Performant Healthcare Inc (PHLT) 2014 Q4 法說會逐字稿

Greetings, and welcome to the Performant Financial Fourth Quarter and Full Year 2014 Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Richard Zubek with Investor Relations. Thank you, you may begin.

Thank you operator. By now, you should have received a copy of the earnings release for the company's fourth quarter 2014 results. If you have not, the 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. Lisa?

Thank you Rich, Good afternoon everyone and thank you for joining us for our earnings call. Today I'll provide you with an overview of our operational results and then after Hakan walks you through the financials in greater detail, I'll discuss our recent events and provide an update on the procurement status for the awards with the Department of Education and CMS. Lastly, I'll discuss our expectations for 2015.

We've had some headwinds that have softened our results in the short term. However, we believe our business will grow in the mid to longer term as we continue to strengthen our position in the market with strong secular growth by aggressively managing and leveraging that which we have control over, productivity, increasing business with current clients, new business buildings and expense restructuring.

Before I begin the business review. I want to thank all of the employees and their performance, with hard work and dedication helped us achieve our results and goals. I also want to thank our clients who have given us the opportunity to serve them in the past year. In 2014, we reported overall revenues and adjusted EBITDA of $195.4 million and $44.7 million respectively. These Results were lower than we anticipated a year ago, but consistent with our more recent guidance due to the ongoing delays associated with the CMS contract renewal process and fee reduction flow-through from our guarantee agency clients.

As we look specifically at our key markets during 2014, total student lending accounted for revenues of $138.3 million, which is down approximately 15.5% from 2013. However total loan placements in 2014 increased 6.7 billion compared to the 6.6 billion we received in 2013. There were a whole couple of few changes to our student lending business in 2014. The first one was expected in July 1, through regulatory requirements, guarantee agency clients incorporated income-based repayment rehabilitation, or IBR for defaulted borrowers. This allowed many more borrowers to qualify for affordable rehabilitation payments based on their income portions of our total outstanding loan balance.

In the mid to long term, this will be a benefit for us as a greater number of defaulted borrowers access rehabilitation. The second change was through the same regulatory change, the retention fees and guarantee agencies have paid also decreased.

As a result, we also saw lower rehabilitation fee which came effective July 1. The ongoing impact is expected to be about $5 million per quarter in revenue and EBITDA. Although, IBR increased the pool of borrowers whose loans qualify for rehabilitation, our guarantee agency clients and the Department of Education imposed additional requirements to establish borrower eligibility which added additional time and interaction with borrowers.

We have to adjust our operations to adeptly accomplish this and frankly, it took four months longer than we anticipated. These new requirements have several effects. One, some loans were delayed from qualifying for rehabilitation timely in Q3 and early Q4. Two, and for those four months, our productivity declined while we've focused on refining our process to obtain the required documentation. This will negatively impact the first half of 2015. And third; furthermore we are seeing more defaulted borrowers choose rehabilitations which is a nine-month process versus the loan restructuring consolidation process, which takes to one to three months and that causes some delays in revenue recognition.

When we did successfully change our operations, we were able to book some of the delayed revenues from the third quarter into the fourth quarter. Furthermore, for the last two months, January and December, we're starting to see some gains in productivity.

As we've modeled out these impacts for our business, we have proactively restructured our expenses so that we can continue to improve productivity and increase our margins.

Lastly, we are still awaiting word about the award of the new contract by the Department of Education. The current contract has been extended to April 2015 and we do not yet know if the new contract will be awarded by that time, or if the Department of Education will exercise another extension with us. Additionally, as previously announced, the Department of Education changed their variability efficiencies from a percentage of loan balance to a flat fee of $1,710, this change will become effective July 1, 2015. We have included these changes in our guidance for 2015 that I will discuss momentarily.

Now turning to our health care business, our healthcare revenues in 2014 was $32.5 million which is much lower than what was reported in 2013. But expected due to the transition and winddown of the original CMS contract. As the full scope of the old contract ended, net claim recovery volume which is measured on a quarterly basis, declined sharply on a sequential basis during the fourth quarter to $21.2 million from $46.1 million in the third quarter. The Medicare Recovery audit contracts experienced a couple of changes during 2014. While we've addressed each of these topics at length on our previous earnings calls, we thought it would be worthwhile to briefly review all of the changes today given their collective impact on our 2014 results and expected impact for 2015.

First the CMS Recovery Audit Contract renewal process has been underway for two years since February 2013. CMS has stated on their website that they will not award any additional regions until CGI's pending appeal is resolved by the Federal Court of Appeals. As you may recall in August, the US Federal Court of Claims found and in favor CMS and denied us to challenging the payment terms in the new contract. But in early September, the Federal Court of Appeals granted a stay of the Contract award to allow an appeal through the Federal Circuit. Both the CMS and CGI have requested an expedited process but we don't have a definitive time when this will be resolved or when the new contracts will be awarded. Although we are uncertain of timing, we have been keeping a strong cash position and balance sheet in preparation for the possibility of two regional awards.

Our results as published by CMS in their 2013 reports to Congress, show us at 99.1% accuracy, while the next best tender was at 97%. Our recovery dollars proof point of auditable Medicare which means we had to adjust our periodic interm payment providers in region A. We are competitive with the best contractor, we're cautiously optimistic that we may be a strong qualifier for two contracts. With respective region 5, CMS made that a what before the 2014 year end, however you will see that it is under protest. While I am not at liberty to discuss the protest in any detail, I refer back to the 2012 and in 2013 CMS reports to Congress. Well it is clear that even when adjusted for periodic interim payment providers, performance recovery of DME was 44% and 28% higher respectively than that of Connolly. If we adjust it for PIP those results are 57% and 36% higher in those respective years. While we don't know what the outcome will be we believe we can drive greater valves to CMS in that program.

Secondly, during 2014, the contract transition and procurement process caused disruptions to the Medicare Recovery operations. In February 2014 CMS communicated that February 21 was the last day recovery auditors could then provide a additional documentation request for ADRs, Furthermore CMS identified June 1 as a the last day of recovery auditor make sense in proper payments filed for adjustments. All operations under the contract were then on hold until August when CMS allowed the recovery auditors to restart a very limited number of automated and complex reviews on certain types of specific claims. The contract was then extended through end of 2015, but the scope of review remains very limited and is expected to have a minimal impact to our 2015 revenues relative to when we were operating under a full contract.

To mitigate these kinds of challenges in the future, we're working to diversify our healthcare revenue and client base. To be specific and successfully running one of the largest payment integrity contracts in the U.S the Medicare Recovery Audit Contract, we are building strong capabilities that can be applied to the commercial Healthcare Integrity market. It has been our strategy to diversify our revenues by growing our commercial healthcare market position and we are gaining traction, generating revenue growth we are excited about the ongoing potential of this business. We've worked with large insurers to create master servicing contracts that would allow us to add statements of work and we identify opportunities to reduce cost for those clients.

We continue to see a nice ramp of revenue from our current offerings. As example we recognized 1 million in revenue during the fourth quarter and for the month of January alone, we recorded 700,000 in revenue. Furthermore, we won two small integrity contracts during the last two months over existing well established players. We continue to believe there are tremendous untapped growth opportunities in the commercial health care space where we can deliver value, and although implementation process for some of our contracts took longer than expected in 2014, we believe our commercial health care business will have tremendous year-over-year growth in 2015. With that, I'd like to turn the call over to Hakan to walk you through the financials. Hakan?

Thank you, Lisa, and good afternoon everyone. Today, we are reporting results for the fourth quarter with revenues of approximately $39.7 million, net loss of $2.4 million or a loss of $0.05 per share and adjusted EBITDA of $4.9 million. Student lending revenue totaled $30.7 million, a decline of $11.3 million compared to the fourth quarter of last year, but sequentially higher than the third quarter by $2.6 million. This increase is due primarily to the recognition of rehabilitation revenues during the fourth quarter that was delayed due to new documentation requirements for loan rehabilitation imposed by our GA clients in the third quarter. We both experienced a meaningful increase in the number defaulted borrowers that elected issues rehabilitation to resolve defaulted status compared to other methods such as loan restructuring because of the ability to enter this program to lower monthly payments.

However, since the loan restructuring or consolidation process generally can be a shorter revenue recognition process, approximately one to three months compared to the rearbitration which is a nine-month process, a shift in more reahibilation work also resulted in a delay of our revenue recognition.

We continue to refine and improve our processes, as it relates to the new documentation requirements. As a reminder we don't recognize these excess fee for rehabilation until all requirements have been met. In the fourth quarter, student loan placements were 1.7 billion, which is up from the 1.47 billion we received in the fourth quarter of 2013 and a slight increased from the 1.68 billion in placements we received in the third quarter of 2014.

Revenues as a percentage of placement borrowing in the fourth quarter were 1.8% compared to 2.9% in the prior year period. For the full year, revenues and still loan placements were 148.3 million and 6.7 billion respectively which represents a decline of 15.5% and an increase of 1.1% respectively over 2013 results. Our healthcare revenues in the fourth quarter were 2.4 million compared to 10.9 million in the fourth quarter of last year, the decrease in the healthcare revenues was primarily due to the delayed CMS contract renewal process while our net claim recovery Volume decreased to $21.2 million, our claim recovery fee rate increased slightly to 11.4%. In 2014, total healthcare revenues declined 51.8% to $32.5 million compared to $67.5 million in 2013.

Revenues from other markets in the fourth quarter were $6.6 million compared to $7 million in the prior year period. This decline is primarily with the result of the tax Amnesty program we contacted in the fourth quarter of 2013.

Overall in 2014, revenues from other markets totaled $24.6 million compared to $24.1 million in 2013. Moving to our expenses, salaries and benefits expense in the fourth quarter were $22.4 million, a decrease of 5.8% compared to $23.8 million in the prior-year period primarily due to lower staffing related to the RAC contract.

Other operating expenses for the quarter was $18.1 million, a decrease of $2.2 million, primarily due to volume related cost. For the fourth quarter of 2014, our reported net loss was $2.4 million or a loss of $0.05 per share compared to net income of $7.9 million or $0.16 a diluted share in the prior year period.

Net income for the full year was $9.4 million or $0.19 per diluted share. Adjusted net loss in the fourth quarter was $244,000 [million] or a loss of less than $0.01 per diluted share compared to adjusted net income of $9.1 million or $0.18 per diluted share in the prior year period.

Fully diluted weighted average outstanding shares were $49.3 million shares in the fourth quarter of 2014. For the full year, adjusted net income declined by 64.3% to $15.3 million or $0.31 per diluted share.

Our adjusted EBITDA in the fourth quarter was $4.9 million compared to $19.4 million in the same period last year. Our adjusted EBITDA for the full year of 2014 declined 50% to $44.7 million and adjusted EBITDA margin was 22.9%

Our effective annual tax rate for 2014 was 45% an increase 4 percentage points compared to 2013. This increase is primarily due to changes in the allocation of the Company's sales, the fact is there is an only state-by-state basis. with enacting of market based sourcing rules in various new states a portion in fact is that it had increase from prior years, cash flows from operating activities for the year ended December 31, 2014 were $29.1 million.

Turning to our balance sheet as of December 31, 2014. We had cash and cash equivalents of 80.3 million, our total outstanding debt as of December 31, was 111.8 million the sequential decrease in outstanding debt reflects continued payments in our long-term debt.

With that, let me now turn the call back to Lisa for some concluding remarks.

Thanks Hakan, I want to discuss some of our recent announcements but first I want to provide you with our outlook for 2015 and give you some perspective around our decision. Due to the short-term impact student loan pricing, combined with minimal RAC revenue, we expect 2015 full year revenue to be in the range of course 150 million to 160 million with adjusted EBITDA to be between 20 million and 22 million well. while the RAC contract maybe awarded this year, we have seen no impact any new RAC contract awards. as i discussed earlier we expect the increasing borrowers with attributable will positively impact the latter part of 2015.

However, the reduced guarantee agency pricing in the first half of 2015 is expected to negatively impact revenue and EBITDA by approximately 5 million per quarter. The Department of Education will reduce pricing on rehabilitations effective July 1, 2015. With that said, we are seeing positive volume build with changes to our production process and we will continue to focus on improving with the efficiency of our operations under this contract. The CMS Recovery Audit Contract has been in a diminished state during the two year long procurement process. In the meantime, according to CMS, the payment error for 2014 in Medicare increased to almost 13% or about $46 billion a significant increase from prior year of 10.1% and 36 billion. The impact of this contract on our financial results is expected to be minimal during 2015.

Our commercial health care business is starting to strengthen as we enter 2015. We anticipate that this part of our business will continue to grow and provide the diversification of our business in the mid to longer-term. We are optimistic about the growth trends that we are experiencing as we continue our efforts to expand the contracts that we have in place with our commercial healthcare clients. Based on the changes to our operating landscape that we discussed including the student loan pricing flowthrough, (inaudible) Medicare Recovery Audit Contract process. We expect 2015 to be a significant transitional year regardless of the timing of the contract awards.

As I mentioned we have implement changes in our student loan operations to improve productivity, also our commercial healthcare businesses is specifically start to driving more meaningful revenue this year, and we expect this growth trend to continue. We have experienced some headwinds, but we will aggressively address all of the controllable levers to build our growth from here.

Lastly, I want to talk to you regarding our recently announced M&A opportunities. We view PHX as an exceptional business which is highly complementary to ours. We believe that the combined company would create an industry-leading comprehensive cost management company in commercial healthcare. With PHX we believe we will be able to expand and accelerate our presence in products within the large and growing healthcare cost integrity market, more readily diversify and grow our client base. And very importantly reduced our reliance on large government-related contract.

Diversifying and growing our revenue base has been one of our main goals since our IPO. And we continue to believe that acquiring PHX would be a key step to accomplishing that through their strong revenue growth and their over 200 different customers. As part of the broad and deep diligence process associated with the acquisition of PHX, we carefully evaluated many different financing alternatives. And after a strong evaluation with our advisors, we determined that the financing method chosen was the most appropriate.

We did not believe however that the market reaction on January 29 respective of value of performance and clearly not the value of the value of the combined entity. So we pulled that financing from the market. However we are continuing discussions with PHX and continue to review and evaluate appropriate alternative financing arrangements that would permit us to complete the transaction. We intend to find and execute on opportunities to grow our business through combinations that accelerate strong growth and drive shareholder value.

While 2015 looks to be a challenging year, our plan is to come out of this year with growth in the commercial healthcare market through strong product and value delivery to our clients. We are addressing the changes we saw in 2014 head-on and have already made good strides in improving operational efficiency and we'll continue to streamline our operation with the goal of maximizing productivity. Moreover, we will continue to focus on the goal of diversifying our revenue, creating a strong competitive position and driving top line growth, with good margin structure. With that I'd like to open up the call for questions.

Okay. Okay. Please hang up and try, your quality if you'd like to please dial 0 and the talent operator will be happy to help you please hang up and try your call again. If you'd like to please dial 0 and the talent operator will be happy to help you and the

(Operator Instructions) Michael Tarkan, Compass Point.

Thank you. Just first on the revenue guidance, I think it'll be helpful if you provide a little more clarity on how that breakdown by segment. I guess specifically, last quarter, I believe you mentioned you expect 3 million to 5 million of revenue from the RAC business per quarter given the limited scope and I don't think anything has changed the terms of the scope, just wondering if that still the case on the RAC side?

Yes, hi Mike as we look at the RAC revenue guidance for 15, the range that we provided last quarter of 3 million to 5 million is still intact. We are projecting at this point on the lower end of that range. So that's what we expect from RAC. Then you have touch on the student lending revenues because they just, quite a still moving parts as it relates to student lending and investing. So first of all, we expect student lending revenues to decrease by approximately 20% next year compared to last year.

And we also expect the whole new revenue to be fairly even on a quarterly basis as we look at it during the year. And some of the key reasons here for the, in fact we will have the full year impact of the lower fees from GA's. At the same time we expect that fee reductions will be somewhat mitigated in the second half of the year with increasing rehab volume from the GA's. And again that would be something that would be a benefit to us in the second half of the year.

Nevertheless, as we look at the guidance, we still expect that impact for both being approximately 16% 1.5% of this overall reduction again from '14 to '15. Certainly, we also have July 1, where the personal verification is reducing to see certainly the rehabilitation. In potential volume offsets as we discussed earlier in this, it's still to be determined. So that's another approximately 25% of the reduction in revenue. And then, firstly in addition we mentioned we are seeing a meaningful movement from consolidation revenues and rehab revenue which we expect was delaying rev RAC. The important thing with us is that it's not lost revenue it should be a function of the longer direct process associated with rehabiliation, selectively it's a shift of revenue and that's approximately another 25% as we look at the 20% reduction.

And then finally we're about to taken into account the impact assoscited with the recent documentation requirements that is also having a delaying impact through [rev] RAC also absent a shift in revenue and we will estimate that to be approximate about 25% as well. So whether it would be a little bit more on 16, since we didn't have a lot of moving parts but that will be expect on the student lending side. As it relates to the commercial healthcare revenue, we are encouraged by the ramp that we are seeing in this area and today and we believe that the commercial healthcare would be at approximately $10 million in 2015.

And then as you look at the other part of our revenue stream, that tends to be pretty consistent (perspective) which we expect in 2015 as well.

Okay, thanks for that color. On the healthcare side, I guess, what gives you confidence that I think you mentioned you're cautiously optimistic you have a chance to win to regional contracts. I know you are cautiously optimistic; you could take down the home health DME contract, what gives you confidence you could potentially win both of those contracts, forget the DME but the two regional contracts?

As we look at the days where tax rate procurement, we have had the benefit that we had another full year of results that CMS reported declined growth, and when I fully look at our results versus all of the other vendors who have been operating on the contract, we do post very strong results. So as I mentioned earlier, our accuracy rate is 99.1 which is the highest. And then if you look at our recovery dollars on a per point of Medicare that we were able to work keep in mind that we were not able to work with PIP volume which is pretty significant, it's about 27% of our dollars. So if we look at the detour and stated dollars that we recovered on footpoint of what we could audit in Medicare, we're very competitive with the number one recovery dollars under in terms of our ability to return dollars to the Medicare program.

There is a couple of other aspects that, that are not, these are not our CMS reports but clients do report that what service levels are, where the recovery, when I say clients, I mean providers with CMS, they will report that in their own publications, service levels for our contracts and we consistently have rated the number one service provider, and by that we mean we went back to the great potential providers, we will get back to them within a day. response of our quality and that we have the best response that every single quarters those hospitals have been reporting these numbers, every single quarter will get us to top and we've been close to what over 80% the net standard standard down is I think somewhat around 60%. And so we look at a lot of factors including the official report for 2012, reducing that has become a big consideration when there is a less revenue we are cautiously optimistic.

We're not guaranteeing that we will get to. But we really believe that our results and particularly with accuracy and solid returns from Medicare point, meaningful and as I mentioned earlier and when we look at DME results, those are significant results they are not 10% or 5% over we are between 2012 and 2013 our results are significantly better as again I don't know what the outcome will be, but we clearly believe that we can drive greater value in the program when we look at program integrity.

Do you have any insight as to why CMS went with Connolly on the home health CME contracts then?

I don't think I can speak specifically to that, but the, our efficacy as you may know the requirement is the best value, so that I can't speak to why they would have chosen, another vendor.

Okay, and then lastly Hakan, you had mentioned in addition to the 3 million to 5 million on the healthcare on the RAC side that you had expected it to be potentially able to run the RAC program at breakeven EBITDA in 2015, is that still the case?

That is still the case, yes.

Okay. thank you.

S.K. Prasad,Goldman Sachs

Thanks for taking my question, first on the commercial healthcare revenues. Can you give us an idea around pipeline. I recollect there are like six contracts in the pipeline, what is the status of pipeline now?

Pipeline of new contracts or contracts. The revenue that we are forecasting is actually based on contracts we have in operations. and so none of the '15 is essentially based on pipeline, but we certainly have a lot more clients that we've been working with and our pipeline is, I would say fairly robust. We've got I think the last time that I looked at that, with our sales force, we have into the Q2 or mid year client, we've got a lot of activity, again, these are probably going in terms of start-up, there is a process to get the contract implement that including defining the contract, and then being able to do all of the data transfers. So we don't expect there to be revenues from pipeline in this queue. It's possible but we're not anticipating or forecasting that. So the revenue for this year is strictly based on our current main operations.

Okay, that's clear. Probably more from acquisition point of view, you did talk about possibly concerning other financing means, in case that doesn't turn out to be in your favor you are looking at other smaller acquisitions given cash you have.

Absolutely and as I mentioned earlier in my comments, we are going to drive shareholder value. I am one of the largest shareholders. Well, the larger shareholders in the company has been, when we look at growth and providing a sustainable growth company that is the key priority of our and we do intend to find and execute on opportunities to grow our business. And that is going to include M&A activity.

That's pretty much from my end, thank you.

Thank you, (Operator Instructions) Oscar Turner, Suntrust.

Good afternoon, and that, thanks for taking my question. I was wondering can you talk about striking the balance between maintaining some level of profitability in the short term and that some of it is maintaining profitability in the short term or it's been, and then also being prepared to win future business in the medium to long term, I think based on the guidance that definitely looks like you guys are focused more on the long-term, and I have just wondering how you will look at that for some reason you are not able to win those two contracts.

Let me first to guess that your question on call and that will be something that we are at very cautious, we are balancing with the, are going to be incurring with the impact on future wrapping and you also have --as we talked about that the situation that we had and grow in the commercial healthcare business, we are at -- it's a fine balance, but we are very focused to ensure that we are going to continue to drive strong long-term revenue growth. So that's going to the balance that we are striking here as it relates to our operating costs. But clearly, as we look at operating costs, we have a significant portion of our costs that is variable, which we have the ability to lever as appropriate as we look the business evolving during the year.

And then the question about how we continue to grow. We clearly have clients with whom we can continue to grow in student lending as well as in other parts of the federal government markets. We mentioned our commercial health care and we also mentioned specifically M&A activity.

So a combination of good growth both organically as well as some M&A activity is a quite that of growth strategy and we also mentioned the style competitively improvement, when you fully integrated operation as we are, you know asset quality platform it is fully integrated from front to back end including all of our analytics.

So we have significant challenges which we would consider to be significant changes. So I want we really have to have a big focus on how we are going to change our entire platform in order to maximize productivity. That's why it took us longer to get the business in play. We also have an operational strategy when we look at how we train our employees, how we incentivized and how we drive our productivity in order to drive value to client with revenue we have change from fundamental core areas of that, it does pick up a little bit of time, but think and we're optimistic that we are starting to see that turn and we have the what we call same-store sales were that is an opportunity for us as we move into the back of this year. And then in 2, 3 years as well so that further key ingredients to growth, not just one and we're going to focus on all of those.

Thank you. Ladies and gentlemen there are no questions in queue at this time. I would like to turn the floor back over to management for any closing remarks.

I just want to thank everyone for being with us on the call today and as we look at 2015, while it would be a challenging year. We are committed to coming out of this year with growth and with the strong platform that we can deliver share, value to shareholder over the mid to longer term as well. and we will certainly keep you appraised as with the events top in our business. So again, thank you very much.

Thank you.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful evening.