Performant Financial Corporation
Q3 2013 Earnings Call Transcript

Published: 8 Nov 2013

[Operator:]

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Performant Financial Corporation’s 2013 Third Quarter Earnings Conference Call. (Operator Instructions). As a reminder, this conference is being recorded today, Thursday, the 7th of November, 2013. I would now like to turn the call over to Rich Zubek with Investor Relations. Please go ahead.

[Rich Zubek:]

Thank you, operator. Good afternoon everyone. By now you should have received the copy of the earnings release for the company’s third quarter 2013 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 the risks and uncertainties described in the Risk Factors section of the company’s Form 10-K and other 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 any responsibility 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 tables attached to our press release. I would now like to turn the call over to Lisa Im.

[Lisa Im:]

Thank you, Rich. Good afternoon everyone and thank you for joining us for our earnings call today. The third quarter was another solid quarter for Performant. Today we are reporting revenues of approximately $77 million, which is a year-over-year increase of nearly 44%. Adjusted EBITDA in the third quarter was approximately $32 million. Adjusted EBITDA margin for the third quarter was 41%. Adjusted earnings per diluted share was $0.34 in the third quarter. When we spoke to you last quarter, we expected that our third quarter revenues would be a little bit softer than they were in Q2. As a result of some favorable circumstances in both the student loan and healthcare markets that I'll address momentarily, our performance during the third quarter was actually better than our internal expectation. In the student lending market we once again outperformed our internal projections. The quarter benefited from the favorable timing of over $2.1 billion in loan placements that we received late in 2012. In addition, we continue to successfully execute on a specialized portfolio contract that we were awarded by one of our leading guarantee agency clients. Both of these items meaningfully contributed to our revenue growth during the quarter. Our healthcare business was equally strong during the quarter as net claim recovery volumes for the third quarter exceeded what we reported for the first two quarters of 2013 combined. In addition, as we indicated to you on our last quarter's call, we anticipated recognizing a significant amount of revenues during the quarter that was previously delayed due to a lack of automated processing capabilities of [TEP] claims. Approximately $10 million of our CMS RAC revenue during the third quarter were attributable to such claims. With respect to new business, we recently signed a contract with a top-tier commercial payer and expect it will begin contributing to our revenues in 2014. We continue to have strong pipeline activities across both government and commercial markets. We have a number of exciting opportunities that we are discussing and are hopeful that we will be able to provide you with more detail on our future calls. Based on our positive results from the third quarter, we are increasing our guidance for full year 2013 for revenues and adjusted EBITDA to $253 million to $257 million and $83 million to $87 million, respectively. During the third quarter, a number of announcements and decisions were made by our key customers in both our student lending and healthcare markets. Although many of these items have been previously discussed in various forums, we felt it was important to revisit these topics and address the potential impact they could have on our 2014 operating results. During the quarter, the Department of Education issued an RFP for its new recovery contract and is employing a two-phased approach to narrow the list of potential vendors. We submitted our response to phase one in mid-August, and based on the current published timeline, we expect the Department of Education to make its decision on which companies qualify for phase two in the near future. That said, it is unclear what impact the recent government shutdown will have on the timing of this process and if the contract is still on schedule to be awarded in early 2014. Regardless, we remain confident that our strong performance on each and every one of the past four contracts over the past 22 years will serve us well in being reselected as one of the final vendors on the new contract. Total loan placements in the third quarter were $2.1 billion, of which approximately $1 billion were from the Department of Education. We are encouraged by the sequential and year-over-year improvement and we believe that we should continue to see meaningful placements from the Department of Education into 2014. In addition to the favorable loan placement volume, our year-to-date results also includes previously deferred revenue, revenue that was pushed forward due to timing constrains, the initial ramp-up of new contracts, and the introductory usage of IDR strategy. While we will continue to benefit from improved loan placements, many of the items that supported our growth in 2013 will have a lesser impact on our 2014 results. With respect to our healthcare business, as we reported last quarter, in the fourth quarter we are going to start feeling the effects of the procedures that CMS has implemented as part of the transition to the second recovery audit contract, including seizing the request of medical records from providers beginning on November 15, 2013. Other restrictions we're facing include the following. First, CMS restricted all of its recovery audit contractors and subcontractors from sending any new medical record request to periodic interim payments or PIP providers, which represent 20% of Medicare claims in our region. We had been actively engaged with CMS regarding this decision and we are pleased to report that CMS just informed us that we would be allowed to review requesting medical records from PIP providers through November 15th. Although we do not expect that this brief listing of the restriction will be meaningful to our near-term results, we view this as a positive step and confirmation that CMS is committed to working with recovery audit vendors to ensure that recoveries on the successful program will not be delayed for longer than is necessary to affect a smooth contract transition. Second, you will recall that we were prohibited for the entire month of July from submitting new medical record requests to hospital providers in our region. This inability to submit new record requests during the month of July created a noticeable lag in our auditing processes which will primarily impact our fourth quarter revenue. Third, CMS implemented some additional limits on the number and types of claims we can make during this transition period. Under the revised contract, the review of any one particular claim type is now limited to 70% -- seven-zero percent -- of the provider's limits. And on September 26, CMS announced that between October 1st and December 31st, recovery auditors would be unable to review and audit whether inpatient care delivered to patients with hospital stays lasting less than two midnights was medically necessary and therefore deserving of the higher reimbursement level under Medicare Part A, or whether inpatient treatment was medically necessary for admissions spanning more than two midnights. Earlier this week CMS extended this timeline by three months to March 31, 2014. We expect that these transition rules will have an adverse effect on our results during the first half of 2014. Lastly, it remains unclear to us how long the transition period to the second recovery audit contract will last and accordingly how long these restrictions will remain in place. Much will depend on when the contracts will be awarded and whether there are protests, other developments that delay its effectiveness. As we have said before, we believe there is a strong incentive for CMS to take the necessary steps to keep this highly successful program running without a significant amount of downtime. That said, however, CMS's current thinking, subject to change, is that the transition procedures will remain in effect until the new contract is awarded and that CMS is expected to announce sometime before the current work period expires on February 4, 2014. Based on some of our recent conversations with CMS, it is our understanding that at the end of the current extension to November 15, 2013, we will be prevented from requesting new medical records until a contract is re-awarded. While the near-term outlook for the new CMS recovery audit contract award is uncertain, we believe that the long-term benefits of winning contract renewal would be highly beneficial not only for us but also to the Medicare program in reducing waste caused by incorrect billings. Given all of this, it is clear to us at this point that our CMS recover audit revenues in 2014 will be lower than this year because most of the effects of our inability to request records beginning later this month and the restrictions placed on our audit activities since August will be felt full in 2014 when we would normally begin to see revenues from our second half 2013 audit and recovery activities. While we typically do not provide our fiscal year 2014 guidance until our fourth quarter call, we wanted to provide you with some color as it pertains to our CMS recovery audit revenue in 2014. Overall we expect our CMS recovery audit revenues will be at least 20% lower in 2014 relative to our expected full-year results in 2013. While the downside case could be significantly greater, there are still a number of unknowns both positive and negative that have potential to impact our expected 2014 results, including the timing of the awards for the recovery audit contract renewal. We continue to work actively with CMS to ensure optimal outcomes as we go through the contract transition, and once we have additional clarity, we will provide you with a more defined perspective on next year. Thus far, 2013 has been a very atypical year for us in terms of the amounts of external noise that has impacted our operating conditions, particularly within our healthcare business. Although there are multiple scenarios that could impact our results in 2014, this is the not the first time that we have faced these types of difficulties. And through strong execution, we have been able to produce some very positive revenue and EBITDA results in 2013. The midpoint of our updated guidance represents year-over-year revenue growth of 22% and EBITDA margin of 34%. We remain committed to growing our business and continue to explore new avenues of expansion. With that, I'd like to turn the call over to Hakan who will now walk you through the financials. Hakan?

[Hakan Orvell:]

Thank you, Lisa, and good afternoon everyone. As Lisa mentioned, revenues in the third quarter were $76.8 million, an increase of 43.8% from the prior-year period. Of the $23.4 million revenue increase, one-time items accounted for $12 million. The largest component of our revenue mix is student lending which grew by $10.4 million or 31.6% to $43.4 million compared to the third quarter of last year. Third quarter placements were $2.1 billion, up 63.7% year over year. Revenues as a percentage of placement volume were 2% compared to 2.5% in the prior-year period. The key drivers of the year-over-year improvement in revenues were the positive impact of the strong loan placements received during the second half of 2012 and the continued execution from the specialized portfolio contracts with one of our guarantee agency clients. In addition, we have been going through a detailed data reconciliation of transaction activities with the Department of Education related to recent upgrades. And as a result of this reconciliation process, we were able to recognize approximately $2 million in revenues, most of which was previously recorded as deferred revenue on our balance sheet. Revenues from our healthcare business increased $14.8 million or 109.6% to $28.3 million compared to the third quarter of last year. Net claim recovery volume increased by $132.2 million or 111% to $251.3 million. And as Lisa mentioned, our net claim recovery volume in the third quarter was also more than what we had recorded in the first two quarters combined. Our claim recovery fee rate was 11.3% in both periods. In addition to the higher recovery of volume, the increased healthcare revenue in the quarter is a reflection of being able to successfully submit automatic claims involving PIP providers. During the third quarter we recognized approximately $10 million of delayed PIP revenues, which represents all of the remaining delayed revenue related to PIP providers. As a reminder, we have already incurred a significant amount of the expenses relating to this delayed revenue, which is the primary reason behind our strong adjusted EBITDA growth this quarter. Revenues from other markets were $5.1 million. Regarding our expenses, our salaries and benefit expense was $25.1 million, an increase of 19.3% as compared to $21 million in the prior-year period; while other operating expense for the quarter was $23.6 million, an increase of $5.3 million. The higher operating expenses are consistent with the growth of the company's recovery activities over the past year. For the third quarter of 2013, our reported net income was $15.5 million or $0.31 per diluted share, compared to net income of $6.4 million or $0.13 per diluted share in the prior-year period. Adjusted net income in the quarter was $16.6 million or $0.34 per diluted share compared to $8.1 million or $0.17 per diluted share in the prior-year period. Fully diluted average outstanding shares increased to 49.6 million shares in the third quarter 2013, reflecting the exercise of stock options. Lastly, our adjusted EBITDA in the quarter was $31.7 million compared to $18.3 million in the third quarter of 2012. The adjusted EBITDA margin in the third quarter of 2013 was 41.2% compared to 34.2% in the prior-year period. This was primarily a function of the delayed revenue of $12 million that was recognized in the quarter for which we had already recognized a significant amount of the expense. With that, I'd like to open up the call for questions. Operator?

[Operator:]

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions). Our first question comes from the line of Bob Napoli with William Blair. Please proceed with your question.

[Bob Napoli:]

Thank you. Good afternoon. A question I guess, Lisa, what are your thoughts on expense management as you move through waiting for CMS to do whatever they're going to do? It's unbelievable how disjointed they've acted in this overall situation. But what are your plans and strategies for your employee base as we move into 2014? And I mean if there's -- do you feel like they're going to make a decision by the end of November or do you think it's going to -- this is going to drag out?

[Lisa Im:]

Well, Bob, what they have -- what they've told us is that they expect to have the award before this current contract ends, which is February 4. So I don’t know if that will be November or December or January. I can just tell you what we've been told.

[Bob Napoli:]

Right.

[Lisa Im:]

I think they've gone out and stated that they intend to award the contract. Now with respect to expense management, as you all know, much of our cost structure is variable expense, so we absolutely intend to manage that aggressively, particularly as we can anticipate what's happening with the contracts if there are further delays in the work or if we need to ramp up, we have an ability to lever our variable cost structure.

[Hakan Orvell:]

And then one thing in addition, Bob, I mean as we look at the document requests, which was stopped currently November 15, however, the work period ends in February at the end of this contract. So again we're going to doing audits and doing our recovery work through the end of the current contract or until the new contract goes into effect. So it isn't like it stops here November 15.

[Bob Napoli:]

Okay. The two night hospital stay, I mean I know you said it's a substantial portion of your revenues. I think others are -- I think I've heard half of the revenue. Are you able to, you know, assuming this contract gets extended, are you able -- how much of that are you able to make up? And do you need higher prices? I mean to me that seems like some of the low-hanging fruits probably that's out there in the business. Can you replace that once you're back on line? And do you think that this, you know, in the contract process, that this calls for higher pricing across the industry?

[Lisa Im:]

It's a little bit tougher for me to talk through the pricing piece of it just because it is really just kind of a discussion point. But I think with respect to issues and whether we can make up for what is currently happening with the two-midnight stay, as we look at the contract, it's -- you know, let's say we're awarded a contract in the early part of February, even if we can't audit that two-midnight stay or the overnight stays, we have other issues that we concurrently work. We have over 600 issues that we're working from, as well as identifying new issues. Now CMS has not approved any new issues since earlier this year, but we certainly have many of them that we can submit for approval and have additional work that we can use to fill up some of this gap.

[Bob Napoli:]

Okay.

[Hakan Orvell:]

And just to add to that, I mean one of the -- one example of this is where we have been focusing our efforts are issues and procedures associated with coding orders. So we've been able to improve our accuracy and scoring and selecting issues with coding orders with successful results. So again that's an area where our technology is having a good -- really good benefit as we kind of refocus our attention to those types of issues.

[Bob Napoli:]

Okay. And last question, the student loan business, do you think that you can -- I mean you've had some benefits this year from 2012 and a nice contract from one of your GAs. Can you grow revenue next year? Do you expect to grow revenue in the student lending business next year? And do you expect other revenue to start to become more material?

[Hakan Orvell:]

-- early in the call, Bob, we typically give guidance on next year on our fourth quarter call, so we're not going to go into that here today. But you are accurate, I mean we did have some benefits here this year based on some of these placements that came in and then -- in late 2012 that was related to the technology conversion at the Department of Education. That had a benefit, positive benefit this year. And then we also had the positive benefit of the Department of Education [reconciliation] process we've gone through where we recognized about $3 million here this quarter. So we've had some of those in a benefit this year. But again as we look at our guidance for next year, we'll do that next quarter.

[Lisa Im:]

And Bob, to your question about other revenue, when we look outward, we currently have eight -- number eight signed or we're negotiating terms with clients, so this would be new contracts. We're currently working pretty close to including that 14 total new contracts that we think will be able to gain some momentum and talk to you more about as we get into our February call, that will impact 2014 in a positive way.

[Bob Napoli:]

Great. Thank you, Lisa. Thanks, Hakan.

[Operator:]

Thank you. Our next question comes from the line of Michael Tarkan with Compass Point. Please proceed with your question.

[Michael Tarkan:]

Good afternoon. I appreciate the comment around managing expenses on the healthcare side pretty aggressively. I guess just to be clear, given the potential weakness on the healthcare revenue side, do you fully expect to be profitable in healthcare in 2014 despite the revenue weakness?

[Hakan Orvell:]

Mike, again we're not going to give that guidance on next year and we don't talk about profitability outside of the total company. So again that -- this is something that we'll defer to next quarter. But overall we're going to take prudent steps as we look at how the orders unfold and managing our cost structure appropriately going forward.

[Michael Tarkan:]

Okay. The volume this quarter on the healthcare side, is it fair to say that you maybe worked that a little bit harder this quarter in anticipation of the slowdown or that was potentially some catch-up from some delays in the first half of the year? How should we think about how strong that volume was this quarter?

[Hakan Orvell:]

So Mike, just to clarify, you're talking about our student lending revenue?

[Michael Tarkan:]

No, sorry. On the healthcare side, the net claims recovery volume.

[Hakan Orvell:]

Well, again I mean as we look at this quarter, we benefited from the PIP revenue coming through again at $10 million. So we hadn't anticipated. And then we gave -- we talked about this in the last quarter, that we had about $9 million worth of PIP revenue that will be recognized in Q3 and Q4. We saw that come through sooner than what we expected, so we [weighed up] the book the full amount. And then we had some conservatism built in as we looked at the $9 million. So the number that was actually booked in the quarter as you know now is $10 million. So that will not rematerialize in Q4. So Q4 will not benefit from any delay of PIP revenue. That's all been recognized at this point.

[Michael Tarkan:]

Okay. On the education side, just two quick ones here, the -- another new proposal is out there to change or to allow for IBR for rehabilitations for not only Department of Education direct loan holders but also I think legacy [indiscernible] holders, and I'm just wondering if that has the potential to maybe allow the guarantee agencies to let you utilize IBR as well.

[Hakan Orvell:]

That is accurate. I mean there is a regulation that is being proposed to have that IBR also go into effect for [indiscernible] agencies starting in July of next year. We don't believe this regulation has been finalized yet, but when it does -- if it does get finalized and it does go into effect in July, that would -- we would see that having a positive impact to our business. But again, that's going to drive revenue in the 2015 time period just based on the nine-month deposits that we're looking at on rehabilitation.

[Michael Tarkan:]

Okay. Can you just remind us what percentage of your volume generally is currently agency versus Department of Education currently?

[Hakan Orvell:]

Well, as we look at the actual -- at the placements that we received, about close to 50% is coming from the Department of Education.

[Michael Tarkan:]

Okay. And what about your actual inventory?

[Hakan Orvell:]

That is the inventory, that's the placements, you know, that --

[Michael Tarkan:]

All right. Thank you.

[Hakan Orvell:]

But let me just clarify that. That's -- for this quarter, we're talking about 50%. But if we look at it from a year-to-date perspective, you're looking at more like 35% that's coming from -- 40% that's coming from Department of Education.

[Michael Tarkan:]

Great. Thanks.

[Operator:]

Thank you. Our next question comes from the line of Suzy Stein with Morgan Stanley. Please proceed with your question.

[Suzy Stein:]

Hi. Can you just remind us what happened to pricing last time the Department of Education contract was awarded? And are there any other big changes that could happen in that contract other than just a list of vendors?

[Lisa Im:]

Pricing on the last contract was pretty consistent with the one prior. There was a little bit of movement -- small movement down on rehabilitation which actually got brought back up a couple of years after the contract started. We think in this upcoming contract the pricing is likely to stay pretty stable, at least based on what we've seen so far. We don't believe there will be a material change in what we could anticipate. There may be more documentation required around and conveyed through payment program participants which administrative tasks like that can sometimes change. But we're, at this time, we have -- we do not believe that there will be a material change in the Department of Education contract.

[Suzy Stein:]

Okay. And then can you just drill down a little into how you're thinking about fiscal '14 for healthcare? I guess I don't understand what that 20% assumes. Does that reflect business as usual starting say in February when, you know, the time that you know the contract will be in place? Or does that -- are there other underlying assumptions there that we should be thinking about?

[Lisa Im:]

I think the message we've tried to convey is that there are variables that we still don't know, both positive -- could be both positive or negative. We at this time think the 20% is reflective of, one, timing, contract transition, because there will be some months of rolling into the new contract and work process, as well as this two-midnight stay rule which again, through the end of March, this particular class of audit will be prohibited. So the 20% is what we think a little bit of timing, some of the prohibitions currently in place between now and when the new contract starts as you know in some months, and much could change in terms of our view of 2014 just based on updates from CMS between now and then.

[Suzy Stein:]

Okay. All right, thank you.

[Operator:]

Thank you. Our next question comes from the line of Richard Cheever with Suntrust. Please proceed with your questions.

[Richard Cheever:]

Hi. Thanks for taking my call. Just a point of clarification, Hakan, I think you said that of the $10 million of the PIP -- the $10 million of the PIP revenue that flowed through this quarter, you had $9 million in your guidance previously?

[Hakan Orvell:]

That's right. As we talked about in our last quarterly call, we had estimated about $9 million of delayed revenue that will be recognized in Q3 and Q4. We had built in a little bit of our conservatism into that number and the number that was actually booked again was $10 million. So we had a $1 million upside to that $9 million that we discussed.

[Richard Cheever:]

Okay. And as far as any sort of delayed revenue recognition, it sounds like that's all caught up, it sounds like the Department of Ed technology upgrade issue, that's all caught up. Is there any other unrecognized revenue out there that could still flow through?

[Hakan Orvell:]

Not at this time. The PIP revenue has been processed and we have recognized what we had on the balance sheet on Department of Education. So we don't see anything else sitting out there that could benefit Q4.

[Richard Cheever:]

Okay. And that revenue, is there a corresponding claim volume in the current quarter or -- $251 million that posted that -- that -- those separate?

[Hakan Orvell:]

I'm sorry, you're talking about the --

[Richard Cheever:]

-- the claim volume

[Lisa Im:]

$251 million, that's in the current quarter.

[Richard Cheever:]

Yes, right. So that's unrelated to the PIP volumes that we've seen?

[Lisa Im:]

That includes the PIP volume. So all of the processing, Richard, that went through CMS's automated PIP processing system would have pushed all of those into the $251 million. So that represents the full quarter's claim volume that was reported to CMS.

[Richard Cheever:]

I see. Okay. And then as we look into, and you know I appreciate that you can't really give us any other color on revenues or guidance for '14, but maybe in the fourth quarter, how should we think of margins on more of a normalized basis since this quarter had a lot of sort previously recognized expenses in it? Or the revenue had already -- you've already incurred your expenses for the revenue that you recognized.

[Hakan Orvell:]

Well, as we talked about earlier, we did provide our full-year guidance for 2013, so you should be able to back in to that, you know, previously by taking the delta between our guidance and what we're already year to date. So it would be, you know, what I would say more normalized EBITDA margin versus what we saw this quarter.

[Richard Cheever:]

Okay. All right, I appreciate it.

[Operator:]

Thank you. Our next question comes from the line of Paul Thomas with Goldman Sachs. Please continue with your questions.

[Paul Thomas:]

Hi, Lisa and Hakan. I wanted to follow up on the earlier question about the auditing and what you guys have been focused on since you haven't been able to look at the overnight stays. Hakan, you talked about the 600 different errors that you guys can go after in the interim. Have you been focused on just the top ten of those? Is it, you know, 50% of those? Or how do we think about your ability to audit outside of just the overnight stay error that you've been focused on, I guess most of the [rec] contractors have been focused on.

[Hakan Orvell:]

I can't give you a percentage of the 600-plus issues that we have approved. But as I mentioned earlier, we are -- have been successfully able to focus on issues and procedures out of the 600-plus issues and procedures that we have approved that associated with coding orders. So the coding order is something we've been actively doing during the recent period. And we've been, as I mentioned, successful in improving our scoring and selectioning of this type of issues.

[Paul Thomas:]

Okay. And then maybe on student lending, you don't want to give guidance for next year I realize, but if we look at the volume -- placement volumes you had since you had that sort of lump late last year, they've been on a downward trend at least magnitude-wise. So, should we be thinking about -- there's nothing else that's going to come in that's going to help that revenue increase over that period, right? The placement volumes you've been working are small every successive quarter after that big lump from last year, is that the right way to think about it?

[Hakan Orvell:]

Well, not really. I mean as we look at our placements this quarter, I mean this quarter we had $2.1 billion worth of placements which was very close to the placement level that we had in Q4 of last year. So at this point, as we look at 2014, we still had a quarter worth of placements to come through that again we'll factor into our revenue next year. So as we look at our placements to date this year, I mean they're trending pretty well year to date versus what we saw last year.

[Paul Thomas:]

Okay. Just last one on the volume, the $2.1 million, you mentioned that was 50% from the Department of Education in this quarter. There's nothing on the upward trend, are you guys getting more placement volume based on performance improvements from the Department of Education or has there been any change on the volume allocation we should be thinking about in the next year?

[Hakan Orvell:]

Yes. What we saw this quarter is some catch-up. If we look at last quarter, we only had about $300 million worth of placements from Department of Education. There's still a bit of lumpiness that we're dealing with it which relates to their technology tuning. I mean the technology -- system technology transition is behind us, but we're seeing a little bit of lumpiness still on the placement side. So what we saw this quarter is the catch-up of some of the lower placements that we had in Q1 and Q2 from the Department of Education.

[Paul Thomas:]

Okay. Thanks a lot guys.

[Operator:]

Thank you. Our next question comes from the line of Edward Caso with Wells Fargo Securities. Please proceed with your question.

[Edward Caso:]

Hi. Good afternoon, Lisa and Hakan. Can you talk a little bit about the other things besides RAC and the student loan stuff? I think Lisa mentioned some numbers, eight and 14. I didn't quite understand them. But can you talk more about those opportunities order of magnitude, how fast they could be growing, maybe some examples? Thanks.

[Lisa Im:]

Sure. So we have 14 -- we're working on 14 contracts that are in fairly late stage in terms of either booking. And of those 14, eight have already been signed or we're negotiating final terms with our clients. There's a couple of them that are actually just now operational. It's a little early to give a total dollar amount because we're probably literally one month into operationalizing those contracts. And of those, several of them are with large healthcare payers in the commercial space. We have four different contracts where we've partnered with Grant Thornton with different federal agencies, and they might be either in a pilot stage or in a negotiation to do a demonstration-type project. We have a couple of contracts where we partnered with Magellan and using their obviously very deep expertise in pharma with a couple of healthcare payers. And so those again from a dollar standpoint, if we sort of rack up how those contracts look, they range anywhere between say $500,000 to over $10 million in terms of final sizing when we get to a fully operational stage. So it's at this point a little early to provide specific numbers related to the contracts that are operational, which is why we're hoping by the time we get into the early part of next year, we've had a few months under our belt. Our client is comfortable with us publicizing the relationship and the value that we're driving for them. But those are the descriptions of what those contracts look like.

[Edward Caso:]

Just so I'm clear, is 14 the total number, what you talked about pieces, or is it 14 plus eight?

[Lisa Im:]

Fourteen is the total number that are -- that, you know, to -- in our -- within our company we would tell you as tier 1. So we, you know, we've got dozens of contracts in tiers 2 and 3 that we're trying to get into the tier 1. Tier 1 is really what we feel is very close or already signed up.

[Edward Caso:]

So this is revenue at this point in time or is the expectation that this revenue shows up in your other line or some of it's going to show up in your healthcare line?

[Lisa Im:]

Some of it will show up in our healthcare line because some of these are healthcare contracts.

[Edward Caso:]

Okay. Is CMS's delay here, and obviously it started before the shutdown, is this just the hospitals just having incredible success and putting pressure on Congress which in turn is putting pressure on CMS? I mean, is this -- even though the program has been widely successful to date, CMS is behaving in such a way that is taking funds away from the government. I mean, so is there -- is the sentiment towards doing this audit stuff fading here?

[Lisa Im:]

Well, as you know, since 2009, the recovery audit contract has returned more than $7 billion back into the Medicare Trust Fund. So it is I think by any measure considered to be a very successful program in achieving its objectives and its mission. We do believe CMS is always in a difficult position trying to balance proper payments with the providers' needs, healthcare policy. So when we look at this two-midnight stay and the temporary holiday that starts in October 1 of '13 and goes through March 31st, that holiday is specifically for the purpose of trying to teach providers how to implement these two midnight-stay policies. If you go and Google this two-midnight stay policy, you will see any number of hospital associations speaking out on this policy, that it's very complicated, it's difficult for physicians to figure out how to code and how to care for patients. There's criticism from hospital associations that say, you know, this -- "CMS is taking a [drip drip] nature," and I'm quoting this from a hospital association published document, "a [drip drip] nature of the guidance with implementation information coming out piecemeal and changing on a daily basis." That's from a hospital association press release. So this rule or this policy that's been implemented is very controversial from what we can see and very difficult to implement. So I think this is a unique situation where I think -- I mean we have to believe our client believes in the recovery audit program. It's been applauded by the congressional people in terms of an integrity program. I do think there are times when CMS comes across some very difficult situation and we have to believe that their best interest is to continue with recovery audit to ensure proper payment. But in the meantime, they're dealing with this very complex issue which apparently is not very popular with anyone.

[Edward Caso:]

Just some real clarity on the 20% down on the RAC number and Hakan's comment about you can still execute through the end of February. So, should we assume some -- the drop-off to start in the middle of the first quarter and fully hit you in the second quarter, maybe some in the third, and then sort of ramping back up again assuming, you know, under the presumption here that you win again? Is that -- so is the [air pocket] sort of mid first quarter to end of second quarter, maybe into the third? Is there like sort of a big ball shaped to your -- sort of that number for next year?

[Hakan Orvell:]

I mean I would say right now, I mean as we look at it over the next two quarters, I mean we expect that Q4 is going to be quite a bit -- I mean obviously [lots of] even adjusting for the PIPs. It's going to be a tough quarter, and then as we look again at Q1, based on some of these indications, the impact of that will be softer still. As far as beyond that, we cannot see how, you know, what the final decisions are and when the contract is -- new contract is awarded and so forth. So it's too early to talk to, you know, what the following quarters will look like. And again as Lisa mentioned, at least 20% we know that. And then how much more, we don't know, and that's going to be dependent on the next few months here once decisions are made and how we actually transition into the new contract.

[Edward Caso:]

Last question, tax rate for the last quarter, fourth quarter?

[Hakan Orvell:]

Tax rate was 39%, so we're at 41% year to date. And as we look at the full year, we expect to be just shy of 41% for the year as well.

[Edward Caso:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Brian Hoffman with Avondale Partners. Please proceed with your questions.

[Brian Hoffman:]

Hi. Congratulations on a good quarter, and thank you for taking my questions. Most of my questions have been asked, but just one quick one, on the specialty GA contract, I believe that you said last quarter you received $4 million in revenue from that contract and you were expecting to get revenue continuing going forward but at a lower run rate. Was that the case or was there more upside than expected here?

[Hakan Orvell:]

We did see a little bit of upside in this quarter. I mean we booked approximately $2 million in this quarter on that contract, so, a little bit higher than what we had anticipated.

[Brian Hoffman:]

Okay. And then just one other quick question, just for a point of clarification, since CMS extended direct contract a few months ago, was one of the restrictions not being able to audit for [setting the care]?

[Lisa Im:]

Not in the contract extension, no.

[Brian Hoffman:]

Okay. All right, thank you.

[Operator:]

Thank you. Our next question comes from the line of An Singh with Credit Suisse. Please proceed with your question.

[Anjaneya Singh:]

Hi there. Thanks for taking my question. I've got a couple. I guess first off, on a higher level, could you just help us understand the logic behind all the moving pieces with the CMS, particularly, why are they pulling so many different levers to essentially restrict the request of these medical records. It seems like the overall objective was just to lower that amount, they could just delay this award, and sort of clean house and then come out. Or asked a different way, do you think their management of these issues make sense? Could you just help us understand where they're coming from?

[Lisa Im:]

Obviously what we saw is just from an observation standpoint, and again I would go back to the point that we think CMS is managing a very difficult issue with trying to change a policy that is a pretty big policy and affects all the providers. So they are trying to deal with this one-night versus two-midnight stay. And this is an area that has been misunderstood for some time, and so I think they're trying to clarify this through this new policy. The areas of work that they've asked us to tear down or stop are more related to what's happening with this particular policy. Again we're struggling to get this implemented in the provider system, provider is not understanding what the -- how to bill or how to code, and also objecting to the policy. So as we look at what we think CMS is doing, we do think they're trying to balance and manage a very difficult issue and a process. We do believe that they are trying to get through this in a way that helps implement the policy and then review the program. The errors that are made by providers, again, are not nefarious, they're just errors that are made. And I believe CMS's objective is to correct those errors and to recoup dollars on behalf of the Medicare Trust Program. The program itself is legislatively supported. So again I think we're just going through a little bit of a difficult time in terms of trying to get all of this down. And also the federal government shutdown didn't really help the procurement process, as you can imagine. So we're hoping that procurement can kind of get back, get geared up and have a contract, a work process in place, and that we will see a contract award before this contract ends, that we'll be able to start up with all of the other issues and errors that we found and that we can continue to work through those. And then this will eventually be a policy that's implemented at hospitals or have had time to learn it, to implement it, and then it should be one of these areas that are open for audit as well, we're thinking.

[Anjaneya Singh:]

Okay. That's super helpful. Another sort of higher-level question, you've commented several times about just the success of this program since inception. I'm wondering if you can talk a little bit about the other side of the equation as to, how should we think about providers and their response to the auditing? Can you talk about whether in your experience if they've become more precise or pursuing more appeals and whether the incidents of improper billing continues to be as high as it was during the earlier days of this program?

[Lisa Im:]

So let me talk to the accuracy of the audits. So the recovery audit contractors are measured on accuracy of audits. And we are -- Performant is somewhere I think above 97%. The other auditors are very much in the mid-90s to high 90s as well. So from a quality of work, the audit program that CMS is running, one, has great transparency, great oversight by CMS. The providers have very known processes that are explained to them through provider outreach that we conduct. And so when we think about it from the provider side, of course they don't love the program, because it is a program that takes dollars back from reimbursement and takes them back into the Medicare Trust Fund. So we know it's not a positive program. But that said, it's an important part of ensuring that waste is reduced in the way CMS runs the Medicare programs. We do have limit, as you know. So, document limits at 2% per month of Medicare claims is pretty small for part of the overall claims that were asked -- that we can ask providers present to us for audit. So in terms of errors that we're finding and the preponderance of errors, that's actually improving over time, versus being reduced over time. So, you know, it's obviously a program like that, it's the first contract. So we think some of what we're seeing is first contract, newness, and as the contract becomes a part of the normal program, it's probable that some of the education that we see will at least ease a little bit over time.

[Anjaneya Singh:]

Okay, thanks. And then I guess the other two are just housekeeping questions. Did you guys guide for the full year adjusted EBITDA for 2013? I'm not sure if I missed that.

[Hakan Orvell:]

We did, yes.

[Lisa Im:]

-- 2013.

[Hakan Orvell:]

2013 we did. So we guided EBITDA at $83 million to $87 million.

[Anjaneya Singh:]

Okay. And just one other quick one for me, could you talk about what contributed to the decline in the other revenue segment sequentially and year over year?

[Hakan Orvell:]

Sure. Well, that relates to, as you may recall, we won a default [diversion] contract last year and we had some initial large placements associated with that contract that benefited us last year. And now we're looking at a more normalized level on that contract. So it's kind of a one-time [ad hoc] in Q2 and Q3 of last year.

[Anjaneya Singh:]

Okay, all right. That's all for me. Thank you so much.

[Operator:]

Thank you. Our next question comes from the line of Toby Wann with Obsidian. Please proceed with your questions.

[Toby Wann:]

Hi, good afternoon guys. A quick question, I've been bouncing around from a couple of different conference calls so I might have missed this. Just want to get clarity on the guidance for the -- the 20% guidance on the RAC revenue, is that for the fourth quarter, is that for next year? I just -- I've been bouncing between conference calls so things are a little tetchy for me at this point.

[Hakan Orvell:]

Well, again it wasn't guidance for next year. What Lisa talked about is that we know at this point that the impact, where we sit today, is at least a 20% reduction on our RAC revenue next year. And there could be potential of more. It's going to be dependent on the number of decisions that are still to be made. So we just wanted you to get -- put out there that there's going to be some revenue impact next year, minimum of 20%.

[Toby Wann:]

Okay, understandable, and that's helpful, and again my apologies for having to bounce around between calls. And then focus -- I know a lot of focus has been on the short-stay audit issue, but -- and the moratorium being extended. But I guess maybe the other issues, like you said, there's 600 other issues you guys can go after. Maybe you could kind of talk about the magnitude or maybe how those other issues compare in magnitude in terms of dollars available versus the short-stay audit. It seems as though that the short-stay audit seems to be something that's, I don't know, a little bit of a low-hanging fruit, so to speak maybe, but the other issue is maybe a little more challenging [indiscernible] to the different contributions from some of those other audit issues as they compare to short-stay audits?

[Hakan Orvell:]

I mean as I mentioned earlier, we do -- we have been successful in focusing on coding orders. We're not giving guidance right now on next year as far as what revenue could be on those types of orders if in fact there should be -- again on the moratorium that we have right now on the short -- on the 24-hour -- sorry, the 48-hour rule. So at this point, I mean we're not ready to give guidance on what the magnitude of those types of orders will be.

[Lisa Im:]

I think --

[Toby Wann:]

Okay. No, I'm not looking -- I'm not looking for guidance, I'm just looking for more -- maybe some clarity or maybe some comparing between short-stay audits, the magnitude of -- the average short-stay audit claim recovery, say, [indiscernible] versus some of the other ones, I mean in terms of dollar, could you kind of give us a comparison between short-stay audits, are they much more lucrative in terms of absolute dollar amounts versus the other list of items you have to go after? It seems like short-stay audits are what everybody is focused on from the recovery auditor standpoint, yourself and your competitors. Obviously there's a reason for that. So I'm just trying to get a sense of, are the non-short-stay from a dollar standpoint, are those smaller dollar claims compared to the short-stay audits? That's kind of where I'm going, not -- I don't -- not about guidance for '14.

[Lisa Im:]

Yes. And I would say, to be fair, Toby, the dollar claims that we currently would have would be less than the short stays. But that said, again as I mentioned earlier, CMS has not approved any new issues since early this year and we certainly would only have new issues that we would wage with CMS that would start to make up the gap. So to be fair, to your point about this contract, yes, short stays have been a more, I would say, more abundant error across all of the recovery audit contractors. There are certainly many more. And I think given the guidelines and parameters of the program, our job for CMS is to find where those errors are, regardless of -- if they're not short-stays, there are certainly other -- a lot of other errors that we can go and find, and have those issues approved and audit for those as well. So as we look sort of outward, there is a, you know, the overall error estimate is close to 9% of $560 billion that are spent every year. And so the errors are not going to be all short-stays. There's certainly a prevalence of types of errors, and our job is to find those and try to fix them and bring those back for CMS for the Medicare Trust Fund. So as the contract comes back and starts rolling in full, we would anticipate that that dynamic of what audits could do will certainly change.

[Toby Wann:]

Okay. No, that's helpful. Thank you. And then one other quick question as it relates to new issues being approved, and you're talking about the beginning of the year that kind of slowed down. Did that timing kind of coincide with the initial RFQ going or -- I'm just curious about that more than anything else as we kind of --

[Lisa Im:]

Yes. It coincided with the new RFQ coming out.

[Toby Wann:]

Okay. So we haven't really seen any new issues of the initial RFQ came out and probably won't see any until the re-procurement probably, is that a fair assumption?

[Lisa Im:]

Yes, that's a fair assumption.

[Toby Wann:]

Okay. Thank you. Thank you much for the time guys, and congratulations on the quarter.

[Lisa Im:]

Thank you.

[Operator:]

Thank you. (Operator Instructions). Our next question comes from the line of Ben Mackovak with Cavalier Capital. Please proceed with your question.

[Ben Mackovak:]

Hello. Very nice quarter, and thank you for taking my question. On the PIP revenue, how many quarters did that take to generate? And I guess the context is, going forward with RAC 2, what kind of opportunity is there that we didn't see on the RAC 1?

[Hakan Orvell:]

I guess one way you can size it up is that 20% of our region is represented by PIP providers. So I mean as you look at our recovery, we've been previously missing 20%. We started auditing in April of last year. And as we look at towards the latter part of the year, we slowed down our focus on it because of the technology challenges. Because when it derives, you know, what the number is going to be based on what the recoveries are that we have booked at today. But the 20% number I think is a good benchmark as we look at what the opportunity is associated with that.

[Ben Mackovak:]

Okay. And then with the November 15 cutoff for the new request, is it safe to assume that there will be enough in the pipeline to keep I guess the infrastructure utilize until the contract expires in February?

[Hakan Orvell:]

Yes, that's a good assumption. I mean we're seeing a somewhat lower volume, but again we're going to be sending out requests through November 15 which would give us work through the end of January.

[Ben Mackovak:]

Okay. Nice quarter. Thank you.

[Hakan Orvell:]

Thank you.

[Operator:]

Thank you. There are no further questions at this time. I would like to turn the floor back over to management for closing comments.

[Lisa Im:]

Great. Thank you. Once again we really appreciate your time and your attention and your very thoughtful questions and your support for the company. So again our thanks to you for joining us today.

[Operator:]

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