Greetings and welcome to the Performant Financial Corp. Third Quarter 2019 Earnings 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 of Investor Relations. Thank you. You may begin, sir..

Thank you, operator, and good afternoon, everyone. By now, you should have received a copy of the earnings release for the company’s third quarter 2019 result. If you have not, a copy is available on the Investor Relations portion of our website. Today’s call will be led by Lisa Im, Chief Executive 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 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, all 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. With that, I’d like to now 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 supplements on our website that walks through our 2019 third quarter financial results in more detailed form.

Our results in the third quarter demonstrate our successful execution on our plans to move back to profitability as we remain on track to achieve our internal long-term goal of $200 million in revenue and 20% EBITDA margins in 2021. We are confident that the successes we have seen in the third quarter will continue into Q4 and beyond.

In Q3 of 2019, we reported revenue of nearly $36 million, which was in line with our internal projections and up over 30% versus the prior year period. Adjusted EBITDA in the third quarter was a loss of just over $3 million compared to a loss of nearly $4.5 million in the prior year period.

Overall Healthcare revenues in the third quarter of 2019 totals $11 million, which was nearly 50% higher than it was in third quarter of 2018. CMS related revenues in the third quarter of 2019 exceeded $7 million compared to just over $4 million in the prior year period, an increase of nearly 69% year-over-year.

Commercial healthcare revenues accounted for nearly $4 million in the third quarter of 2019 compared to just under $3 million in the third quarter of last year.

On a year-to-date basis, the results of our efforts to grow our healthcare operations are even more apparent, as year-to-date revenues in 2019 were just over $29 million, which is 80% higher than they were in 2018 after excluding the onetime CMS appeals reserve of $28.4 million that was recognized in 2018.

Total recovery revenue in Q3, which includes our student lending, tax, IRS and Treasury markets, as well as Premiere was just under $21 million, which was approximately 30% higher than the third quarter of last year.

Lastly, our Customer Care and Outsourced Services revenue of $4 million was flat when compared to the $4 million from the third quarter of last year. Q3 expenses of $42 million were approximately $7 million higher than in the prior year period.

Expense reductions of over $10 million in recovery operations were offset by increases in expenses related to higher headcount growth following our acquisition of Premiere and the overall growth of our healthcare operation. We anticipate continuing to make sound investments to better position us to drive additional revenue into 2020 and beyond.

Finally, we are providing some incremental color on our fourth quarter expectations as well as a slight update to our 2019 revenue guidance ranges to reflect some of the decisions we made as well as challenges that we faced in Q3.

In the fourth quarter, we anticipate reporting meaningfully positive adjusted EBITDA as our contracts become more mature and we start to benefit from our investments over the past two years. For the full year 2019, we are maintaining our EBITDA guidance of a loss between $6 million and a loss of $2 million.

But we are updating our revenue guidance range to $147 million to $152 million, which is down from $158 million to $168 million. There are a few items behind our decision to lower our revenue expectations. One was that we identified some data matching issues related to a single line of business within healthcare.

We’ve since identified the problem and are working with the client to correct the issue, but we believe that the delay will impact revenues by $68 million in the second half of 2019. This is not lost healthcare revenue, but it is also not revenue that will immediately be recouped in the first half of 2020.

Rather, any revenue associated with this issue is best described as being delayed as it gets reworked through the system. Another piece impacting our revenue range is a payment of nearly $4 million for services already rendered that has yet to be paid.

Although, we believe that this payment was going to be made earlier this year, it is becoming increasingly likely that a portion or all of the $4 million payment maybe delayed into 2020.

But as we manage the business, we lowered expenses meaningfully in our Recovery operation in order to partially offset these delays in revenue, which provides confident around the EBITDA range. Moreover, we believe we are well positioned for a profitable fourth quarter.

We are executing against the goals that we established entering 2019, continued successful transformation of the company. Looking beyond the fourth quarter of 2019, we anticipate that 2020 will be a profitable year with revenue growth, particularly in Healthcare, as we continue to execute and build client contracts.

We want to reiterate the longer-term confidence we have in our business strategy and believe that our investments in these contracts will drive revenue and margins to our 2021 goals of $200 million in revenue and 20% EBITDA margin, respectively. With that, I’d like to open up the call for questions..

Thank you. At this time, we will conduct a question-and-answer session. [Operator Instructions] Please proceed with your question..

Good afternoon..

Hey, Brian..

First question is actually on the commercial healthcare business, I guess, a little slower, it was down quarter-over-quarter, obviously, up year-over-year. But I was just kind of – the trends in the Healthcare, I think it has a lot of potential there.

I was just kind of – is that where you had some issues with the data or just kind of what’s the trends in the healthcare business?.

Yeah. That was where we identified the data matching issue with one particular point and one particular single line of business. But as I mentioned in the call, we’ve identified what that issue is and we are working with our client to get that fixed, which we think will happen in this quarter. So we’re back on – we think we’ll be back on track.

But it definitely delayed the work that we were doing with this client in this particular line of business, and that was all in commercial healthcare..

Okay.

Can you discuss your commercial healthcare pipeline, what does it look like? I mean, what can that business look like over the next several years?.

Sure. As I mentioned, if you look at what our year-to-date growth rate is, it’s in the pretty high double-digit range.

And actually, with this particular line of business that we just discussed and with another contract right behind it, which we’ve also delayed some implementation, because we want to make sure that we get this done fixed with our client, we think that there is a strong double-digit growth, again, as we look at growth into 2020 and also into 2021.

So these are contracts that we’ve been implementing, we’ve earned new contracts with these same clients. So, in terms of overall business build, there really isn’t much that that go-get as much as we’re just executing against these.

And occasionally, like, with this particular line of business, if we come across something we have to work out with the client, we’ll – we may have to delay some revenues, but we’ll work that out, because we view these as really, really strong long-term contracts that provide a very sound base for growth..

Okay. Sticking within Healthcare into the CMS, obviously, you’ve got the 2 different contracts there. But my calculations, it looks like the RAC contract had a really nice quarter.

Is there anything as the CMS increased document reviews? Or is there anything they’ve done there? Or is it just execution?.

It’s really just execution. However, with that said, we’re cautiously optimistic that CMS will continue to work with us. We think they view the program as being very successful this time around, particularly with respect to provider abrasion, which really hasn’t been an issue.

So part of that is just execution, just making sure that we’ve got enough of our audits going. And so we feel pretty good about the groundwork that we’ve laid there in terms of just executing against the current contract.

But we’re also cautiously optimistic that we’re going to see a continued increase in our ability to conduct audits on the contract as well. But we’ll see that more into 2020..

Okay.

I want to just shift over to the Recovery business, and the placements fell again this quarter down to $574 million, does that include the subcontract – any subcontracting placements? Or is that just strictly direct?.

I don’t think that includes the subcontractors.

So I mean the subcontracting business that we have on the – you’re referring to the Department Of Education?.

That’s correct..

Yeah. That does not exclude those – I mean, it does not include those..

Okay.

So I guess, can you discuss the subcontracting opportunity, I mean compare that to your existing guarantee agency opportunity?.

Sure. As you know, the FFELP channel – no loans were made in the FFELP channel since July of 2010. So as we look at the FFELP business, we see the quality – it’s not going to improve in quality. The volume will decline over the next, probably, 5 to 7 years.

When we look at Department of Education and the small business contractors, we know that they’re doing their best to service those defaulted borrowers. And with our being able to work for several of those subcontractors, we help overall – again, the underserved population, we help quite a bit.

And we actually think that from a sizing standpoint, we think that this probably the subcontracting can be more meaningful as we continue to move forward in the direct loan program. So we’re obviously grateful for the opportunity to work for the small businesses and also for the Department of Education as a subcontractor. We see that volume growing.

Obviously, you see the news as well. Defaulted borrower pool is increasing, and there continues to be a need to service those defaulted borrowers in the direct loan portfolio. So from a sizing standpoint, we actually think this provides maybe even a greater opportunity as we move forward..

Sure. I appreciate the commentary there. Shifting to the balance sheet.

And I guess, can you discuss your comfort level with the covenants? And obviously, the other covenant waivers through mid next year and how much capacity do you have left? Do you anticipate needing to expand that, can you just kind of discuss your balance sheet at the moment?.

Yeah. Sure. So our – when we negotiated the expansion of the credit line last year, we anticipated a need for a certain amount of cash. I think, we feel pretty comfortable with where we are with that. And we also anticipated what our future flow would look like in terms of positive earnings and positive EBITDA.

So the covenant relief, which goes into the mid-half of next year, we feel pretty comfortable with. And as we mentioned on the call, we’re going to start to see profitability. So we’ve done a lot of – as you know, a lot of investments in the contracts. But as we see sort of fourth quarter and moving into 2020, we do expect to see profitability.

So we’re – I think at this point we’re pretty comfortable with where we are..

Sure and last one for me at the moment is actually on expenses. You mentioned you did a decent amount of cost cutting in the Recovery business.

How should we think about expenses going forward? Is there – is it going to be kind of flattish from here, ramping a little bit as the business goes or is it – what is the fixed cost/variable kind of mix?.

Yeah, I think what we’re going to see in Healthcare is obviously as the revenue continues to grow strong high-double-digit, we would expect to continue to hire workforce and we expect to continue to have growth in expenses there. On the Recovery side, I think what we’re seeing is kind of a shift.

So again, as we look at where are the areas of growth in our Recovery, we’ll see some growth in expenses in one place, while we reduce in other places. So we think on the Recovery side it will be relatively flat. And then, of course, our Customer Care side, we would expect that to be flat along with revenue.

So I think overall, we might see slight growth, but I think it’s just really going to be driven by the strong growth that we see in Healthcare..

Okay, thank you for your time..

Thank you, Brian..

Our next question comes from Alex LaPointe with Adviser Investments. Please proceed with your question..

Hi, Lisa..

Hi, Alex..

So my first question is – hi, so my first question is around guidance. I think since you recently gave guidance, there has been a couple of delays, there has been some serious cash burn. It sort of cleared up the growth, just hasn’t been exactly as forecasted. And I just don’t see how you’re going to hit the 2021 guidance or maybe even come close.

And I guess, how confident are you in that? Can you show me a roadmap to that?.

Well, I don’t think I can show you a roadmap on this call. But we certainly can see a strong double-digit growth in our Healthcare business, which has a much higher margin than our Recovery business.

So we actually expect that to continue, because our growth into 2020 in Healthcare, but we’re not providing guidance today, our growth in Healthcare is really hinged on contracts we already have. So we’re just going to continue to expand and ramp up.

And, yes, we have had some misses as you look at the past quarters and when we’re implementing contracts with clients that are fairly large in the healthcare space, not everything goes exactly as we would like. And so, we had some delays in contract implementation. But these are not delays that we expect for the revenue to go away.

We just need to continue to focus on getting these implemented with our clients. So we are cautiously optimistic that we can continue to execute with these clients who’ve made a commitment to us and moved away from legacy vendors as a result of the kind of solutions that we can bring to them.

So we expect going out – coming out of fourth quarter to be profitable in the fourth quarter as well as moving into 2020 and we expect to see fairly strong growth in our Healthcare business..

Okay.

And then, can you give me the true total shares outstanding, fully diluted, including all the warrants that you see [I’m seeking to taking some equity holders] [ph]?.

Yeah, Ian..

Hi, this is Ian Johnston, the Chief Accounting Officer. The fully diluted shares as we stand today are the same as our basic shares, because in a situation where you have a loss there is – it would be anti-dilutive to use diluted shares. So at the September 30 balance sheet day, we have 53,685,000 shares outstanding.

And we don’t – at this current average share price we don’t have a lot of dilution. We do have a number of warrants outstanding with a strike price of $1.93. Those are not currently dilutive. But that would be about 5.5 million warrants outstanding..

Okay. Thank you..

[Operator Instructions] There are no further questions in queue. I’d like to turn the call back over to management for closing comments..

Thank you, operator. Once again, we want to thank our clients for letting us serve them this past quarter. And I want to thank our employees for bringing their very best to Performant every day. We want to thank you for joining us for our earnings call..

Thank you. This does conclude today’s teleconference. You may disconnect your lines at this time and have a great day..