Summary: It was known that a major client contract renewal would come with a significantly reduced price, but it was lower than anticipated. Efforts that were started years earlier to replace the top line declines had not produced results. As EBITDA dropped, the leveraged firm broke loan covenants and investors stepped in to buy time. Over the next two years the firm focused on its core, reducing expenses and increasing sales, and is poised to set new highs. Read about how it all unfolded.
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By Robert Sher
Taking full control of the Performant in early 2004 when the private equity firm executed a leveraged buyout of the founder, CEO Lisa Im set right to work. One of the first objectives was to maximize a five year contract to work tens of thousands of non-performing government loans (for example students loans). Their job was to find and contact the borrowers and renegotiate those loans until they started performing again. They earn their fee after the loan has performed for 12 months. Lisa and her 500 strong staff cranked up throughput and efficiency by 25%. But by fall of 2004 with 18 months to react, they came to understand that when the Department of Education contract was renewed, the terms would be so much worse as to cut their EBITDA by about 35%.
With a 2005 top line breaking past 100 million, Performant placed a six million dollar bet on one new division that seemed to have promise to replace much of the lost EBITDA in the nick of time. They placed a second six million dollar bet on a second new division. But by the time the spring of 2006 rolled around and their earnings dropped, one bet had failed completely, and the other was at breakeven with no hope of accelerating enough to make any difference. And when the new Department of Education terms were finally nailed down, EBITDA took a 60% hit, much worse than expected.
When pro-active efforts to replace the expected top line drop off failed, there was no way to avoid the hit to the bottom line. Performant was still going to profitable--not even close to posting a net loss. The problem was that the new owners had fully leveraged the firm when it was purchased in 2004, and a recent recapitalization had kept the firm maximally leveraged. That’s a great strategy for pushing up ROI in good times, but will cause turmoil when earnings decline.
For example, a firm that is delivering a bottom line of 100 million (EBITDA) in a friendly lending environment could support borrowings of as much as 500 million. So if the business were bought for 700 million, the buyer would have to come up with 200 million in cash, borrow 500 million, and each year, if things continued, would earn a 50% ROI. But if EBITDA drops to 50 million, then the bank would find itself lending at ten times EBITDA, an untenable position. It would look for the company to reduce its debt level from 500 million to 250 million, a more realistic level. But somebody would have to come up with the cash, or the bank will pull the loan.
Smart Money is Critical
While in 2005 Performant’s borrowing was a comfortable 3 times EBITDA, with the earnings hit in 2006 it soared to an untenable 10 times EBITDA. Faced with an immediate breech of loan covenants, Lisa turned to her board and the private equity group that owned the company. While they weren’t happy about the turn of events, they stepped in, negotiated with the bank, and ultimately guaranteed some of the bank debt to reduce the lender’s risk and bought time to pull EBITDA back up.
All money sources are not alike, and seasoned CEOs know that being funded by “smart” money is far better, even if it might be a bit more difficult to get or costly. Smart money understands that business comes with ups and downs, and they will stay rational, even in difficult times. Smart money also knows that reputations are slow to create and quick to be destroyed. They also know that as bad as things might look when the disaster appears, good leadership and a patient hand often lead to a solid turnaround. Lisa’s PE firm valued their reputation in the financial community far too much to risk letting the bank take a hit. They also believed that the business still had considerable value and that Lisa and her team would guide it back toward being an excellent investment.
Slash Costs
Often, a big drop in revenue means there is less production work. But in Performant’s case, the effective price for their services is what collapsed, not the amount of services to be rendered. Their rank and file teams were as busy as ever. So Lisa slashed, in two RIFs (reduction in forces), management and indirect salaries. The indirect headcount and management team had grown as they tried new business units designed to replace lost sales. But those hadn’t worked, so those people weren’t needed. Everyone remaining would have to wear more hats and cover more bases.
It never ceases to amaze me how in nearly every circumstance, a case can be made that all staff members are busy, and that the company will be harmed if anyone is laid off. After all, everyone is working on good projects that were started for good reasons. But it’s not the good things that make a company grow, or turn a company around. It’s by focusing on the best ideas, and the most critical issues that progress is made. Good things are usually just a distraction. Adverse times are the perfect time to swing the axe, painful as it is, and to cut back to only your best people, who will identify the best most critical things to do and will ignore the rest. That’s just what Lisa did. She didn’t cut any of the line workers—they were needed to execute on the firm’s core mission.
Focus on Your Core
Having tried two new business units in an attempt to maintain scale, Lisa focused all the remaining team on building the core business. There was no longer any budget for experiments. No distractions allowed. They had good steady customers that weren’t giving all their business to Performant. They had prospects very similar to existing clients that they hadn’t yet closed. There were opportunities with existing clients to expand the scope of offerings to include parts of the collection process that clients often did themselves, but did poorly. Lisa created clarity throughout Performant about the renewed focus on the core business.
Go Sell Something
Nobody can sell like the CEO. While cost cutting can help somewhat, over the long term the only way to build EBITDA consistently is through sales growth. Lisa hit the road herself, often traveling 50%of the time. She insisted that others on her top team interfaced with the clients and prospects as well.
CEOs often feel that if they leave headquarters too much, operations can suffer and general leadership duties can be neglected. There is truth to this. A balance must be stuck as to where a CEO spends his time, but that balance shifts over time. Both in my own experience and in many conversations with CEOs, the allocation of chief executive’s time shifts as each department or business unit stumbles and appears in need of help. As capabilities are bolstered or leadership changes are made, the “weakest link” becomes another department or business unit, and so shifts the CEOs attention.
Ultimately, most CEO’s greatest contribution comes through being on the “outside” of the firm, knowing customers and competitors well and deeply understanding marketplace shifts. Great internal leaders – COOs, general managers and other second in commands are more easily found and hired to “keep the wheels on the bus”. In Performant’s case, there weren’t a lot of costs that could be cut beyond the RIFs already completed, so pushing revenues up clearly was the “weakest link” and was fully deserving of Lisa’s personal time and effort.
Rally the Team
Forget about secrets. Employees, spending 40 hours a week at work, smell fear and uncertainty. No matter how well a CEO or their top team put on a smile after a difficult meeting, the staff will feel the apprehension. Lisa didn’t wait for the fear to seep in. She told them the truth. She went on the road to their offices in Texas, Oregon and Lathrup, Ca and explained the dramatic change in the contract terms. She explained why so many heads rolled at corporate, and why no heads rolled in production. She asked for their help, and explained clearly how their efforts would help the company and set them all on the path back to prosperity. When she was on the road selling, her new HR executive was making the rounds internally, re-enforcing the message to the team.
She pointed out how the efforts to increase throughput in 2005—long before the current crunch—were already paying big dividends, and that continued progress would clearly move the needle. Even as the headcount grew toward 1000 to support the new contracts, the rank and file felt like they knew their CEO, that they had been treated with respect, that they had been kept aware of the situation, and that their efforts were contributing to the recovery.
By the end of 2007, Performant had increased EBITDA by 54% over the dismal 2006, a huge step forward. 2008 will bring another 35% increase in earnings. Projections for 2009 suggest a new record for EBITDA, likely exceeding 2005 levels.
All of us running companies work hard to avoid disasters. But disasters still arrive, despite our best efforts. CEO Lisa Im’s actions and experiences give us all some good guideposts when the disaster arrives at our door.
Key Takeaways:
1. If you’re going to run a company which uses significant leverage to increase ROI, make sure you have investors willing and able to step in if there is an EBITDA surprise.
2. Making the most of your core business and competencies is the best and first place to focus in order to produce short and mid-term results. New business units are always an experiment.
3. Over-communicate to employees during dark times so that they are a part of the recovery and follow your lead.
Company and Case Facts:
Company: Performant Financial Corporation
Person: Lisa Im, CEO
Alliance Member since: 2007
Business Founded: 1976; New ownership January 2004
Head Count: 1004
Services: Performant is focused on revenue optimization, defaulted portfolio solutions, and risk management. Written: October, 2008
Address: 333 North Canyons Parkway, Suite 100, Livermore, CA 94551
Web Site: http://www.performantcorp.com/
Phone: (925) 960-4771
E-Mail: lim@performantcorp.com
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