Richard Zubek - IR Professional Jeffrey Haughton - President & COO Lisa Im - Chairman & CEO Ian Johnston - VP, Chief Accounting Officer.

Michael Tarkan - Compass Point Brian Hogan - William Blair.

Greetings, and welcome to Performant Financial Corp Second Quarter 2018 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Richard Zubek, with Investor Relations..

Thank you, operator. Good afternoon, everyone. By now, you should have received a the copy of the earnings release for the company's second quarter 2018 result. If you have not, a copy is available on the Investor Relations portion of our website.

Today's speakers are Lisa Im, Chief Executive Officer; and Jeff Haughton, President and Chief Operating 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 risks and uncertainties, including those described in the company's filings with the SEC. Actual results may differ materially from those described during the call.

In addition, all forward-looking statements are made as of today and the company does not undertake to update any forward-looking statements based on new circumstances or revised expectations.

Also, all non-GAAP financial measures discussed during this call are reconciled to the most directly comparable GAAP measures in the table attached to our press release. I would now like to turn the call over to Jeff Haughton..

Thank you, Rich. Good afternoon, everyone, and thank you for joining us for our earnings call. If you haven't already, please find the financial packet on our website that walks through our financial results for the second quarter in more detail.

We also have posted a slide deck related to the agreement we announced today to acquire Premier Credit of North America referred to as Premier from ECMC Group, one of our largest clients and our lender. We are excited about the Premier transaction as we believe it is financial attractive and supports our strategy of growth and diversification.

Importantly, the transaction enhances performance strategic value while supporting our goal of $200 million plus of revenues with 20% plus margins in 2021. Before we discuss our results for Q2 we would like to discuss the transaction in more detail.

Referencing the slide deck posted on our website, there are three components to the overall transaction as detailed on Slide 3. First, we are acquiring Premier, which is a diversified provider of recovery services across state and municipal government, student loan, commercial and healthcare clients.

Premier's client mix is highly complementary to performance and approximately 60% of it's revenues come from non-student loan clients. Premier generated approximately $23 million of revenues for the trailing 12 months ended July 2018.

Our philosophies of ethical and compliant consumer care and client-centric focus are completely aligned with Premier's dedicated 330 employees located in Indianapolis and Nashville. Additional detail regarding Premier's business is summarized on Page 4 of the materials.

Continuing on Page 3 of the materials, the second transaction component is our multi-year agreement with ECMC where the combined performance in Premier will service ECMC's primary student loan recovery provider creating meaningful current and future opportunities to grow our recovery business with ECMC as they increase their managed student loan portfolios.

The third component of the transaction is the beneficial amendment to our credit agreement with ECMC which includes a one-year extension of the initial maturity term out to August of 2021 while retaining the two one-year extensions at performance option that if exercised would extend maturity out to 2023.

In addition, the amendment includes a $10 million expansion of our additional borrowing capacity to $25 million total which will give us more flexibility if needed as we execute on our growth and strategic alternatives.

Moving to Page 5 of the presentation, in exchange for these three transaction components, ECMC will receive 1 million performance shares at closing. In addition, there is a 5-year earn out that is based on achieving revenues through Premier and the expanded ECMC relationship.

We expect the earn out to deliver approximately 1 million additional shares to ECMC over 5 years assuming 100% achievement of targets. The total share consideration reflecting the upfront and potential earn out represents approximately 3.9% of currently outstanding performance shares.

Turning to Page 6 of the materials; there are numerous significant benefit to this transaction. Premier adds a meaningful diversified revenue stream generated by highly complementary clients while expanding and diversifying our call center footprint.

The acquisition accelerates and enhances our growth strategy in providing recovery services for state and municipal government commercial and healthcare clients.

There is meaningful value and revenue opportunity in the expanded client relationship with ECMC which is one of the largest managers of student loan portfolios, and is well positioned to be an aggregator of additional student loan portfolios in the future.

We are honored to be a trusted vendor partner to ECMC and look forward to serving them in a larger capacity in the future. Also the amended credit agreement expands our borrowing capacity while extending the maturity of our capital structure. Finally, the deal structure is financially attractive.

There is a strong alignment of objectives as ECMC is incented to support performance and Premier success through the earn out which represents an estimated 50% of the transaction value.

In addition, Premier's revenue contribution represents approximately 16% of the midpoint of performance 2018 estimated revenue guidance while the expected shares to be delivered to ECMC represents approximately 3.9% of our current outstanding shares.

As shown on Page 7 of the materials, we expect the transaction to provide $7 million to $8 million of revenues in 2018 while reducing 2018 adjusted EBITDA by $800,000 to $1 million assuming the September transaction close.

EBITDA impact reflects both, the timing of realization of cost efficiencies from the transaction, but also additional investment required in 2018 to support new recovery business from the expanded ECMC relationship that won't generate meaningful revenues until 2019.

And though that there is a reconciliation of adjusted EBITDA in the appendix of the materials on our website, for 2019 we expect the transaction to deliver $28 million to $32 million of revenues and adjusted EBITDA in the range of $500,000 to $1 million.

Beyond 2019, we expect the transaction to deliver run rate revenues in the $30 million to $35 million range, and adjusted EBITDA of $3 million to $4.5 million per year. We are happy to answer any questions about the transaction during the Q&A session and after our review of Q2 results.

So moving on to our results for the second quarter; and our student lending business placements of $476 million for $415 million less than prior year Q2 due to the loss of the Great Lakes portfolio management contract in late 2017. Q2 placements are also lower than Q1 2018 by $438 million which is due to an artificially high Q1 number.

That Q1 volume increase was attributable to two large clients accelerating a routine reshuffling of inventory among vendors, it includes a recall of existing inventory and it was also included in guidance given during our last earnings call.

As a reminder, Great Lakes terminated our student loan recovery contract last year due to a strategic decision to bundle loan servicing and recovery for their entire portfolio. The transition of our Great Lake student loan inventory began in October 2017.

Since the termination of our contract with Great Lakes, we have become a sub-contractor for Great Lakes new prime recovery contractor and servicer, Navient. In Q2, we received Great Lakes placement of around $468,000, which is $255 million below prior year when we worked as exclusive vendor partner to Great Lakes.

Student lending revenue in Q2 was $17.5 million, which was down $10 million or 36.4% below the prior year, largely due to a $7.6 million decrease in revenues from Great Lakes. Offsetting the decline in student loan recovery, we continue to build momentum in our healthcare operations across both government and commercial contracts.

The MSPC or C-contract [ph] is ramping as we anticipated and in line with our previously provided guidance of $10 million to $16 million of revenues in 2018. For the Q2 period our revenues were just under $3.1 million for this contract.

For Q2 2018, our commercial healthcare revenues of $2.6 million were up $600,000 or 30% year-over-year, and up $400,000 sequentially.

We continue to ramp up several of our large commercial healthcare programs which also entail coordination of benefits recovery for the Medicaid program although we expect those revenues will become more material in the backhalf of this year. On the CMS Recovery Audit programs, we began work under our Region 1 and 5 contracts during Q2 of 2017.

Due to CMS's slowness and scaling up claims volume for the RAC program and a lower volume of audits in the first half of the year as a result of some internal technology enhancements, revenues were $400,000 during Q2. And the other revenue category; revenues of $7.7 million were up $1.3 million versus last year and up $1.1 million sequentially.

Our customer care operations generated Q2 revenues of $4.7 million which was up $1.8 million versus prior year and $1 million sequentially. In addition, our other revenue line reflects growth from our IRS contract and other state tax recovery contracts which are on-growth target at $2.5 million, up $1 million versus prior year.

These increases were enough to offset delay of revenue from the new treasury contract, that start-up of which has been delayed by several quarters but which we expect to begin soon. Again, this is a timing miss versus lost business as we think about the treasury contract. So with that, I will turn it over to Lisa..

Thanks, Jeff. Expenses of $34.7 million were below prior year by $1.8 million or 5%. The decrease was primarily due to decrease in third-party collection fees related to Great Lakes which were larger in 2017 commensurate with revenue partially offset by investment expenses and salaries due to ramp up in several large contracts.

As we discussed in our last call, several large contracts require investment on front. These investment expenses in Q2 were about in line with our expectations for a total year investment cost estimate of between $9 million and $12 million.

As we mentioned in our last earnings call, we continue to increase investment to support our healthcare contracts including the MSP-CRC contract. It is expected to be a significant contract which will have a positive revenue and EBITDA impact this year despite this being a ramp up year.

During Q2, revenue from this contract was $3.1 million which we believe will continue to grow during Q3 and Q4. We are still ramping up on this contract and achieving strong 2018 results will depend on successfully hiring, training and engaging our healthcare employees.

We will have much better visibility into the timing of the full ramp-up process as we push through Q3. We expect that investment in the first half of the year will drive greater revenues in the backhalf of the year, particularly Q4 and expect to continue investing and ramping these contracts for the balance of the year.

We remain cautiously optimistic that total healthcare will build significant momentum and be in the range of guidance we have provided for the full year.

With Q2 completed, we are adjusting our full year guidance to include the acquisition of Premier which is expected to have a positive revenue impact in Q4 but a small EBITDA loss, and an additional investment for new student loan contract which will have a positive impact in 2019 but be an expense in the backhalf of 2018.

Excluding the impact of the termination of the prior CMS Region A contract, we narrow our 2018 revenue guidance range to $130 million to $150 million. This remains a broad range due to the potential that we have in executing on both, commercial healthcare contracts and the MSP start-up.

Adjusted EBITDA guidance is between $2 million and $3 million, including the impact of the terminated CMS Region A contract which impacted revenue by $27.8 million, expenses by $9.0 million, and EBITDA by $18.8 million, updated guidance for the full year for revenue is $157 million to $178 million, and adjusted EBITDA is in the $21 million to $22 million range.

We look forward to having Premier join the Performant family and thank ECMC for their trust in our service. With that, I'd like to open up the call for questions..

[Operator Instructions] Our first question is from Michael Tarkan with Compass Point..

A few on the student lending side; first on Premier.

Do they currently work with any of the collection agencies, whether it's small business or the other two that are operating under the 2017 AD [ph]? Do they work with any of those as a sub-contractor?.

Yes, they do. They have a relationship there that is new and growing, and compliments the relationships that we have there as well..

Can you touch on -- you mentioned this new student lending opportunity, can you just kind of elaborate on that a little bit?.

It's an additional small business relationship that we have added to -- again, the portfolio that we've developed overtime. So it's a way for us to work Department of Education business while the unrestricted contract is still in this -- undecided term I guess..

You mentioned the relationship with Navient as a sub-contractor, can you just kind of walk us through a little bit more on that; sort of what kind of work are you doing for them and is that sort of new department of education volume, is that legacy volume? Just any kind of color there..

So, last year when Great Lakes transition their servicing over to the Navient platform, I think we talked about having a sub-contract with Navient; so this is actually the Great Lakes business that we're receiving under the Navient management..

The commercial business -- I heard I guess it's a little bit delayed, commercial healthcare; is anything changed in your outlook there or it's just taking a little bit longer to ramp up?.

I wouldn't say we would call delayed, and I don't anything has changed in the outlook there.

It is as we've said along, backhalf loaded in 2018 given the timing of some new audit contracts that come in, as well as some of the newer Medicaid reclamation contracts that we've launched as we see that inventory come in, it's just the timing the revenue recognition and everything that goes into it, it's really Q4 where you start to see some of that additional list on the commercial side.

So I wouldn't characterize it as anything has changed, there is a lot of new opportunities that we've been executing on and foreheads down, focusing on making it happen..

The IRS contract, just -- I think you talked about in connection with another business, just kind of curious where that one stands this quarter?.

With regards to the IRS contract; look, I think if we take a step back we say there is good growth in the program, we feel good about how the program is ramped up.

As we talk about the opportunity, and we haven't talked about specifics in terms of what we expect for IRS, specifically on revenue this year in total but we feel good about the momentum in that program as we think about the opportunity in longer term and the size of what that contract could be..

And Mike I would say, as we've talked in the past, the IRS contract -- the agency itself has been pretty cautious in the ramp up of the contract, just making sure that everything was working, that the quality of service that the vendors were providing was spot on because it's important to them that this program was executed in methodical and cautious way to ensure that the program is rolling out in accordance with their objectives which is obviously to get delinquent tax payers paying taxes but also to make sure those tax payers were cared for in a way that it's consistent with what the IRS objective is.

So with that said, we think -- as we head into sort of Q2 what we believe is that the IRS is now in the black and as we look forward, we think that there is probably an objective to increase the size of the program on the IRS's part. That's what we're thinking..

The run rate EBITDA that you're projecting here for Premier, it looks like that's coming on the expense side for the most part.

Is there a sort of big plan to kind of rationalize the expenses there to squeeze out more economics? And then, at what point -- how long does it take you to get to that run rate? Is that in connection with kind of the 2021 talk as well?.

Yes, certainly there is cost efficiencies, [indiscernible] this transaction as you think about combining our business with theirs and how they complement each other, there is certainly scale, there is a lot of IT and info-set [ph], and compliance and things that we've done for years that have to be meet [ph].

So there is certainly scale here and I think we've got a very strong feel for what those efficiencies could be, so I think that's certainly positive.

As we talk about that guidance, we don't take into account productivity gains or things like that that I actually think -- and I think we still believe -- we think it's certainly out there as we look at both of the businesses together, what are best practices from them and best practices from us, that's not exclusively in there.

But to answer your question specifically, we feel very good about our ability to integrate the platform, drive growth beyond 2018-2019 and as we think about that run rate, that's basically saying; look after 2019 with the platform they have, with some of the growth opportunities that we certainly see in the platform -- that's how we get to those run rate numbers of $30 million to $35 million of revenue and adjusted EBITDA of 3 to 4.5 [ph]..

And I would say at this point, we're still at very -- we're kind of at the tip of the iceberg in terms of understanding what synergies exist between both the organizations, and certainly as we look at the locations of Indianapolis and Nashville which are most cost efficient than our current locations, we look at the opportunity and we say, as we look forward let's be cautious in the way we think about it but let's be aggressive in how we look at the businesses and how we maximize cost structures in both, Performant and Premier.

Let's not say we're rationalizing Premier cost but we're really going to look for efficiencies and figure out a way where is the best place to use something, who is the best at it and try to really get our arms around creating just that sort of best practices around the -- more of the overhead costs, and as well as production.

So, we're kind at the tip of the iceberg because we've obviously worked around it but we're really eager to embrace the organization and the businesses and we think there is additional business opportunity on the platform that they have.

As Jeff mentioned, it's not just working for student loans but they have a fairly decent state and municipal practice, as well as commercial recovery and they're also in the healthcare collections business which is a terrific platform for us to grow business on..

Last one for me, just on the debt facility. I'm assuming that the coupon say the same and then is there anything -- it sounds like you have the option to extend the maturity dates; anything that you would give up for that option? Thank you..

So, nothing in terms of the pricing structure, the deal has changed for the interest rates, the coupons, nothing changed there. The options we have -- we expanded the initial maturity out by one year, so it was initially three years, we're a year into it, we extended it by one year.

The options to extend past that continue at the end of the new maturity period, the terms at which we can extend it are the same as well in terms of what we need to payback the ECMC for that, that hasn't changed either, so that's effectively just keeping those option years [ph] in place..

Our next question is from Brian Hogan with William Blair..

Would you consider Premier some more competitor if you will?.

Yes, in the past -- look they've been on the ED contract, we've seen them in the student loan space and in other spaces overtime, so you could consider them the competitor.

They are one that we would consider very strong and good competitors, it's part of how they've been on our radar over the years and what they've been able to do as a business, like a stay-on [ph] business, we're already seeing from the far and their approach to compliance and clients and everything along those lines.

Now we've been impressed with but -- yes, there is certainly overlap in terms of what they pursued historically and what we've done as well..

With that said Brian, there is a strong enough part of the business affecting non-overlapping where -- and again, we talk about tax and municipal contracts and you know, while we have a handful, it's great to continue to grow that and these state agencies and municipalities, they are fairly particular in terms of who they want to do business with, it's not always easy to just take away and test contracts as it's nice to have added business in that part of our combined businesses, as well as in the healthcare space as you know, all of the work that we do is really on the payer side and interesting platform that works more on the provider side.

So it will be a way for us grow in a different path but really leveraging our core capability or consumer care and recovery..

And just last thing to add; I guess we talked out a moment ago about some of the ED sub-contracting relationships that we have and they have and there is a nice complement there to Lisa's point on the state and municipal government side is very similar, right.

So we've got a portfolio of those clients that are important and good clients to have as do they, and so combined is really -- helps us bring a nice scale to it and an ability for us to go out in the market together and pursue new business in a pretty effective way..

How does the deal come about? I mean, was it a competitive process or what was the talking with ECMC?.

Yes, I mean -- I don't want to get into the specifics of ECMC's processor or thought in terms of the business. Needless to say it's a business that's been out there and it was an investment that ECMC made some time ago and so they get -- have gotten called overtime and have had discussions with folks.

More broadly speaking, I think for us it was a good opportunity, something we've had our eye on for some time and that was the right time to pursue it..

And Brian, ECMC's objective as the holding company of Premier their objective was to grow Premier.

And as we think about scale and growth, and the investment needed for growth; their objective of achieving growth in Premier seemed to be more readily available with a combination company like ours because they know what our objectives are, and clearly, they understand what we've been working through in terms of trying to get through that growth.

And so to achieve their growth objective, they really felt like combining Premier with us was probably the best way for Premier to achieve that growth. And so we were very very happy to engage in those discussions and of course, we have a great deal of respect for ECMC and the work that they do and very excited about how we can help Premier grow.

So it seems -- it was just a good match of philosophy, objectives, as in of course in terms of platform; I think ECMC knows all the players of the market and it was -- for them it was just choosing the right player and we were very honored to be part of that..

The incremental shares -- assuming the earn out, is that going to be prorata over the course of the five years or how does the share account come in?.

It's based on revenue targets that are meet overtime, and then those get converted to a value amount; I think it's converted to shares and the share price at which they are converted has been fixed prior to announcement of the deal. So a high level, that's the mechanism. So, I think a little different than when you say prorata..

The incremental investment tied to the additional student loan and opportunity; how much is that investment?.

If you look at the -- so you're talking about the new opportunities for us staying [ph] alone, excluding Premier?.

That's right. You have mentioned that as a different opportunity [ph]..

I would say it's a relatively sizeable piece of the impact the EBITDA as we look at..

I think we're estimating just based on the volumes that we've seen. We're estimating somewhere between -- it could be between sort of $1 million and $3 million, depending on how quickly we can ramp up..

That said, and then you got to adjust that for what happens in '18..

Sorry, I'm little confused on that last statement..

So at least to say, it's over the course of that contract, right, like any other student loan contract you have to invest for several months as you know before you get the significant portion of revenue which comes from rehabs.

So we were estimating that called $1 million to $3 million -- $2 million to $3 million over the life of that investment period.

What I was specifically talking to was breaking down, when you think about the guidance we gave as part of adjustments to our guidance for this year, in terms of the impact of that -- some of that was Premier as we talked about, like the impact of Premier of $800,000 to $ 1 million, in fact EBITDA and then there is a component of that tied to this contract, that was the point I was making..

And as for your guidance, I understand that's a wide range and I heard you mention like execution on some of the contracts but what gets you to the high-end or the low-end of your guidance and looks quite blackout Premier; you -- do I look at it right as you lowered the midpoint slightly, is that true?.

No, I think our original guidance was somewhere between 125 to 150, so we're just bringing it into sort of 130 to 150 range.

I think -- as we think about what difference to the top end Brian, just -- so you know, I mean, we -- to Jeff's point, we were working through a lot of the work on the reclamation for Medicaid, we're also as you know, ramping up Medicare, NSPC [ph], we're just -- we're still in the early part of ramping that up but we're seeing some really good productivity and so our objective is to significantly ramped up progress with our clients as we head into the third quarter which would actually get us to a very strong fourth quarter.

And so the top end of that range really comes about being able to not only get the work completed but also to book the revenue. So as we think about end of Q4 sort of rolling into Q1 what we're hoping is that we can get all of that revenue into Q4. Certainly there is a risk that some of that could slip into 2019..

And the tax rate, it's still around 27.5% or is it what….

I'm going to ask Ian, our Chief Accounting Officer to answer that question for you..

For the 2018 year, our expectation of effective rate is about 21%, and we have revised our full profitability rate from 27.5%, up more in the range of 30% to 32%.

That has to do with mainly looking at our state tax structure and the states in which we're doing good business with our subsidiaries but 21% for 2018 and as we move into full profitability in the future, a range of 30% to 32%..

[Operator Instructions]. There are no more questions at this time. I would like to turn the conference back over to management for closing remarks..

Thank you. We thank you for being with us today. We're very excited about welcoming Premier to the Performant family of companies. We want to thank ECMC for their trust, and we look forward to servicing them in a larger capacity.

We also want to thank the rest of our clients with their trust in us, and as you know, our objective is to provide the best service to them at the best value. I want to thank our Performant employees for bringing their best, and Premier employees for bringing their best to the workplace every day. And again, we thank you for being with us today..

Thank you. This concludes today's conference. You may disconnect your lines at this time. And thank you for your participation..