Richard Zubek - IR Lisa Im - CEO Hakan Orvell - CFO.

Michael Tarkan - Compass Point Brian Hogan - William Blair.

Greetings and welcome to the Performant Financial Fourth Quarter and Full-year 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instruction] As a reminder, this conference is being recorded.

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

Thank you, operator. Good afternoon, everyone. By now, you should've received a copy of the earnings release for the company's fourth quarter and full-year 2016 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 risks and uncertainties including those described in the company's filings with the SEC. Actual results may differ materially from those described during the call.

In addition, all forward-looking statements are made as of today and the company does not undertake to update any forward-looking statements based on new circumstances or revised expectations.

Also, 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 give you a quick overview of our 2016 operational results.

Then after Hakan will provide the detailed financial update and will talk about how we are building the business, the implementation of IRS and CMS contract and status for the Department of Education. I will also provide guidance and thoughts on 2017. Full-year 2016 revenues and EBITDA were $141.4 million and $25.9 million respectively.

Revenue decline of $18 million versus prior year is entirely due to the wind down of the old department of education and CMS region A recovery audit contract. Operating expenses without the customer relationship impairment were down $18.6 million or 12.2%from prior year.

As we look specifically at our full-year key market total student lending accounted for revenue of $109.6 million which is down from last year by $9.8 million, growth of $6.1 million or 7.5% up. For other clients partially offset the Department of Education one off decline of $15.9 million.

Health care revenues of $11.4 million is down versus prior year by $8.5 million due to the prior recovery audit contract end. Revenue from other operation were $20.4 million slightly up $300,000 from prior year. With that I would like to turn the call over to Hakan to walk you through the financial. Hakan..

Thank you, Lisa, and good afternoon, everyone. Today, we're reporting results for the fourth quarter with revenues of $33.8 million, net loss of $12.3 million or $0.24 per share and adjusted EBITDA of $4.9 million.

Beginning with our student lending business, revenues totaled $27.4 million, a decrease of $5.5 million compared to the fourth quarter of last year. During the quarter, the Department of Education accounted for $3.7 million of revenues, while guaranty agencies generated $23.7 million.

These amounts represent declines of $5.9 million and an increase of $0.5 million respectively when compared to the fourth quarter of 2015. The decrease in our student lending revenues is the reflection of Performant not receiving any new student loan placements from the Department of Education since April 2015.

Further more because we were not included in the December Department of Education contract award from an accounting perspective it was appropriate to access the $15.4 million Department of Education customer relationship intangible asset for impairment.

While we believe that there are strong grounds for our protest, given the uncertainty around it, outcome of the protest we were not able to conclude that the Department of Education customer relationship met the definition of an asset with probable future economic benefit.

Based on this conclusion and non-cash expense of $15.4 million was taken in Q4 2016 to write off the Department of Education customer relationship intangible asset. With respect our guaranty agency results, we benefited primarily from strong placement volumes that we received at the end of last year.

Student loan placements from guaranty agencies during the fourth quarter of 2016 totaled $0.6 billion, down from $0.9 billion in the fourth quarter of 2015. Our healthcare revenues in the fourth quarter were $2.3 million, compared to $4.3 million in the fourth quarter of last year.

Revenues from our work with the centers for Medicare and Medicaid was $0.6 million, down from $2.8 million in the prior year period. And our commercial healthcare business generated revenues of $1.8 million, an increase from the fourth quarter of 2015.

Although we are anticipating we are able to begin auditing providers in region one and five under the CMS, Medicare fee-for-service recovery audit program contract in the second quarter 2017 we do not anticipate our results to have meaningful impact on our 2017 financial results.

Lastly, our other market generated revenues of $4.1 million in the fourth quarter compared to $3.9 million in the prior year period. Moving to our expenses, salaries and benefits expense in the fourth quarter was $18.8 million, a decrease of 8.3% compared to $20.5 million in the prior-year period.

Other operating expense for the quarter was $14.6 million, a decrease of 7.7% compared to the fourth quarter of 2015, primarily due to a reduced volume related costs and other completed cost reduction initiative.

For the fourth quarter 2016, our reported net income loss was $12.3 million or $0.24 per diluted share, compared to a net income of $2.2 million or $0.04 per diluted share in the prior year.

Adjusted net loss in the fourth quarter was $1.5 million or $0.03 per diluted share, compared to an adjusted net income of $4 million or $0.08 per diluted share in the prior year period. Fully diluted weighted average outstanding shares were 50.2 million shares in the fourth quarter of 2016.

Our adjusted EBITDA in the fourth quarter was $4.9 million, compared to $9.8 million in the same period last year. Adjusted EBITDA margin was 14.6%. Our effective income tax rate increased to 28% for the year ended December 31, 2016 from 17% for the year prior.

The increase in the effective tax rate is primarily due to the increase in 2016 net loss as a net loss in 2015 was closer to break even and the impact of permanent differences and state taxes was therefore reduced on a percentage basis by the larger loss in 2016 offset by the recorded evaluation allowance in 2016.

Cash flows from operating activities for the fiscal 2016 were $17.8 million. Turning to the balance sheet as of December 31, 2016, we had cash, and cash equivalents of $33 million and our total outstanding debt was $55.2 million, reflecting our continued focus of paying down our long-term debt.

Lastly, as we mentioned in last quarter, we entered into an amendment of our credit agreement adjusting several of our covenants through fourth quarter of 2017. This amendment is expected to provide us with additional flexibility to operate our business uninterrupted through fiscal 2017.

Additionally we have started a process of assisting our options as it relates to re-financing of our debt that becomes due in March of 2018. As part of this process we are practically solicited proposes from a number of financial advisers and investment banker and would be looking to peruse the best available options for Performant.

Now I'll turn the call back to Lisa for some concluding remarks..

Thanks, Hakan. In our last earnings call we announced the contract award for one of four positions on the IRS recovery contract. This program is a ten year $2.4 billion take for in the December 2015 highly transportation bill. The target timeline for implementation remain Q2.

Thus far the IRS's internal implementation team has been very focused on assessing and auditing company for operational preparedness. We believe will add to a strong foundation in creating a very successful program.

Because this operation is one of building repayment plan for tax payers -- taxes we believe it may take 18 to 24 month to see a solid run rate. Therefore, we do not anticipate material impact in 2017. We are honored to be one of the initial vendors and believe that this contract can be very successful with great long term potential.

We also received two new recovery audit contract awards for both region one and region five from CMS. Region one was reconstructed to include 11 states in the North East and Mid West. You may recall this CMS equalized regions proportionally for the new contract some states dropped out and others were added. All in we believe this is the positive.

Region five is the national durable medical equipment and home health and hospice contract. We have been working with this CMS operational team with the goal of beginning to implement the new contracts in April.

However, due to the timing of revenue recognition we do not expect these contracts to have material impact during 2017 but believe they remain strong future opportunity as CMS continues in their efforts to correcting proper payment.

Even CMS in 2016 reported error rates of 11% for total growth errors and 46.3% error rate on durable medical equipment, we are consciously optimistic that CMS will continue to thoughtfully increase audit scope and volume limits in the recovery audit program.

With regards to the Department of Education contract in January we have protested that the department's contract award decision. Although I cannot specifically comment on the details of our protest, we do know that the process moving forward while we can't speculate on the outcome the current target timeline for GAO’s ruling is mid April.

Regardless we do believe we have strong grounds for protesting the award and will continue in that effort. As a reminder, even if you were to receive an award early this year it would not have material impact until next year.

With these factors we believe 2017 will be a year in which we continue to execute against our growth strategies in other markets of healthcare. While we have not spent much time talking about our other markets we have been growing this revenue stream which include specialty customer care contracts.

These are contracts that require [indiscernible] level expertise and care. And given our high level of regulatory compliance and trade work force we are seeing some early success in expanding into this market.

The current forecast is built on a handful of contracts already implemented which drives our growth of that business to be in the $25 million to $28 million revenue range for 2017 which represents growth of approximately 30% versus prior year.

You may recall that we have structured our commercial healthcare operation in 2016 which started to show improving results in Q4 of 2016. With contracts and products implemented our audit and data mining run rate revenues are starting to trend upwards during Q4 2016 and heading into 2017.

Additionally, with the start of two CMS recovery audit contract, which will start to show some revenue in late Q2 we estimate healthcare revenue to be in the $15 million to $20 million range in 2017 representing sustainable revenue growth of over 50% versus prior year.

During 2017 we will continue to focus on providing the best service possible to our clients and competitively differentiate ourselves to regulatory compliance and customer care. We are seeing growth and expansion in other markets and healthcare.

That said, given the IRS, a CMS contract timeline during 2017, we do not expect those to have meaningful revenue contribution in this startup year.

All those factors combined, we expect revenue and EBITDA to decline versus the prior year as the old Department of Education business runs off and with currently known factors, our 2017 revenue and EBITDA guidance is in the range of $125 million to $145 million and $10 million to $13 million respectively.

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

Thank you. [Operator Instructions] Our first question is from Michael Tarkan of Compass Point. Please go ahead..

Thanks for taking the question. Just a few on the education side. As it relates to the ED contract, can you just walk us through a little bit of how the GAO process works.

You get a chance to meet with the GAO or did they just decide based on your written protest and their decision expected in April?.

Yes. GAO process is back and forth. So, there is some dialogue but largely through our counsel. And so, at this point we had a couple of different communications with the GAO through our counsel. And the GAO as I mentioned in the call, the target date is mid-April. So, the process continues but we don’t have direct interface with the GAO..

Okay, that's helpful. And then I guess of the contingency, if the GAO would deny the process, how are you thinking about other opportunities potentially serve as a subcontractor on the education contracts for some of those that did win the contract.

Is that possible?.

It is definitely possible and to be perfectly honest, we are already starting that up with some of the folks that we already know. So, we're looking at all of the ways that we can participate in the contract. There are different path, one of them is certainly subcontracting with that, we're already down that path.

And as we look at that part of the process, the small business that is side contract was awarded before the unrestricted category. And so, this small businesses are getting large placements and we are we can work in with a few of those smaller businesses on the ED portfolio..

Okay. I guess shifting gears a little bit but staying in education. On the guaranty agency business, yes, I know you have a long relationship with Great Lakes, I know that a big GA was just consolidated underneath Great Lakes.

And I'm just wondering sort of how you think about opportunities to expand that relationship potentially winning that contract going forward?.

Well, we think they will be processed. As you may know, in the market there are not that many organization to do for portfolio management or master servicing agreement. We believe Great Lakes historically is always a very fair and very conscience, not for profit organization. So, we believe there probably will be some sort of a process.

Today, we've had a very long-term relationship with Great Lakes and our service to them has been such an ongoing dialogue of achieving not only their results but overachieving their results, continuing to improve our customer service to them. So, we believe there will be an opportunity to at least be a player in at least in the ring.

So, I think that probably more to come on that as the year passes..

Okay, thanks.

How can Lisa, from a modeling perspective, what are you guys assuming for CapEx for 2017?.

We expect CapEx to be pretty consistent with the CapEx that we've had in '16. So well, you're looking at approximately around $8 million..

Okay. And then I guess lastly from me, just big picture here. You have three valuable contracts in hand but they're not going to be a material contributor to revenue in 2017 and your asset build expenses. You have a stable guaranty agency collection business with upside.

At what point does it make sense for you guys to start thinking about strategic alternatives for somebody who maybe is a little bit better capitalized that would see value in those contracts where you wouldn’t have to be a standalone independent entity anymore? Thanks..

Well, we regularly as a board we regularly have dialogue around the right capital structure for the company and alternative. So, I will tell you that as a board we are very conscience of company's outlook about the long-term prospect and about strategic alternatives. So, that is an ongoing dialogue at the board level and that has been.

So, we will continue to discuss that..

Okay, thank you..

Thank you. The next question is from Brian Hogan of William Blair. Please go ahead..

Good afternoon..

Hi, Brian..

One little, my question is around the initially they're on the revenue growth cadence by quarter.

Obviously the first quarter be a little soft, you don’t have the any of those contracts that's ramped up yet? Both including 2017, what do you think the kind of the revenue cadence will be, so it's going to be backend loaded?.

Yes. It would be better than mix, Brian. First of all, yes, we do have a ramp on the healthcare part of our business and in other. We do so have some kind of it from the Department of Education contract in particular in Q1, so that that was actually a bit of an offset. So, as is of cadence, it's back loaded if not significantly so..

That's I think to our earlier comment, the CMS contract and the IRS contract will really not be at their full ramp by fourth quarter, Brian. So, they will still be very soft sort of phase of those contract even at the end of 2017..

Have you cited up what the actual run rate of those contracts and when it's going to fully ramped would be?.

It's hard for us to say one. As I mentioned the DME error rate nationally is 46.3%. Almost all of that is just in proper payments versus on documents that are missing documentation. Was working with CMS to get a sense of exactly how they're going to post their contract relative to document limits or audit scope.

We think clearly that error rate needs to come down and we think that's a contract that has a separate kind of view and revenue potential then the regional sort of complex audit scope contract. On the IRS contract, there is a deliberate and very careful start.

That said the last number that we have is in 2011 there were a $160 billion of unpaid back taxes. Speculating here, but I'm guessing that number probably hasn’t come down.

We're not saying we're going to access to all of that but we do believe that the IRS will very carefully start the contract and the longer term run rate will depend on how well the contract is going. As I mentioned earlier, this is actually paid for.

So, there is a need to drive $2.4 billion in a period of 10 years to pay for the process that were included in the highway transportation bill. If you kind of just take that number and say back into it, in a 10 year time frame, that number has to be achieved.

So, at this point, we don’t know exactly, we I can't tell you in 2018 or '19 this will be the run rate. I can tell you that this program we believe the IRS is starting, again these little programs has to be done well. They have to start well. They have to have the level of compliance that can stand up to any criticism. That said, it's a big paid for.

So, we do anticipate that at some point it's going to hit a run rate that starts to achieve that paid for need..

Alright, thanks for the color, I appreciate it. The Great Lakes consolidating in the USA funds, to understand USA funds was quite large.

Can you actually size up that opportunity? Obviously there's a lot of puts and takes there and you have to just, but can you size that mostly?.

Yes. I have to say to give you sort of sizing up the opportunity. What I can tell you is and it's publicly available information but in terms of overall student loans, self-student loan portfolio, Great Lakes is about $30 billion and new stat is about 50 billion..

And I assume they had the same delinquency rates, since they are so large?.

I don’t have those actually at hand but I don’t think there probably be too much difference between those..

All right. Staying in education with the GAO protest. What happened if you or the other 42 protests are successful, is it rebid, is it on an individual case basis.

What in that scenario what happens?.

Well, there are several paths that the agency, that any federal agency can take if they are ordered by the GAO to take corrective action. So, that corrective action could be and obviously the examples from historical cases. Some agencies have just added the contract just to protest it.

It's unlikely that that will be the case here because of the number of protest that are outstanding. The agency could choose to cancel the procurements and hit a reset button and that for the Department of Education could come in the form of reissuing and RFP which you know is public.

Or an R2, which is a more focused search for vendor partners and want to say actually historically taken prior to this particular procurement. So, they could do that and then the third is try to negotiate but again I doubt that any of those path would be taken.

So, it just depends on what decision they make, what's the GAO instruct them to do, they could also Department of Education could also send a clarification to the responses in the RFP for example.

If there were some flaw in the procurement that GAO pointed out specifically, Department of Education could choose to send out an amendment to the procurement and ask vendors for clarifying sections and to be resubmitted. So, there are several different paths that could be taken..

Sure. And then the thoughts on the I guess federal student lending program in general given the change in the administration and as it relates to this contract as well.

Do you have any thoughts on that?.

I have many thoughts on that. But I think you've probably read as much as I have. Much of the criticism of what the old administration left behind and I think my what I would tell you is I read a lot of and probably be more with what the Wall Street Journal has printed just in terms of what the liability is for the federal government.

There is a specific article that was posted at January the 22nd, which and I quote "The combination of cynicism and then a confidence is what made the Obama administration's regulatory machine so destructive.

One of the biggest message at least behind is the government take over student loans that is likely to settle tax payers with 100s of billions in losses. The Trump administration now has to begin the cleanup job." I think it's a very complex situation. I do think when you when we've read comments by Mrs.

Virginia Foxx who is the Chair of the Education and Labor Workforce Committee. She publicly stated that she would like to endeavor a more effective public private partnership that would be a benefit to the government and to the ultimate students as well.

So, we're hopeful that there will be a chance for private public partnership that doesn't look just like the old program but maybe more successful and better for tax payers and for student loan borrowers..

And you would have a partnership with the private guys such as the GA that maybe partaking that.

Is that your view?.

We will have to see what the structure looks like Brian. I don’t think, I really could not speculate at this point what that structure is. I think this is certainly not something that would be probably be done in the first 100 days. So, I think a bit longer term endeavor.

But our hope is that there will be a good program that is constructed for future title -- this entitlement program for future borrowers and for the government as well..

Sure. Shifting to the healthcare, the commercial healthcare in particular. You said you're ramping up and saw a nice ramp up in the fourth quarter.

What is that trend and I know you gave some numbers like $15 million to $20 million total in healthcare, how much is that commercial and trajectory of that please?.

Yes, as Lisa mentioned the guidance we gave in healthcare area is on revenues of $15 million to $20 million. The growth we expect to come from commercial. We are today not seeing specifics as far as how much is back and how much is commercial but in total we are looking at the guidance of $15 million to $20 million..

Alright.

And then, can you elaborate on the $25 million to $28 million of the other revenue and why is it up 30%? Is that cannot be IRS and backend loaded?.

No IRS is a very strong part of that. We obviously have - we have a customer care contract that we are implementing and it's already implemented so we should see that revenue and that's given us an ability to see where we can play in that kind of market.

So it's actually a new contract implementation and our efforts will continue in that space during the course of this year..

Alright.

And then finally from me, debt covenants how are you progressing on those and what are your conversations with your lenders?.

Sure. So first of all we as you know we amended on covenants last quarter through the ends of 2017. So the covenants are -- we feel good about meeting the covenants and so no issues from that perspective.

What we are doing as I mentioned in my opening remarks is that with the debt becoming due in March of 2018 we started the process of evaluating options and have been in contact with different financial advisers and investment bankers to come up with a best approach and best solution for Performant. So that's in process right now..

I guess and then one last one the placement from the GA it was 0.6 in the quarter is that what you expect going forward or is it going to be kind of lumpy or should we expect some growth?.

Yes, it does fluctuate from quarter to quarter as you have seen over the last few years. And we had couple of quarters ago we had placements in the GA space of $1.3 billion.

So it's just fluctuates and there is impact on our - we stay very focused looking very closely and performing with our GA clients and in such there are opportunities where we have been able to increase our market share so that's a strong focus and then you have the opportunities through consolidations that had taken place in the past and some of our strategic clients not GA clients or often times the aggregators of that business.

So assuming that there is business that is aggregated in, I mean that provides us again with placement pickup. So with all that said, we expect it's going to be little bit fluctuate for the nature of those moving parts but overall as you look at year-over-year it's fairly stable..

Thank you..

Thank you. [Operator Instruction] Okay. We have no further questions at this time. I would like to turn the conference back over to management for closing remarks..

Thank you. Our 2016 results succeeded our expectations as we continue to execute improvements in productivity, grow share with our current clients and effectively manage our expenses.

We are implementing the IRS and recovery audit contract award and believe these evidence are ability to succeed in our market and it expands into close adjacencies so we can leverage our core skills. We also believe these contracts have room to grow and become very valuable program to our client and to our business.

Our competitive differentiation continues to be our overarching client centric focus, our service value proposition, our consumer sensitivity and deep commitment to regulatory compliance. And before I go, I want to again thank our clients for letting us serve them and thank our employees for bringing their very best efforts to our organization.

We thank you for being with us on the call today..

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