Performant Financial Corporation (NASDAQ:PFMT) Q3 2022 Results Conference Call November 8, 2022 5:00 PM ET
Company Participants
Richard Zubek – Investor Relations
Lisa Im – Chief Executive Officer
Simeon Kohl – President
Rohit Ramchandani – SVP of Finance and Strategy
Conference Call Participants
James Rush – Craig-Hallum
Kyle Bauser – Lake Street Capital
Kyle Bauser – Lake Street Capital
Operator
Good afternoon, ladies and gentlemen, and welcome to the Performant Financial Corp. Third Quarter 2022 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded.
I would now like to turn the conference over to Richard Zubek, Investor Relations. Please go ahead.
Richard Zubek
Thank you, operator. Good afternoon, everyone. By now, you should have received a copy of the earnings release for our third quarter 2022 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; Simeon Kohl, President; 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, 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. Our 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 the press release.
I would now like to turn the call over to Lisa Im. Lisa?
Lisa Im
Thank you, Rich. Good afternoon, everyone, and thank you for joining us for our earnings call. Our third quarter results have us well positioned to achieve our full year goals and we continue to find new avenues of growth among our federal and commercial clients.
A huge thank you to our incredible, hardworking team members. Without your dedication and commitment to Performant, none of this would be possible.
With that, I’ll turn things over to Simeon Kohl to discuss our third quarter and other initiatives in greater detail. Sim?
Simeon Kohl
Thanks, Lisa, and good afternoon, everyone. The third quarter of 2022 marks another quarter of continued year-over-year growth in our Healthcare revenues. Overall, our Healthcare revenue in the third quarter was $23.5 million, an increase of approximately 18% when compared to the same period last year. Revenue from our claims and eligibility-based offerings were up 43% and 3%, respectively, over the third quarter of last year.
We are excited to see the continued top line growth, but we do want to acknowledge that one of our new eligibility implementations was delayed, which impacted our results. The delay pushed back the timing of the program ramp by at least one full quarter. It’s important to note this revenue is not lost but merely delayed. And as we’ve long discussed, the primary challenge we encounter with implementations is timing. This new program is now operational as of the fourth quarter of 2022. And despite the delay, we remain confident in our ability to achieve $92 million to $96 million in Healthcare revenues for 2022.
Speaking of implementations, year-to-date, we have completed 15 new implementations with an additional seven that are scheduled to be completed by the end of 2022. We also expect to see a similar cadence into the first half of 2023.
In addition to our implementation pipeline, we are excited about our growing sales pipeline and our ability to convert on the significant opportunities before us with the small and midsized health plans. One example of this is our recently announced strategic engagement with Priority Health. This opportunity highlights our ability to deliver tailored solutions that address a health plan’s specific needs. We are excited to collaborate with Priority Health to deliver an industry-first, enterprise integrity solution, and we are optimistic in confirming similar partnerships into next year.
Overall, our sales pipeline is robust and has continued to produce new wins. We currently anticipate our pipeline will continue to bolster our long-term growth, although it’s imperative that we implement and ramp these new wins as quickly as possible. Ramping new contract wins requires discipline and potentially some internal platform and workflow improvements to ensure we scale the business as efficiently as possible.
In tandem with continued product development, we are focused on driving efficiencies in the areas of the business within our control. We are optimistic that these efforts will help us to compress the time it takes to implement new opportunities.
Moving forward, we expect to continue to refine our technology to create value for our clients and open new market opportunities. Combined with our commercial footprint, we have leveraged our technology platform to amass a health care data repository comprised of over 200 million covered lives, making Performant a uniquely competitive data-matching option over larger incumbent vendors.
In addition, we are developing an infrastructure that will allow our proprietary technology to be available as a self-purposing platform. We presently enjoy the benefits of this differentiation in our current offerings and we are excited to deliver new products that further empower our customers.
By aggressively addressing the hiring concerns that we shared earlier in the year, we are focusing our efforts in both product development and the implementation enhancements discussed earlier while also refocusing our energies to drive greater efficiencies in our claims-based auditor workflows. Claims auditing is the most resource-intensive offering within our product suite and represents a significant opportunity to drive increased margins.
Finally, as we recently announced, CMS awarded Performant an 8.5-year contract to serve as the Region 2 recovery audit contractor. The contract was initially awarded to Performant on March 24, 2022, via a full and open competitive procurement. And following a voluntary corrective action process, CMS reaffirmed its initial award determination that Performant’s proposal represents the best value for the government.
This win validates our competitive technology platform and highlights our ability to compete with incumbents of all sizes. This extension of our long-standing partnership with CMS underscores our team’s hard work and dedication and is a reflection of CMS’ belief in Performant’s value proposition.
As a result of this award, we are now the exclusive Medicare fee-for-service auditor for 26 of the 50 states; the exclusive DME, home health and hospice claims auditor for all 50 states; the sole nationwide medical reviewer for the Health and Human Services Office of the Inspector General; and the exclusive eligibility and recovery contractor for the Medicare Secondary Payer Commercial Repayment Center.
These federal contracts serve as strong foundational pillars that reinforce Performant’s brand as the leading independent provider of quality, payment integrity and eligibility services. They also provide payment integrity leaders within commercial health plans the confidence to rely on Performant to stay ahead of market trends and gleaning timely and valuable insights in the process.
In reviewing these updates, I’m incredibly proud of the work that we have done for CMS and for our commercial health plan partners, and we thank them for their trust in choosing Performant. Overall, we are executing well and are encouraged by both our new contract wins and the expansion of our sales pipeline. We believe we are well positioned for a strong end to the year and achieving our stated Healthcare revenue guidance target.
As we look ahead to 2023, we are excited for the first full year untethered from our legacy recovery markets, one in which Performant will be operating from a position of strength given our seasoned leadership team’s deep experience and insight in the health care payer and payment integrity market. As we focus on continuing to scale our health plan operations and further refine our technology, we’re thrilled to be operating as Performant Healthcare Solutions, a pure-play health care technology company.
With that, I’ll hand it over to Rohit Ramchandani, our Senior Vice President of Finance and Strategy, for a discussion of the financials. Rohit?
Rohit Ramchandani
Thanks, Sim. As Sim mentioned, our results in the third quarter of 2022 were largely in line with our expectations, overall, total revenues of $27.2 million, which included Healthcare revenues of $23.5 million or an 18% increase as compared to our Healthcare revenues from the third quarter of 2021. We are also excited with the increasing momentum in our business, promoting our growth rates and continue pushing us beyond our current run rate revenues.
Our total Customer Care/Outsourced Services revenues were $3.6 million for the quarter, a slight decline from last quarter but in line with our expectations for this market. The continued process of the federal student loan forgiveness and expected payment restart in the beginning of 2023 should help guide our expectations for the future of the customer care market.
Total non-health care recovery revenue in the third quarter of 2022 was $41,000, in line with our anticipation of this revenue stream going to zero by year’s end. It’s also worth noting that we continue to incur some costs related to our legacy recovery market activities and other expenses not needed to achieve future growth plans. We believe that we should have these essentially cleared out by year’s end.
Adjusted EBITDA in the third quarter was a loss of $275,000 compared to the $2.7 million in the prior year period. Our growth in Healthcare revenues has offset the year-over-year departure from recovery market revenues, though we’ve additionally seen recent growth in operating expenses driven by investment into continued Healthcare growth, as previously shared.
Claims-based, known as claims auditing revenues, in the third quarter of ’22 were roughly $10.4 million, which was an increase of nearly 43% compared to the $7.3 million in the third quarter of 2021. This represents strong growth from both implementations we’ve been sharing as well as continued volume increases as existing statements of work continue to scale.
Revenue from our eligibility services for the third quarter were $13.1 million, representing a modest increase from the $12.7 million in the prior year third quarter. Our CMS work continues to operate at a rough steady state, providing an anchor on eligibility growth rates. The remainder of our eligibility market work is growing at healthy double-digit rates, in line with expectations.
As Sim noted, our sales and implementation pipelines are healthy, and we anticipate seeing balanced growth trends across all of our health care product offerings over the foreseeable future, but we acknowledge and recognize that the balance of each year may look different.
Moving on to expenses. Operating expenses in the third quarter were $29.5 million or $1 million higher compared to Q3 of last year. This increase was primarily driven by the increases in salary expenses due to our continued investment into hiring for our health care markets.
I thought it would be helpful to provide an example of investment into growth by way of our complex claims-based auditing work. A nurse or coder may be hired today. Consequently, they will go through two to four months of training and ramp up work with heavy quality control. They then typically hit steady-state production around the four- to six-month mark. This then couples with the flow of work product delivered to revenue, which can waterfall in two to six months’ plus from the date of work effort being conducted. Altogether, you can note it may be many months to see the returns from the date of hire on an individual basis.
Separately, as mentioned earlier, we did see some increased costs within the quarter related to our company transformation from legacy markets served to today. We’ve been able to manage headcount and salary expenses planned but have seen some unforeseen increases in outside services and other vendor spend. These were to the tune of roughly $0.5 million above plan in the quarter, and we currently anticipate some of those may continue into the fourth quarter.
Finally, as part of our transition into a pure-play health care company, combined with the learnings of COVID-19, we have recalibrated our operational footprint and successfully sold buildings that had previously existed as call center operations, which resulted in a net gain of $1.1 million. We maintain a strong cash position and believe that our cash and currently untapped revolver combined to position us well to pursue organic growth opportunities.
Given our continued achievements in the third quarter, building upon our success in the first half of 2022, we remain pleased with how we are tracking towards current year expectations and, more importantly, our long-term goals. As Sim mentioned, we are also pleased to reiterate our Healthcare revenue guidance of $92 million to $96 million.
With the affirmation of the RAC Region 2 contract, we anticipate to start spending on the implementation work in the current month. We are excited to get ramped up on the contract as soon as feasible and start seeing it contribute to our top line results. It is also worth noting that we ultimately opted to engage with outside counsel as it relates to the protest process for RAC Region 2 given the significance of this contract. This RAC-related spend, in tandem with some of the increased expense trends discussed earlier, leads us to a revised EBITDA range for the year of negative $1 million to a positive $1 million.
As we look to wrap our first year as a health care technology focused company, we have been pleased with our results. Our long-term strategy remains intact, and we are very excited about the future.
Operator, would you please open up the line for questions.
Question-and-Answer Session
Operator
[Operator Instructions] And our first question is from the line of George Sutton with Craig-Hallum.
James Rush
This is James on for George. Congrats on the RAC Region 2 win. So I’d imagine that RAC Region 2, you guys getting that contract sort of created some buzz in the space around your capabilities. So I guess, are you seeing any increased momentum on the commercial side? Or has inbound interest or conversations with prospects changed at all since the award?
Simeon Kohl
James, look, I think that the confirmation of the award was certainly something that our commercial clients were glad to see and our prospects, I think, took note of that. So with a little bit of the protest period, there are some questions about that out there. So I think coming in and having CMS confirm that we are the best value, it does underscore what we’ve been saying for some time. And certainly what the sales folks talk about quite a bit is that CMS is, with what they manage in terms of their spend and the rigor they go through in evaluating program integrity vendors, it’s a big attribute to be able to say that we were selected and selected for yet another region. So a little too early to tell in terms of how we’re seeing it directly impact the pipeline. But to your point, the buzz is there.
James Rush
Great. And then with the macro backdrop, sort of concerns about a recession next year, maybe some payers trying to rationalize costs a little bit, could you talk about how you think about cyclicality or economic sensitivity in the business? Or do you see potential for payers to outsource more payment integrity functions as a way to cut costs?
Simeon Kohl
Yes. Look, we’ve long talked about the business being relatively recession-proof. I do think, though, that, look, payers are engaged and trying to find ways to reduce costs. Conversations are definitely amping up as we think about this time of the year and folks looking at the various targets and thinking about them in terms of where they are today for ’22 and what they’re projecting for ’23. So I do think the backdrop, the macro effect of kind of where we sit with the economy, is making payers take some notice in terms of how they think about program integrity as a critical component to their business as we think about kind of the margins at which they operate.
In terms of outsourcing, I think it’s just a consistent message. I think payers understand what they do well. They understand kind of their own internal capacities, and they understand the role that vendors like Performant certainly play in supporting. And again, I think this ties to what we talked about for some time now, and we’ve highlighted this with that priority engagement, some of those smaller payers and the midsized payers, they just don’t have the capacity to be able to engage either with multiple vendors or, frankly, the capacity internally to really give program integrity the commitment that it needs and deserves in the context of participating to the bottom line. And so I think that’s where we continue to be really excited to come up with an offering that we refer to as this enterprise integrity solution, which is that full end-to-end suite. So again, I think the macro impact of the economy in the market is actually a win for Performant.
Operator
And our next question is from the line of Kyle Bauser with Lake Street Capital.
Kyle Bauser
Congrats on the updates here. So I think you mentioned five programs were implemented in Q3 and you expect another seven in Q4 with similar cadence in the first half of ’23. So I just wanted to kind of verify this. To be clear, is that about five programs per quarter going forward?
Rohit Ramchandani
Kyle, yes, thanks, a good question. I think five to seven per quarter is a reasonable expectation as we see it today in terms of similar.
Kyle Bauser
Okay. Got it. So I guess following up on that, with 2022 largely a year of kind of operationalizing the wave of recent contract wins, I think, 48 since the fourth quarter of 2020, can you talk a little bit about how we should expect margins to eventually evolve over the past maybe 12 to 24 months? I know you’re not giving guidance, but would just love to hear kind of the latest on what your longer-term margin goals are.
Rohit Ramchandani
Absolutely. And I think you hit it there, as those programs continue to ramp towards a steady state and the new ones do as well, those should all be bolstering our scale, which is the strategic plan we’ve laid out. And therefore, I think we maintain the long-term view of the margins in the 20s. As we think about the nearer term, I do think outside of that, the RAC Region 2 implementation will be depressive on margins for the coming quarters until that program can ramp up just given its potential size. So our long-term goal remains intact. And in fact, RAC Region 2 may help accelerate in that medium term, but in the short term, it actually will have a negative impact on margins.
Kyle Bauser
Okay. Got it. Appreciate that. And maybe following up on that, regarding the revised EBITDA guidance. So appreciate the color on some of the costs associated with that, the transformation from the legacy markets. Is most of the change, I guess, related to costs associated with operationalizing Region 2? Or if you wouldn’t mind maybe kind of teasing out what that delta is and which buckets they go in.
Rohit Ramchandani
Absolutely. I would actually say that probably the bigger bucket would be those excesses related to the transformation, something we planned for but did see a few kind of go a little past plan. When it comes to the RAC expense, given we haven’t had our kickoff meetings yet, we don’t know the exact cadence to ramp up size, but we are going to get started on the IT front. So it will be a little dependent on how much our IT team is able to accomplish along with some other vendor spend. So on that piece, Q4 is a bit up in the air, how much will get spent on Region 2. So that could change that answer. But as it sits today, I think the majority of it was actually the unforeseen excesses related to the transformation.
Kyle Bauser
Okay. Got it. I appreciate that. Well, I’ll jump back in queue, really nice updates.
Rohit Ramchandani
Thanks, Kyle.
Operator
And we have no further questions. I will now turn the call over to Mr. Kohl for closing remarks.
Simeon Kohl
Thank you, operator. We’d like to thank everyone for joining us today, and we thank our customers for their trust and partnership, and we’d also like to thank our team members for their unmatched commitment and dedication to serving our clients. We look forward to speaking to you again on our Q4 call. Thank you.
Operator
Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.
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