Richard Zubek - IR Professional Lisa Im - Chairman & CEO Jeffrey Haughton - President & COO.

Michael Tarkan - Compass Point Research & Trading Brian Hogan - William Blair & Company.

Thank you for standing by. This is the conference operator. Welcome to the Performant Financial First Quarter 2018 Earnings Call. [Operator Instructions]. I would now like to turn the conference over to Richard Zubek, Investor Relations. Please go ahead..

Thank you, Operator. Good afternoon, everyone. By now, you should have received a the copy of the earnings release for the company's first quarter 2018 result. If you have not, a copy is available on our website, www.performantcorp.com. Today's speakers are Lisa Im, Chief Executive Officer; and Jeff Haughton, President and Chief Operating Officer.

Before we begin, I'd 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, 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. If you haven't already, please find the financial packet on our website that walks through our financial results for the first quarter in more detailed form.

As you recall, on January 11, 2018, the Department of Education announced that Performant Recovery, Inc., and another company had been awarded contracts to provide debt collection services on defaulted federal student loans. Those contracts have been the subject of protest by unsuccessful bidders at the U.S. Court of Federal Claims.

On May 3, 2018, the Department of Justice, on the Department of Education's behalf, notified the U.S. Court of Federal Claims that the Department of Education has decided to cancel this procurement, and as a result, will terminate for convenience the contracts awarded to Performant and the second awardee.

The performance of which has been stayed since award due to the protest.

The notice states that the Department of Education has decided to cancel the current procurement as part of its plan to make substantial changes in the collection and administrative resolution of defaulted federal student loans, which the Department of Education concluded would eliminate the need for this procurement.

We do not understand their rationale for this decision, particularly given that as of September 30, 2017, Department of Education managed $120 billion in defaulted student loans, both direct and Department of Ed Managed [indiscernible] loan. This is up $40 billion, or 50% from just 2 years prior.

From 2015 to 2017, over $62 billion in direct student loans defaulted. These numbers imply that the Department of Education's recovery rate for defaulted loans went down from 19.2 % in 2015 to 9.3% in 2016 and 2017. We will continue to stay close to the situation because default rates are going to necessitate that actions be taken before long.

That said, as we entered 2017, we provided details for 2018 guidance with a snapshot of our view of Performant in 2021, which reflects our business with $200 million of revenues and 20% EBITDA margins. This vision for 2021 excludes any positive impact of an EV award.

In our Student Lending business, placements of $914 million were 34% higher than prior year Q1 and 66% higher than Q4 of 2017.

This volume increase is attributable to 2 large clients accelerating a routine reshuffling of inventory among their vendors, includes recall of existing inventory and is included in guidance given during our last earnings call.

Additionally, as a reminder, Great Lakes terminated our student loan recovery contract last year due to a strategic decision to bond the loan servicing and recovery for their entire portfolio. The transition of our Great Lakes student loan inventory began in October of 2017.

Since the termination of our contract with Great Lakes, we have become a subcontractor for Great Lakes new prime recovery contractor and servicer, Navient. In Q1, we received Great Lakes placement of $32 million, which is $245 million below prior year when we worked as exclusive vendor partner to Great Lakes.

Student lending revenue in Q1 was $19.1 million, which was down $5.4 million or 22% below the prior year, largely due to timing of placements during the 2017 year. With that, I'd like to turn the call over to Jeff Haughton to talk about our health care and other markets..

Thanks, Lisa. Our healthcare revenues for Q1 2018, excluding the benefit of the CMS reserve released, totaled $3.5 million, which represent a 113% increase versus Q1 of 2017. Healthcare growth was driven by the launch of our new MSP recovery contract in expansion versus last year of our commercial clients in our geographic region contract.

We began operations under the MSP CRC contract in mid-February with 60 employees and are currently about 1/3 of the way through reaching our targeted scale of approximately 250 employees. In terms of our financial results for the MSP program, revenues for Q1, which was basically just a month of March, were just under $900,000.

While still early, we're excited about the initial progress and are confident in our expectation that this will be a sizable long-term opportunity.

Along those lines, I would reiterate our comments from last quarter regarding the potential size of the MSP program, which stated that Centers for Medicare and Medicaid have published annual results for the MSP program, which include administrative costs over the last 2 fiscal years and range from approximately $18 million to over $24 million annually.

Most of these costs represent continued fees paid to the CRC recovery contractor, which is now Performant. In addition to the MSP program, we're continuing to ramp up several of our large commercial health care programs, which also entail coordination of benefits recovery for the Medicaid program.

Although those revenues will become more material in the back half of this year.

For Q1 2018, our commercial health care revenues of $2.2 million were up $645,000, or an increase of 41% year-over-year, but down $1 million sequentially due to ordinary course timing impacts on recoveries and revenue recognition, particularly related to newer client programs.

On the CMS Recovery Audit programs, we began work under our Region 1 and 5 contracts during Q2 of 2017. Although growing, revenues are impacted by CMS's measured pace and scaling of claims volume for the RAC program. RAC revenues, excluding the benefit of the old RAC Region A liability reserve release totaled $400,000 during Q1 of 2018.

We are targeting the full year revenues for these 2 regions to be in line with our 2018 estimate of $4 million to $6 million. As our old RAC Region A contract expired at the end of January, we released the remaining liability reserves, which added to revenue and EBITDA by $27.8 million and $18.8 million, respectively.

Finally, as we pivot from healthcare and we look at our other revenue category, we are seeing nice overall growth across clients in this revenue category. The 1 exception is our new treasury recovery contract, which was awarded last year.

This new contract has been delayed for launch and the Treasury Department works toward implementing a new technology platform. While we are currently working recovery inventory for treasury under the old contract, we have not received a new placement in 6 months.

As a result, total revenue in the other category equaled $6.6 million and was down $300,000 versus last year. We estimate that revenues in this other category would have been approximately $2 million higher, if the new treasury contract had been flat versus the old contract in Q1 of 2017.

We view this as delayed revenue that we should be able to recapture with the start of the new contract. The new treasury contract is expected to launch in the next couple of months.

The areas of growth in this category aside from our treasury contract include our customer care operation, which generated Q1 revenue of $3.8 million, which is an increase of $500,000 versus the prior year. In addition, our IRS and other state tax recovery contracts grew by $1.1 million over Q1 last year.

We expect to drive overall revenue growth in this category in 2018 based on our previously provided guidance of $35 million to $42 million of revenues. With that, I'll turn it back to Lisa..

Thanks, Jeff. Touching on Q1 operating expenses, excluding expenses of $9 million related to the impact of CMS Region A RAC contract closeout, our expenses of $35.8 million were above prior year by $1.7 million or 5%. As we discussed in our last call, several large contracts require investments up front.

These investments expenses in Q1 were about in line with our expectations for total year investment cost estimate of between $9 million and $12 million.

If we include CMS Region A RAC contract closeout, total revenues were $57 million and expenses were $44.8 million, which includes expenses adjustments related to the subcontractors who served on that old contract.

As we mentioned in our last earnings call, we continue to increase the investment and build on our health care contracts, including the MSP CRC contract. It is expected to be a significant contract, which will have a positive revenue and EBITDA impact this year, despite this being a ramp-up year.

As we mentioned, $900,000 of revenue in Q1 represents about 5 weeks of work at 1/3 of total headcount achieving strong 2018 results will depend on successfully hiring, training and engaging health care employees. Over the next few months, we will have much better visibility into the timing of the full ramp-up process.

We expect that investment in the first part of the year will drive greater revenues in the back half of the year, particularly Q4, and expect to continue investing and ramping these contracts for the balance of the year.

As we look at the results for Q1, although health care revenue seems light and commercial healthcare is still a bit lumpy, we continue to see momentum in the work required to move these revenues towards the back half of the year.

As we mentioned, MSP CRC revenues really just represent March, and we have only hired about 1/3 of the total final headcount we believe this contract will need for this full ramp. We remain cautiously optimistic that total health care will build significant momentum and be in the range of guidance we have provided for the full year.

With Q1 completed, we reiterate our 2018 revenue guidance range of $123 million to $150 million, excluding revenues associated with the termination of the prior CMS Region A contract. This is a broad range due to the potential that we have in executing on both commercial health care contracts and the MSP CRC start-up.

Adjusted EBITDA guidance remains between $2 million and $6 million. Our value proposition to our client continues to be based on a client-centric foundation with strong innovation, analytics, compliance and actual recovery of dollars for them. We add value to our clients financial picture through results.

We enhance the reputation by the quality and care of the work that we perform. And we distinguish ourselves from competitors through innovative and unique programs that are tailored to our client. With that, I'd like to open up the call for questions..

[Operator Instructions]. Our first question comes from Michael Tarkan of Compass Point..

Just regarding the Department of Education. Have you received any additional color from them as to what direction they may go from here? It sounds like they're content with their existing crew and just collectors or incumbents.

Just wondering if you think there is potential for a reprocurement or if there's a thought that they could bring it into treasury, just kind of any color there?.

Mike, and we haven't really heard anything from the Department of Education.

But as you probably can access also the numbers that are published by Department of Education really point to a program where the volumes, just borrowers and dollars that are defaulted continue to increase pretty substantially, which, again, as I said in the call, would point to a recovery reduction -- dramatic reductions from 2015 into 2016 and 2017, which, as you know, coincides with the end of the old unrestricted contracts.

So we have not heard anything from them, but it's hard to believe that they are just going to plug along at what probably will be less than the 2016, '17 recovery rate. I also think because as you know, the Department of Education is a performance-based organization, I do think that they are held to a standard with congressional oversight.

So I'm not sure what they plan to do. But I think there has to be some sort of action, I don't think that they at a 90-day administrative action will suffice to actually address this portfolio..

Okay. I mean, assuming it is -- that's the case, right, that they go with their incumbents and we don't have that contract coming back.

Do you -- are their abilities -- do you think there is ability to potentially serve as a subcontractor for those who are doing the work? And then as a secondary question, are you currently carrying some expenses associated with that contract?.

The answer to your first question is absolutely. And as we have been and we certainly intend to ramp up those efforts. With respect to the second question, are we carrying excess cost, I'm actually going to let Jeff Haughton answer that question.

Jeff?.

Yes, there is some modest cost there, Mike, I wouldn't view them as overly significant as we watched the old process play out. We wanted to see through the end before we invested significantly.

So there's some, but I would say it's pretty modest and frankly, it just means on some of the expenses we are making elsewhere, we will just reprioritize for the items that we have near site visibility and the revenues up..

Okay.

The cash position moved down a little bit sequentially, is there timing issues associated with that?.

Yes, Mike, so we did anticipate a reduction in cash just as a result of increasing our investment in some of these contracts as we mentioned. One of the areas that we've been working on with our clients is the Great Lakes portfolio moved over to Navient. There's a bit of logistics that we have to manage with local organizations.

So we are seeing that come back around. So we think of our cash position, as we look out over the next few quarters will actually be back kind of in the range that we expected..

Okay.

So we should expect it to pick back up then sequentially, is what you're saying?.

Yes, we just have to work that through. And as you know with these kinds of transitions, not everything goes as smoothly as everyone would like. So we just -- we're working on it, we can tell you that we believe that it will fix itself without constant monitoring.

But we are definitely going to -- we're seeing some improvement and we are cautiously optimistic that we will see that get fixed in the next few months..

[Indiscernible] accounts receivable pick up at the end of the quarter on the balance sheet..

Got you. Yes, yes. Last question from me is, again, I guess, the Ed situation has been pretty fluid, as you look out over the next 12 months, 24 months or so and you're still in investment mode, which makes sense you have some valuable contracts that needs to be invested in to grow.

I'm just kind of wondering how you guys view yourselves in terms of being an independent entity versus considering strategic alternatives, which should give you a little bit flexibility because this is the way you want?.

Yes, and Mike, you've asked that question before and our answer remains actually pretty consistent, which is we are -- at the Board level, constantly and continually discussing what should be the right strategy for the company. And we will continue to have that as a Board topic for discussion.

So we'll continue to monitor the situation, but as you know, we have to consider what's the best strategic outcome for the company and shareholders..

Our next question comes from Brian Hogan of William Blair..

On the MSP contract, just really 1 month you said $0.9 million of revenues. How -- and, obviously, after staff that you target at least.

How should we think of the ramp, is that really take the margin multiplied by 3 to get the quarterly run rate and as you ramp up and step up from there is it -- and I understand that you give the 18 to 24 historically what they paid out, just kind of looking the more of like what's the ramp?.

Yes, so....

Yes, go ahead, Jeff..

I'm sorry, Lisa. Here is how I would think about it. Yes, certainly, we're going to get a full quarters worth of operations under our belt in these deals so you can see the pickup from that. The way the contract does work is initially you work transition cases.

So these are cases that were started and were in some amount of completion when we took over the contract. And so we've been working those transition cases. And there's certainly, some service level agreements that we need to meet with CMS in order to make sure we're working those cases in a timely way, and we have been doing very effectively.

Over time, what you'll see is those cases will start to get completed and then we will be building new cases on our own. And that's the process that's largely going to be happening this quarter. So our revenue perspective we're showing and you going to see a pickup in MSP revenues in Q2.

But also in Q2, we're going to see a little bit of a transition from transition cases to new cases. My point being that it's the new cases ultimately that will get the run rates revenues towards the back end of this year, they are certainly larger, more reflective of having an organization that 250 people working full time on this.

So I don't mean to imply that is going to certainly dip in Q2, but you're definitely going to see some growth at the back half of the year that is greater than the $900,000 you see in initial side. And in Q2, we're going be working through this transition process. So it's not perfectly linear but that's kind of how the mix blends together..

Yes. And staying on healthcare, but shifting to commercial.

Obviously, it can be a little lumpy there, I guess, but can you express what we should think of in cadence there, I thought you had a nice pipeline going there and taken a little bit of step back in 1Q quarter-over-quarter, but kind of outline your thoughts on the commercial health care ramp?.

Sure. It's Jeff, again. As we think about the commercial business, what you're seeing there is share revenue recognition and just timing of revenue recognition from the audits that claims in you reviewed going back 6 months, that's a little bit of what you see.

I would say the second impact, as you look at that commercial businesses, we've got some newer recovery programs and those recovery programs will start with a certain amount of inventory that will work, and then we work to kind of expand those programs. And so there's a little bit of just timing differences.

When you think about when that inventory comes in and when it generates that revenue, the pint being, again, it's not going to be perfectly linear.

When we look at the opportunity ahead of us and what we're working moving the right trajectory as we look at that overall program, in particular, as you think about the new recovery programs that drive a little bit of the lumpiness in first quarter.

So it's a function of all those factors that are playing together as we look about the timing of those revenues. Don't know what that's going to look like throughout 2018..

All right. And shifting to Great Lakes contract.

How would you compare the profitability of the prior exclusive contracts with the subcontract?.

Jeff, would you like to take that question also?.

Sure. I would say it's pretty consistent. We know the inventory that we're getting, it's very similar to what we before it's just different in size and I would say just in terms of profitability because we are working effectively the same way. So I wouldn't view that business as being overly different from what we working about.

There are some -- the pricing changes, we've taken into account over time, but overall, I would say it's largely consist [indiscernible]..

And then just to add to that, Brian, on the Great Lakes contract because we when we were managing the whole portfolio we all had subcontractors just so from a -- just a mathematical pure margin standpoint.

There should be a higher margin on this business, simply because we're not managing subcontractors, which, as you might recall, was almost a straight flow through in fees, I mean, better percentage of margin..

Yes, that's right. My [indiscernible] focused specifically on the business we're working versus what the subcontractors working at..

Sure. And then how we should think about the placements from Great Lakes which we saw in the second quarter here reasonable or is that....

Jeff, do you want to take that question also?.

Sure. Yes, I think, for now, that's the right way to look at it and then over time it's our performance, we would hopefully be able to increase our market share. But I think for now that's the right volume to look at..

All right. And then the treasury contract you referred to is like a delayed launch to the government's technology implementation.

How confident are you that's going to start in a couple of months? And can you get back up to that run rate pretty quick of what you were doing?.

Yes, so it's a great question. I would say there's always risk, right, that gets delayed further, although they've been working through this for some time. So sure, there is some risk to that. I think there's other ways and programs we can take up in terms of some of that risk.

But I think right now it's fair to say the next several months 2 to 3 months is what we're expecting. And that's certainly farther back on the specific timetable that treasury has given us. So we're giving us a bit of cushion there. But that's something we're definitely watching closely and we'll to see how that plays out..

Right. And then I mean as a taxpayer, obviously, very disappointed in the Department of Education's decision to cancel the contracts. But anyway, I would shift to just thoughts on debt covenants. I know you redid your debt in much looser debt covenants.

I guess, any concerns around debt covenants, obviously 2018 being a ramp up year and I'm sure your lenders understand that?.

Jeff, would you like to take that question also?.

Sure. No, we have no concerns about our covenants whatsoever just, both in terms of how it's structured, in terms of our forecasted results. Obviously with the unwind of the CMS payable in this quarter that certainly helps from an EBITDA perspective, which is part of how we think about the covenants.

And then overall our lender, in this case [indiscernible] business partner of ours too. So we don't anticipate any issues with our covenants going forward.

We also have a dialogue with them that allows us to if we look to invest in our business and grow our business, it gives us some flexibility make sure we can invest and grow how we want to an increase longer-term value. So overall, no concern..

[Operator Instructions]. This concludes the question-and-answer session. I would now like to turn the conference back over to Mr. Lisa Im for any closing remarks..

Thank you. Thank you very much for joining us today. We are excited about the contracts that we are ramping up.

And, although it does require investment both Q1 and Q2, we see the path to strong revenue growth as we look towards the end of Q3 and particularly as we roll into Q4, we see the opportunity to have a very strong run rate on a steady-state basis. So we look forward to continuing this dialogue in the quarters ahead.

Thank you so much for joining us today..

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day..