Greetings, and welcome to Performant Financial Corporation's First Quarter 2021 Earnings Conference Call. [Operator Instructions]. Please note, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Richard Zubek, Investor Relations. Thank you. You may begin..

Thank you, operator, and good afternoon, everyone. By now, you should have received a copy of the earnings release for our first quarter 2021 results. If you have not, a copy is available on the Investor Relations portion of our website.

On today's call will be Lisa Im, Chief Executive Officer; and Rohit Ramchandani, Senior Vice President of Finance and Strategy. Before we begin, I'd like to remind you that some of the comments made on today's call are forward-looking statements.

These statements are subject to risks and uncertainties, including those described in our filings with the SEC. Actual results may differ materially from those described during the call.

In addition, any 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. 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. As you likely know, we are currently going through a multipronged approach with regard to our company composition.

The COVID-19 pandemic disrupted our legacy recovery business, which included the acceleration of already declining student loan recovery revenues, and a broader recovery ecosystem that continues to face more and more regulatory pressure.

Our approach includes an agreement to sell a portion of our non-healthcare recovery contract to a buyer that specialized in outsourced receivable solutions while winding down other aspects of our recovery operation.

As part of the wind down, we will continue to fulfill our current recovery contracts, but we do not plan to renew or restart existing contracts or pursue new non-healthcare recovery opportunities.

This decision reflects our plan to fully dedicate our resources and efforts on expanding our position in the healthcare market, where we continue to demonstrate success in taking business from long-term industry incumbents.

We also plan to maintain our customer care outsourced services operations as we see a potential for growth through a tighter integration with our healthcare market offering. Furthermore, we expect the multipronged approach with our recovery contracts will generate cash flows for the purpose of delevering the company.

We continue to believe that our strength and focus on the high-growth healthcare market is in the best interest of our shareholders. Although we have made the decision to focus on healthcare going forward, our quarterly results in 2021 will continue to reflect the blend of our healthcare and some legacy recovery operations.

For the first quarter of 2021, we had revenues of over $31 million and essentially a breakeven adjusted EBITDA. Both of these figures were lower compared to the first quarter of last year due to the impact of the coronavirus pandemic.

We anticipated Q1 to be a smaller quarter in 2021 due to the trickle down of COVID impacts, but are excited to share that the current and long-term trends remain very positive.

Further, our 2021 targets remain unchanged, and we are confident in our ability to achieve our previously stated guidance of annual healthcare revenue in the range of $83 million to $90 million and positive EBITDA.

Our recovery business served as a foundational backbone to launch our healthcare operations with CMS in the 2000s, but since then, we've developed a comprehensive offering focus both on healthcare commercial clients, and we continue to expand our relationship with CMS.

Most recently, CMS awarded us a renewal of our Region One recovery audit contract, or RAC, for a base term of 8.5 years. This recompete award is in addition to our ongoing national CMS Region 5 durable medical equipment, home health and hospice contract.

We are excited to further focus our efforts within the healthcare markets to build upon our position as an industry leader in payment integrity. We're successfully winning new business and expanding our existing contracts through the combination of our client-centric focus and our proprietary and differentiated technology platform.

Within healthcare payment integrity, both of our offering categories, namely claims based and eligibility based services operate on the same data platform regardless of the service. This platform provides us a competitive advantage in terms of capabilities, processing times and flexibility.

This allows us to center our focus on driving greater value while perfecting our offering. The healthcare payment integrity industry is not a new market or something that we created. Much of our success has come via our ability to effectively take market share from the existing incumbents.

We will continue to invest in technology and attract industry-leading talent to further scale the business. We believe we have a solid foundation for meaningful growth in the short and medium term. We will always remain a client-centric company to our core.

We are excited to strengthen our commitment to healthcare, focus our resources on helping our clients, manage the rising cost of healthcare services. With that, I'd like to introduce Rohit Ramchandani, our Senior Vice President of Finance and Strategy, to walk you through the results of the quarter.

Rohit?.

Thanks, Lisa. As Lisa mentioned, in Q1 of 2021, we reported total revenues of $31.4 million, which was lower than the $45.9 million that we reported in the prior year period due to the impact of the COVID-19 pandemic. Adjusted EBITDA in the first quarter was negative $0.2 million compared to $7.1 million in the prior year period.

Overall, we remain excited about the continued growth and expectations of our healthcare business. And in an effort to provide greater accuracy and clarity to the health and growth of this business, we have taken a step to reclassify how healthcare revenues are reported into claims space versus eligibility based offerings.

In providing this breakdown back through 2019, you will better be able to see the significant progress we have made over the past 2-plus years, which evidences our history of consistent quarterly growth in both offerings.

We additionally anticipate that our customer care outsourced service revenues could expand in the back half of this year if our activities return to pre-pandemic levels.

Claims based, also meaning claims audit, revenue in the first quarter of 2021 was more than $5.3 million, which was lower than the $6.6 million in the first quarter of 2020, but sequentially higher than the $4.7 million we reported in the fourth quarter of 2020.

We anticipate claims based revenue to continue to trend upward as we imminently return to pre-COVID levels and continue executing on new and expanding programs within clients. We can see some of these trends evidenced by the trends in the largest payors of the U.S.

having lower utilization rates in 2020, which are expected to normalize across the course of 2021. Tangentially, non-COVID related claims during the public health emergency, which have largely been untouched, also represent an interesting future volume opportunity.

Revenue from our eligibility services for the first quarter of 2021 were approximately $8 million, slight decrease from the $10.9 million in the first quarter of 2020 and sequentially lower than the $14 million we recorded in the fourth quarter of 2020.

Of note, our ongoing operations and related KPIs are demonstrating growth year-over-year, but lower sequentially due to normal seasonality. We expect these to continue growing through the year as programs ramp.

Around the end of the first quarter, we detected discrete exposure on some of our eligibility work within an SOW at 1 of our clients, who we do serve via multiple SOWs. And based on this new information, we have accrued a $3.3 million liability against revenues.

We expect that this liability will close out in the coming year or so via future offsets and based on our analysis, we do not anticipate to incur future liabilities. This charge is reflected in our total healthcare revenues of $13.3 million in the first quarter or $16.6 million prior to the charge.

While revenues were lower than the $17.5 million we reported in the first quarter of 2020, we continue to make progress with our expansion efforts, including the 10 new healthcare programs that we announced last quarter.

Based on the progress that we have made thus far, including leveraging our prior years of investment, we expect that a majority of these programs will be through the investment onboarding phase by the end of 2021.

Of note, we see the return to the pre-COVID levels in the short-term with expected significant growth in the back half of 2021 from expansion of our current programs and the effects of the new programs we are implementing.

While we anticipate that the second half of 2021 will represent a significantly outsized portion of 2021 revenues, as Lisa mentioned, we maintain confidence in our 2021 expectations and at this stage, over 95% of our 2021 revenue expectations are contracted.

As we look forward to the remainder of this year and beyond, our implementation pipeline and sales pipeline remain strong with a diverse mix of new clients and expansion of services within current customers. For illustration, we launched an additional 5 programs in the first quarter of 2021.

4 of these are audit based or claims based and 1 is eligibility based. All of these programs were examples of land and expand opportunities within existing clients.

We are very excited about our healthcare business, and we believe our decision to channel future investments into the healthcare payment integrity market will continue to yield strong results, revenue and EBITDA growth.

Total non-healthcare recovery revenue in the first quarter of 2021 was $14.5 million, while total customer care outsourced services revenues were $3.6 million for the quarter.

Both of these amounts were lower than the prior year period, with a decrease in our customer care outsourced services revenues being entirely driven by temporary slowdown in activities related to the CARES Act.

We anticipate that our non-healthcare recovery revenue will continue to decline throughout the remainder of 2021 as we work through our multi-pronged approach, and we do not anticipate reporting any such revenue at the start of 2022.

As Lisa and I, both mentioned earlier, there is potential for growth in the customer care outsourced services revenues via a return to pre-COVID levels or as a result of tighter integration with our healthcare offerings.

Operating expenses in the first quarter were $34.4 million, which after excluding our goodwill impairment charge in the prior year period is $6.6 million lower. The decrease in costs were mostly due to expense reductions in response to the pauses and slowdown in recovery activities, reductions, which we anticipate to continue.

With that, I'd like to turn the call back over to Lisa before we open up to your questions.

Lisa?.

Thanks, Rohit. We continue to be very focused on healthcare growth opportunities as we move further into 2021. We believe the solid traction that we achieved during the 18 months of contract implementations evidences our ability to serve healthcare clients with products that better meet their needs than offered by competitors.

As we've previously mentioned, we launched 10 new diversified programs in Q4 of 2020, several of which were based on competitive procurements, which is a key component of our growth strategy and is further bolstered by the additional 5 programs we launched in Q1 of 2021.

As we execute the streamlining of our business, we look to a future of revenue growth, improved margins and much stronger execution and focus from our growing healthcare brand. We are also exploring renaming the company as we execute this strategy.

We are confident about the long-term prospects of Performant and believe that we will continue to grow and scale our business in the coming years. With that, we'd like to open the call up and take your questions..

[Operator Instructions]. Our first question comes from the line of Chris Krug with Chatham Harbor Capital..

Fantastic quarter, guys, five new program starts is great in addition to the 10 last quarter. I understand there's a natural time lag between when you start a program and when the revenues show up.

Would you mind walking me through this time line?.

Certainly, Chris..

Sure. Go ahead, Rohit..

So yes. So as we implement the programs, as we mentioned, we believe, given the investments we've made in prior years, it will be a quicker implementation and that these should all be fully up and running by the end of this year.

So you'll start seeing some good impacts from these in Q4, but real material impacts into 2022 as they're all at steady state..

Okay. Great. So based on that answer, given that over the last few years, you've signed dozens of contracts, you must have seen a very clear usage patterns.

What does that mean -- would that mean that you have an incredibly strong visibility into your revenue for the 12 months out, given that you know that the revenues will start ramping up in Q1 of next year?.

Absolutely. And I think that's certainly what lends to the confidence we have in our guidance with over 95% of being contracted. And then our projections based on that experience and history that you just described. So we do have strong visibility into how the next 12 months will play out..

Great. Great. Great. And so the guidance of 30% this year, you're very confident about.

What about 2022 and beyond? Do you think 30% growth rate is sustainable in the future?.

We do feel that strong double digit growth rates are sustainable in the future. I think we'd be in a better position to opine on the exact growth rates of '22 and beyond as we continue progressing through this year and execute against our near term goals..

Okay. That makes sense. So you've grown really rapidly.

How fast is the end market growing? Is it reasonable to assume that you're taking market share away from HMS and Cotiviti?.

The overall healthcare market -- go ahead, Lisa..

Yes, I was going to say, the overall healthcare, you can speak to where the market is going. But I think I mean, generally speaking, the healthcare spend in the U.S. is growing probably sort of mid-single digits.

And I would say that as we think about market and who the players are, certainly, HMS and Cotiviti are large players that have a significant share of the market. But there are other players that certainly have competed in the market. I think what we've seen in the last probably 12 to 18 months is a lot of aggregation of companies.

And so I think it will be interesting for us to sort of step through the next coming months and year or so, and get a better lay of land on exactly what will happen with that consolidation in the industry. But generally speaking, I mean, Chris, the rate of payment errors isn't declining materially.

There's just a certain -- and frankly, the commercial payors do a great job. Commercial market does a great job already of controlling that.

But based on just the sheer volume of claims that are processed and submitted on a daily level, we think that the market will continue to be -- if not steady, will continue to grow at that sort of single-digit growth level and then taking market share away will be how we enhance that growth for us.

Rohit, do you want to add to that?.

No, I think you encompassed it well..

Okay. So HMS was just acquired by Veritas for 17x times their EBITDA. They also own Cotiviti as well. And they're growing top line single digits and had 30% EBITDA margins.

Is it reasonable to assume because of the similarities between you and HMS, that the EBITDA margins at maturity would be in the same range of 30%, looking out 5, 10 years?.

I think that will be a reasonable approach..

Okay. Okay. So what I'm hearing is, if you can grow -- well, you said that you can grow at double digits, but over the next couple of years, I mean, you could get close to $150 million in revenue, my numbers, but by 2023.

And then if you can do 30% EBITDA margins in a steady state, if we use HMS's multiple of 17x EBITDA or EBITDA growing at single digits, and you're going to be growing this year at 30%. That could be in a couple of years, you could do $40 million or $50 million in steady state EBITDA.

Hopefully, you're not you're not going to have 30% margins in a couple of years, because you'll be growing. But I mean, to me, I mean, it seems like you could easily be trading at HMS' multiple of 17x EBITDA and the market cap then would be somewhere around $850 million, which is almost 8x what it is today. So I mean that's great.

So moving on to the debt. As for sale and recovery, what does this mean through debt? You said in 1 of the press releases that you were going to use the proceeds to pay down some of the debt.

And if our math is correct, you have something like $38 million in net debt and between free cash you generated this year and the sales recovery, this is gone from in the end of 2019, if my math is correct, $59 million in net debt to now $38 million, which seems extremely manageable.

Is that correct?.

Yes. I think your debt math is tracking well, and we do believe that we will continue being able to service our debt as well as growing our healthcare business, which relates itself to the other thing at the close of recovery transaction as we would be extending the maturity 1 year out to 2022..

[Operator Instructions]. Our next question comes from the line of Craig Melcher with Tudor Investment Corporation..

Congrats from me on a great quarter as well. Really pleased with all the progress and continued share gains in healthcare. In thinking about the share gain opportunity, if I were the incumbent, it might be tempting to maybe lower prices in terms of either take rate charged or offer other incentives to try to maintain my position.

Can you speak to a bit about why this might not be enough to sort of maintain share? Or put differently, how customers might be thinking about pricing versus quality when they're selecting among vendors?.

Yes. I think, Rohit, I can start and you can jump in. But thanks, Craig, for that question. So this is an industry and a business that's 2 types of different pricing, right? There's sort of a per member per month pricing, then there is the success fee-based pricing. And on the success fee-based pricing, obviously, I'll choose a very simple example.

So if a competitor is currently returning $10 a month, and we return $20. Even if our fees -- even if they lower their fees, that's not going to substantially improve the actual dollar return to the client. And the client are sophisticated enough where, one, they don't just sort of willy nilly change vendors.

It takes them a long time, like part of the implementation sort of time line for us is really meshing with our client data systems, which takes a while, it takes a long time. And so it's not without cost. And so as we think about our clients, they're very savvy. They don't change vendors just on the fly.

They don't change vendors because somebody has offered a lower pricing, and we don't compete on that level anyway. We think that we have to drive better results that our clients can feel they can -- they have that in their bank account.

We have to provide great client service to all of the constituents that our clients deal with, so that there isn't any -- there isn't abrasion. There is a good explanation and that we can actually turn the activities into dollars sooner. So as we think about that climate and competitors, these are all respectable companies that we compete against.

None of them are shoddy companies at all. They're very respectable companies. They've gained their share. They've done good work, but I think what we provide as a competitive product or service is just -- is a product or service that is just better from a return standpoint.

We also think that the way we -- again, as we interact with constituents and all the constituents that deal with our clients, it's really important to have great customer service, and that is -- has always been our philosophy and our company is that we're going to be client centric.

So irrespective of whether -- if you're returning say, $10 a month and you reduce your fee, unless you reduce it substantially, you're still never going to drive sort of $20, right, versus -- I mean -- our fees may not be -- our fees may be a little bit higher in some cases. They're certainly not -- probably not twice as high.

But I think our clients really base their decision on what are the results that I'm seeing from Performant. What is the quality of work that they're doing? How are they treating my constituents? As payors in the commercial healthcare market, we want to be sure that we're being sensitive and very conscientious of the way we work with providers.

We think that, that is an extremely important role in an aspect of the work that we provide. So I think it's not a matter of pricing. I think the incumbents have, again, they're great companies. They've been in this space for a long time.

I think what we're providing is just something that is just a step above what's happened in the market, just all the way around. So pricing concession, I don't think it's going to drive a change back to a vendor.

And again, given that vendor switching costs are pretty high, we think as long as they can provide that level of sort of exceptional work that got us the contract in the first place, we think we can continue to -- as we -- our philosophy is land and expand, continue to provide greater services to clients..

Great. That makes a ton of sense to me. So it really does sound like an industry where competition is based really exclusively on quality. And it's a good kind of industry to be in when you have invested really a lot to create the highest quality product. And I guess just as a follow-up on that, you mentioned your sort of land and expand model.

And from the -- either the customer perspective or from yours, how easy is it -- I know you mentioned this a bit in the opening remarks, but how easy is it to expand within the existing customer base? And as I understand it, you might be brought on to kind of have a bit of a trial run and then get upgraded in the stack as you continue to post better and better results.

So I guess, like in what -- roughly, like in how many of your clients or percentage of your clients or however you think about it, are you in the sort of non-primary or trial position where you could see upside as long as you can continue to drive these better client outcomes.

So I guess just to speak a bit about the pipeline opportunity and existing customers would be great..

Yes. I think maybe -- yes, we can use a real life example, and you can talk about some of the contracts we've implemented recently..

Certainly. And so I'll include that as well. And to your question, it really does vary client-by-client in terms of the pace of that expansion. It's typically just predicated on the performance. And what they have available or what switches they're willing to make.

But for example, if you think about those 10 new programs from the fourth quarter and looking at those, it's roughly a 50-50 split between a net new client or expanding within current clients. And if we think about in the first quarter with the 5 new programs, it's almost entirely expansion within our current contracted client set.

And so with that in mind, as we think about the base, I think in almost every client we have, there is still continued opportunity to expand further within their covered live spaces or within the eligibility and claims based product offerings.

So it's something that we've demonstrated over the past few years, and I think we still have a good amount of ramp ahead of us to continue doing so..

Awesome. That's super helpful. And the benefit of that as well, I would imagine, expanding within existing customers should come at, all else equal, a higher incremental margin.

And so I guess, just on that last point, my final question would just be, so once you are plugged in and running with a client, with your existing client base, like as far as the actual operations to bring $100 of revenue into your company, how much of the work is done by this technology and your algorithms versus how much is done by Performant employees? I guess I'm just trying to drill down a bit on the components of contribution margin and the incremental margin opportunity.

And that's it for me..

Certainly. And so that's the first. So in our eligibility based offerings, more of the employee work is done on that implementation and mental setup. And once it's operating, it's primarily the technology at play. And on the claims based side it was split, whether it's an automated audit or whether it's a more complex audit.

And so on the complex side, I would say the initial heavy lifting is all done by the technology platform and then a nurse or coder will come behind to validate. And if it's an automated audit, it would be done entirely by the technology platform. So it varies between which specific product offering it is..

And with that, we've reached the end of our question-and-answer session. And I would now like to turn the call back over to management for any closing remarks..

Thank you, operator. We want to thank you for joining us for our earnings call today. We also want to thank our clients for, once again, allowing us to serve you this past quarter. We also want to thank our team members, who have continued to bring their best every day to Performant even through changing the business composition.

We appreciate all of the efforts and all of the productivity. And again, we thank our shareholders for supporting us..

And with that, this concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day, everyone..