on for Ed. I just -- I saw with the RAC restart. That's good news while they kind of work this out. I was hoping that you might be able to provide a little bit more color just on sort of the scope of the work that you might be able to get back from that and when we can start to see maybe some revenue from the more automated audits.

Hi, Tyler. The automated audits will be as soon as we start, which -- I'm not sure as I sit here whether we have a signed document, countersigned document with CMS, but the automated should start very quickly. And then there currently are a limited number of complex audits. We will start to see some revenue in the back half of this year but, as I mentioned, because we have to re-engage our providers after a couple months or so of pulling back, we're not going to see a lot of revenue in 2014.

But as we -- I think, as I mentioned, we're optimistic this is indicative of CMS' affirmation of the program. It's return since the beginning of the program, the recovery audit program, including the demonstration has returned over $10 billion back to the Medicare Trust Fund. That's a lot. And that is including auditing of less than 2% of all Medicare claims. So, we believe that CMS sees the value of the program. It is the most improved program according to Health & Human Services' OGI Report. And as we look at what that does in terms of public policy, we believe CMS is indicating their strong support for the program.

Absolutely. And how long does this kind of restart? Is it just kind of open-ended until the new contract is awarded or is there a stop date?

We believe there is an open end. And again, CMS is clearly trying to do the right thing by public policy. And there are statements actually on their website, due to the continued delay in awarding new recovery auditor contracts, and if we interpret that we believe CMS is initiating this contract modification in order to restart the work. So, it's our belief from their statement that they are intending to ensure that a good program continues.

Great, great. And then just to switch gears a little bit, the Department of Education contract, the recompete, is that going to kind of be the same model as the old contract where there's going to be an allocation based on the internal ranking? I remember that the system was a challenge with an upgrade and then there was an impact from the recompete. So do you have any color kind of on that, or is it still in the early phases of those negotiations or contracting issues?

Well, when the awards are made on their -- on the upcoming contract, the Department of Education will select a specific number of vendors. And they will actually, if they follow historical behavior, which we believe they will, they will allocate based on number of vendors and it's for a performing period of six months. And then based on performance from month seven forward, every quarter they will reallocate based on performance.

Okay. Alright, great. And actually, I'll just sneak one more in on the commercial side. I was wondering if you've had any early success or what the possibilities are to kind of take what you've been doing on the commercial healthcare side and sort of apply it to other industries. And that will be my last question. Thank you.

Well, on the commercial healthcare contracts, these are very specific related to each of the insurers, but they're along the same lines as the work that we're doing with respect to auditing claims according to payment policy. We've had some early success and we're pleased with that. As I mentioned, it's just -- and I think I mentioned this in the last call as well, it's just a little bit slower startup than what we had hoped for. So, definitely we have the ability to initiate the similar products and services across other healthcare payers.

Alright, great. Thank you very much.

Michael Tarkan, Compass Point.

Thank you. Just on the guidance you mentioned, you maintained the low end on the revenue side, but you took down the low end of EBITDA by about $9 million. Can you just reconcile that a bit for us?

First of all, as we look at the guidance that we did, we're narrowing the guidance based on the broad guidance that we gave earlier in the year with some of the uncertainties that we were faced with at the beginning of the year. So as you look at -- as Lisa stated earlier, we have now clarity around the RAC contract on the transition that we are looking at there and its implications on this year, as well as on the commercial healthcare contracts and the [GAV].

So again, if you look at the midpoint that we were at before, we were at $51 million. Now you're looking at a midpoint of about $50 million, which is slightly higher overall as a percentage of revenue slightly up.

Oh, sorry. I misunderstood. I thought you had said the low end of the EBITDA guidance was $38 million. That's my mistake. So it's $48 million on the low end?

$48 million, correct. Okay.

Okay.

That makes sense then.

On the healthcare side, with June being sort of the last time for new claim activity, how should we think about RAC revenue in the third and fourth quarters here? Not looking for specific guidance, but outside of these limited changes that CMS is now allowing?

Sure. If you look at the old contract, there is a runoff since we recognize revenue when the settlement or payment is done, so you will definitely see a material reduction in Q3 versus Q2. There will be revenue in both Q3 and Q4 as we -- again, as the settlements are made on everything that we identified prior to -- well, to June 1st.

Okay. And then -- I don't if you have this answer yet, but the new auditing that you're allowed to do again, are you allowed to audit PIP providers as part of that?

Not at this time.

Not at this time. Okay. Any idea if that's going to change under the new contract or are you still under the impression that the new contract -- you will be allowed to audit PIP like you would normally audit any other providers?

We believe that periodic interim payment providers should be included in the new contract. And as you recall, part of the rationale for not being able to audit them for the majority of the old contract was due to a lack of automated conferencing which, as you recall, was actually implemented last year. So, we believe in the new contract that they should be included in the scope of work.

Okay. And then just on the education side, I know you mentioned second quarter of last year there was maybe some one-time stuff in there. Can you give us that number?

The one-time -- there were two factors that impacted (inaudible) revenue last year. First of all, you had the (inaudible) of placements. So Q1 of last year was a softer quarter in student lending and then you had some favorable timing implications in Q2. And when we had the initial placement from a specialized portfolio of work that we were doing for one of our leading DA clients, that provided some benefit in Q2. But I would say that the timing of placements was really the most materially issue.

Okay. I mean can you give just a little bit more clarity there? So, the $45 million that you did in student lending in the second quarter of 2013, any sense as to how much that was benefited from either of these two issues?

I would think from the specialized portfolio that we had, that was about -- it was close to $4 million of revenue that we recognized in Q2.

Okay. And then lastly, I guess the overall revenue on the education side came in a little lighter than what I was looking for, especially in light of the big placement that we saw in the third quarter of last year and so I'm wondering if you have any color there. I would have thought, I guess, that with that $2.1 billion in the third quarter of 2013 that we would have started to see some of that revenue kick in. And then I'll hop back into queue. Thank you.

Sure, yes. If we look at this, Mike, I mean we have some impact with (inaudible) in prior quarters depending on when the placements were made during the quarter. And especially if you look at some of these larger placements and the catch-up that we had on Department of Education, there was a large placement at the time, at the beginning of the quarter. So you have -- the timing of placements during the quarter is going to have some impact here. (Inaudible) necessarily a direct correlation with a three quarters out.

Okay, thanks.

Richard Close, Avondale Partners.

Yes. Thanks for allowing the questions. On the commercial contracts or commercial healthcare, if you can walk us through some of the dynamics there with respect to the slower ramp. Exactly what is causing that or maybe some -- what are the hurdles you're facing in that? And then as you think about 2015 and the contribution I guess to 2015 revenue from the commercial side of the house.

Sure. So I'll just give you a couple of the examples. With one of the (inaudible) we have I believe it's six or eight different contracts that we've signed under the MSA, but getting those negotiated and signed has been a bit of a back and forth process. So, we were obviously hoping for a much more shorter close, but that's dragged on a bit and so our ability to actually start the work was delayed by several months.

And one of the other healthcare providers we've -- just for example, data transmission testing and working through that aspect of it has been a bit slower than what we had envisioned. So as we go into 2015, we believe that obviously these issues are being resolved. And as we ramp into our commercial contracts that, again, we've signed and implemented, we think 2015 represents a much lesser multiple of what we're seeing in 2014.

Okay. But for 2015 -- or for 2014 we should be expecting $5 million, the low end of what you -- I mean, I said -- or said a couple quarters ago? Is that correct, $5 million?

Yes. The lower end of our range, yes.

Is that -- do you have a gut feeling that that's conservative or is that a stretch based on some of these delays to get to that $5 million with, I guess, five months to go?

It's obviously -- our job is to try to accelerate revenue and growth in our business, so we're certainly going to work towards that this year, but I think at this point we feel like that's probably our best estimate.

Okay. With the GAs in the midpoint of the impact that you thought it was going to have, just want to be clear on that. That was a $5 million to $15 million negative impact to EBITDA in the second half of the year, correct?

That's correct, yes.

And so you're looking at the midpoint of that. With respect to the conversations with the GAs, and we thought maybe some of impact potentially would be offset by higher volumes as people did the income-based payments, if I'm not mistaken. So why don't you talk to us a little bit about what you're thinking on GA volume based on the income-based payments and whether that really has a juice to your volumes.

Well, the income-based payment programs are rehabilitation driven, so there is a start period, obviously, effective in July, but we're not going to see those volumes uptick in our numbers until we get to the end of the rehabilitation process. So the program is designed to allow borrowers who have not had a chance to adjust their level with a payment to their income, and so what we have are borrowers who either have not been able to enter a program or have made payments, but not being able to officially enter the rehabilitation process. And so we will see some of those numbers start to uptick, but we need -- again, not in 2014. That will be a 2015 impact.

Okay. My final question is on the healthcare revenue. You mentioned -- Hakan, I believe you said that the decrease was primarily related to the RAC. What else would be in there that might have led to the decrease? Is there anything else or was that -- am I reading too much into that?

I mean, it's very much related to the RAC contract. And as you look at the wind down on the old contract, we stopped work in June 1st. So as we were, again, winding down an old contract, yes, that's primarily why you're seeing a reduction from Q1 on the healthcare revenue. And similarly, as we just discussed, there will be a similar reduction going into Q3 as we look -- as we see the runoff from the old contract.

Okay. So it's all the RAC business. There's nothing else that decreased in the quarter in the healthcare.

No, the other healthcare -- the commercial healthcare contracts are growing, so that's a counter. But again, that's been a slower process but that's going in the right direction.

Okay. And I guess my final question for you guys is, if you -- obviously there's been a lot of balls that have been juggled here over the last year or in the air still and we're waiting on things. But how would you characterize the business overall as -- I mean obviously you're dealing with these contracting issues, but do you think the business, after we get beyond this, is better than ever or -- I mean, just what's your longer-term outlook in terms of where performance sits in just this fraud, waste and abuse area?

Yes. I think once we get through the contracting process, which has been long, we feel very good about where we are in the market. Our -- and again, we talked about a little bit of slowness in the commercial healthcare, but we believe we have the right solution. We're working with our clients to drive innovation in our services. We also believe that expanding our presence across the healthcare market, not just to the largest payers, but to other payers in the market, will drive additional business for us more quickly. We also believe that technology is a differentiator for us when we think about working with our clients. And we're very -- it takes a lot of hard work, right, to create a good business, but we are putting that in spades and we feel pretty good about the position that we're in as we look outward into the future.

Okay. Thank you.

(Inaudible) addition -- just one thing in addition to that. As you look at the long-term trends in the market we operate in, here's (inaudible) the healthcare spend is increasing. You look at the student loan volumes, we have seen that historically for us has been growing. So if you look at the overall dynamics of these long-term trends, they have been -- they look very positive.

Okay, great. Thank you.

(Operator Instructions) Toby Wan, Obsidian Research Group.

Good afternoon, everybody. Quickly, I know the Part A and Part B Medicare RAC contract's still -- that's hanging out there and who knows when that whole thing gets resolved, but any thoughts on the DMA home health contract? I don't think there's any protests or delays with regard to that contract. Any thoughts there on that being awarded?

Hi, Toby. I think it's our belief, and CMS clearly has not made a public statement about this, but when we look across the RFQs and the contracts that have been released for response, the DMA and home health contract, while it was not protested or included in the lawsuit, still has payment terms that would be affected depending on which way the case goes. So, I mean we believe CMS was just being cautious--.

Okay.

By ensuring that they don't have to go back and change anything. So that's where we think they're headed.

Okay, fair enough. And then kind of along similar lines, maybe kind of talk about you all's thoughts with regards to CMS recently, within the last week or so, putting out kind of -- I don't want to say official RFQs, but the preliminary steps to an RFQ coming down the road on Part C and Part D and your all's thoughts about maybe market expansion opportunities within those aspects of the Medicare program. Thanks.

Yes, we saw the -- I think the Part C is actually an RFI. It's actually the second time that the RFI has come out and it certainly presents an opportunity to expand the work scope for CMS. We're contemplating and considering what that means to our business. The Part D, as you might know, was awarded to a small company and ran its original contract [for us]. And our view is that we have to really read it to make sure that we want to bid on it. We just want to make sure the terms and the scope of work indeed would provide opportunity for growth. So, we are certainly contemplating those.

Okay, thanks. Congratulations on the quarter.

Thank you.

Thank you. At this time we have no further questions. I will turn the call back over to Lisa Im for closing comments.

Thank you. We'd like to thank all of you for participating again in our earnings call. We do continue to be cautiously optimistic the CMS recovery audit contract will be awarded soon. And as we've said, we believe CMS has restarted the work under the old contract is indicative of their support of this very good public policy program, as well as an acknowledgement of the dollars that this program returns to Medicare Trust Fund. And as we discussed today, we're very excited about our growth in the commercial healthcare business. And although a bit slower than what we would like, we believe the future is a very good prospect for us in that market.

So again, thank you again for your attention and participating in our call.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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